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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________________ to ________________________
Commission File Number: 0-19594
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INSURANCE AUTO AUCTIONS, INC.
-----------------------------
(Exact name of registrant as specified in its charter)
Illinois 95-3790111
- --------------------------------------------------------------------------------------------------------------
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
850 East Algonquin Road, Suite 100, Schaumburg, Illinois 60173-3855
- --------------------------------------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(847) 839-3939
- --------------------------------------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12B-2 of the Exchange Act.) Yes |_| No [X]
APPLICABLE ONLY TO CORPORATE ISSUERS
Number of shares outstanding of each of the issuer's classes of common stock, as
of April 30, 2003:
Class Outstanding
----- ------------
Common Stock, $0.001 Par Value 11,548,719 shares
INDEX
INSURANCE AUTO AUCTIONS, INC.
PAGE NUMBER
PART I. FINANCIAL INFORMATION.............................................................. 3
Item 1. Financial Statements (Unaudited)................................................... 3
Condensed Consolidated Statements of Operations for the
Three Month Periods ended March 30, 2003 and March 31, 2002................... 3
Condensed Consolidated Balance Sheets
as of March 30, 2003 and December 29, 2002.................................... 4
Condensed Consolidated Statements of Cash Flows for the
Three Month Periods ended March 30, 2003 and March 31, 2002 .................. 5
Notes to Condensed Consolidated Financial Statements............................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................................... 9
Overview........................................................................... 9
Critical Accounting Policies....................................................... 9
Results of Operations.............................................................. 10
Financial Condition and Liquidity.................................................. 11
Factors That May Affect Future Results............................................. 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk......................... 14
Item 4. Controls and Procedures............................................................ 15
PART II. OTHER INFORMATION.................................................................. 15
Item 1. Legal Proceedings.................................................................. 15
Item 2. Changes in Securities and Use of Proceeds.......................................... 15
Item 3. Defaults upon Senior Securities.................................................... 15
Item 4. Submission of Matters to a Vote of Security Holders................................ 15
Item 5. Other Information.................................................................. 15
Item 6. Exhibits and Reports on Form 8-K................................................... 15
SIGNATURE ............................................................................... 16
CERTIFICATION ............................................................................. 17
2
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands except per share amounts)
THREE MONTH PERIODS ENDED
-------------------------
MARCH 30, MARCH 31,
2003 2002
--------------------------
(Unaudited)
Revenues:
Vehicle sales $ 13,304 $ 27,751
Fee income 42,736 41,469
--------- ---------
56,040 69,220
Cost of sales:
Vehicle cost 11,771 26,057
Branch cost 32,964 31,192
--------- ---------
44,735 57,249
--------- ---------
Gross profit 11,305 11,971
Operating expense:
Selling, general and administration 7,168 7,179
Business transformation costs 797 1,949
--------- ---------
Earnings from operations 3,340 2,843
Other (income) expense:
Interest expense 55 248
Other income (79) (57)
--------- ---------
Earnings before income taxes 3,364 2,652
Provision for income taxes 1,388 1,140
--------- ---------
Net earnings $ 1,976 $ 1,512
========= =========
Net earnings per share:
Basic $ .16 $ .12
========= =========
Diluted $ .16 $ .12
========= =========
Weighted average shares outstanding:
Basic 12,045 12,198
Effect of dilutive securities --stock options 96 245
--------- ---------
Diluted 12,141 12,443
========= =========
Other data
Gross proceeds $ 182,355 $ 195,136
========= =========
See accompanying notes to condensed consolidated financial statements.
3
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands except share amounts)
MARCH 30, DECEMBER 29,
2003 2002
------------------ ----------------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 30,484 $ 10,027
Accounts receivable, net 47,698 45,594
Inventories 10,612 11,158
Other current assets 2,325 3,571
--------- ---------
Total current assets 91,119 70,350
--------- ---------
Property and equipment, net 52,800 49,342
Deferred income taxes 8,555 7,663
Intangible assets, net 2,037 1,710
Goodwill, net 131,248 130,474
Other assets 94 111
--------- ---------
$ 285,853 $ 259,650
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 28,388 $ 28,656
Accrued liabilities 13,334 15,312
Obligations under capital leases 3,687 2,552
Current installments of long-term debt 7,544 43
Income taxes 1,454 -
--------- ---------
Total current liabilities 54,407 46,563
--------- ---------
Deferred income taxes 15,545 14,835
Other liabilities 2,730 2,736
Obligation under capital leases 1,897 1,355
Long-term debt, excluding current installments 22,548 59
--------- ---------
Total liabilities 97,127 65,548
--------- ---------
Shareholders' equity:
Preferred stock, par value of $.001 per share
Authorized 5,000,000 shares; none issued - -
Common stock, par value of $.001 per share
Authorized 20,000,000 shares, 12,306,128 shares issued and
11,548,719 outstanding as of March 30, 2003 and 12,292,599
shares issued and outstanding as of December 29, 2002 12 12
Additional paid-in capital 144,635 144,420
Treasury stock, 757,409 shares (7,401) -
Accumulated other comprehensive income (loss) (911) (745)
Retained earnings 52,391 50,415
--------- ---------
Total shareholders' equity 188,726 194,102
--------- ---------
$ 285,853 $ 259,650
========= =========
See accompanying notes to condensed consolidated financial statements.
4
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
THREE MONTHS ENDED
--------------------------
MARCH 30, MARCH 31,
2003 2002
---------- ----------
(Unaudited)
Cash flows from operating activities:
Net earnings $ 1,976 $ 1,512
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 2,352 2,014
Gain on disposal of fixed assets (42) -
Gain on change in fair market value of derivative financial instrument (307) -
Changes in assets and liabilities (excluding effects of acquired
companies):
(Increase) decrease in:
Accounts receivable, net (1,259) 4,323
Inventories 546 1,834
Other current assets 1,263 2,341
Other assets (379) 432
Increase (decrease) in:
Accounts payable (268) (1,942)
Accrued liabilities (1,843) (1,472)
Income taxes, net 1,272 1,245
-------- --------
Total adjustments 1,335 8,775
-------- --------
Net cash provided by operating activities 3,311 10,287
-------- --------
Cash flows from investing activities:
Capital expenditures (2,769) (2,885)
Proceeds from sale of investments - 2,643
Proceeds from disposal of property and equipment 44 -
Payments made in connection with acquisitions, net of cash acquired (2,360) -
-------- --------
Net cash used in investing activities (5,085) (242)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock 215 709
Proceeds from term loan 30,000 -
Purchase of treasury stock (7,401) -
Principal payments on long-term debt (10) (20,010)
Principal payments -- capital leases (573) -
-------- --------
Net cash provided (used) by financing activities 22,231 (19,301)
-------- --------
Net increase (decrease) in cash and cash equivalents 20,457 (9,256)
Cash and cash equivalents at beginning of period 10,027 24,467
-------- --------
Cash and cash equivalents at end of period $ 30,484 $ 15,211
======== ========
Supplemental disclosures of cash flow information:
Cash paid or refunded during the period for:
Interest $ 317 $ 863
======== ========
Income taxes paid $ 20 $ 24
======== ========
Income taxes refunded $ 1,250 $ 2,250
======== ========
Non-cash financing activities:
Property and equipment additions resulting from capital leases $ 2,250 $ -
======== ========
See accompanying notes to condensed consolidated financial statements.
5
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. GENERAL
The unaudited condensed consolidated financial statements of Insurance
Auto Auctions, Inc. and its subsidiaries (collectively, the "Company")
have been prepared on the same basis as the annual audited consolidated
financial statements and, in the opinion of the Company, reflect all
adjustments necessary for a fair presentation for each of the periods
presented. The results of operations for interim periods are not
necessarily indicative of results for full fiscal years.
As contemplated by the Securities and Exchange Commission ("SEC") under
Rule 10-01 of Regulation S-X, the accompanying consolidated financial
statements and related notes have been condensed and do not contain
certain information that is included in the Company's annual consolidated
financial statements and notes thereto. For further information, refer to
the consolidated financial statements and notes thereto included in the
Company's annual report on Form 10-K for the year ended December 29,
2002.
Fiscal year 2002 consisted of 52 weeks and ended December 29, 2002.
Fiscal year 2003 will consist of 52 weeks and will end on December 28,
2003.
Certain reclassifications have been made to the prior year financial
information to conform to the current year presentation.
2. INCOME TAXES
Income taxes were computed using the effective tax rates estimated to be
applicable for the full fiscal years, which are subject to ongoing review
and evaluation by the Company.
3. GOODWILL AND INTANGIBLES
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill
and Other Intangible Assets", which changes the accounting for goodwill
and intangibles with an indefinite life from an amortization method to an
impairment only approach. In accordance with SFAS No. 142, the Company
completed the transitional impairment test of intangible assets during
the first quarter of 2002. The results of this test did not indicate any
impairment. The Company's annual impairment test is performed in the
first quarter of each year. The current year annual impairment test did
not indicate any impairment.
Goodwill and other intangibles are recorded at cost, less accumulated
amortization, and consist of the following at March 30, 2003 and December
29, 2002:
March 30, December 29,
Assigned Life 2003 2002
------------- ----------- -----------
(dollars in millions)
Goodwill Indefinite $131.3 $130.5
Covenants not to compete 5 to 15 years 2.0 1.7
----------- ------------
$133.3 $132.2
=========== ============
6
Amortization expense for the three months ended March 30, 2003 and March
31, 2002 was less than $0.1 million in both periods. This amount is
included within selling, general and administration expense on the
Company's Condensed Consolidated Statements of Operations. Based upon
existing intangibles, the projected annual amortization expense for 2003,
2004, 2005 and 2006 is $0.4 million and $0.3 million for 2007.
4. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) consists of net earnings and the change in
fair value of the Company's interest rate swap agreement as follows:
Three Months Ended
---------------------------
March 30, March 31,
2003 2002
----------- -----------
Net earnings $ 1,976 $ 1,512
Other comprehensive loss
Change in fair value of interest rate
swap agreement (266) -
Income tax benefit 100 -
--------- ---------
Comprehensive income (loss) $ 1,810 $ 1,512
========= =========
The change in fair value of the Company's interest rate swap agreement
for the first quarter 2003 was due to a decline in interest rates.
5. FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
The Company, as a matter of policy, does not enter into derivative
contracts for trading or speculative purposes. During the first quarter
of 2002, the Company entered into an interest rate swap to mitigate its
exposure to interest rate fluctuations and to effectively fix its
borrowing rate at 5.6%. The interest rate swap agreement has a notional
amount of $30.0 million under which the Company pays a fixed rate of
interest of 5.6% and receives a LIBOR-based floating rate. In 2002, the
Company recorded a non-cash charge of $0.3 million related to the change
in fair value for the portion of its interest rate swap agreement which
did not qualify for hedge accounting. At December 29, 2002, the Company
also recorded $0.7 million as a comprehensive loss related to the change
in fair market value of the remaining portion of its interest rate swap
agreement which qualified for hedge accounting.
During the first quarter of 2003, the Company recorded a $0.3 million
non-cash benefit related to the change in fair value of the interest rate
swap agreement. The Company also recorded $0.2 million in the quarter for
an accumulated comprehensive loss related to the change in fair market
value of the remaining portion of its interest rate swap agreement, net
of applicable tax effects. At March 30, 2003, the entire swap agreement
qualified for hedge accounting.
On February 15, 2003, the Company borrowed all available funds related to
its $30.0 million credit facility. The credit facility was a one-year
revolver that converted on February 15, 2003, into a four-year term loan
carrying a variable rate based upon LIBOR. The aggregate principal
balance of the loan will be paid in sixteen consecutive equal quarterly
installments commencing on March 31, 2003. As of March 30, 2003, the
Company was not in compliance with the fixed charge ratio provision of
its $30.0 million term loan. The Company has obtained from the lenders a
waiver regarding the noncompliance.
6. TREASURY STOCK
The Company records treasury stock purchases using the cost method of
accounting. In March 2003, the Company repurchased 757,409 shares at an
average price of $9.77 per share and a total cost of $7.4 million.
7
7. STOCK OPTIONS
The Company accounts for its fixed plan stock options under the intrinsic
value-based method of accounting prescribed by Accounting Principles
Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees,"
and related interpretations. As such, compensation expense would be
recorded on the date of grant and amortized over the period of service
only if the current market value of the underlying stock exceeded the
exercise price. No stock-based employee compensation cost is reflected in
net earnings, as each option granted under these plans had an exercise
price equal to the market value of the underlying common stock on the
date of grant.
The following table illustrates the effect on net earnings if the Company
had applied the fair value recognition provision of Statement of
Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation," to stock-based employee compensation,
including a straight-line recognition of compensation costs over the
related vesting periods for fixed awards:
Three Months Ended
------------------------
March 30, March 31,
2003 2002
----------- -----------
Net earnings as reported $ 1,976 $ 1,512
Deduct: Total stock-based employee
compensation expense determined under the
fair value based method for all awards,
net of related tax effects 436 328
--------- ---------
Pro forma net earnings $ 1,540 $ 1,184
========= =========
Earnings per share:
Basic -- as reported $ .16 $ .12
========= =========
Basic -- pro forma $ .13 $ .10
========= =========
Diluted -- as reported $ .16 $ .12
========= =========
Diluted -- pro forma $ .13 $ .10
========= =========
8. ACQUISITION
On January 10, 2003, the Company acquired Salvage Management Inc. (SMI),
an operator of two auto salvage facilities in Buffalo and Rochester, New
York, for $2.4 million in cash. The acquisition agreement provides for
additional funds to be paid to the seller, in the future, depending upon
the achievement of various performance expectations. The acquisition was
accounted for as a purchase business combination, and the results of
operations are included in the Company's condensed consolidated financial
statements from the date of acquisition.
9. SUBSEQUENT EVENTS
On April 4, 2003, the Company announced the acquisition of Wichita
Insurance Pool Inc. located in Wichita, Kansas. The Company also acquired
Mountain States Salvage Pool in Salt Lake City, Utah on April 30, 2003.
Both acquisitions are accounted for as purchase business combinations and
the results of operations of these acquired businesses will be included
in the Company's future consolidated financial statements from the dates
of acquisition.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The discussion in this section contains forward-looking information that is
subject to certain risks, trends and uncertainties that could cause actual
results to differ materially from those projected, expressed, or implied by such
forward-looking information. In some cases, you can identify forward looking
statements by our use of words such as "may, will, should, anticipates,
believes, expects, plans, future, intends, could, estimate, predict, projects,
targeting, potential or contingent," the negative of these terms or other
similar expressions. The Company's actual results could differ materially from
those discussed or implied herein. Factors that could cause or contribute to
such differences include, but are not limited to, those discussed herein under
"Factors that May Affect Future Results" and in the Company's annual report on
Form 10-K for the fiscal year ended December 29, 2002. Among these risks are:
changes in the actual cash value of salvage; the quality and quantity of
inventory available from suppliers; the ability to pass through increased towing
costs; that vehicle processing time will improve; legislative or regulatory
acts; competition; the availability of suitable acquisition candidates and
greenfield opportunities; the ability to bring new facilities to expected
earnings targets; the dependence on key insurance company suppliers; the ability
of the Company and its outside consultants to successfully complete the
re-design of the Company's information systems, both in a timely manner and
according to costs and operational specifications; and the level of energy and
labor costs.
OVERVIEW
Insurance Auto Auctions, Inc. offers insurance companies and other
vehicle suppliers cost-effective salvage processing solutions on either a
consignment or purchase agreement method of sale. Consignment method sales are
consummated under either a percentage of sale or fixed fee basis. The percentage
of sale consignment method offers potentially increased profits over fixed fee
consignment by providing incentives to both the Company and the salvage provider
to invest in vehicle enhancements, thereby maximizing vehicle selling prices.
Under the percentage of sale and fixed fee consignment methods, the vehicle is
not owned by the Company and only the fees associated with processing the
vehicle are recorded as revenue. The proceeds from the sale of the vehicle
itself are not included in revenue. Under the purchase agreement sales method,
the vehicle is owned by the Company, and the proceeds from the sale of the
vehicle are recorded as revenue.
Since its initial public offering in 1991, the Company has grown
primarily through a series of acquisitions and opening of new sites to now
include 72 sites. During the first quarter of 2003, the Company established new
facilities in Rochester and Buffalo, New York, Dothan, Alabama and Little Rock,
Arkansas. In April 2003, the Company acquired facilities in Wichita, Kansas and
Salt Lake City, Utah.
The Company's operating results are subject to fluctuations, including
quarterly fluctuations, that can result from a number of factors, some of which
are more significant for sales under the purchase agreement method. See "Factors
That May Affect Future Results" below for a further discussion of some of the
factors that affect or could affect the Company's business, operating results
and financial condition.
CRITICAL ACCOUNTING POLICIES
The preparation of the consolidated financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, as well as the related disclosures.
The Company bases its estimates on historical experience and on various
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates. As such, the Company
continuously evaluates its estimates. The Company believes the following
critical accounting policies are directly affected by the more significant
judgments and estimates used in the preparation of its consolidated financial
statements.
9
GOODWILL
In accordance with SFAS No. 142 "Goodwill and Other Intangible Assets",
the Company assesses goodwill for possible impairment on an annual basis or
whenever events or changes in circumstances indicate that the carrying value of
this asset may not be recoverable. Important factors that could trigger an
impairment review include significant under-performance relative to expected
historical or projected future operating results; significant negative industry
or economic trends; significant decline in the Company's stock price for a
sustained period; and a significant decline in the Company's market
capitalization relative to net book value. If the Company determines that the
carrying value of goodwill may not be recoverable based upon the existence of
one or more of the above indicators of impairment, the Company would measure any
potential impairment by comparing the implied value of goodwill with the
carrying amount of that goodwill. In accordance with Statement No. 142, the
Company completed the transitional impairment test for goodwill during the first
quarter 2002. This test indicated no adjustment was required. The Company
performs its annual test of potential impairment during the first quarter of
each year. In the first quarter of 2003, the annual impairment test was
completed and did not indicate any impairment existed.
DEFERRED INCOME TAXES
The Company has determined that it may not realize the full tax benefit
related to the deferred tax asset. Therefore, a valuation allowance to reduce
the carrying value of the deferred tax asset has been recorded.
LONG-LIVED ASSETS AND CERTAIN IDENTIFIABLE INTANGIBLES
The Company evaluates long-lived assets and certain identifiable
intangibles for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets is measured by a comparison of the asset's carrying amount to the
estimated undiscounted future cash flows expected to be generated by the asset.
If the estimated undiscounted future cash flows change in the future, the
Company may be required to reduce the carrying amount of an asset to its fair
value.
RESULTS OF OPERATIONS
Three Months Ended March 30, 2003 Compared to the Three Months Ended March 31,
2002
Revenues were $56.0 million for the three months ended March 30, 2003,
down from $69.2 million for the same three month period in 2002. The decline in
revenues is primarily due to the Company's continued shift away from vehicles
sold under the purchase agreement method. Under the purchase agreement method,
the entire purchase price of the vehicle is recorded as revenue compared to only
recording the fees collected on the sale of a vehicle under the lower risk
consignment fee based arrangements. Vehicles sold under the purchase agreement
method accounted for 8% of the total vehicles sold in the first quarter of 2003,
versus 13% for the same quarter last year and 8% for the fourth quarter of 2002.
Fee income in the first quarter increased 3% to $42.7 million versus $41.5
million in the first quarter of last year.
Net revenues, defined as gross revenues less vehicle cost, increased to
$44.3 million for the three months ended March 30, 2003 from $43.2 million for
the same three month period last year. The Company utilizes this revenue
measurement to evaluate its performance by computing all revenues on a
consignment equivalent basis.
Cost of sales decreased $12.5 million to $44.7 million for the three
months ended March 30, 2003, versus $57.2 million for the same period last year.
Vehicle cost of $11.8 million is $14.3 million less than last year's amount of
$26.1 million. This decrease is primarily related to the Company's shift away
from vehicles sold under the purchase agreement method. Branch cost of $33.0
million increased $1.8 million from $31.2 million for the same period last year.
This increase is primarily the result of additional operating costs related to
new branch facilities.
Gross profit decreased 1.1% to $11.3 million for the three months ended
March 30, 2003, from $12.0 million for the comparable period in 2002.
10
Selling, general and administration expense of $7.2 million is
unchanged from the first quarter of last year. Amortization of intangible assets
is now included within this category of expense and amounted to less than $0.1
million in each year.
Business transformation costs for the three months ended March 30, 2003
were $0.8 million versus $1.9 million in the same period last year. Business
transformation costs currently include expenses related to data base
conversions, training and other activity related to the roll out of the new
information technology system. In 2002, business transformation costs included
the information technology system redesign project, the business process
re-engineering project, severance costs and accelerated depreciation associated
with the Company's existing computer infrastructure. The Company began recording
business transformation costs during the second quarter of 2001.
Interest expense decreased to $0.1 million for the three months ended
March 30, 2003, from $0.2 million for the comparable period in 2002. Included in
interest expense for the three months ended March 30, 2003 was a non-cash
benefit of $0.3 million related to the change in fair value of the interest rate
swap agreement. Interest income was unchanged from the prior year's amount.
The Company's effective income tax rate was 41.3% and 43.0% in 2003 and
2002, respectively.
FINANCIAL CONDITION AND LIQUIDITY
At March 30, 2003, the Company had current assets of $91.1 million,
which includes $30.5 million of cash and cash equivalents. Current liabilities
were $54.4 million. The Company had working capital of $36.7 million at March
30, 2003, a $12.9 million increase from December 29, 2002.
At March 30, 2003, the Company's long-term debt, including current
installments, consisted of $0.1 million in notes payable, bearing interest at a
rate of 8.0%, and $30.0 million borrowed under its credit facility. The credit
facility was a one-year revolver that converted on February 15, 2003, into a
four-year term loan carrying a variable rate based upon LIBOR. As of March 30,
2003, the Company was not in compliance with the fixed charge ratio provision of
its $30.0 million term loan. The Company has obtained from the lenders a waiver
regarding the noncompliance. During the first quarter of 2002, the Company
entered into an interest rate swap to mitigate its exposure to interest rate
fluctuations. Under the interest rate swap agreement, the Company pays a fixed
rate of interest of 5.6%. Other long-term liabilities include a post-retirement
benefits liability that relates to the acquisition in 1994 of Underwriters
Salvage Company. The amount recorded at March 30, 2003 for the post-retirement
benefits liability is approximately $2.7 million.
Capital expenditures were $2.8 million for the three months ended March
30, 2003. These capital expenditures include capitalization of certain
development costs related to the Company's new information technology system
along with various branch improvements including upgrades to existing branches
and the addition of capacity in key markets. In addition to the cash capital
expenditures, property and equipment additions of $2.3 million resulted from
capital lease transactions entered into during the quarter. At March 30, 2003,
the Company's total future obligations under all capital leases was $5.6
million.
On January 10, 2003, the Company acquired Salvage Management Inc.
(SMI), an operator of two auto salvage facilities in Buffalo and Rochester, New
York, for $2.4 million in cash. The acquisition agreement provides for
additional funds to be paid to the seller, in the future, depending upon the
achievement of various performance expectations. The acquisition was accounted
for as a purchase business combination, and the results of operations were
included in the Company's consolidated financial statements from the date of
acquisition. In March 2003, the Company signed a purchase agreement to acquire a
salvage pool for an initial investment of approximately $3.0 million and
subsequent additional funds to be paid to the seller, in the future, depending
upon the achievement of various performance expectations. The completion of this
agreement is contingent upon the seller's ability to satisfy certain operational
requirements.
The Company's Board of Directors authorized the purchase of 1,500,000
shares of its common stock in September 2000 and an additional 750,000 shares in
April 2003, for a combined authorization of 2,250,000 shares. Purchases may be
made from time to time in the open market or in privately negotiated
transactions, subject to the requirements of applicable laws, and will be
financed with existing cash and cash equivalents, marketable securities, and
cash from operations. As of March 30, 2003, the Company had purchased 757,409
shares pursuant to this authorization at an average price of $9.77 per share.
11
The Company believes that existing cash and cash equivalents, as well
as cash generated from operations will be sufficient to fund capital
expenditures and provide adequate working capital for operations for the next
twelve months. Part of the Company's plan is to pursue continued growth,
possibly through new facility start-ups, acquisitions, and the development of
new claims processing services. At some time in the future, the Company may
require additional financing. There can be no assurance that additional
financing, if required, will be available on favorable terms.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company operates in a changing environment that involves a number
of risks, some of which are beyond the Company's control. The following
discussion highlights some of these risks.
Quarterly Fluctuations. The Company's operating results have in the
past and may in the future fluctuate significantly depending on a number of
factors, some of which are more significant for sales under the purchase
agreement method. These factors include: fluctuations in Actual Cash Value
("ACV" - the estimated pre-accident fair value of the vehicle) of salvage
vehicles, changes in the market value of salvage vehicles, delays or changes in
state title processing, general weather conditions, changes in regulations
governing the processing of salvage vehicles, the availability and quality of
salvage vehicles and attendance at salvage auctions. The Company is also
dependent upon receiving a sufficient number of total-loss vehicles as well as
recovered theft vehicles to sustain its profit margins. Factors that can affect
the number of vehicles received include: reduction of policy writing by
insurance providers, which would affect the number of claims over a period of
time, and changes in direct repair procedures that would reduce the number of
newer, less damaged total-loss vehicles, which tend to have the higher salvage
values. The decreases in the quality and quantity of inventory, and in
particular the availability of newer and less-damaged vehicles, are further
aggravated under the purchase agreement method of sale and can have a material
adverse effect on the operating results and financial condition of the Company.
Additionally, in the last few years there has been a declining trend in theft
occurrences. As a result, the Company believes that period-to-period comparisons
of its results of operations are not necessarily meaningful and should not be
relied upon as any indication of future performance. Furthermore, revenues for
any future quarter are not predictable with any significant degree of accuracy,
while the Company's expense levels are relatively fixed. If revenue levels are
below expectations, operating results are likely to be adversely affected. Due
to all of the foregoing factors, it is likely that in some future quarters the
Company's operating results will be below the expectations of public market
analysts and investors.
Competition. The Company faces intense competition for the supply of
salvage vehicles as well as competition from processors of vehicles from other
regional salvage pools. It is possible that the Company may encounter further
competition from existing competitors and new market entrants that are
significantly larger and have greater financial and marketing resources. Other
potential competitors could include used car auction companies, providers of
claims software to insurance companies, certain salvage buyer groups and
insurance companies, some of which presently supply auto salvage to the Company.
While most insurance companies have abandoned or reduced efforts to sell salvage
without the use of service providers such as the Company, they may in the future
decide to dispose of their salvage directly to end users. There can be no
assurance that the Company will be able to compete successfully against current
or future competitors or that competitive pressures faced by the Company will
not have a material adverse effect on its operating results and financial
condition.
Dependence on Key Insurance Company Suppliers. Historically, a limited
number of insurance companies has accounted for a substantial portion of the
Company's revenues. For example, in 2002, vehicles supplied by the Company's
three largest suppliers accounted for approximately 39% of the Company's total
unit sales. The largest suppliers, State Farm Insurance, Farmers Insurance, and
Allstate, each accounted for approximately 16%, 14%, and 9%, respectively, of
the Company's unit sales. A loss or reduction in the number of vehicles from any
of these suppliers, or adverse changes in the agreements that such suppliers
have with the Company, could have a material adverse effect on the Company's
operating results and financial condition.
12
Purchase Agreement Method. Under the purchase agreement method of sale,
the Company is required to purchase, and the insurance company and other
non-insurance company suppliers are required to sell to the Company, virtually
all total-loss and recovered theft vehicles generated by the supplier in a
designated geographic area. The agreements are customized to each supplier's
needs, but typically require the Company to pay a specified percentage of a
vehicle's ACV, depending on the vehicle's age and certain other conditions,
including whether the vehicle is a total-loss or a recovered theft vehicle. The
Company assumes the risk of market price variation for vehicles sold under a
purchase agreement, and therefore works to enhance the value of purchased
vehicles in the selling process. Revenue recorded from the sale of a purchase
agreement vehicle is the actual selling price of the vehicle. Because the
Company's purchase price is fixed by contract, changes in ACVs or in the market
or auction prices for salvage vehicles have an impact on the profitability of
the sale of vehicles under the purchase agreement method. Beginning late in the
second quarter of 2000 and continuing through 2002, purchase agreement
profitability was impaired by a combination of rising ACVs and flat to lower
sale prices at auctions in certain areas of the country. Further increases in
ACVs or declines in the market or auction prices for salvage vehicles could have
a material adverse effect on the Company's operating results and financial
condition. In 2002 and 2001, respectively, approximately 10% and 19% of the
units processed by the Company were processed through the purchase agreement
method of sale. Vehicles sold under the purchase agreement method accounted for
8% of the total vehicles sold in the first quarter of 2003, versus 13% for the
same quarter last year and 8% for the fourth quarter of 2002. The Company
expects the purchase agreement method to represent a decreasing percentage of
units sold in future years and ultimately to represent less than 4% of total
units sold.
Business Process Reengineering Project. During the third quarter 2001,
the Company retained Synergetics Installations Worldwide, a consulting firm
based in New Hampshire, to assist the Company in its process of creating and
applying new standards and best practices in an effort to improve operational
efficiency, standardize processes, and implement tools to measure performance
within critical areas of field operations. The Company completed its best
practices model and rolled out the procedures into all of its branches in the
first half of 2002.
Enterprise-Wide System Redesign Project. The Company retained the
services of SEI Information Technology to develop a new enterprise-wide
application to manage the salvage and auction process. The new Web-based system
will support and streamline vehicle registration and tracking, financial
reporting, transaction settlement, vehicle title transfer, and
branch/headquarters communications. It will speed all aspects of the Company's
operations, support growth and expansion plans, provide improved reliability and
maintainability, and ultimately, deliver increased profits. The estimated cost
of $10 million includes equipment, telecom, training, and implementation along
with the application development. As a result of its investment in the Business
Process Re-engineering Project and the Enterprise-Wide System Redesign Project,
the Company expects to reduce its annual pre-tax operating costs by a minimum of
$10 million, and potentially as much as $15 million from the two projects
combined. Development of the application and testing began in the third quarter
of 2001. The Company began rolling out the new system to its branches during the
third quarter of 2002. As of April 30, 2003, the Company had implemented the
system in 24 of its 28 original databases. The Company expects to complete the
roll-out in 2003. There are, however, inherent risks associated with both
projects that could adversely impact the Company's expected results with respect
to timing, costs and cost savings.
Governmental Regulation. The Company's operations are subject to
regulation, supervision and licensing under various federal, state and local
statutes, ordinances and regulations. The acquisition and sale of totaled and
recovered theft vehicles is regulated by state motor vehicle departments in each
of the locations in which the Company operates. Changes in law or governmental
regulations or interpretations of existing law or regulations can result in
increased costs, reduced salvage vehicle prices and decreased profitability for
the Company. In addition to the regulation of sales and acquisitions of
vehicles, the Company is also subject to various local zoning requirements with
regard to the location of its auction and storage facilities. These zoning
requirements vary from location to location. Failure to comply with present or
future regulations or changes in existing regulations could have a material
adverse effect on the Company's operating results and financial condition.
Provision of Services as a National or Regional Supplier. The provision
of services to insurance company suppliers on a national or regional basis
requires that the Company expend resources and dedicate management to a small
number of individual accounts, resulting in a significant amount of fixed costs.
The
13
development of a referral based national network service, in particular, has
required the devotion of financial resources without immediate reimbursement of
such expenses by the insurance company suppliers.
Expansion and Integration of Facilities. The Company seeks to increase
sales and profitability through acquisition of other salvage auction facilities,
new site expansion and the increase of salvage vehicle volume at existing
facilities. There can be no assurance that the Company will continue to acquire
new facilities or add additional facilities on terms economically favorable to
the Company or that the Company will be able to increase revenues at newly
acquired facilities above levels realized prior to acquisition. The Company's
ability to achieve these objectives is dependent on, among other things, the
integration of new facilities, and their information systems, into its existing
operations, the identification and lease of suitable premises, and the
availability of capital. There can be no assurance that this integration will
occur, that suitable premises will be identified or that additional capital will
be available to fund expansion and integration of the Company's business. Any
delays or obstacles in this integration process could have a material adverse
effect on the Company's operating results and financial condition. Furthermore,
the Company has limited sources of additional capital available for
acquisitions, expansions and start-ups. The Company's ability to integrate and
expand its facilities will depend on its ability to identify and obtain
additional sources of capital to finance such integration and expansion. In the
future, the Company will be required to continue to improve its financial and
management controls, reporting systems and procedures on a timely basis and
expand, train and manage its employee work force. The failure to improve these
systems on a timely basis and to successfully expand and train the Company's
work force could have a material adverse effect on the Company's operating
results and financial condition.
Volatility of Stock Price. The market price of the Company's common
stock has been and could continue to be subject to significant fluctuations in
response to various factors and events, including variations in the Company's
operating results, the timing and size of acquisitions and facility openings,
the loss of vehicle suppliers or buyers, the announcement of new vehicle supply
agreements by the Company or its competitors, changes in regulations governing
the Company's operations or its vehicle suppliers, environmental problems or
litigation.
Environmental Regulation. The Company's operations are subject to
federal, state and local laws and regulations regarding the protection of the
environment. In the salvage vehicle auction industry, large numbers of wrecked
vehicles are stored at auction facilities for short periods of time. Minor
spills of gasoline, motor oils and other fluids may occur from time to time at
the Company's facilities and may result in soil, surface water or groundwater
contamination. Petroleum products and other hazardous materials are contained in
aboveground or underground storage tanks located at certain of the Company's
facilities. Waste materials such as waste solvents or used oils are generated at
some of the Company's facilities and are disposed of as non-hazardous or
hazardous wastes. The Company believes that it is in compliance in all material
respects with applicable environmental regulations and does not anticipate any
material capital expenditure for environmental compliance or remediation.
Environmental laws and regulations, however, could become more stringent over
time and there can be no assurance that the Company or its operations will not
be subject to significant compliance costs in the future. To date, the Company
has not incurred expenditures for preventive or remedial action with respect to
contamination or the use of hazardous materials that have had a material adverse
effect on the Company's operating results or financial condition. The
contamination that could occur at the Company's facilities and the potential
contamination by previous users of certain acquired facilities create the risk,
however, that the Company could incur substantial expenditures for preventive or
remedial action, as well as potential liability arising as a consequence of
hazardous material contamination, which could have a material adverse effect on
the Company's operating results and financial condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to interest rate fluctuations on its floating
rate $30.0 million credit facility. In 2002, the Company entered into an
interest rate swap to mitigate its exposure to interest rate fluctuations, and
does not, as a matter of policy, enter into hedging contracts for trading or
speculative purposes. The interest rate swap agreement has a notional amount of
$30.0 million under which the Company pays a fixed rate of interest of 5.6% and
receives a LIBOR-based floating rate. The Company recorded a non-cash benefit of
$0.3 million in the quarter related to the change in fair value for a portion of
its interest rate swap
14
agreement. The Company also recorded $0.2 million in the quarter for an
accumulated comprehensive loss related to the change in fair value of the
remaining portion of its interest rate swap agreement. At March 30, 2003, the
entire swap agreement qualified for hedge accounting.
On February 15, 2003, the Company borrowed available funds related to
its $30.0 million credit facility. The credit facility was a one-year revolver
that converted on February 15, 2003, into a four-year term loan carrying a
variable rate fixed upon LIBOR. The aggregate principal balance of the loan will
be paid in sixteen consecutive equal quarterly installments commencing on March
31, 2003.
ITEM 4. CONTROLS AND PROCEDURES
a. Evaluation of Disclosure Controls and Procedures
Based on an evaluation of the Company's disclosure controls and
procedures conducted within 90 days of the date of filing this report
on Form 10-Q, the Company's Chief Executive Officer and its Chief
Financial Officer have concluded that the Company's disclosure controls
and procedures, as defined in Rules 13a-14 and 15d-14 promulgated under
the Securities Exchange Act of 1934, are effective.
b. Changes in Internal Controls
The Company is in the process of rolling out a new enterprise-wide
application to manage the salvage and auction process. The new system
contains many changes and enhancements to the existing control
procedures. Completion of the new system roll-out is expected to be
completed in 2003.
PART II. OTHER INFORMATION.
ITEM 1. LEGAL PROCEEDINGS. Inapplicable
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. Inapplicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. Inapplicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Inapplicable
ITEM 5. OTHER INFORMATION. Inapplicable
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K.
(A) EXHIBITS.
99.1 Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(B) REPORT ON FORM 8-K. The Company furnished to the SEC a current
report on Form 8-K on April 29, 2003 which included a press
release which contained a report on first quarter earnings; an
update on the Company's growth and expansion strategy; and
discussed the decision of the Company's current Chairman of the
Board not to stand for re-election to the Company's Board and
the appointment of a new Chairman of the Board upon his
re-election as a director at the Company's 2003 Annual Meeting.
15
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
INSURANCE AUTO AUCTIONS, INC.
Date: May 14, 2003 By: /s/ Scott P. Pettit
------------ ------------------------------------------------
Name: Scott P. Pettit
Title: Senior Vice President and Chief Financial Officer
(Duly Authorized Officer and Principal Financial
Officer)
16
CERTIFICATION PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
(PURSUANT TO RULE 13A-14 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED)
I, Thomas C. O'Brien, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Insurance Auto
Auctions, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 14, 2003 /s/ Thomas C. O'Brien
------------------------------------------
Thomas C. O'Brien, Chief Executive Officer
17
CERTIFICATION PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
(PURSUANT TO RULE 13A-14 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED)
I, Scott P. Pettit, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Insurance Auto
Auctions, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 14, 2003 /s/ Scott P. Pettit
------------------------------------------
Scott P. Pettit, Chief Financial Officer
18
EXHIBIT INDEX
EXHIBIT NO.
99.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.