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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 26, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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 (I.R.S. Employer
incorporation or organization) Identification Number)
TWO WESTBROOK CORPORATE CENTER, SUITE 500
WESTCHESTER, ILLINOIS 60154
(708) 492-7000
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.001
par value
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]
The aggregate market value of Registrant's voting stock, based on the
closing price of the Registrant's Common Stock as of June 27, 2004, was
approximately $83,549,809. For purposes of this calculation, the Registrant's
directors, executive officers and 5% shareholders have been assumed to be
affiliates. As of March 1, 2005, the Registrant had outstanding 11,853,123
shares of common stock, $0.001 par value.
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INSURANCE AUTO AUCTIONS, INC.
FORM10-K
TABLE OF CONTENTS
PAGE
----
PART I.
Item 1. Business............................................................................... 3
Item 2. Properties............................................................................. 13
Item 3. Legal Proceedings...................................................................... 13
Item 4. Submission of Matters to a Vote of Security Holders.................................... 14
PART II.
Item 5. Market for Registrant's Common Equity, Related Shareholder Matters
and Issuer Purchases of Equity Securities.............................................. 15
Item 6. Selected Financial Data................................................................ 16
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 17
Item 7A. Quantitative and Qualitative Disclosures about Market Risk............................. 22
Item 8. Financial Statements and Supplementary Data............................................ 23
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure... 23
Item 9A. Controls and Procedures................................................................ 23
PART III.
Item 10. Directors and Executive Officers of the Company........................................ 25
Item 11. Executive Compensation................................................................. 27
Item 12. Security Ownership of Certain Beneficial Owners and Management......................... 31
Item 13. Certain Relationships and Related Transactions......................................... 33
Item 14. Principal Accountant Fees and Services................................................. 33
PART IV.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K....................... 35
2
PART I
ITEM 1. BUSINESS.
This Report contains forward-looking statements that are 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 statements. In some cases, you can identify forward looking
statements by 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 in "Factors That
May Affect Future Results" below and "Management's Discussion and Analysis of
Financial Condition and Results of Operations." You should not place undue
reliance on any forward-looking statements. Except as expressly required by the
federal securities laws, the Company undertakes no obligation to publish, update
or revise any forward-looking statements, whether as a result of new
information, future events, changed circumstances or any other reason.
RECENT ANNOUNCEMENT OF MERGER
On February 22, 2005, the Company entered into a merger agreement ("Merger
Agreement") pursuant to which the company will be merged with an affiliate of
Kelso & Company, L.P., a New York-based equity investment firm (the "Merger")
that specializes in acquisition transactions ("Kelso").
Pursuant to the Merger Agreement, each outstanding share of company common
stock will be exchanged for the right to receive $28.25 in cash, without
interest. The acquisition will be subject to a number of conditions, including
shareholder approval and approval by regulatory authorities in the United
States. The Company's shareholders are expected to vote on the proposed
acquisition in June 2005.
Pending the satisfaction of the conditions mentioned above and others
included in the Merger Agreement, IAAI and Kelso expect the acquisition of the
Company to be complete by June 15, 2005, although there are no assurances the
Merger will close at that time or at any other time.
Information contained in this Annual Report, especially forward looking
information, should be read in light of the Merger.
OVERVIEW
Insurance Auto Auctions, Inc., together with its subsidiaries, provides
insurance companies and other vehicle suppliers cost-effective salvage
processing solutions. In an accident, theft or other claims adjustment process,
insurance companies typically take possession of a vehicle because (i) based on
economic and customer service considerations, the vehicle has been classified as
a "total loss" and the insured replacement value has been paid rather than the
cost of repair or (ii) a stolen vehicle is recovered after the insurance company
has settled with the insured. The Company generally sells these salvage and
theft-recovered vehicles at live or closed bid auctions on a competitive-bid
basis at one of the Company's facilities, or via the internet through proxy or
live internet bidding.
The Company processes salvage vehicles primarily under two methods: fixed
fee or percentage of sale consignment. Under the fixed fee consignment and
percentage of sale consignment methods, the Company sells vehicles on behalf of
insurance companies, which continue to own the vehicles until they are sold to
buyers at auction. Under these methods, the Company generally conducts either
live or closed bid auctions of the automotive salvage in return for agreed upon
sales fees. In addition to fees, the Company generally charges its fixed fee
consignment and percentage of sale consignment vehicle suppliers for various
services, including towing and storage. The Company still processes a small
percentage of vehicles under the purchase method. Under the purchase method, the
Company generally purchases vehicles from the insurance companies upon clearance
of title, under financial terms determined by agreement with the insurance
company supplier, and then resells these vehicles
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for the Company's own account at the Company's auctions. Under all methods of
sale, the Company also charges the buyer of each vehicle various buyer-related
fees.
The Company has grown through the acquisition of additional auto salvage
pool operations and opening of new facilities in strategic locations, resulting
in a network of 78 sites in 32 states as of March 1, 2005. A majority of the
vehicles currently processed by the Company are sold under the fixed fee and
percentage of sale consignment arrangements. In 2004, 68% of the vehicles
processed by the Company were sold under the fixed fee consignment method, 28%
were sold under the percentage of sale consignment method, and 4% were sold
under the purchase agreement method.
The Company obtains the majority of its supply of vehicles from insurance
companies and smaller quantities from non-insurance company suppliers such as
rental car companies and non-profit organizations. Historically, a limited
number of insurance companies have accounted for a substantial portion of the
Company's revenues. In 2004, vehicles supplied by the Company's three largest
suppliers accounted for approximately 37% of the Company's unit sales. The
largest suppliers, State Farm Insurance, Zurich Insurance, and GEICO accounted
for approximately 16%, 11%, and 10%, respectively, of the Company's 2004 unit
sales.
HISTORY
The Company was organized as a California corporation in 1982 under the
name Los Angeles Auto Salvage, Inc. ("LAAS"). In January 1990, all the
outstanding capital stock of LAAS was acquired in a leveraged buyout and, in
October 1991, LAAS changed its name to Insurance Auto Auctions, Inc. The Company
completed its initial public offering in November 1991. Its common stock is
traded on the Nasdaq National Market(R) under the symbol "IAAI". In 1997, the
Company reincorporated in the State of Illinois.
FIXED FEE CONSIGNMENT SALE METHOD
In 2004 and 2003, the percentage of vehicles processed by the Company that
were sold under the fixed fee consignment sale method was approximately 68% and
52%, respectively. Under this sale method, the Company charges fees to the
insurance company supplier for specific services. These fees typically include a
salvage sales fee plus towing, title processing and storage fees. With this
method of sale, the Company acts as an agent for the insurance company, arranges
for the salvaged vehicle to be towed to its facility and processes it for sale.
Because the Company never takes ownership of the vehicle, the Company's revenues
per vehicle from consignment sales are received only from these fixed fees
rather than from the revenue from the sale of the vehicle. As a result,
exclusive of the buyer fees, revenue recognized per vehicle under the fixed fee
consignment method of sale is approximately 5% to 15% of the revenue recognized
per vehicle under the purchase method, where the Company's revenue is
principally comprised of the sale price of the vehicle.
PERCENTAGE OF SALE CONSIGNMENT METHOD
In 2004 and 2003, the percentage of vehicles processed by the Company that
were sold under the percentage of sale consignment method was approximately 28%
and 42%, respectively. Pursuant to this method of sale, the Company acts as an
agent for the insurance company and receives a negotiated percentage of the
vehicle's selling price. As an agent, the Company arranges for the salvaged
vehicle to be towed to its facility and processes it for sale for a fee based on
a percentage of sales price. The percentage of sale consignment method provides
suppliers with a potentially greater upside as the Company's fees are tied to
selling prices and, thus, the salvage supplier has a greater incentive to invest
in improvements to salvage vehicles in order to maximize sales prices. Because
the Company never takes ownership of the vehicle, the Company's revenues per
vehicle from percent of sale consignment sales are generated from these sales
fees rather than from the revenue from the sale of the vehicle. As a result,
exclusive of the buyer fees, revenue recognized per vehicle under the percentage
of sales consignment method is approximately 5% to 15% of the revenue recognized
per vehicle under the purchase method, where the Company's revenue is
principally comprised of the sale price of the vehicle.
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PURCHASE METHOD
In 2004 and 2003, the percentage of vehicles processed by the Company that
were sold under the purchase method of sale was approximately 4% and 6%,
respectively. Under the purchase method of sale, the Company purchases
total-loss and recovered theft vehicles. The purchases are customized, but
typically require the Company to pay a fixed price or a specified percentage of
a vehicle's actual cash value, or ACV, which is equal to the estimated
pre-accident fair value of the vehicle. ACV for any given vehicle depends on the
vehicle's age and condition. The Company assumes the risk of market price
variation for vehicles sold under a purchase method, and therefore, works to
enhance the value of purchased vehicles in the selling process. Because the
Company's purchase price is fixed, 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 method. Revenue recorded from the sale of a purchase
vehicle represents the actual selling price of the vehicle. The cost of the
vehicle under this method is reflected in the vehicle cost line of cost of
sales.
SERVICES PROVIDED TO ALL SUPPLIERS
The process of salvage disposition through the Company's system begins at
the first report of loss, or when a stolen vehicle has been subsequently
recovered. An insurance company representative consigns the vehicle to the
Company, either by phone, facsimile or electronically through the Company's
online CSA Today(SM) system.
CSA Today is the Company's proprietary data management system. The system
enables insurance company suppliers to enter vehicle data electronically, and
then track and manage the progress of salvage vehicles throughout the
disposition process in terms of both time and salvage recovery dollars. With
this tool, vehicle providers have 24-hour access to their total-loss data. The
information provided through this system ranges from the details associated with
a specific total-loss vehicle, to comprehensive management reports for an entire
claims center or geographic region. Additional features of this system include
inventory management tools and a powerful new "Average Salvage Calculator" that
helps customers determine the approximate salvage value of a potential
total-loss vehicle. This tool is helpful to adjusters when evaluating the
"repair" vs. "total" decision. The management tools provided by CSA Today enable
claims personnel to monitor and manage total-loss salvage effectively. CSA
Today's daily updates provide current and meaningful data to the Company's
vehicle providers.
The Company also offers a total-loss appraisal service, FastTrack(R).
FastTrack utilizes an early total-loss recognition system to identify, appraise
and move probable total-loss vehicles sooner than the conventional claims
process. FastTrack cuts through many of the delays typically associated with
traditional claims handling by combining a comprehensive appraisal service with
the Company's salvage service resources. Completed appraisals, including a
condition report and an array of digital images, are electronically transmitted
to a secure, password-protected Web site, providing adjusters with same-day
access to the information via the Internet. The result is faster completion of
total-loss appraisals, significant savings on accrued shop storage and car
rental expenses, and exceptional customer satisfaction.
The Company's FastTow(R) service provides towing services that guarantee
vehicles will be delivered to a Company branch storage facility, usually within
one to two business days of consignment in a designated service area. When
retrieving a vehicle, the FastTow service will also advance, on behalf of the
supplier, any storage and towing charges incurred when towing the vehicle from
the accident scene or recovered theft site to the temporary storage facility or
repair shop. Once these advance towing and storage charges have been reviewed
and verified by the Company, the towing subcontractor generally will pay the
charges on behalf of the Company at time of vehicle pick up and deliver the
vehicle to the predetermined Company auction and storage facility. The rapid
retrieval time and review of advance charges are also intended to increase the
insurance company's net return on salvage.
In order to further minimize vehicle storage charges incurred by insurance
company suppliers at the temporary storage facility or repair shop, and also to
improve service time for the policyholder, the Company and a certain group of
its insurance company suppliers have established vehicle inspection centers, or
VICs, at many of the Company's facilities. A VIC is a temporary storage and
inspection facility located at a Company site that is operated by the insurance
company. Suspected total-loss vehicles are brought directly to the VIC from the
temporary storage facility or repair shop. The insurance company typically has
appraisers stationed on the VIC site in order to expedite the appraisal process
and minimize storage charges at outside sites. If the insurance company
determines that a
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vehicle is a total loss, it can easily be moved to one of the Company's vehicle
storage areas. If the vehicle is not totaled, it is promptly delivered to the
insurer's selected repair facility. The Company also has the ability to provide
digital images as a service to its customers, electronically displaying pictures
of the damaged cars to insurance adjusters in their offices.
After a totaled vehicle is received at a Company facility, it remains in
storage but cannot be auctioned until transferable title has been submitted to
and processed by the Company. For most vehicles stored at the Company's
facilities, no storage charges accrue for a contractually specified period of
time. The Company provides management reports to the insurance company
suppliers, including an aging report of vehicles for which title documents have
not been provided. In addition, the Company customarily offers the insurance
companies' staff training for each state's Department of Motor Vehicles ("DMV")
document processing. These services expedite the processing of titles, thereby
reducing the time in which suppliers receive their salvage proceeds, in addition
to decreasing their administrative costs and expenses. The Company then
processes the title documents in order to comply with DMV requirements for these
vehicles. This may involve re-registering the vehicle and obtaining a salvage
certificate, after which the Company is entitled to sell the vehicle.
I-bid LIVE is the Company's live auction Internet bidding solution that
enables buyers to join live auctions through any Internet-enabled computer and
bid in real time along with the live local bidders and other Internet bidders.
From the Bidders's screen, buyers can view images of vehicles and listen to the
live call of the auctioneer -- just as the auction is happening. I-bid LIVE
helps buyers use time more efficiently by allowing them to "virtually" attend
many auctions over a broad region without having to leave their office.
The Company generally conducts auctions either every week or bi-weekly at
each of its locations. These auctions are either live or sealed bid. Auction
lists can be viewed online on the Company's Web site, where buyers can either
review all vehicles at a location or search for specific vehicles. Vehicles are
marketed at each respective auction site as well as via an online auction list
that allows prospective bidders to preview vehicles prior to the actual auction
event. The Company's Auction Center, at www.iaai-bid.com(SM), is an online,
Internet-based bidding forum to preview and bid on salvage vehicles at all of
the Company's facilities throughout the United States. It provides buyers with
an open, competitive bidding environment that reflects the dynamics of the live
salvage vehicle auction. The Auction Center includes such services as
comprehensive auction lists featuring links to digital images of vehicles
available for sale, an "Auto Locator" function that promotes the search for
specific vehicles within the auction system, and special "Flood" or other
catastrophe auction notifications. Higher returns are generally driven by
broader market exposure and increased competitive bidding.
The Company remits payment to the insurance company suppliers within a
contractual time period or shortly after sale of the vehicle and collection from
the buyer. In addition, most insurance company suppliers receive monthly summary
reports of all vehicles processed by the Company. The reports track the
insurance companies' gross return on salvage, net return on salvage, exact
origin, details of storage charges and other useful management data. The Company
also provides many of its suppliers with a quarterly Comprehensive Salvage
Analysis of salvage trends.
OTHER SERVICES
The Company offers its vehicle suppliers a National Salvage Network that
allows an insurance company supplier to consign all of its salvage vehicles to a
call center. This call center enables the Company to distribute vehicle
consignments throughout most of the United States, even in markets where the
Company does not currently have a facility, and is designed to minimize the
administrative workload for insurance companies. In certain areas where the
Company does not have a facility, such vehicles are distributed to the Company's
selected ServicePartners(TM).
The Company also offers, through its Specialty Salvage Division, salvage
services for specialty vehicles such as trucks, heavy equipment, farm equipment,
boats, recreational vehicles and classic and exotic cars. Marketing these
vehicles nationwide to specialty buyers provides insurance companies with the
opportunity for better returns on units that typically do not sell for as much
at local salvage pools due to a limited number of local buyers. These vehicles
can be viewed online through the Company's Internet Web site at www.iaai.com.
6
The Company also provides certain insurance company suppliers with
anti-theft fraud control programs for vehicle salvage processing. The Company's
CarCrush(R) service helps insurance companies by ensuring that severely damaged
or stripped "high profile" cars are crushed to prevent their vehicle
identification numbers (VINs) from being used in auto theft. The Company also
provides computerized reporting of vehicle sales to the National Insurance Crime
Bureau (NICB). This includes detailed buyer information obtained through the
Company's registration process.
The Company's BidFast(R) service provides insurers with binding bids for
salvage vehicles that historically may have been owner-retained. The return on
such vehicles (owner-retained salvage vehicles) is, many times, measurably
improved for the supplier using this service and enables compliance with many
states' Department of Insurance Regulations. Vehicles purchased under BidFast
are accounted for under the purchase agreement method of sale.
GROWTH STRATEGIES
The Company seeks to increase revenues in a profitable manner by offering
to insurance company suppliers a variety of methods of sale (including fixed fee
consignment and percentage of sale consignment) in addition to various other
services. Management also strives to expand revenue by (i) increasing market
share at existing sites; (ii) achieving greater market penetration through
acquisitions; (iii) expanding the number of sites; (iv) developing
national/regional supplier agreements; and (v) offering new services to
insurance companies to help reduce the time and cost associated with the claims
process.
Increasing Market Share and Profitability at Existing Sites
The Company's primary strategy for organic growth in its existing markets
is to contract for additional vehicles by promoting better returns on salvage
vehicles and offering a broad selection of services to prospective suppliers.
The expansion of the number of vehicles processed at existing sites typically
makes the Company's auctions more attractive, resulting in increased buyer
participation. The Company is also promoting its Run & Drive(R) service in which
certain salvage vehicles are driven during the auction to demonstrate to
prospective buyers that the major component parts of a vehicle still operate.
These product offerings are designed to maximize returns for both the Company
and the salvage provider.
Continued Market Penetration Through Acquisitions
Since the Company's initial public offering in November 1991, the Company
has acquired additional salvage pool operations across the United States to
offer better national coverage to its insurance company suppliers. As of March
1, 2005, the Company operated 78 sites in 32 states.
The Company intends to continue to pursue acquisitions of strategically
located salvage pools. Through such acquisitions, it seeks to enhance
geographically broad-based relationships with key insurance company suppliers,
in addition to offering its specialized salvage services to new insurance
companies and other suppliers. In pursuing its acquisition strategy and plans,
the Company recognizes that there will be continuing challenges in effectively
and efficiently integrating new facilities into its existing operations. Among
other things, future acquisitions will require continued investment in
infrastructure. See "Factors That May Affect Future Results."
New Site and Existing Site Expansion
While the Company expects to continue pursuing growth through
acquisitions, it will also continue to seek growth through the opening of new
sites and the expansion of existing sites in markets where it can leverage
existing relationships with vehicle providers. The opening of new sites offers
advantages in certain markets and allows the Company to capitalize on regional
and national customer accounts.
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Development of National/Regional Supplier Agreements
The Company's expanded geographic base of operations, plus its National
Network, facilitates its strategy of offering existing and prospective customers
national and regional supplier agreements. These agreements can provide a more
consistent reporting and control function to the Company's customers, who
benefit from a reduction in the number of service providers through which they
must do business.
Additional Services
The Company is actively pursuing opportunities for growth through the
identification and development of new, non-traditional customer-valued services
and business offerings that leverage the Company's current competencies,
geographic presence and assets. The primary focus of these new services is to
provide to the insurance industry new, innovative options and alternatives for
reducing the time and costs associated with processing insurance claims.
Electronic Data Interchange and Electronic Funds Transfer (EDI/EFT)
facilitate faster, more accurate service from consignment and vehicle pickup
through sale and final settlement. EDI helps minimize insurance staff
involvement, lowers error rates and diminishes administrative requirements
through direct communication between the Company's system and the insurance
company's system. EDI/EFT electronically expedites the total-loss recovery
process. Reduced manual intervention combined with faster, more accurate service
translates into quicker turnaround on the final settlement.
SurePay(R) is the Company's electronic funds transfer service that
improves the speed and accuracy of the billing and final settlement process by
automatically depositing salvage proceeds directly into customer bank accounts.
MARKETING
The Company's internal sales force is its primary method of marketing its
services to insurance company and non-insurance company salvage suppliers. These
individuals solicit prospective vehicle providers at the national, regional and
local level. Branch managers also provide support in the form of day-to-day
customer service and address customer needs at the local level.
In an effort to generate additional revenues and improve customer
satisfaction, direct mail is also used to communicate services and benefits to
customers. This initiative includes a national quarterly newsletter, entitled
OnTrack, and other local market updates that discuss how the Company addresses
specific customer needs. In addition, the Company participates in a number of
local, regional and national trade show events that further promote the benefits
of its products and services.
Using historical data supplied by prospective suppliers, the Company can
provide suppliers with a detailed analysis of their current salvage returns and
a proposal detailing ways in which the Company can improve salvage returns,
reduce administrative costs, and provide proprietary turn-key claims processing
services.
In addition to providing insurance companies and certain non-insurance
company suppliers with a means of disposing of salvage vehicles, the Company
also offers services intended to increase the net amount of salvage sale
proceeds received by suppliers while also reducing the time required to receive
net proceeds. The Company seeks to become an integral part of its suppliers'
salvage processes, and it views such mutually beneficial relationships as an
essential component of its effort to attract and retain suppliers.
The Company also seeks to expand its supply relationships through
recommendations from individual insurance company branch offices to other
offices of the same insurance company. The Company believes that its existing
relationships, and the recommendations of branch offices, play a significant
role in its marketing of services to national insurance companies. Indeed, as
the Company has expanded its geographic coverage, it has been able to market its
services to insurance company suppliers on a national basis or within an
expanded geographic area.
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The Company sells the majority of its vehicles through live auctions and
maintains databases that contain information regarding over 38,500 registered
buyers. No single buyer accounted for more than 5% of the Company's revenue in
2004, highlighting the diversity of the Company's buyer base. The Company
generally accepts cash, money orders, cashier's checks, wire transfers and
pre-approved checks for purchased vehicles. Vehicles are sold "as is" and "where
is." In advance of an auction, sales notices listing the vehicles to be
auctioned on a particular day at a particular location are usually available at
the auction facility or online on the Company's Web site. Such notices list the
rules of the auction and details about the vehicle, including its year and make,
the nature of the damage, the status of title and the order of the vehicles in
the auction. Multiple images of certain vehicles are available for review on the
Company's Web site at www.iaai.com.
COMPETITION
The Company faces intense competition for the supply of salvage vehicles
as well as competition from processors of vehicles from other national and
regional salvage pools. 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
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 vehicles 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. The Company may not be able to compete
successfully against current or future competitors, which could impair its
ability to grow and achieve or sustain profitability.
GOVERNMENTAL REGULATION
The Company's operations are subject to regulation, supervision and
licensing under various federal, state and local agencies, statutes and
ordinances. 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. See "Factors That May Affect Future
Results."
ENVIRONMENTAL REGULATION.
The Company's operations are subject to federal, state and local
environmental laws and regulations. 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. To date, the Company has not incurred significant
expenditures for preventive or remedial action with respect to contamination or
the use of hazardous materials. Environmental laws and regulations, however,
could become more stringent over time and the Company may be subject to
significant compliance costs in the future. Future contamination at any one or
more of the Company's facilities, or the potential contamination by previous
users of certain acquired facilities, create the risk, however, that the Company
could incur significant 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.
9
EMPLOYEES
At March 1, 2005, the Company employed 923 full-time persons. The Company
is not subject to any collective bargaining agreements and believes that its
relationship with its employees is good.
AVAILABLE INFORMATION
The Company files annual, quarterly, and current reports, proxy
statements, and other documents with the Securities and Exchange Commission (the
"SEC") under the Securities Exchange Act of 1934 (the "Exchange Act"). The
public may read and copy any materials that the Company files with the SEC at
the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, D.C. 20549.
The public may obtain information on the operation of the Public Reference Room
by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains a Web site that
contains reports, proxy and information statements, and other information
regarding issuers, including the Company, that file electronically with the SEC.
The public can obtain any documents that the Company files with the SEC at
http://www.sec.gov.
The Company also makes available free of charge on or through its Web-site
(http://www.iaai.com) copies of the Company's Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable,
amendments to those reports filed or furnished pursuant to Section 13(a) of the
Exchange Act as soon as reasonably practicable after the Company electronically
files such materials with, or furnishes them to, the SEC.
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.
Period Fluctuations. The Company's operating results have in the past and
may in the future fluctuate significantly depending on a number of factors.
These factors include, but are not limited to, the ACV 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 buyer 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, but are not limited to, driving patterns,
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. Future decreases in the quality and
quantity of vehicle inventory, and in particular the availability of newer and
less-damaged vehicles would 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, and the Company's operating
results may vary significantly due to its relatively fixed expense levels. Due
to all of the foregoing factors, it is likely that in some future quarters the
Company's operating results will fall below the expectations of public market
analysts and investors. Any failure to meet expectations of securities analysts
or the market in general could adversely affect the market price of the
Company's common stock.
Competition. The Company faces intense competition for the supply of
salvage vehicles as well as competition from processors of vehicles from other
national and regional salvage pools. 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 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
vehicles without the use of service providers such as the Company, they may in
the future
10
decide to dispose of their salvage directly to end users. The Company may not be
able to compete successfully against current or future competitors, which could
impair its ability to grow and achieve or sustain profitability.
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 2004, vehicles supplied by the Company's
three largest suppliers accounted for approximately 37% of the Company's total
unit sales. The largest suppliers, State Farm Insurance, Zurich Insurance, and
GEICO, accounted for approximately 16%, 11%, and 10%, 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 these suppliers have
with the Company, could have a material adverse effect on the Company's
operating results, financial condition and quantity or quality of inventory.
Dependence on Information and Technology Systems. The Company's ability to
provide cost-effective salvage vehicle processing solutions to the Company's
customers depends in part on the Company's ability to effectively utilize
technology to provide value-added services to the Company's customers. The
Company has implemented a new web-based operating system, which allows the
Company to offer hybrid internet/live auctions and to provide vehicle tracking
systems and real-time status reports for the Company's insurance company
customers' benefit. The Company's ability to provide the foregoing services
depends on the Company's capacity to store, retrieve and process data, manage
significant databases and expand and periodically upgrade our information
processing capabilities. As the Company continues to grow, the Company will need
to continue to make investments in new and enhanced information and technology
systems. Interruption or loss of the Company's information processing
capabilities or adverse consequences from implementing new or enhanced systems
could have a material adverse effect on the Company's operating results and
financial condition. As the Company's information system providers revise and
upgrade their hardware, software and equipment technology, the Company may
encounter difficulties in integrating these new technologies into the Company's
business. Although the Company has experienced no significant breaches of the
Company's network security by unauthorized persons, the Company's systems may be
subject to infiltration by unauthorized persons. If the Company's systems or
facilities were infiltrated and damaged by unauthorized persons, there could be
a significant interruption to the Company's ability to provide many of the
Company's electronic and web-based services to the Company's customers. If that
were to occur, it could have a material adverse effect on the Company's
operating results and financial condition.
Governmental Regulation. The Company's operations are subject to
regulation, supervision and licensing under various federal, state and local
agencies statutes and ordinances. 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 could 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
development of a referral- based national network service, in particular, has
required the devotion of financial resources without immediate reimbursement of
these expenses by the insurance company suppliers. The Company may not realize
sufficient revenue from these services to cover these expenses, in which case,
its results of operations may be materially adversely affected.
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. The Company may not be able to continue to acquire new facilities or
add additional facilities on terms economically favorable to the Company, or at
all, or 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 the expansion and integration
of the Company's business. Any delays or obstacles in this integration process
could have a material
11
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. In the future, the Company will also be required
to continue to improve its financial and management controls, reporting systems
and procedures on a timely basis and to expand, train and manage its employee
work force. The failure to improve these systems on a timely basis and to
successfully expand, train and manage 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 will 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. Any failure to meet expectations of securities analysts or the
market in general could adversely affect the market price of the Company's
common stock.
Environmental Regulation. The Company's operations are subject to federal,
state and local environmental laws and regulations. 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. To date, the Company
has not incurred significant expenditures for preventive or remedial action with
respect to contamination or the use of hazardous materials. Environmental laws
and regulations, however, could become more stringent over time and the Company
may be subject to significant compliance costs in the future. Future
contamination at any one or more of the Company's facilities, or the potential
contamination by previous users of certain acquired facilities, create the risk,
however, that the Company could incur significant 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.
Sarbanes-Oxley Act Compliance. During the Company' third fiscal quarter
2004, the Company retained the services of Jefferson Wells International to
assist the Company in complying with the requirements of Section 404 (c) of the
Sarbanes Oxley Act of 2002 ("Section 404 (c)"). Pursuant to Section 404 (c), the
Company's management must (i) establish and maintain adequate internal control
over its financial reporting; (ii) identify the framework used by management to
evaluate the effectiveness of those controls; (iii) assess and attest to the
effectiveness of those controls; and (iv) provide an attestation by the
Company's independent auditors as to management's assessment of its internal
controls over financial reporting. In order to comply with Section 404(c), the
Company has to date incurred significant costs and anticipates further
significant financial expenditures and strain on managerial resources in its
compliance efforts. Though the Company expects to fully comply with the
requirements of Section 404 (c), it cannot be certain that it will do so in the
prescribed time or that it will be able to do so without further significantly
impacting its operations. The failure of the Company to comply with Section
404(c) and complete its assessment of its internal controls in the prescribed
time and obtain from its independent auditors an attestation to management's
assessment of the effectiveness of its internal controls over financial
reporting could have a material adverse affect on the Company's business or
stock price.
12
ITEM 2. PROPERTIES.
The Company's principal administrative, sales, marketing and support
functions are located in Westchester, Illinois. The lease on the office space in
Westchester expires on August 31, 2016. The Company and its subsidiaries also
lease approximately 67 properties in Alabama, Arkansas, Arizona, California,
Connecticut, Florida, Georgia, Hawaii, Idaho, Illinois, Kansas, Louisiana,
Maryland, Massachusetts, Michigan, Minnesota, Missouri, Nebraska, New Jersey,
New York, North Carolina, Oregon, Pennsylvania, South Carolina, Texas, Utah,
Virginia, Washington and Wisconsin. The Company owns 11 properties located in
Illinois, Kansas, Michigan, New Mexico, New York, Oklahoma, South Carolina and
Texas. All of these properties are used primarily for auction and storage
purposes consisting on average of approximately 21 acres of land. Management
believes that the Company's properties are adequate for its current needs and
that suitable additional space will be available on reasonably acceptable terms
as required.
ITEM 3. LEGAL PROCEEDINGS.
The Company is party to a number of lawsuits arising in the normal course
of its business. The Company does not believe that any pending litigation will
have a material adverse effect on its consolidated financial position.
Emery Air Freight Accident
On February 4, 2003, the Company filed a lawsuit in the Superior Court of
California, County of Sacramento, against Emery Air Freight, Tennessee Technical
Services, and Bob and Corrine Spence. The lawsuit seeks to recover damages
caused by the crash of an Emery DC-8 aircraft onto the Company's Rancho Cordova,
California facility on February 16, 2000. The aircraft was destroyed, and the
three crew members aboard the aircraft were killed. The crash and the resulting
release of jet fuel and fire destroyed a significant part of the Company's
facility and contaminated it with ash, hydrocarbon, lead and other toxic
materials. Emery refused to clean up the contamination, and the Company was
required to do so. The Company suffered more than $3.0 million in inventory
loss, clean-up and remediation costs, business interruption losses, legal and
consulting fees, and other losses, costs, and expenses. The Company maintained
insurance policies that covered a significant portion of its losses. The
Company's insurer, Reliance Insurance Company, paid almost $1.0 million on the
Company's lost inventory claims. However, in October 2001, the Pennsylvania
Insurance Commissioner put Reliance into reorganization, a petition in
bankruptcy was filed, and it appears unlikely that Reliance will make any
further payments to the Company. The Company has filed claims with the
California Insurance Guarantee Association, which provides coverage for
California property losses insured by an admitted insurer that is unable to pay
covered claims. The Association has refused to pay the Company's claims and has
taken the position that its liability to the Company is limited to $0.5 million.
In its lawsuit, the Company seeks to recover from Emery and Tennessee
Technical Services for negligence, trespass, and negligent maintenance of the
aircraft. The Company also filed suit against the Spences, alternatively,
seeking to recover from the Spences for breach of provisions in the Company's
lease requiring that they as landlord either pay for or share the cost of
remediation of hazardous wastes. The Spences filed a cross-complaint against the
Company alleging breach of contract. On October 6, 2004, the Company entered
into a Settlement and Arbitration Agreement with the Spences whereby each
dismissed, without prejudice, its claims against the other. The Agreement
provides for settlement of several unrelated disputes that the parties had with
one another and for the further arbitration of claims related to the crash
should the Company be unsuccessful in its on-going suit against Emery and
Tennessee Technical Services. The Company has and anticipates that it will
continue to incur substantial legal fees and costs in its efforts to recover its
losses, and there is no guarantee that the Company will be successful.
13
Relocation of the Woodinville Branch
On September 16, 2003, the Company received notice from the King County
Wastewater Treatment Division, Department of Natural Resources, that King County
was in the process of building a water treatment facility and that the Company's
Woodinville, Washington branch was located within the boundaries of the likely
site for placement of this facility. In the notice, the Company was advised that
if the site was selected, King County would pursue acquisition of the property
from the Company's landlord, Waterman Properties.
On October 3, 2003, the Company received further notice from King County
that it had extended an offer to purchase the Woodinville site from Waterman
Properties and that, if the offer was accepted, the Company would be expected to
enter into a lease arrangement with King County until such time as King County
directed it to vacate the facility. The notice stated that the Company would be
entitled to at least ninety (90) days notice prior to being required to vacate.
In an open house meeting on December 1, 2003, King County announced that it
expected all property owners and tenants to vacate the proposed water treatment
site no later than the end of 2004. The Company never received formal notice of
this timeline from King County; instead, the Company was advised of the timeline
from counsel who attended the open house meeting.
The Company has retained counsel and other consultants to assist in its
relocation effort, to protect the Company's interests in the value of leasehold
improvements made to the premises, and to recover costs resulting from the
relocation. Pursuant to applicable law, the Company is entitled to reimbursement
of certain costs associated with the relocation of its business from this site
to another suitable location.
Under the Company's lease with Waterman Properties, the Company is
entitled to the value of its leasehold improvements invested in the property.
There is currently a dispute between the Company and Waterman Properties
regarding how to value the improvements made to the Woodinville facility. On
March 4, 2004, the Company filed a lawsuit in Snohomish County Superior Court
against King County and Waterman Properties asking the Court to appoint a
receiver to manage a portion of the funds (up to $1.5 million) that Waterman
Properties might receive from King County and to award the Company a portion of
the condemnation award in an amount equal to the value of its leasehold
improvements. The outcome of this action is uncertain at this time.
Since that date, the Company began searching for an alternate location on
which to relocate, believing that in all likelihood it would be required to
vacate the Woodinville facility by year's end. On November 16, 2004 the Company
entered into a new lease for property located in Tukwila, Washington.
Simultaneously, the Company negotiated a settlement with King County whereby the
Company terminated its lease with Waterman Properties and dismissed its
complaint against King County to permit the sale and purchase of the Woodinville
property. The settlement further provided for $900,000 of the purchase price to
be placed into escrow for payment of any judgment that might be awarded in the
Company's on-going suit against Waterman Properties. The outcome of this action
remains uncertain at this time. At year end, the Company exited the Woodinville
facility and the Company wrote off its leasehold improvements of approximately
$991,000. The Company expects to recover approximately $375,000 of which
$200,000, that was recorded in 2004 as a reduction of the loss, is for branch
re-establishment and $175,000 is for relocation of inventory.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth
quarter ended December 26, 2004.
14
PART II
ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
The Company's common stock is traded on The Nasdaq National Market under
the symbol IAAI. The following table sets forth the range of high and low sales
prices per share for the Company's common stock for the periods indicated. At
March 1, 2005, the Company had 594 holders of record of its common stock,
approximately 1,537 beneficial owners and 11,853,123 shares outstanding.
FISCAL 2004 FISCAL 2003
----------- ------ ----
HIGH LOW HIGH LOW
------ ------ ------ ------
First Quarter $15.37 $13.05 $17.05 $ 8.64
Second Quarter 16.56 13.64 14.85 10.94
Third Quarter 17.79 15.18 14.80 10.70
Fourth Quarter 22.78 17.00 14.85 10.95
The Company has never declared or paid any cash dividends on its common
stock and does not anticipate paying any cash dividends in the foreseeable
future. The Company currently intends to retain any future earnings to finance
the growth and development of its business. In addition, the Company's financing
agreement limits the Company's ability to pay cash dividends to no more than 25%
of the Company's consolidated net income earned over a specified period.
The Company records treasury stock purchases using the cost method of
accounting. In the first and second quarters of 2004, the Company did not
repurchase any shares. During the third quarter of 2004, the Company repurchased
95,800 shares and in the fourth quarter the Company repurchased 3,471 shares. In
the last two years, the Company has repurchased 906,480 shares of its common
stock at an average price of $10.63 per share and a total cost of $9.6 million.
ISSUER PURCHASES OF EQUITY SECURITIES
(c) TOTAL NUMBER OF (d) MAXIMUM
(a) TOTAL SHARES PURCHASED AS NUMBER OF
NUMBER OF (b) AVERAGE PART OF PUBLICLY SHARES THAT MAY YET BE
SHARES PRICE PAID ANNOUNCED PLANS OR PURCHASED UNDER THE
PERIOD PURCHASED PER SHARE PROGRAMS(1) PLANS OR PROGRAMS
- -------------- --------- ----------- ------------------- ----------------------
First quarter - $ - - 1,442,791
Second Quarter - - - 1,442,791
Third Quarter 95,800 16.17 95,800 1,346,991
Fourth quarter 3,471 21.75 3,471 1,343,520
(1)The Company's Board of Directors authorized the purchase of 1,500,000
shares of the Company's 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, and cash from operations. As of December 26, 2004, the
Company had purchased 906,480 shares pursuant to this authorization at an
average price of $10.63 per share. The repurchase authorization expires
upon the repurchase of all authorized shares.
15
EQUITY COMPENSATION PLAN INFORMATION
YEAR ENDED DECEMBER 26, 2004
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
NUMBER OF SECURITIES TO WEIGHTED-AVERAGE FUTURE ISSUANCE UNDER
BE ISSUED UPON EXERCISE EXERCISE PRICE OF EQUITY COMPENSATION PLANS
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, (EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (a))
- ------------- ----------------------- -------------------- -------------------------
(a) (b) (c)
Equity compensation plans
approved by security holders
(2003 Stock Incentive Plan) 487,586 $ 14.23 130,323
Equity compensation plans
approved by security holders
(Amended and Restated 1991
Stock Option Plan) 1,248,266 $ 13.25 -
Equity compensation plans not
approved by security holders
(1995 Supplemental Plan) 9,640 $ 9.64 39,390
Total 1,745,492 $ 13.50 169,713
ITEM 6. SELECTED FINANCIAL DATA.
The tables below summarize the selected consolidated financial data of the
Company as of and for each of the last five fiscal years. This selected
financial information should be read in conjunction with the Company's
Consolidated Financial Statements and Notes thereto and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included
elsewhere in this Report. The statement of earnings data for 2004, 2003 and 2002
and the balance sheet data as of December 26, 2004 and December 28, 2003 below
have been derived from the Company's Consolidated Financial Statements included
elsewhere herein that have been audited by KPMG LLP, independent certified
public accountants, whose report is also included herein. The income statements
data for 2001 and 2000 and balance sheet data for 2002, 2001 and 2000 is derived
from audited consolidated financial statements not included herein.
2004 2003 2002 2001 2000
---------- ---------- --------- --------- --------
(in thousands, except per share amounts)
Selected Statement of Earnings Data:
Revenues $ 240,179 $ 209,650 $ 234,197 $ 292,990 $333,176
Earnings (loss) from operations 20,909 5,011 7,530 (5,209) 17,894
Net earnings (loss) 12,265 2,332 4,008 (4,360) 10,489
Earnings (loss) per share - diluted 1.04 .20 .32 (.37) .88
Weighted average common
shares - diluted 11,814 11,732 12,531 11,940 11,950
2004 2003 2002 2001 2000
---------- ---------- --------- --------- --------
(in thousands)
Selected Balance Sheet Data:
Working capital $ 16,881 $ 25,159 $ 27,058 $ 29,683 $ 55,090
Total assets 305,460 287,793 259,650 278,204 265,707
Long-term debt, excluding
current installments 9,375 16,887 59 103 20,141
Total shareholders' equity $ 202,651 $ 189,086 $ 194,102 $ 188,994 $187,741
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
Insurance Auto Auctions, Inc. provides insurance companies and other
vehicle suppliers cost-effective salvage processing solutions principally on a
consignment or purchase agreement method of sale. The consignment method
includes both a percentage of sale and 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.
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. The
discussion in this section contains forward-looking statements that are based on
the beliefs of the Company's management, as well as assumptions made by, and
information currently available to, management. The Company's actual results
could differ materially from those discussed or implied herein. Refer to the
section "Factors That May Affect Future Results" for a further discussion of
some of the factors that affect or could affect the Company's business,
operating results and financial condition.
The following discussion and analysis should be read in conjunction with
the Selected Financial Data, the consolidated financial statements and notes
thereto and the Factors That May Effect Future Results appearing elsewhere in
this Report.
ACQUISITIONS AND NEW OPERATIONS
Since its initial public offering in 1991, the Company has grown through a
series of acquisitions and opening of new sites to include 78 sites as of March
1, 2005. In 2004, the Company acquired a branch in Jackson Mississippi and also
opened new operations in Tucson, Arizona; El Paso, Texas; and Lincoln, Illinois
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 26, 2004 COMPARED TO THE YEAR ENDED DECEMBER 28, 2003
Revenues increased 15% to $240.2 million for the year ended December 26,
2004, from $209.7 million in 2003. The increase in revenues was primarily due to
a higher volume of vehicles sold and a higher average selling price for vehicles
sold at auction. The $8.5 million or 21% decline in vehicle sales is primarily
related to the Company's shift away from vehicles sold under the purchase
method. Vehicles sold under the purchase method accounted for less than 4% of
the total vehicles sold in 2004, versus approximately 6% in 2003. Fee income for
2004 increased 23% to $208.7 million versus $169.7 million in 2003. Fee income
increased primarily due to higher unit volumes.
Cost of sales increased $13.5 million to $184.0 million for the year ended
December 26, 2004, versus $170.5 million for last year. Vehicle cost of $26.7
million decreased $8.6 million in 2004 from $35.3 million in 2003. This decrease
is primarily related to the Company's shift away from vehicles sold under the
purchase method. Branch cost of $157.3 million increased $22.1 million in 2004
from $135.2 million in 2003. Branch cost includes tow, office and yard labor,
occupancy, depreciation and other costs inherent in operating the branch. New
branches opened in 2004 account for approximately $1.7 million of additional
branch costs. Excluding the impact of new branches, branch costs increased $20.4
million primarily due to increased volumes and increases in towing,
performance-based bonus, and insurance expense.
17
Gross profit of $56.2 million for the year ended December 26, 2004
increased $17.0 million, or 43%, from $39.2 million for 2003.
Selling, general and administrative expense of $35.0 million in 2004 was
$4.8 million more than the expense of $30.2 million in 2003. This increase was
primarily due to performance-based bonus expense, costs related to compliance
with the requirements of the Sarbanes-Oxley Act of 2002, and higher depreciation
expense associated with the implementation of the Company's new information
technology system. Professional services related to the audit and the compliance
with Sarbanes-Oxley was $1.9 million in 2004. Amortization of intangible assets
is now included within this category of expense and amounted to $0.6 million in
2004 and $0.5 million in 2003.
Loss on sale of property and equipment increased to $0.3 million in 2004.
The loss primarily relates to a $0.8 million loss on the exit of the Woodinville
facility which was partially offset by a $0.5 million gain on the sale of South
Boston.
There were no business transformation costs for the year ended December
26, 2004, versus $3.9 million for last year. Business transformation costs
included expenses related to data base conversions, training, and other activity
related to the rollout of the Company's new information technology system.
Interest expense of $1.6 million for the year ended December 26, 2004
increased $0.1 million from $1.5 million for 2003. On March 19, 2004, the
Company entered into a Second Amended and Restated Credit Agreement with its
lenders, which is described in "Financial Condition and Liquidity" below. At
December 26, 2004, the outstanding balance related to the term loan with its
lenders was $16.9 million and $6.0 million related to the revolver. At December
26, 2004, the interest rate on the term loan was 5.4%.
Income tax expense for the year 2004 was $7.1 million, an increase of $5.8
million from the income tax expense of $1.3 million for 2003. The Company's
effective tax rates for the years 2004 and 2003 was 37% and 36%, respectively.
The Company expects that its effective tax rate in 2005 will be approximately
36%.
The Company's net earnings for the year 2004 was $12.3 million, an
increase of $10.0 million from the Company's net earnings of $2.3 million for
the fiscal year 2003.
YEAR ENDED DECEMBER 28, 2003 COMPARED TO THE YEAR ENDED DECEMBER 29, 2002
Revenues decreased 10% to $209.7 million for the year ended December 28,
2003, from $234.2 million in 2002. The decline in revenues was 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
less than 6% of the total vehicles sold in 2003, versus approximately 10% in
2002. Fee income for 2003 increased 4% to $169.7 million versus $162.8 million
in 2002. Fee income increased primarily due to higher unit volumes.
Cost of sales decreased $20.5 million to $170.5 million for the year ended
December 28, 2003, versus $191.0 million for last year. Vehicle cost of $35.3
million in 2003 was $30.2 million less than the $65.5 million reported in 2002.
This decrease is primarily related to the Company's shift away from vehicles
sold under the purchase agreement method. Branch cost of $135.2 million
increased $9.7 million in 2003 from $125.5 million in 2002. New branches opened
in 2003 account for approximately $7.0 million of additional branch costs.
Excluding the impact of new branches, branch costs increased $2.7 million
primarily in tow and depreciation expense.
Gross profit of $39.2 million for the year ended December 28, 2003
decreased $4.0 million, or 9%, from $43.2 million for 2002.
Selling, general and administrative expense of $30.2 million in 2003 was
$2.5 million more than the expense of $27.7 million in 2002. This increase was
primarily due to expenses associated with the implementation of the Company's
new automated salvage auction processing system. Amortization of intangible
assets is now included within this category of expense and amounted to $0.5
million in 2003 and $0.3 million in 2002.
18
Business transformation costs for the year ended December 28, 2003 were
$3.9 million, versus $8.1 million for 2002. Business transformation costs
include expenses related to the Company's systems redesign project, the business
process re-engineering project, severance costs and accelerated depreciation
associated with the Company's former computer infrastructure. The Company began
recording business transformation costs during the second quarter of 2001. As
part of its substantial business transformation, the Company is providing
visibility to several significant components of its cost structure. Business
transformation costs and other unusual charges are discussed in detail in
"Significant Items Affecting Comparability" below.
Interest expense of $1.5 million for the year ended December 28, 2003
increased $0.8 million from $0.7 million for 2002. Included in interest expense
for 2002 was a non-cash charge of $0.3 million to recognize the ongoing cost of
the interest rate swap on the unused portion of the Company's credit facility.
In February 2002, the Company used excess cash and proceeds from the sale of
investments to repay its $20.0 million of 8.6% senior notes that matured on
February 15, 2002, and entered into a new $30.0 million five-year unsecured
credit facility. At December 29, 2002, there was no outstanding balance related
to this credit facility. The credit facility was a one-year revolver that
converted on February 15, 2003 into a four-year term loan. On February 15, 2003,
the Company borrowed the entire $30.0 million under the unsecured credit
facility. At December 28, 2003, the outstanding balance related to the term loan
with its lenders was $24.4 million. At December 28, 2003, the interest rate on
the term loan was 5.7%. On March 19, 2004, the Company entered into a Second
Amended and Restated Credit Agreement with its lenders, which is described in
"Financial Condition and Liquidity" below.
Income tax expense for the year 2003 was $1.3 million, a decrease of $1.7
million from the income tax expense of $3.0 million for 2002. The Company's
effective tax rate for the years 2003 and 2002 was 36% and 43%, respectively.
The Company's net earnings for the year 2003 was $2.3 million, a decrease
of $1.7 million from the Company's net earnings of $4.0 million for the fiscal
year 2002.
SIGNIFICANT ITEMS AFFECTING COMPARABILITY
The Company has recorded certain charges that have affected the
comparability of its reported results of operations. The Company recorded
business transformation costs in 2003 of $3.9 million and $8.1 million in 2002.
Business transformation costs include expenses relating to the Company's systems
redesign project, the business process re-engineering project, severance costs
and accelerated depreciation pertaining to the Company's prior computer
infrastructure. No business transformation costs were recorded in 2004.
FINANCIAL CONDITION AND LIQUIDITY
At December 26, 2004, the Company had current assets of $84.6 million,
including $13.3 million in cash and current liabilities of $67.7 million and
working capital of $16.9 million, which represents an $8.3 million decrease from
December 28, 2003.
The Company's accounts receivable increased $2.0 million from $48.4
million in 2003 to $50.4 million in 2004. Accounts receivable consists of
balances due from the Company's salvage providers, typically large insurance
companies. Accounts receivable include advance charges paid for by the Company
on behalf of salvage providers. These charges typically include storage and tow
fees incurred at a temporary storage or repair shop prior to the Company moving
the vehicle to one of its facilities. Inventory increased $0.9 million from
$13.6 million in 2003 to $14.5 million in 2004. Inventory consists of
capitalized tow charges on vehicles on hand and the cost of purchase vehicles
once title is received. Both inventory on receivable balances increased due to a
larger inventory of consigned vehicles on hand at year-end 2004.
At December 26, 2004, the Company's long-term debt, including current
installments, consisted of $16.9 million borrowed under its term 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 interest rate based upon
LIBOR. The aggregate principal balance of the loan is required to be paid in
sixteen consecutive equal quarterly installments which began on March 31, 2003.
19
On March 19, 2004, the Company entered into a Second Amended and Restated
Credit Agreement relating to its senior credit facility. The agreement amends
certain financial covenants, provides that advances made under the facility will
be subject to a monthly asset coverage test equal to 85% of eligible
receivables, and requires the Company to provide collateral for amounts due
under the facility in the event it fails to meet certain financial projections
for two consecutive quarters. As of March 19, 2004, the Company's senior credit
facility consisted of a $20.0 million revolving credit facility and a $22.5
million term credit facility. As of December 26, 2004, the Company has borrowed
$6.0 million against the revolving line of credit and $16.9 million under the
term credit facility. At December 26, 2004, the Company was in compliance with
its credit agreement covenants, except its expenditure basket for which it
received a waiver in March 2005.
Other long-term liabilities include the fair market value on the Company's
interest rate swap along with the Company's post-retirement benefits liability
that relates to the Company's prior acquisition. The amount recorded at December
26, 2004 for the post-retirement benefits liability was approximately $2.4
million.
In 2002, the Company entered into a capital lease agreement to obtain the
use of new computer equipment required as part of the Company's new operating
system. The capital lease terms are three years or less depending on the nature
of the equipment. In 2003, property and equipment additions of $3.4 million
resulted from capital lease transactions entered into during the year. At
December 26, 2004, the Company's total future obligation under the capital lease
is $1.8 million.
Capital expenditures were approximately $28.7 million for the year ended
December 26, 2004. These capital expenditures consisted of various branch
improvements, including upgrades to existing branches, the development of new
facilities, and continued enhancements to the Company's new information
technology system.
The Company acquired one salvage pool in fiscal 2004. This acquisition was
accounted for using the purchase method of accounting. The results of operations
of the acquired business are included in the Company's consolidated financial
statements from the date of acquisition. The total cost of adding this new
facility was less than $2.0 million.
The Company's Board of Directors authorized the purchase of 1,500,000
shares of the Company's 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, and cash from
operations. As of December 26, 2004, the Company had purchased 906,480 shares
pursuant to this authorization at an average price of $10.63 per share.
In 2003, the Company initiated a restricted stock program. Under the
Company's restricted stock grant program, shares of common stock of the Company
may be granted at no cost to certain officers and key employees. Plan
participants are entitled to cash dividends and to vote their respective shares
received pursuant to the program. Restrictions limit the sale or transfer of
these shares over a four-year period. The sale and transfer restrictions on
shares received under the program expire at a rate of 25% per year or earlier,
on the achievement of certain performance based goals. Upon issuance of shares
of common stock under the plan, unearned compensation equivalent to the market
value of the shares at the date of the grant is charged to shareholders' equity
and subsequently amortized to expense over the restriction period. In 2003,
66,500 restricted shares were granted and in 2004, 182,600 restricted shares
were granted. Compensation expense of $0.6 million, including $0.3 million
recognized due to the anticipated achievement of performance goals in 2005, was
recorded in the twelve months ended December 26, 2004. In fiscal 2004 and 2003,
there were no forfeitures of restricted shares.
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 or acquisitions, and the development of new claims processing
services. At some time in the future, the Company will likely require additional
financing. There can be no assurance that additional financing, if required,
will be available on favorable terms.
20
SUMMARY DISCLOSURE ABOUT CONTRACTUAL OBLIGATIONS
The following table reflects a summary of the Company's cash obligations
for each of the next five years and thereafter as of December 26, 2004:
2005 2006 2007 2008 2009 Thereafter Total
------- ------- ------- ------- ------- ---------- --------
(dollars in thousands)
Long-term debt:
Unsecured term loan $ 7,500 $ 7,500 $ 1,875 $ - $ - $ - $ 16,875
Notes payable 12 - - - - - 12
Capital leases(1) 1,203 387 316 33 - - 1,939
Operating leases(2) 21,528 19,731 16,355 14,345 12,178 67,623 151,760
Other long-term obligations:
Non-compete agreements 188 253 223 163 - - 827
------- ------- ------- ------- ------- ---------- --------
Total $30,431 $27,871 $18,769 $14,541 $12,178 $ 67,623 $171,413
======= ======= ======= ======= ======= ========== ========
(1)Includes related interest expense.
(2)Includes amounts due to both unrelated and related parties.
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 affect its more significant judgments and estimates
used in the preparation of its consolidated financial statements.
GOODWILL
As of December 26, 2004 the Company had $137.5 million of net goodwill
recorded in its consolidated financial statements. In accordance with Statement
of Financial Accounting Standards (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 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 impairment based on the excess of
carrying amount over fair value measured using a projected discounted cash flow
model or other valuation techniques.
DEFERRED INCOME TAXES
As of December 26, 2004, the Company had $11.2 million of deferred tax
assets recorded. The deferred tax assets relate to net operating losses incurred
in several of the states where the Company operates. The Company has determined
that it may not realize the full tax benefit related to certain of the deferred
tax assets. As such, a valuation allowance to reduce the carrying value of the
deferred tax assets has been recorded.
21
LONG-LIVED ASSETS AND CERTAIN IDENTIFIABLE INTANGIBLES
As of December 26, 2004, the Company had $74.7 million of net property and
equipment along with net intangible assets of $1.7 million. 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 151 (SFAS 151), "Inventory Costs
an amendment of ARB No. 43, Chapter 4." SFAS 151 discusses the general
principles applicable to the pricing of inventory. Paragraph 5 of ARB 43,
Chapter 4 provides guidance on allocating certain costs to inventory. This
Statement amends ARB 43, Chapter 4, to clarify that abnormal amounts of idle
facility expense, freight, handling costs, and wasted materials (spoilage)
should be recognized as current-period charges. As required by SFAS 151, we will
adopt this new accounting standard at the beginning of our first interim or
annual reporting period that begins after June 15, 2005. The Company is
currently evaluating the impact of adoption of SFAS 151 on our financial
statements.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 153 (SFAS 153), "Exchanges of Nonmonetary Assets--an amendment
of APB Opinion No. 29." SFAS 153 addresses the measurement of exchanges of
nonmonetary assets. It eliminates the exception from fair value measurement for
nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB
Opinion No. 29 "Accounting for Nonmonetary Transactions" and replaces it with an
exception for exchanges that do not have commercial substance. A nonmonetary
exchange has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. As required by
SFAS 153, we will adopt this new accounting standard at the beginning of our
first interim or annual reporting period that begins after June 15, 2005. The
adoption of SFAS 153 is not expected to have a material impact on our financial
statements.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123R (SFAS 123R) "Share-Based Payment." SFAS 123R requires that
the cost resulting from all share-based payment transactions be recognized in
the financial statements. SFAS 123R establishes fair value as the measurement
method in accounting for share-based payments to employees and eliminates the
alternative use of the intrinsic value method of accounting under APB Opinion
No. 25, "Accounting for Stock Issued to Employees." This statement is effective
for public entities as of the beginning of the first interim or annual reporting
period that begins after June 15, 2005. The Company is currently evaluating the
impact of adoption on our financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to interest rate fluctuations on its floating rate
credit facility, under which the Company has outstanding a $16.9 million term
loan at December 26, 2004. 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. At December 26, 2004, the interest rate swap agreement had a notional
amount of $16.9 million, and provided that the Company paid a fixed rate of
interest of 4.4% and received a LIBOR-based floating rate on the notional
amount. At December 26, 2004, the interest rate on the term loan was 5.4%. At
December 26, 2004, the entire swap agreement qualified for hedge accounting. The
Company believes that its exposure to adverse changes in interest rates is not
significant.
22
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Item 15(a) for an index to the Consolidated Financial Statements which
are included herein.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A. CONTROLS AND PROCEDURES.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
We conducted an evaluation of the effectiveness of the design and operation of
our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act") as of the end of the period covered by this Form 10-K. The controls
evaluation was conducted under the supervision of our Audit Committee, and
with the participation of management, including our Chief Executive Officer and
Chief Financial Officer. Based on that evaluation, our Chief Executive Officer
and Chief Financial Officer, have concluded that our disclosure controls and
procedures were effective to provide reasonable assurance that (i) the
information required to be disclosed by us in this Annual Report on Form 10-K
was recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms, and (ii) information required to be
disclosed by us in our reports that we file or submit under the Exchange Act is
accumulated and communicated to our management, including our principal
executive and principal financial officers, or persons performing similar
functions, as appropriate to allow timely decisions regarding required
disclosure.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The Company's management is responsible for establishing and maintaining
adequate internal control over financial reporting, as that term is defined in
Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the
participation of the Company's management, including the Chief Executive Officer
and Chief Financial Officer, the Company is in the process of conducting an
evaluation of its internal control over financial reporting based on the
framework in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission.
The Company's evaluation of its internal control over financial reporting has
not yet been completed.
Pursuant to Securities and Exchange Commission Release No. 34-50754, which,
subject to certain conditions, provides up to 45 additional days beyond the due
date of this Form 10-K for the filing of management's annual report on internal
control over financial reporting required by Item 308(a) of Regulation S-K, and
the related attestation report of the independent registered public accounting
firm, as required by Item 308(b) of Regulation S-K, management's report on
internal control over financial reporting and the associated report on the audit
of management's assessment of the effectiveness of the Company's internal
control over financial reporting as of December 26, 2004, are not field herein
and are expected to be found no later than April 25, 2005.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During 2004, we made numerous changes to our controls and procedures as part of
our ongoing monitoring and improvement of our controls. However, none of these
changes has materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting.
INHERENT LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS
Our management, including our Chief Executive Officer and Chief Financial
Officer, does not expect that our disclosure controls and procedures or our
internal controls will prevent or detect all errors and all fraud. A control
23
system, no matter how well conceived and operated, can provide only reasonable,
not absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that there are
resource constraints, and the benefits of controls must be considered relative
to their costs. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that misstatements due to
error or fraud will not occur or that all control issues and instances of fraud,
if any within the Company have been detected.
These inherent limitations include the realities that judgments in
decision-making can be faulty and that breakdowns can occur because of simple
error or mistake. Controls can also be circumvented by the individual acts of
some persons, by collusion of two or more people, or by management override of
the controls. The design of any system of controls is based in part on certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions. Projections of any evaluation of controls effectiveness to
future periods are subject to risks. Over time, controls may become inadequate
because of changes in conditions or deterioration in the degree of compliance
with policies or procedures.
24
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.
DIRECTORS
Set forth below is information regarding the directors of the Company,
including information furnished by them as to principal occupations, certain
other directorships held by them, any arrangements pursuant to which they were
or are selected as directors, and their ages as of March 1, 2005:
YEAR FIRST ELECTED OR
DIRECTORS AGE POSITION WITH COMPANY APPOINTED DIRECTOR
- --------- --- -------------------------- ---------------------
Peter H. Kamin(1)(3) 43 Chairman of the Board 1999
Thomas C. O'Brien 51 President, Chief Executive 2000
Officer and Director
Todd F. Bourell(3) 34 Director 2003
Maurice A. Cocca (1)(2)(3) 61 Director 1997
Philip B. Livingston(1)(2)(3) 48 Director 2003
John K. Wilcox (2)(3) 69 Director 1998
- ----------
(1) Member of the Nominating, Governance and Compensation Committee.
(2) Member of the Audit Committee.
(3) These directors satisfy the independence requirements of the
Sarbanes-Oxley Act of 2002 and the corporate governance listing
requirements of the NASDAQ National Market.
PETER H. KAMIN has been a director of the Company since February 2001. Mr.
Kamin had previously served as a director from January 1999 through October
2000. In July 2000, Mr. Kamin joined, as a founding partner, ValueAct Capital
Partners, L.P. From January 1992 to July 2000, Mr. Kamin was a partner of Peak
Investment, L.P.
THOMAS C. O'BRIEN has been the President, Chief Executive Officer and a
Director of the Company since November 2000. As President and Chief Executive
Officer, Mr. O'Brien oversees the Company's overall corporate administration as
well as strategic planning. Prior to joining the Company, Mr. O'Brien served as
President of Thomas O'Brien & Associates from 1999 to 2000, Executive Vice
President of Safelite Glass Corporation from 1998 to 1999, Executive Vice
President of Vistar, Inc. from 1996 to 1997 and President of U.S.A. Glass, Inc.
from 1992 to 1996.
TODD F. BOURELL has been a director of the Company since October 2003. Mr.
Bourell is a partner of ValueAct Capital Partners, L.P. Prior to joining
ValueAct, Mr. Bourell worked as an analyst for Wellington Management Company in
Boston, Massachusetts. Mr. Bourell is a graduate of the Wharton School of
Business.
MAURICE A. COCCA has been a director of the Company since February 1997.
From November 1993 to November 1995, Mr. Cocca was Managing Director of The
Fisons Laboratory Supplies Division of Fisons PLC, a distributor of laboratory
supplies that was later acquired by Fisher Scientific. Mr. Cocca served as Vice
Chairman of J & W Scientific Holdings from April 1996 through April 2000.
PHILIP B. LIVINGSTON has been a director of the Company since March 2003.
In January 2005, Mr. Livingston became Vice Chairman of Approva Corp. From March
2003 to 2004, Mr. Livingston served the Chief Financial Officer and a director
of World Wrestling Entertainment, Inc. Mr. Livingston served as President and
Chief Executive Officer of Financial Executives International from January 1999
to April 2003. Mr. Livingston is also a director of Cott Corporation, a
manufacture of private-label beverages.
25
JOHN K. WILCOX has been a director of the Company since February 1998.
From November 1994 until November 1997, Mr. Wilcox was Group Vice President,
Personal Lines Finance and Planning of Allstate Insurance Company.
EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth the names, ages and offices of all of the
executive officers of the Company as of March 1, 2005:
NAME AGE OFFICE HELD
---- --- -----------
Thomas C. O'Brien 51 President and Chief Executive Officer
Donald J. Hermanek 56 Senior Vice President, Sales and Marketing
Sidney L. Kerley 30 Vice President, General Counsel and Secretary
John W. Kett 41 Senior Vice President, Planning and Business Development
David R. Montgomery 48 Senior Vice President and Chief Operating Officer
John R. Nordin 48 Senior Vice President and Chief Information Officer
Scott P. Pettit 42 Senior Vice President and Chief Financial Officer
THOMAS C. O'BRIEN became President and Chief Executive Officer in November
2000. As President and Chief Executive Officer, Mr. O'Brien oversees the
Company's overall corporate administration as well as strategic planning. Prior
to joining the Company, Mr. O'Brien served as President of Thomas O'Brien &
Associates from 1999 to 2000, Executive Vice President of Safelite Glass
Corporation from 1998 to 1999, Executive Vice President of Vistar, Inc. from
1996 to 1997 and President of U.S.A. Glass, Inc. from 1992 to 1996.
DONALD J. HERMANEK joined the Company in August 2000 as Senior Vice
President of Sales and Marketing. Mr. Hermanek is responsible for the sales and
marketing functions, including field sales and the corporate accounts group.
Prior to joining the Company, Mr. Hermanek served as Vice President of Business
Development for Consolidated Services Corp. from 1997 to 2000. He also served as
Vice President - National Sales for Safelite Glass Corporation from 1992 to
1997.
SIDNEY L. KERLEY joined the Company in April 2001 as Corporate Counsel.
Mr. Kerley currently serves as the Company's Vice President, General Counsel and
Secretary. He is responsible for the general legal affairs of the Company,
including SEC compliance and filings, mergers and acquisitions, corporate
finance and litigation. Prior to joining the Company, Mr. Kerley served as an
attorney for Fairbank & Vincent.
JOHN W. KETT joined the Company in August 2001 as Vice President of Field
Support. In June 2004, he was named Senior Vice President of Planning and
Business Development. Mr. Kett is responsible for planning, pricing, financial
analysis, and has primary responsibility for business development. Prior to
joining the Company, Mr. Kett served as Assistant Comptroller for Central Steel
and Wire Co. from 1998 to 2001 and Controller of Vistar, Inc. from 1996 to 1998.
From 1992 to 1996 Mr. Kett held various positions at Vistar including Regional
Operations Manager.
DAVID R. MONTGOMERY joined the Company in April 2001 as Senior Vice
President and Chief Operating Officer. Mr. Montgomery is responsible for Company
operations, including the Company's National Network and specialty salvage
business. Prior to joining the Company, Mr. Montgomery served as Chief Executive
Officer of Greenleaf Acquisitions, LLC, a subsidiary of Ford Motor Company, from
1999 to April 2001. From 1996 to 1999, he served as Area Vice President of
Safelite/Vistar Autoglass. From 1988 to 1996, he served in various management
capacities at Windshields America, Inc., one of the two entities combined to
form Vistar, Inc.
JOHN R. NORDIN joined the Company in November 2003 as Vice President,
Chief Information Officer. Mr. Nordin is responsible for information services
functions, including software application acquisition and development, computer
operations and telecommunications. Prior to joining the Company, Mr. Nordin
served as Vice President and Chief Information Officer at A. M. Castle & Co.
from 1998 to November 2003. From 1995 to 1998, he served as Vice President and
Chief Information Officer at Candle Corporation of America.
26
SCOTT P. PETTIT joined the Company in April 2001 as Senior Vice President,
Chief Financial Officer and Secretary. Mr. Pettit is responsible for financial
functions, real estate and investor relations. Prior to joining the Company, Mr.
Pettit served as Senior Vice President and Chief Financial Officer of
Corsolutions Medical Inc. from 1998 to April 2001. From 1996 to 1998, he served
as Vice President Finance and Chief Financial Officer of Vistar, Inc. From 1994
to 1996, he served as Senior Vice President and Chief Financial Officer of Globe
Glass & Mirror Co., one of the two entities combined to form Vistar, Inc.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
the Company's directors and executive officers, and persons who own more than
ten percent of a registered class of the Company's equity securities, to file
with the SEC initial reports of ownership and reports of changes in ownership of
Common Stock and other equity securities of the Company. Officers, directors and
greater than ten percent shareholders are required by SEC regulation to furnish
the Company with copies of all Section 16(a) reports they file.
Based solely upon a review of the copies of such reports furnished to the
Company and written representations from such officers, directors and greater
than ten percent shareholders, all Section 16(a) filing requirements applicable
to the Company's directors, executive officers and greater than ten percent
shareholders have been met, except that Mr. Kett was late on one occasion in
filing his Form 3 "Initial Statement of Beneficial Ownership of Securities" and
Form 4 "Statement of Changes in Beneficial Ownership".
ITEM 11. EXECUTIVE COMPENSATION.
The following table provides certain information concerning the
compensation earned, for services rendered in all capacities to the Company and
its subsidiaries during each of the last three years, by the Company's Chief
Executive Officer and each of the Company's other four most highly compensated
executive officers in 2004, collectively the "Named Executive Officers."
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION AWARDS
ANNUAL COMPENSATION -------------------------
---------------------------------------------------- RESTRICTED SECURITIES
NAME AND PRINCIPAL OTHER ANNUAL STOCK UNDERLYING ALL OTHER
POSITION YEAR SALARY($)(1) BONUS($) COMPENSATION($) AWARDS($)(2) OPTIONS(#) COMPENSATION($)
- ------------------------------ ------- ------------ --------- --------------- ------------ ---------- ---------------
Thomas C. O'Brien 2004 $ 400,000 $ - $ 18,000(3) $ 663,000 - $ 13,000(4)
President and Chief 2003 400,000 163,000 18,000(3) 207,750 60,000(5) 6,000(4)
Executive Officer 2002 350,000 - 18,000(3) - 60,000(6) 8,000(4)
David R. Montgomery ......... 2004 257,000 - 18,000(3) 331,500 - 8,000(4)
Sr. Vice President and 2003 257,000 87,000 18,000(3) 103,875 30,000(5) 8,000(4)
Chief Operating Officer 2002 232,000 - 18,000(3) - 30,000(6) 7,000(4)
Scott P. Pettit ............. 2004 230,000 - 18,000(3) 331,500 - 7,000(4)
Sr. Vice President and 2003 230,000 76,000 18,000(3) 103,875 30,000(5) 8,000(4)
Chief Financial Officer 2002 205,000 - 18,000(3) - 30,000(6) 7,000(4)
Donald J. Hermanek ......... 2004 220,000 - 18,000(3) 331,500 - 9,000(4)
Sr. Vice President - Sales 2003 220,000 75,000 18,000(3) 103,875 30,000(5) 7,000(4)
and Marketing 2002 200,000 - 18,000(3) - 30,000(6) 7,000(4)
John R. Nordin .............. 2004 180,000 - 18,000(3) 331,500 - 7,000(4)
Sr. Vice President, Chief 2003 21,000(7) - 1,500 103,875 30,000(8) -
Informational Officer 2002 - - - - - -
(1) Includes salary deferred under the Company's 401(k) Plan and Internal
Revenue Service Section 125 Plan. All amounts are rounded to the nearest
thousand.
27
(2) The market value of the Common Stock underlying restricted stock units
(RSUs) was determined by using the closing price per share of the Common
Stock on the applicable grant date, as reported on the NASDAQ Stock
Market, and without recognizing any diminution in value attributable to
the restrictions on RSUs. Fiscal 2004 RSUs were granted on November 19,
2004 (the closing price on that date was $22.10) and vest in a series of
equal and successive annual installments with the first installment to
vest on November 19, 2005. Fiscal 2003 RSUs were granted on November 14,
2003 (the closing price on that date was $13.85) and vest in a series of
equal and successive annual installments with the first installment vested
on November 14, 2004. The restricted shares will fully vest on an
accelerated basis upon the Company's achievement of a predetermined level
of earnings per share in any given fiscal year during the four year
vesting period.
(3) Reflects amounts paid by the Company pursuant to an automobile allowance.
(4) Represents matching contributions that the Company made to its 401(k) Plan
on behalf of the Named Executive Officer.
(5) Includes a grant of options to purchase shares of Common Stock at a price
of $13.85 per share pursuant to a resolution adopted by the Board of
Directors on September 16, 2003.
(6) Includes a grant of options to purchase shares of Common Stock at a price
of $15.50 per share pursuant to a resolution adopted by the Board of
Directors on December 4, 2002.
(7) Mr. Nordin became an employee on November 14, 2003. The salary paid to Mr.
Nordin for the 2003 fiscal year was based on his employment agreement
dated October 23, 2003.
(8) Mr. Nordin received a grant of options to purchase 30,000 shares of Common
Stock at a price of $13.85 per share pursuant to his employment agreement
dated October 23, 2003.
STOCK OPTIONS
There were no stock options granted to the Named Executive Officers during
2004.
The following table sets forth information with respect to unexercised
options held as of the end of the 2004 fiscal year by the Named Executive
Officers. No stock appreciation rights were outstanding at the end of 2004.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT
OPTIONS AT FISCAL YEAR-END(#) FISCAL YEAR-END ($)(1)(2)
---------------------------- ----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ----------- -------------
Thomas C. O'Brien............. 345,000 75,000 $ 3,728,550 $ 573,750
David R. Montgomery........... 97,500 62,500 891,375 529,925
Scott P. Pettit............... 97,500 62,500 891,375 529,925
Donald J. Hermanek............ 77,500 47,500 562,885 369,095
John R. Nordin................ 7,500 22,500 62,325 186,975
- ----------
(1) "In-the-money" options are options whose exercise prices were less than
the market price of the Common Stock on December 26, 2004, the last day of
the 2004 fiscal year.
(2) Based upon the market price of $22.16 per share, which was the closing
price per share of the Common Stock on the NASDAQ National Market on
December 26, 2004, less the exercise price payable per share
28
COMPENSATION OF DIRECTORS
Since 2003, non-employee directors are entitled to receive an annual
retainer fee of $22,000, a $1,000 fee for each regularly scheduled Board meeting
attended in person, a $500 fee for each committee meeting attended in person, a
$250 fee for each Board or committee meeting attended by phone, an annual fee of
$3,000 if such non-employee director served as the Chairperson of the Governance
Committee, and an annual fee of $5,000 if such non-employee director served as
the Chairperson of the Audit Committee. Non-employee directors are also
reimbursed for expenses incurred in attending Board and committee meetings.
Employee directors are not compensated for their services as directors of the
Company.
Each non-employee director is also eligible to receive periodic option
grants for shares of Common Stock pursuant to the automatic option grant program
in effect under the Company's 2003 Stock Incentive Plan. Under this automatic
option grant program, each individual who becomes a non-employee Board member is
granted an option to purchase 10,000 shares of Common Stock on the date such
individual joins the Board. In addition, each non-employee director is also
entitled to receive an automatic option to purchase 5,000 shares of Common Stock
on the last business day of the second quarter of each fiscal year during which
such individual continues to serve on the Board. Each automatic option grant
becomes exercisable in four successive quarterly installments with the first
such installment to become exercisable on the last day of the fiscal quarter
immediately following the grant date, provided the non-employee director
continues to serve on the Board. However, each option will become immediately
exercisable for all of the option shares in the event of a change of control of
the Company.
Melvin R. Martin served as Director of the Company from 1993 until his
retirement in August 2004. Mr. Martin and the Company are parties to an
agreement pursuant to which Mr. Martin is compensated on a daily basis for
consulting services, primarily in the areas of acquisitions and real estate. Mr.
Martin received no compensation pursuant to the agreement in 2004.
EMPLOYMENT CONTRACTS AND CHANGE-IN-CONTROL ARRANGEMENTS
The following is a description of the employment or consulting agreements
in effect between the Company and the Named Executive Officers.
The compensation paid to Thomas C. O'Brien, President and Chief Executive
Officer of the Company, for the 2004 fiscal year was based on an amended and
restated employment agreement (the "O'Brien Agreement") dated April 2, 2001.
Under the O'Brien Agreement, Mr. O'Brien is entitled to an annual base salary of
$350,000 and a performance incentive bonus of 40% of his annual salary based
upon the achievement of target performance goals. Mr. O'Brien will be entitled
to receive in excess of 40% of his annual salary as a performance incentive if
the Company's performance exceeds the goals and objectives determined by the
Board. Also, pursuant to the O'Brien Agreement, the Company granted Mr. O'Brien
an option to purchase 300,000 shares of Common Stock in November 2000, which are
exercisable in four equal annual installments.
The compensation paid to David R. Montgomery, Sr. Vice President and Chief
Operating Officer, for the 2004 fiscal year was based on an April 2, 2001
employment agreement (the "Montgomery Agreement"). Under the Montgomery
Agreement, Mr. Montgomery is entitled to an annual base salary of $225,000 and a
performance incentive bonus of 40% of his annual salary based upon the
achievement of target performance goals. Pursuant to the Montgomery Agreement,
the Company also paid Mr. Montgomery a signing bonus of $25,000 and granted him
an option to purchase 100,000 shares of the Common Stock in April 2001, which
are exercisable in four equal annual installments.
The compensation paid to Scott P. Pettit, Sr. Vice President and Chief
Financial Officer, for the 2004 fiscal year was based on an April 2, 2001
employment agreement (the "Pettit Agreement"). Under the Pettit Agreement, Mr.
Pettit is entitled to an annual base salary of $195,000 and a performance
incentive bonus of 40% of his annual salary based upon the achievement of target
performance goals. Pursuant to the Pettit Agreement, the Company paid Mr. Pettit
a signing bonus of $35,000 and granted him an option to purchase 100,000 shares
of Common Stock in April 2001, which are exercisable in four equal annual
installments.
29
The compensation paid to John R. Nordin, Sr. Vice President and Chief
Information Officer, for the 2004 fiscal year was based on an October 23, 2003
employment agreement (the "Nordin Agreement"). Under the Nordin Agreement, Mr.
Nordin is entitled to an annual base salary of $180,000 and a performance
incentive bonus of 50% of his annual salary based upon the achievement of target
performance goals. Pursuant to the Nordin Agreement, the Company granted him an
option to purchase 30,000 shares of Common Stock, which are exercisable in four
equal annual installments.
Additionally, each of the agreements for the above Named Executive
Officers has a change of control provision that provides that in the event that
the Named Executive Officer's employment with the Company is terminated
involuntarily or without cause within two years of the effective date of a
change in control (as defined therein), the Named Executive Officer will be
entitled to receive 18 months worth of annual base salary, accrued obligations,
plus continued coverage under the Company's health benefit plans for up to 18
months, unless the Named Executive Officer first obtains full time employment
elsewhere and provided, however, that the Named Officer properly elects coverage
pursuant to COBRA.
EXECUTIVE SEVERANCE PLAN
Effective August 9, 2000, the Company adopted a severance plan for its
executive officers (the "Executive Plan"), which provides certain severance
benefits to executive officers in the event an executive officer's employment
with the Company is terminated under certain circumstances.
Unless otherwise increased by the Company in its sole discretion, if the
Company terminates the executive officer's employment for any reason other than
"for Cause" (as defined therein), or if the executive officer voluntarily
terminates employment with the Company and all of its affiliates for "good
reason", (as defined therein), the executive officer will receive, in exchange
for providing the Company with a duly executed "Waiver and Release Agreement", a
benefit, generally representing a one-month severance pay for each year of
service with a minimum severance pay of six months and a maximum severance pay
of 12 months, in an amount equal to the product of (i) times (ii), where:
(i) represents the sum of:
(A) the executive officer's annualized base salary at the time the
executive officer's employment is terminated, plus
(B) the executive officer's average annual bonus received over the
eight fiscal quarters of the Company immediately preceding the
Company's fiscal quarter during which the executive officer's
employment is terminated, without exceeding the executive officer's
target bonus for the Company's fiscal year during which the
executive officer's employment is terminated, plus
(C) the executive officer's auto allowance for the fiscal year
during which the executive officer's employment is terminated; and
(ii) represents a fraction the numerator of which is the number of whole
completed years of employment with the Employer or any of its Affiliates,
but not less than six nor more than 12, and the denominator of which is
12; provided, however, that in the event that the executive officer's
termination of employment occurs within one year following the date on
which a new chief executive officer is hired by the Company, the executive
officer shall receive 12 months of severance pay generally calculated on
the basis of the amounts set forth; provided, however, that the amount
taken into account as the executive officer's bonus shall be equal to the
executive officer's target bonus for the fiscal year during which the
executive officer's employment is terminated.
Under the Executive Plan, an executive officer is not entitled to any
benefit if the Company terminates such executive officer's employment for cause,
if the executive officer voluntarily terminates employment with the Company for
any reason other than good reason, or if the executive officer's employment is
terminated as a result of death or disability.
30
Furthermore, to the extent that an executive officer has an employment
agreement, he is not entitled to severance benefits under the Executive Plan.
Currently, there are no executive officers without an employment agreement.
CODE OF ETHICS
The Company's Board of Directors has adopted a Code of Ethics that applies
to all of its directors, officers and employees, including its principal
executive officer, principal financial officer, controller and principal
accounting officer. The Company's Code of Ethics is available on its Web-site at
www.iaai.com. Any amendments to, or waivers from, the Code of Ethics will be
disclosed on the Company's Web site within the prescribed time period.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
OWNERSHIP OF SECURITIES
The following table sets forth certain information known to the Company
regarding the ownership of Common Stock as of December 26, 2004 (except as
otherwise indicated) with respect to the beneficial ownership of shares of the
Company's common stock by (1) each director of the Company, (2) each of the
Chief Executive Officer and the other four most highly compensated executive
officers of the Company for fiscal 2004 (the "Named Executive Officers"), (3)
all directors and executive officers of the Company as a group, and (4) each
person, who, to the best of the Company's knowledge, beneficially owns more than
5% of the Company's common stock.
NUMBER OF PERCENT OF TOTAL
NAME AND ADDRESS SHARES SHARES OUTSTANDING(1)
---------------- --------- ---------------------
ValueAct Capital Partners, L.P.(2)(4)(5).. 3,387,400 28.7%
One Maritime Plaza, Suite 1400
San Francisco, CA 94111
Dimensional Fund Advisors (3) ............ 970,559 8.2%
1299 Ocean Ave., 11th Fl.
Santa Monica, CA 90401
Peter H. Kamin(2)(4) ..................... 3,492,357 29.6%
Todd F. Bourell(2)(5) .................... 3,399,900 28.8%
Thomas C. O'Brien(6) ..................... 392,442 3.3%
Scott P. Pettit(6) ....................... 125,983 1.1%
David R. Montgomery(6) ................... 122,541 1.0%
Donald J. Hermanek(6) .................... 100,743 *
Maurice A. Cocca(6) ...................... 69,500 *
John K. Wilcox(6) ........................ 32,500 *
John R. Nordin(6) ........................ 29,649 *
John W. Kett(6) .......................... 26,211 *
Philip B. Livingston(6) .................. 18,200 *
Sidney L. Kerley(6) ...................... 11,052 *
All officers (including Named
Executive Officers) and Directors as a
group (12 persons)(7) ................... 4,433,678 37.6%
- ----------
* Less than one percent of the outstanding shares of IAAI common stock.
(1) Percentage of beneficial ownership is calculated assuming 11,792,385
shares of Common Stock were outstanding on December 26, 2004. This
percentage includes any shares of Common Stock of which such individual or
entity had the right to acquire beneficial ownership within sixty days of
December 26, 2004, including, but not limited to, the exercise of an
option; however, such shares of Common Stock shall not be
31
deemed outstanding for the purpose of computing the percentage
beneficially owned by any other individual or entity.
(2) This information is based on Schedule 13D filed with the SEC jointly by
ValueAct Capital Partners, L.P. ("ValueAct Partners"), ValueAct Capital
Partners II, L.P. ("ValueAct Partners II"), ValueAct Capital
International, Ltd. ("ValueAct International"), ValueAct Capital Master
Fund, L.P., ValueAct Capital Partners Co-Investors, L.P., VA Partners,
L.L.C ("VA Partners"), Jeffrey W. Ubben, George F. Hamel, Jr. and Peter H.
Kamin on February 28, 2005 and reflects shares of Common Stock held as of
February 25, 2005. Messrs. Hamel, Kamin and Ubben are each managing
members, principal owners and controlling persons of VA Partners and
directors and principal executive officers of ValueAct International.
Shares beneficially owned by each of ValueAct Partners, ValueAct Partners
II, ValueAct Master Fund and Value Act Co-Investors and ValueAct
International, are reported as beneficially owned by VA Partners, as
investment manager or general partner of each of such investment
partnerships, and by the managing members as controlling persons of the
general partner. VA Partners and the managing members also, directly or
indirectly, may own interests in one or both of such partnerships from
time to time. By reason of such relationships, each of the partnerships is
reported as having shared power to vote or to direct the vote, and shared
power to dispose or direct the disposition of, such shares of Common Stock
with VA Partners and the Managing Members. ValueAct Partners is the
beneficial owner of 1,550,310 shares of Common Stock, representing
approximately 13.4% of the outstanding shares of Common Stock. ValueAct
Partners II is the beneficial owner of 219,692 shares of Common Stock,
representing approximately 1.9% of the outstanding shares of Common Stock.
ValueAct International is the beneficial owner of 0 shares of Common
Stock. ValueAct Master Fund is the beneficial owner of 3,345,261 shares of
Common Stock, representing 29.0% of the Issuer's outstanding Common Stock.
ValueAct Co-Investors is the beneficial owner of 42,139 shares of Common
Stock, representing 0.4% of the Issuer's outstanding Common Stock. VA
Partners, Mr. Ubben, Mr. Kamin and Mr. Hamel may be deemed the beneficial
owner of an aggregate of 3,387,400 shares of the Common Stock,
representing approximately 29.3% of the outstanding shares of Common
Stock. In addition to the 3,387,400 shares of Common Stock that Mr. Kamin
may be deemed to beneficially own by reason of his being a managing member
of VA Partners, Mr. Kamin also personally owns 58,457 shares of Common
Stock (or when combined with the 3,387,400 shares of Common Stock he may
be deemed to beneficially own by reason of his being a managing member,
29.8% of the outstanding shares of Common Stock). This amount also
includes options to purchase 78,000 shares of Common Stock that are
exercisable on December 26, 2004 or will become exercisable within 60 days
after that date, consisting of (a) 46,500 options granted to Mr. Kamin,
(b) 19,000 options granted to Mr. Ubben, and (c) 12,500 granted to Mr.
Bourell. These options were assigned to ValueAct Partners by Messrs.
Kamin, Ubben and Bourell. The options are owned directly by ValueAct
Partners and indirectly by ValueAct Partners II and ValueAct
International, as general partners of ValueAct Partners, and indirectly by
Messrs. Kamin, Ubben and Bourell as managing members and controlling
persons of VA Partners.
(3) This information is based on a Schedule 13G filed by the Dimensional Fund
Advisors, Inc. ("Dimensional") with the SEC on February 9, 2005 and
reflects shares of Common Stock held as of December 31, 2004. According to
such Schedule 13G, Dimensional has sole voting and dispositive power with
respect to all the shares.
(4) This amount includes 58,457 shares of Common Stock over which Mr. Kamin
has sole voting and dispositive power and 3,387,400 shares of Common Stock
owned by ValueAct Partners over which Mr. Kamin shares voting and
dispositive power. This information is based on a Schedule 13D filed by
ValueAct Partners with the SEC on May 25, 2004 and reflects shares of
Common Stock held as of May 18, 2004. This amount also includes options to
purchase 46,500 shares of Common Stock that are exercisable on December
26, 2004 or will become exercisable within 60 days after that date. These
options were assigned to ValueAct Partners and Mr. Kamin disclaims
beneficial ownership of the underlying shares of Common Stock.
(5) Represents 3,387,400 shares owned by ValueAct Partners over which Mr.
Bourell shares voting and dispositive power. This amount also includes
options to purchase 12,500 shares of Common Stock that are exercisable on
December 26, 2004 or will become exercisable within 60 days after that
date. These options were assigned to ValueAct Partners and Mr. Bourell
disclaims beneficial ownership of the underlying shares of Common Stock.
32
(6) Includes that portion of options to purchase shares of Common Stock
granted under the 1991 Stock Option Plan and 2003 Stock Incentive Plan
that are exercisable on December 26, 2004 or will become exercisable
within 60 days after that date: Mr. O'Brien - 345,000 shares; Mr. Pettit -
97,500 shares; Mr. Montgomery - 97,500 shares; Mr. Hermanek - 77,500
shares; Mr. Cocca - 29,500 shares; Mr. Wilcox - 17,500 shares; Mr.
Livingston - 12,500 shares; Mr. Kett - 9,375 shares; Mr. Kerley - 8,125
shares and Mr. Nordin - 7,500 shares.
(7) Includes options to purchase shares of Common Stock granted under the 1991
Stock Option Plan and 2003 Stock Incentive Plan that are exercisable on
December 26, 2004 or will become exercisable within 60 days after that
date.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
M & M Acquisition. In January 1992, the Company purchased the auto salvage
pool operations of M & M Auto Storage Pool, Inc. ("M & M"), and acquired an
option to purchase the original 35 acres of land on which M & M's operation is
located. Melvin R. Martin, the founder, chief executive officer and principal
shareholder of the auto salvage operation, was elected a director of the Company
in January 1992. Mr. Martin retired from the Board in August 2004. The Company
is required to pay rent to Mr. Martin during the 10-year term, or extended term,
of the lease relating to the real property owned by Mr. Martin. In 2004, the
Company paid $557,000 pursuant to the lease. The Company believes the terms of
the lease are no less favorable than those available from unaffiliated third
party lessors or licensors.
Dallas, Texas Lease. The Company leases certain property located in
Dallas, Texas from a partnership in which Mr. Martin is a partner. In 2004, the
Company paid $644,000 in rent under this lease. The Company believes the terms
of the lease are no less favorable than those available from unaffiliated third
party lessors.
Temporary Use License Agreement. On March 1, 2004, the Company entered
into a Temporary License Agreement with Mr. Martin for the month-to-month rental
of additional property adjacent to the Company's Phoenix facility. Pursuant to
the Temporary License Agreement, the Company is expected to pay Mr. Martin
$3,000 per month in additional rents. In 2004, the Company paid $30,000 pursuant
to the temporary license agreement. The Company believes the terms of the
Temporary License Agreement are no less favorable than those available from
unaffiliated third party lessors or licensors.
Mr. Martin and the Company are parties to an agreement pursuant to which
Mr. Martin is compensated on a daily basis for consulting services, primarily in
the areas of acquisitions and real estate. Mr. Martin received no compensation
pursuant to the agreement in 2004.
On February 15, 2001, the Company entered into a Shareholder Agreement
(the "Shareholder Agreement") with ValueAct Capital Partners, L.P., ValueAct
Capital Partners II, L.P., VA Partners, LLC, Jeffrey W. Ubben, Peter H. Kamin,
and George F. Hamel. Pursuant to the terms of the Shareholder Agreement, Mr.
Kamin and Mr. Ubben were elected as members of the Board in 2001. Mr. Ubben
resigned from the Board on September 30, 2003 and was replaced by Todd F.
Bourell on October 17, 2003.
ITEM 14. PRINCIPAL ACCOUNANT FEES AND SERVICES
The Company paid KPMG LLP the following fees for services provided for the
fiscal years 2004 and 2003:
2004 2003
-------- --------
Audit Fees $640,000 $355,000
All Other Fees 26,000 17,000
-------- --------
Total $666,000 $372,000
======== ========
In the above table, "audit fees" include fees billed to the Company for
professional services in connection with the audit of the Company's consolidated
financial statements and internal controls included in its Annual Report on Form
10-K and
33
review of financial statements included in its Quarterly Reports on Form 10-Q,
or for services that are normally provided by KPMG LLP in connection with
statutory and regulatory filings or engagements. "All other fees" include fees
related to the audit of the Company's defined contribution employee benefit
plan.
34
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
Page
----
(a) 1. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
The following Consolidated Financial Statements of Insurance Auto
Auctions, Inc. and its subsidiaries are filed as part of this Annual
report on Form 10-K:
Report of Independent Registered Public Accounting Firm............. 41
Consolidated Balance Sheets......................................... 42
Consolidated Income Statements...................................... 43
Consolidated Statements of Shareholders' Equity..................... 44
Consolidated Statements of Cash Flows............................... 45
Notes to Consolidated Financial Statements.......................... 47
2. CONSOLIDATED FINANCIAL STATEMENT SCHEDULES
All schedules have been omitted because the matter or conditions are not
present or the information required to be set forth therein is included in
the Consolidated Financial Statements and related Notes thereto.
3. EXHIBITS
See Item 15(c) below.
(b) REPORTS ON FORM 8-K.
The Company filed a current report on Form 8-K, dated October 22, 2004,
which contained a press release announcing financial results for the
quarter ended September 26, 2004.
The Company filed a current report on Form 8-K, dated February 23, 2005,
which contained a press release announcing a Definitive Merger Agreement
to be Acquired by Kelso & Company.
The Company filed a current report on Form 8-K, dated March 14, 2005,
which contained a press release announcing financial results for the
quarter ended December 26, 2004.
35
(C) EXHIBITS
Exhibit No Description
- ---------- -----------
2 (19) Agreement and Plan of Merger by and among Insurance Auto Auctions, Inc.
Axle Holdings, Inc. and Axle Merger Sub, Inc. dates as of February 22,
2005.
3.1(7) Articles of Incorporation of the Registrant, as filed with the Illinois
Secretary of State on August 7, 1997.
3.2(8) Bylaws of the Registrant.
3.3(9) Bylaws of the Registrant, as amended as of March 21, 2001.
4.1(1) Specimen Stock Certificate.
4.2(4) Registration Agreement dated December 1, 1993, by and among the Registrant
and Tech-Cor.
4.3(10)* Shareholder Agreement, dated February 15, 2001, among the Company,
ValueAct Capital Partners, L.P., ValueAct Capital Partners II, L.P., VA
Partners, LLC, Jeffrey W. Ubben, Peter H. Kamin and George F. Hamel, Jr.
4.4(10)* Registration Rights Agreement, dated February 15, 2000, among the Company,
ValueAct Capital Partners, L.P. and ValueAct Capital Partners II, L.P.
9(19) Voting Agreement dated as of February 22, 2005 by and among Axle Holdings,
Inc., ValueAct Capital Partners, L.P., ValueAct Capital Partners II, L.P.,
ValueAct Capital Master Fund, L.P. and ValueAct Capital Partners
Co-Investors, L.P. and together with Value Act Capital Partners, ValueAct
Capital Partners II and ValueAct Master, each a "Shareholder" and
collectively, the "Shareholders".
10.1(5)* Form of Notice of Grant of Stock Option -- employee, officer.
10.2(3)* Form of Non-Statutory Stock Option Agreement, Insurance Auto Auctions,
Inc. 1991 Stock Option Plan, as restated (including Form of Notice of
Grant of Stock Option) -- employee.
10.3(3)* Form of Stock Option Agreement: Non-Employee Director, Automatic Option
Grant, Insurance Auto Auctions, Inc. Stock Option Plan, as restated
(including Form of Notice of Grant of Stock Option).
10.4(3)* Form of Incentive Stock Option Agreement, Insurance Auto Auctions, Inc.
1991 Stock Option Plan, as restated (including Form of Notice of Grant of
Stock Option) -- employee.
10.5(3)* Form of Non-Statutory Stock Option Agreement, Insurance Auto Auctions,
Inc. 1991 Stock Option Plan, as restated (including Form of Notice of
Grant of Stock Option) -- officer.
10.6(3)* Form of Incentive Stock Option Agreement, Insurance Auto Auctions, Inc.
1991 Stock Option Plan, as restated (including Form of Notice of Grant of
Stock Option) -- officer.
10.7(6)* Form of Incentive Stock Option Agreement, Insurance Auto Auctions, Inc.
1995 Supplemental Stock Option Plan.
36
10.8(18)* Form of Non-Statutory Stock Option Agreement, Insurance Auto Auctions,
Inc. 2003 Stock Incentive Plan replacing the 1991 Stock Option Plan as
amended and restated.
10.9(2) Facilities Lease Agreement dated January 17, 1992, by and between Melvin
R. Martin and MASP.
10.10(16) Facilities Lease Agreement dated August 7, 2003, by and between MRM
Investments, L.L.P. and Insurance Auto Auctions, Inc. as amended.
10.11(16) Facilities Lease Agreement dated August 7, 2003, by and between MJB
Properties and Insurance Auto Auctions, Inc. as amended.
10.12(16) Temporary Use License Agreement dated March 1, 2004 by and between MRM
Investments Limited Partnership and Insurance Auto Auctions, Inc.
10.13(4) Lease, dated December 1, 1993, by and between Allstate Insurance Company
and BCAC.
10.14(16) Second Amended and Restated Credit Agreement, dated as of March 19, 2004,
among the Registrant and the lenders from time to time parties hereto, and
LaSalle Bank National Association, as Administrative Agent.
10.15(7)* Form of Change of Control Employment Agreement by and between the Company
and certain of its executive officers.
10.16(14) Credit Agreement between the Registrant and LaSalle National Bank dated as
of February 15, 2002.
10.17(14) Rate Swap Agreement pursuant to the Credit Agreement between the
Registrant and LaSalle National Bank dated as of March 13, 2002.
10.18(15) Amended and Restated Credit Agreement between the Company and LaSalle
National Bank dated as of June 25, 2003.
10.19(12)* Insurance Auto Auctions, Inc. Employee Stock Purchase Plan, as amended as
of June 30, 2001.
10.20(8) Form of Indemnification Agreement dated as of February 24, 1999 by and
between the Company and its Directors and Executive Officers.
10.21(13)* Insurance Auto Auctions, Inc. 1991 Stock Option Plan, as amended and
restated as of June 19, 2002.
10.22(9)* Executive Severance Plan for Officers dated August 9, 2000, by and between
the Company and the Company's executive officers.
10.23(9)* Employment agreement, dated November 17, 2000, by and between the Company
and Thomas C. O'Brien.
10.24(11)* Amended and Restated Employment Agreement dated April 2, 2001 by and
between the Company and Thomas C. O'Brien.
10.25(11)* Employment Agreement dated April 2, 2001 by and between the Company and
David R. Montgomery.
10.26(11)* Employment Agreement dated April 2, 2001 by and between the Company and
Scott P. Pettit.
10.27(13)* Insurance Auto Auctions, Inc. 2002 Long Term Incentive Plan.
37
10.28(16)* Employment Agreement dated October 23, 2003 by and between the Company and
John R. Nordin.
10.29(17) Lease Agreement dated April 13, 2004, by and between Westbrook Corporate
Center, L.L.C. and Insurance Auto Auctions, Inc.
10.30(18)* Employment Agreement dated July 23, 2004 by and between the Company and
John Kett.
10.31(19)* 2005 Shareholder Value Incentive Plan.
10.32* Employment Agreement dated October 6, 2004 by and between the Company and
Sidney L. Kerley.
10.33 Waiver dated March 3, 2005 to the Second Amended and Restated Credit
Agreement dated as of March 19, 2004 by and among the Company and LaSalle
Bank National Association.
10.34 Lease Agreement dated September 20, 2004 by and between the Company and
MCI.
10.35 Lease Agreement dated January 23, 2004 by and between the Company and
Savin Corporation.
10.36(20) Insurance Auto Auctions, Inc Employee Stock Purchase Plan, as amended
as of June 30, 2004.
21 Subsidiaries of the Registrant.
23 Consent of Independent Registered Public Accounting Firm.
24 Power of Attorney (see signatures page).
31.1 Certification of Thomas C. O'Brien, Chief Executive Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Scott P. Pettit, Chief Financial Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Thomas C. O'Brien, Chief Executive Officer, pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Scott P. Pettit, Chief Financial Officer, pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(1) Incorporated by reference from an exhibit filed with the Registrant's
Registration Statement on Form S-1 (File No. 33-43247) declared effective
by the Securities and Exchange Commission ("SEC") on November 20, 1991.
(2) Incorporated by reference from an exhibit included in the Registrant's
Current Report on Form 8-K (File No. 0-19594) filed with the SEC on
January 31, 1992.
(3) Incorporated by reference from an exhibit included in the Registrant's
Annual Report on Form 10-K (File No. 0-19594) for the fiscal year ended
December 31, 1992.
(4) Incorporated by reference from an exhibit included in the Registrant's
Current Report on Form 8-K (File No. 0-19594) filed with the SEC on
December 15, 1993.
(5) Incorporated by reference from an exhibit included in the Registrant's
Annual Report on Form 10-K (File No. 0-19594) for the fiscal year ended
December 31, 1993.
38
(6) Incorporated by reference from an exhibit included in the Registrant's
Quarterly Report on Form 10-Q (File No. 0-19594) for the fiscal quarter
ended June 30, 1997.
(7) Incorporated by reference from an exhibit included in the Registrant's
Annual Report on Form 10-K (File No. 0-19594) for the fiscal year ended
December 31, 1997.
(8) Incorporated by reference from an exhibit included in the Registrant's
Quarterly Report on Form 10-Q (File No. 0-19594) for the fiscal quarter
ended March 31, 1999.
(9) Incorporated by reference from an exhibit included in the Registrant's
Current Report on Form 10-K (File No. 0-19594) for the fiscal year ended
December 31, 2000.
(10) Incorporated by reference from an exhibit included in the Registrant's
Quarterly Report on Form 10-Q (File No. 0-19594) for the fiscal quarter
ended April 1, 2001.
(11) Incorporated by reference from an exhibit included in the Registrant's
Quarterly Report on Form 10-Q (File No. 0-19594) for the fiscal quarter
ended July 1, 2001.
(12) Incorporated by reference from an exhibit included in the Registrant's
Current Report on Form 10-K (File No. 0-19594) for the fiscal year ended
December 30, 2001.
(13) Incorporated by reference from an exhibit included in the Registrant's
Current Report on Form S-8 (File No. 0-19594) filed with the SEC on
August 5, 2002.
(14) Incorporated by reference from an exhibit included in the Registrant's
Current Report on Form 10-K (File No. 0-19594) for the fiscal year ended
December 29, 2002.
(15) Incorporated by reference from an exhibit included in the Registrant's
Quarterly Report on Form 10-Q (File No. 0-19594) for the fiscal quarter
ended June 29, 2003.
(16) Incorporated by reference from an exhibit included in the Registrant's
Current Report on Form 10-K (File No. 0-19594) for the fiscal year ended
December 28, 2003.
(17) Incorporated by reference from an exhibit included in the Registrant's
Quarterly Report on Form 10-Q (File No. 0-19594) for the fiscal quarter
ended March 28, 2004.
(18) Incorporated by reference from an exhibit included in the Registrant's
Quarterly Report on Form 10-Q (File No. 0-19594) for the fiscal quarter
ended June 27, 2004.
(19) Incorporated by reference from an exhibit included in the Registrant's
Current Report on Form 8-K (File No. 0-19594) filed with the SEC on
February 23, 2005.
(20) Incorporated by reference from an exhibit included in the Registrant's
Current Report on Form S-8 (File No. 0-19594) filed with the SEC on
July 1, 2004.
* This item is a management contract or compensatory plan or arrangement
required to be filed as an exhibit to this form pursuant to Item
601(b)(10)(iii) of Regulation S-K.
39
SIGNATURES
Pursuant to the requirements 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.
By: /s/ Thomas C. O'Brien
-------------------------------------
President and Chief Executive Officer
Date: March 14, 2005
POWER OF ATTORNEY
We, the undersigned directors and executive officers of Insurance Auto Auctions,
hereby severally constitute Thomas C. O'Brien and Scott P. Pettit, and each of
them singly, our true and lawful attorneys with full power to them and each of
them to sign for us, and in our names in the capacities indicated below, any and
all amendments to the annual Report on Form 10-K filed with the Securities and
Exchange Commission, hereby ratifying and confirming our signatures as they may
be signed by our said attorneys to any and all amendment to said Annual Report
on Form 10-K.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on this 14th day of March, 2005.
/s/ Thomas C. O'Brien President and Chief Executive Officer, Director
- -------------------------- (Principal Executive Officer)
Thomas C. O'Brien
/s/ Scott P. Pettit Senior Vice President and Chief Financial Officer
- -------------------------- (Principal Financial Officer)
Scott P. Pettit (Principal Accounting Officer)
/s/ Peter H. Kamin Chairman of the Board of Directors
- --------------------------
Peter H. Kamin
/s/ Todd F. Bourell Director
- --------------------------
Todd F. Bourell
/s/ Maurice A. Cocca Director
- --------------------------
Maurice A. Cocca
/s/ Philip B. Livingston Director
- --------------------------
Philip B. Livingston
/s/ John K. Wilcox Director
- --------------------------
John K. Wilcox
40
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Insurance Auto Auctions, Inc.:
We have audited the accompanying consolidated balance sheets of Insurance Auto
Auctions, Inc. and subsidiaries as of December 26, 2004 and December 28, 2003,
and the related consolidated income statements, statements of shareholders'
equity, and cash flows for each of the fiscal years in the three-year period
ended December 26, 2004. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Insurance Auto Auctions, Inc. and subsidiaries as of December 26, 2004 and
December 28, 2003, and the results of their operations and their cash flows for
each of the fiscal years in the three-year period ended December 26, 2004, in
conformity with U.S. generally accepted accounting principles.
/s/ KPMG
Chicago, Illinois
March 11, 2005
41
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
(dollars in thousands except per share amounts)
DECEMBER 26, DECEMBER 28,
2004 2003
------------ ------------
ASSETS
Current assets:
Cash $ 13,325 $ 15,486
Accounts receivable, net 50,443 48,375
Inventories 14,498 13,602
Deferred income taxes 4,693 4,180
Other current assets 1,613 3,099
--------- ---------
Total current assets 84,572 84,742
--------- ---------
Property and equipment, net 74,684 60,187
Deferred income taxes 6,481 5,608
Intangible assets, net 1,747 2,101
Goodwill, net 137,494 135,062
Other assets 482 93
--------- ---------
$ 305,460 $ 287,793
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 38,505 $ 36,658
Accrued liabilities 13,513 12,556
Obligations under capital leases 1,094 2,822
Income taxes payable 1,067 -
Obligation under line of credit 6,000 -
Current installments of long-term debt 7,512 7,547
--------- ---------
Total current liabilities 67,691 59,583
--------- ---------
Deferred income taxes 20,729 17,748
Other liabilities 4,353 2,598
Obligation under capital leases 661 1,891
Long-term debt, excluding current installments 9,375 16,887
--------- ---------
Total liabilities 102,809 98,707
--------- ---------
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; 12,709,758 shares issued
and 11,569,156 outstanding as of December 26, 2004; and
12,325,482 shares issued and 11,518,273 outstanding
as of December 28, 2003 12 12
Additional paid-in capital 151,793 145,856
Treasury stock, 906,480 shares at December 26, 2004 and
807,209 shares at December 28, 2003 (9,637) (8,012)
Deferred compensation related to restricted stock (4,343) (892)
Accumulated other comprehensive income (loss) (186) (625)
Retained earnings 65,012 52,747
--------- ---------
Total shareholders' equity 202,651 189,086
--------- ---------
$ 305,460 $ 287,793
========= =========
See accompanying Notes to Consolidated Financial Statements
42
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Consolidated Income Statements
(dollars in thousands except per share amounts)
2004 2003 2002
--------- --------- ---------
Revenues:
Fee income $ 208,743 $ 169,687 $ 162,845
Vehicle sales 31,436 39,963 71,352
--------- --------- ---------
240,179 209,650 234,197
Cost of sales:
Branch cost 157,297 135,157 125,530
Vehicle cost 26,694 35,301 65,463
--------- --------- ---------
183,991 170,458 190,993
--------- --------- ---------
Gross profit 56,188 39,192 43,204
Operating expense:
Selling, general and administrative 34,978 30,225 27,711
Loss/(gain) on sale of property and equipment 301 54 (104)
Business transformation costs - 3,902 8,067
--------- --------- ---------
Earnings from operations 20,909 5,011 7,530
Other (income) expense:
Interest expense 1,572 1,505 678
Other income (67) (130) (171)
--------- --------- ---------
Earnings before income taxes 19,404 3,636 7,023
Income taxes 7,139 1,304 3,015
--------- --------- ---------
Net earnings $ 12,265 $ 2,332 $ 4,008
========= ========= =========
Earnings per share:
Basic $ 1.06 $ .20 $ .33
========= ========= =========
Diluted $ 1.04 $ .20 $ .32
========= ========= =========
Weighted average shares outstanding (in thousands):
Basic 11,526 11,652 12,235
Effect of stock options 288 80 296
--------- --------- ---------
Diluted 11,814 11,732 12,531
========= ========= =========
See accompanying Notes to Consolidated Financial Statements
43
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
(dollars in thousands)
Common Stock Deferred Accumulated
------------------- Additional Compensation Other Total
Number Paid-in Treasury Restricted Comprehensive Retained Shareholders'
of shares Amount Capital Stock Stock) Income (Loss) Earnings Equity
---------- -------- ---------- ---------- ------------ ------------- ---------- -------------
Balance at December 30, 2001 12,162,290 $ 12 $ 142,575 $ -- $ -- $ -- $ 46,407 $ 188,994
========== ======== ========== ========== ============ ============= ========== =============
Net earnings -- -- -- -- -- -- 4,008 4,008
Other comprehensive loss
Change in fair value of
interest rate swap contract
(net of tax benefit, $467) -- -- -- -- -- (745) -- (745)
-------------
Comprehensive income 3,263
Stock options exercised 115,555 -- 1,341 -- -- -- -- 1,341
Tax benefit related to stock
options exercised -- -- 247 -- -- -- -- 247
Shares issued for the employee
stock purchase plan 14,754 -- 257 -- -- -- -- 257
---------- -------- ---------- ---------- ------------ ------------- ---------- -------------
Balance at December 29, 2002 12,292,599 $ 12 $ 144,420 $ -- $ -- $ (745) $ 50,415 $ 194,102
========== ======== ========== ========== ============ ============= ========== =============
Net earnings -- -- -- -- -- -- 2,332 2,332
Other comprehensive income -
Change in fair value of
interest rate swap contract
(net of tax, $78) -- -- -- -- -- 120 -- 120
-------------
Comprehensive income 2,452
Stock options exercised 6,920 -- 127 -- -- -- -- 127
Tax benefit related to stock
options exercised -- -- 15 -- -- -- -- 15
Shares issued for the employee
stock purchase plan 25,963 -- 373 -- -- -- -- 373
Treasury stock purchased (807,209) -- -- (8,012) -- -- -- (8,012)
Deferred compensation relating
to restricted stock grants -- -- 921 -- (921) -- -- --
Amortization of deferred
compensation -- -- -- -- 29 -- -- 29
---------- -------- ---------- ---------- ------------ ------------- ---------- -------------
Balance at December 28, 2003 11,518,273 $ 12 $ 145,856 $ (8,012) $ (892) $ (625) $ 52,747 $ 189,086
========== ======== ========== ========== ============ ============= ========== =============
Net earnings
Other comprehensive income - 12,265 12,265
Change in fair value of
interest rate swap contract
(net of tax, $273) -- -- -- -- -- 439 -- 439
-------------
Comprehensive income 12,704
Stock options exercised 104,231 -- 1,297 -- -- -- -- 1,297
Tax benefit related to stock
options exercised -- -- 275 -- -- -- -- 275
Shares issued for the employee
stock purchase plan 29,298 -- 329 -- -- -- -- 329
Treasury stock purchased (99,271) -- -- (1,625) -- -- -- (1,625)
Deferred compensation relating
to restricted stock grants -- -- 4,036 -- (4,036) -- -- --
Amortization of deferred
compensation -- -- -- -- 585 -- -- 585
Restricted stock released 16,625 -- -- -- -- -- -- --
---------- -------- ---------- ---------- ------------ ------------- ---------- -------------
Balance at December 26,2004 11,569,156 $ 12 $ 151,793 $ (9,637) $ (4,343) $ (186) $ 65,012 $ 202,651
========== ======== ========== ========== ============ ============= ========== =============
See accompanying Notes to Consolidated Financial Statements
44
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(dollars in thousands)
2004 2003 2002
---------- -------- --------
Cash flows from operating activities:
Net earnings $ 12,265 $ 2,332 $ 4,008
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 12,985 10,661 9,901
Loss (gain) on disposal of fixed assets 301 54 (104)
Loss (gain) on change in fair market value of derivative - (307) 307
Deferred compensation related to restricted stock 585 29 -
Deferred income taxes 1,595 788 2,827
Tax benefit related to employee stock compensation 275 15 247
Changes in assets and liabilities
(excluding effects of acquired companies):
(Increase) decrease in:
Accounts receivable, net (1,536) (752) 9,180
Inventories (896) (2,442) 2,347
Other current assets 1,486 489 594
Other assets (1,438) (975) (64)
Increase (decrease) in:
Accounts payable 1,612 6,349 (12,795)
Accrued liabilities 3,151 (878) 2,289
Income taxes 1,067 0 0
---------- -------- --------
Total adjustments 19,187 13,031 14,729
---------- -------- --------
Net cash provided by operating activities 31,452 15,363 18,737
---------- -------- --------
45
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows (continued)
(dollars in thousands)
2004 2003 2002
-------- -------- --------
Cash flows from investing activities:
Capital expenditures $(28,717) $(16,343) $(15,241)
Proceeds from sale of investments - - 2,643
Proceeds from disposal of property and equipment 1,520 60 187
Payments made in connection with acquired companies,
net of cash acquired (1,912) (7,872) (1,510)
-------- -------- --------
Net cash used in investing activities (29,109) (24,155) (13,921)
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock 1,626 500 1,598
Proceeds from borrowings 6,000 30,000 -
Principal payments of long-term debt (7,547) (5,668) (20,041)
Purchase of treasury stock (1,625) (8,012) -
Principal payments - capital leases (2,958) (2,569) (813)
-------- -------- --------
Net cash provided by (used in) financing activities (4,504) 14,251 (19,256)
-------- -------- --------
Net increase (decrease) in cash (2,161) 5,459 (14,440)
Cash at beginning of year 15,486 10,027 24,467
-------- -------- --------
Cash at end of year $ 13,325 $ 15,486 $ 10,027
======== ======== ========
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 1,723 $ 1,639 $ 1,433
======== ======== ========
Income taxes paid $ 5,404 $ 855 $ 2,492
======== ======== ========
Income taxes refunded $ 1,011 $ 1,390 $ 3,860
======== ======== ========
Non-cash financing activities:
Capital leases $ - $ 3,375 $ 4,720
======== ======== ========
See accompanying Notes to Consolidated Financial Statements
46
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES
BACKGROUND
Insurance Auto Auctions, Inc. (the "Company") operates in a single
business segment - providing insurance companies and other vehicle
suppliers cost-effective salvage processing solutions including selling
total loss and recovered theft vehicles.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant
intercompany transactions and balances have been eliminated in
consolidation.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior year financial
information to conform with the current year presentation.
FISCAL PERIODS
Fiscal years 2004, 2003 and 2002 each consisted of 52 weeks and ended on
December 26, 2004, December 28, 2003 and December 29, 2002, respectively.
REVENUE RECOGNITION
Revenues (including vehicle sales and fee income) are generally recognized
at the date the vehicles are sold at auction. Revenue not recognized at
the date the vehicles are sold at auction includes certain buyer-related
fees, which are recognized when payment is received.
INVENTORIES
Inventories are stated at the lower of cost or estimated realizable value.
Cost includes the cost of acquiring ownership of total loss and recovered
theft vehicles, charges for towing and, less frequently, reconditioning
costs. The costs of inventories sold are charged to operations based upon
the specific-identification method.
DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments include cash and cash equivalents,
accounts receivable, short and long-term debt and derivative financial
instruments. The fair values of these instruments approximate their
carrying values.
GOODWILL IMPAIRMENT
As part of an ongoing review of the valuation and amortization of
intangible assets, management assesses the carrying value of the Company's
intangible assets if facts and circumstances suggest that such assets may
be
47
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
impaired. If this review indicates that an asset is impaired as determined
by a comparison of the fair value to the carrying amount, including
goodwill, the carrying value of the asset would be reduced to its
estimated fair market value. The annual impairment test of intangible
assets is performed in the first quarter of each year. The fiscal 2004
annual test did not indicate any impairment.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company evaluates long-lived assets 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 assets 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.
USE OF ESTIMATES
The Company has made a number of estimates and assumptions relating to the
reporting of assets and liabilities and the disclosure of contingent
liabilities to prepare these consolidated financial statements in
conformity with accounting principles generally accepted in the United
States of America. Actual results will likely differ from these estimates,
but management believes that such differences are not material.
DEPRECIATION AND AMORTIZATION
Depreciation of property and equipment is computed using the straight-line
method over the estimated useful lives of the related assets ranging from
three to forty years. Leasehold improvements are amortized on a
straight-line basis over their estimated economic useful life or the life
of the lease, whichever is less.
INCOME TAXES
The Company accounts for income taxes under the asset and liability
method, whereby deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases, as well as operating loss and tax credit carry
forwards. The effect of a rate change on deferred tax assets and
liabilities is recognized in the period of enactment.
CREDIT RISK
Vehicles are sold generally for cash; therefore, very little credit risk
is incurred from the selling of vehicles. Receivables arising from advance
charges made on behalf of vehicle suppliers, most of which are insurance
companies, are generally satisfied from the net proceeds payable to the
vehicle suppliers. A small percentage of vehicles sold do not have
sufficient net proceeds to satisfy the related receivables, and in these
cases, the receivable is due from the vehicle suppliers. Management
performs regular evaluations concerning the ability of its customers and
suppliers to satisfy their obligations and records a provision for
doubtful accounts based upon these evaluations. The Company's credit
losses for the periods presented are insignificant and have not exceeded
management's estimates.
RESTRICTED STOCK
In 2003, the Company initiated a restricted stock program. Under the
Company's restricted stock grant program, shares of common stock of the
Company may be granted at no cost to certain officers and key
48
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
employees. Plan participants are entitled to cash dividends and to vote
their respective shares received pursuant to the program. Restrictions
limit the sale or transfer of these shares over a four-year period. The
sale and transfer restrictions on shares received under the program expire
at a rate of 25% per year or earlier, on the achievement of certain
performance based goals. Upon issuance of shares of common stock under the
plan, unearned compensation equivalent to the market value of the shares
at the date of the grant is charged to shareholders' equity and
subsequently amortized to expense over the restriction period.
In 2003, 66,500 restricted shares were granted. In 2004, 182,600
restricted shares were granted. Compensation expense in 2004 was $0.6
million and in 2003 was less than $0.1 million. Compensation expense was
accelerated by $0.3 million in the fiscal year ended December 26, 2004 due
to the achievement of certain performance levels. In fiscal 2004 and 2003,
there were no forfeitures of restricted shares.
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 related to stock option grants
is recognized in net earnings, as all options granted 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 provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation", awards of stock options and restricted stock to employees,
including straight-line recognition of compensation cost over the related
vesting periods for fixed awards:
2004 2003 2002
-------- -------- --------
(dollars in thousands)
Net earnings as reported $ 12,265 $ 2,332 $ 4,008
Add: Stock-based employee compensation
expense included in reported net earnings,
net of related tax effects 370 45 -
Deduct: Total stock-based employee
compensation expense determined
under the fair value based method
for all awards, net of related
tax effects (2,835) (1,795) (1,288)
-------- -------- --------
Pro forma net earnings $ 9,800 $ 582 $ 2,720
======== ======== ========
Pro forma earnings per share
Basic $ .85 $ .05 $ .22
======== ======== ========
Diluted $ .83 $ .05 $ .22
======== ======== ========
The per share weighted average fair value of stock options granted during
2004, 2003 and 2002 was $11.98 $9.65 and $10.13, respectively, based upon
grant date valuations using the Black-Scholes option pricing model with
the following weighted average assumptions in 2004, 2003 and 2002:
expected dividend yield of 0.0% in all years; expected volatility of .89%,
.84% and .83%, respectively; risk-free interest rate of 3.7%, 3.1% and
2.8%, respectively; and an average expected option life of 5.2, 5.0 and
4.9 years, respectively.
49
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
CAPITALIZED SOFTWARE COSTS
The Company capitalizes certain internal use computer software costs, after
technological feasibility has been established in accordance with SOP 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use". Capitalized software costs are amortized utilizing the
straight-line method over the economic lives of the related assets not to exceed
five years.
DERIVATIVE FINANCIAL INSTRUMENT
In 2002, the Company entered into an interest rate swap to mitigate its exposure
to interest rate fluctuations, but does not, as a matter of policy, enter into
hedging contracts for trading or speculative purposes. The interest rate swap
has been accounted for in accordance with the provisions of SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended. The
swap has been designated as a cash flow hedge. Changes in fair value of the swap
are recorded in other comprehensive income to the extent that the swap is
effective as a hedge and reclassified to earnings in the same period that
earnings are affected by the variability in cash flows of the hedged item.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 151 (SFAS 151), "Inventory Costs
an amendment of ARB No. 43, Chapter 4." SFAS 151 discusses the general
principles applicable to the pricing of inventory. Paragraph 5 of ARB 43,
Chapter 4 provides guidance on allocating certain costs to inventory. This
Statement amends ARB 43, Chapter 4, to clarify that abnormal amounts of idle
facility expense, freight, handling costs, and wasted materials (spoilage)
should be recognized as current-period charges. As required by SFAS 151, we will
adopt this new accounting standard at the beginning of our first interim or
annual reporting period that begins after June 15, 2005. The Company is
currently evaluating the impact of adoption on our financial statements.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 153 (SFAS 153), "Exchanges of Nonmonetary Assets--an amendment of
APB Opinion No. 29." SFAS 153 addresses the measurement of exchanges of
nonmonetary assets. It eliminates the exception from fair value measurement for
nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB
Opinion No. 29 "Accounting for Nonmonetary Transactions" and replaces it with an
exception for exchanges that do not have commercial substance. A nonmonetary
exchange has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. As required by
SFAS 153, we will adopt this new accounting standard at the beginning of our
first interim or annual reporting period that begins after June 15, 2005. The
Company is currently evaluating the impact of adoption on our financial
statements.
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 123R (SFAS 123R) "Share-Based Payment." SFAS 123R requires that the cost
resulting from all share-based payment transactions be recognized in the
financial statements. SFAS 123R establishes fair value as the measurement method
in accounting for share-based payments to employees and eliminates the
alternative use of the intrinsic value method of accounting under APB Opinion
No. 25, "Accounting for Stock Issued to Employees." This statement is effective
for public entities as of the beginning of the first interim or annual reporting
period that begins after June 15, 2005. The Company is currently evaluating the
impact of adoption on our financial statements.
(2) GOODWILL AND OTHER INTANGIBLES
Goodwill and other intangibles are recorded at cost less accumulated
amortization and consist of the following at December 26, 2004 and December 28,
2003:
COST
--------------------------------------
ASSIGNED LIFE 2004 2003
------------- ------ ------
(dollars in millions)
Goodwill Indefinite $167.0 $164.6
Covenants not to compete 3 to 5 years 4.2 4.0
------ ------
$171.2 $168.6
====== ======
ACCUMULATED AMORTIZATION
--------------------------------------
ASSIGNED LIFE 2004 2003
------------- ------ ------
(dollars in millions)
Goodwill Indefinite $ (29.5) $ (29.5)
Covenants not to compete 3 to 5 years (2.5) (1.9)
------- -------
$ (32.0) $ (31.4)
======= =======
50
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Goodwill increased by $2.4 million in fiscal 2004. During the year, the
Company acquired one new facility. The excess of the purchase price over
the fair market value of the net identifiable assets acquired of $1.4
million has been recorded as goodwill. The balance of $1.0 million was due
to earnout payments made in 2004 associated with prior year acquisitions.
Amortization expense for the years ended December 26, 2004, December 28,
2003 and December 29, 2002 was $0.6 million, $0.5 million and, $0.3
million, respectively. These amounts are included within selling, general
and administrative expense on the Company's Consolidated Income
Statements. Based on existing intangibles, the projected annual
amortization expense for each fiscal years 2005 and 2006 is $0.6 million,
$0.4 million for 2007 and $0.2 million for 2008. The assets will be fully
amortized by 2009.
(3) COMPREHENSIVE INCOME
Comprehensive income consists of net earnings and the change in fair value
of the Company's interest rate swap agreement for the years ended December
26, 2004, December 28, 2003 and December 29, 2002 as follows (dollars in
thousands):
2004 2003 2002
-------- -------- --------
(dollars in thousands)
Net earnings $ 12,265 $ 2,332 $ 4,008
Other comprehensive income (loss)
Change in fair value of interest
rate swap agreement 712 198 (1,212)
Income tax benefit (expense) (273) (78) 467
-------- -------- --------
Comprehensive income $ 12,704 $ 2,452 $ 3,263
======== ======== ========
The changes in fair value of the Company's interest rate swap agreement
were due to changes in interest rates.
(4) CREDIT FACILITIES
Long-term debt is summarized as follows:
2004 2003
-------- -------
(dollars in thousands)
Unsecured term loan, interest payable at variable rate based
upon LIBOR. Principal repaid in 16 equal installments
commencing March 31, 2003 $ 16,875 $24,375
Notes payable issued in connection with the acquisition
of a subsidiary, interest payable at 8% 12 59
-------- -------
16,887 24,434
Less current installments 7,512 7,547
-------- -------
$ 9,375 $16,887
======== =======
51
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Total principal repayments required for each of the next three fiscal
years under all long-term debt agreements are summarized as follows:
(dollars in thousands)
2005 $ 7,512
2006 7,500
2007 1,875
--------
$ 16,887
========
On February 15, 2003, the Company borrowed all remaining available funds
under 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 was required to be paid in sixteen
consecutive equal quarterly installments commencing on March 31, 2003.
On June 25, 2003, the Company entered into an amended and restated credit
facility. This facility added a $20.0 million revolving line of credit,
carrying a variable rate based on LIBOR, to the existing term loan. This
amended and restated facility also modified all existing covenants except
for the rent expense covenant. The amended credit facility also granted
the Company latitude to purchase additional shares of its outstanding
common stock.
On March 19, 2004, the Company entered into the Second Amended and
Restated Credit Agreement relating to its senior credit facility. The
agreement amends certain financial covenants, including those applicable
as of December 28, 2003 and those applicable for fiscal 2004, provides
that advances made under the facility will be subject to a monthly asset
coverage test equal to 85% of eligible receivables, and requires the
Company to provide collateral for amounts due under the facility in the
event it fails to meet certain financial projections for two consecutive
quarters. The Company's financing agreement limits potential future
dividend payments to no more than 25% of the Company consolidated net
income earned over a specified period. As of December 26, 2004, the
Company has borrowed $6.0 million against the revolving line of credit and
$16.9 million under the term credit facility. At December 26, 2004, the
Company was in compliance with its credit agreement covenants, except its
expenditure basket covenant for which it received a waiver in March 2005.
(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%. Under the interest rate swap agreement, the
Company pays a fixed rate of interest of 5.6% and receives LIBOR-based
floating rate payments. During the year ended December 29, 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 (net of tax) as a comprehensive loss related to
the change in fair market value of the portion of its interest rate swap
agreement which qualified for hedge accounting.
In 2003, the Company recorded a $0.3 million non-cash benefit related to
the change in fair value of the interest rate swap agreement. At December
28, 2003, the Company also recorded $0.1 million (net of tax) as
52
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
comprehensive income related to the change in fair market value of its
interest rate swap agreement. At December 26, 2004, the entire swap
agreement qualified for hedge accounting and all charges in the fair value
of the swap were recorded, net of tax, through other comprehensive income
(see Note 3.
53
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) INCOME TAXES
Income tax expense is summarized as follows:
2004 2003 2002
-------- --------- ----------
(dollars in thousands)
Current:
Federal $ 5,028 $ 573 $ (161)
State 790 19 (116)
-------- --------- ---------
5,818 592 (277)
-------- --------- ---------
Deferred:
Federal 1,092 509 2,756
State 229 203 536
-------- --------- ---------
1,321 712 3,292
-------- --------- ---------
$ 7,139 $ 1,304 $ 3,015
======== ========= =========
The Company evaluates the realizability of its deferred tax assets on an ongoing
basis. In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during
the periods in which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities, projected future
taxable income, and tax planning strategies in making this assessment. Based
upon the level of historical taxable income and projections for future taxable
income over the periods in which the deferred tax assets are deductible,
management believes it is more likely than not that the Company will realize the
benefits of these deductible differences, net of the existing valuation
allowances at December 26, 2004. The Company has established a valuation
allowance when the utilization of the tax asset is uncertain. Additional timing
differences, future earning trends and/or tax strategies may occur which could
warrant a need for establishing an additional valuation allowance or a reserve.
Deferred income taxes are composed of the effects of the components listed
below. A valuation allowance has been recorded to reduce the carrying value of
deferred tax assets for which the Company believes a tax benefit will not be
realized.
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities at December 26, 2004 and
December 28, 2003 are presented below:
2004 2003
------------ ----------
(dollars in thousands)
Deferred tax assets attributable to:
Inventories $ 2,261 $ 1,931
Other 2,432 2,249
Depreciation 5,946 5,219
State net operating losses carried forward 1,618 2,108
----------- ---------
Gross Deferred Tax Assets 12,257 11,507
Valuation allowance (1,083) (1,719)
----------- ---------
Net deferred tax assets 11,174 9,788
Deferred tax liabilities attributable to:
Intangible assets (20,729) (17,748)
----------- ---------
Net deferred tax liabilities $ (9,555) $ (7,960)
=========== =========
54
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
The actual income tax expense differs from the "expected" tax expense computed
by applying the Federal corporate tax rate to earnings before income taxes as
follows:
2004 2003 2002
-------- -------- --------
(dollars in thousands)
"Expected" income tax expense $ 6,791 $ 1,236 $ 2,388
State income taxes, net of Federal effect 662 146 277
Increase (decrease) in valuation allowance (636) 264 308
Reduction of tax accruals - (527) (291)
Other 322 185 333
-------- -------- --------
$ 7,139 $ 1,304 $ 3,015
======== ======== ========
The Company is obligated to file tax returns and pay Federal and state income
taxes in numerous jurisdictions. The reductions in income tax accruals relate to
amounts that were no longer required, due primarily to closed tax return audits
and closed tax years for a number of jurisdictions.
At December 26, 2004, the Company had state income tax net operating loss
carryforwards of approximately $34.4 million. The net operating loss
carryforwards expire in the years 2005 through 2024.
Due to the fact that NOLs can be audited well beyond a normal three-year
statutory audit period and the inherent uncertainty of estimates of future
taxable income, the amount of the NOLs which may ultimately be utilized to
offset future taxable income may vary materially from the Company's estimates.
The Company has established a reserve for NOL-related contingencies based on
its estimates of the amount of benefit from these NOLs that it may ultimately
be unable to realize due to factors other than estimates of future taxable
income. Subsequent revisions to the estimated realizable value of the deferred
tax asset or the reserve for tax-related contingencies may cause the Company's
provision for income taxes to vary significantly from period to period, although
cash tax payments will remain unaffected until the NOLs are utilized.
(7) EMPLOYEE BENEFIT PLANS
The Company adopted the Insurance Auto Auctions, Inc. 2003 Stock Incentive
Plan (the 2003 Plan) in June 2003 to replace the Insurance Auto Auctions,
Inc. 1991 Stock Option Plan (the 1991 Plan), as amended and restated,
covering 3,100,000 shares of the Company's common stock. The 2003 Plan
provides for the grant of incentive stock options and restricted stock to
key employees and nonqualified stock options and stock appreciation rights
to key employees, directors, consultants and independent contractors. The
2003 Plan expires June 18, 2013. In general, new non-employee directors
will automatically receive grants of nonqualified options to purchase
10,000 shares and subsequent grants to purchase 5,000 shares at specified
intervals.
During 1995, the Company adopted the Insurance Auto Auctions, Inc.
Supplemental Stock Option Plan (the 1995 Plan) covering 200,000 shares of
the Company's common stock. The 1995 Plan provides for the grant of
nonqualified stock options to employees, other than executive officers,
consultants and other independent advisors who provide services to the
Company. The 1995 Plan will expire on October 1, 2005.
Under the Plans, as of December 26, 2004, options to purchase an aggregate
of 1,745,492 shares were outstanding at a weighted average exercise price
of $13.50 per share and 169,713 shares remained available for future
grant.
In 2003, the Company initiated a restricted stock program. Under the
Company's restricted stock program, common stock of the Company may be
granted at no cost to certain officers and key employees. Plan
participants are entitled to cash dividends and to vote their respective
shares. Restrictions limit the sale or transfer of these shares over a
four year period. The sale and transfer restrictions on shares received
under the program expire at a rate of 25% per year or earlier, based on
the achievement of certain performance based goals. Upon issuance of stock
under the plan, unearned compensation equivalent to the market value of
the shares at the date of grant is charged to shareholders' equity and
subsequently amortized to expense over the restriction period. In 2004,
182,600 restricted shares were granted and in 2003, 66,500 restricted
shares were granted. Compensation expense in 2004 was $0.6 and less than
$0.1 million in 2003. Compensation expense was accelerated by $0.2 million
in the fiscal year ended December 26, 2004 due to anticipated achievement
of performance goals in 2005. In fiscal 2004, there were no forfeitures of
restricted shares.
55
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Activity under the Plans during 2004, 2003 and 2002 is as follows:
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
2004 EXERCISE 2003 EXERCISE 2002 EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- --------- -------- ---------- --------
Balance at beginning of year 1,821,000 $ 13.49 1,518,000 $ 14.13 1,397,000 $ 14.48
Options granted 75,000 16.72 490,000 13.89 377,000 15.75
Options canceled (47,000) 20.60 (180,000) 20.09 (140,000) 24.13
Options exercised (104,000) 12.44 (7,000) 11.61 (116,000) 11.62
--------- -------- --------- -------- --------- --------
Balance at end of year 1,745,000 $ 13.50 1,821,000 $ 13.49 1,518,000 $ 14.13
========= ======== ========= ======== ========= ========
Options exercisable at end of year 1,122,000 824,000 596,000
========= ========= =========
Additional information about options outstanding as of December 26, 2004
is presented below:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------- --------------------
WEIGHTED AVERAGE
----------------------
REMAINING WEIGHTED
CONTRACTUAL AVERAGE
RANGE OF EXERCISE NUMBER OF LIFE EXERCISE NUMBER OF EXERCISE
PRICES OPTIONS (IN YEARS) PRICE OPTIONS PRICE
- ------------------ --------- ----------- -------- --------- --------
$ 7.00 to $ 10.00 34,000 3.59 $ 9.21 34,000 $ 9.21
10.38 to 13.95 1,198,000 6.06 12.54 833,000 12.11
14.11 to 22.75 509,000 7.56 15.93 251,000 15.95
28.63 to 32.50 4,000 .41 28.63 4,000 28.63
--------- ---------
$ 7.00 to $ 32.50 1,745,000 6.44 13.50 1,122,000 12.94
========= =========
The Company has a 401(k) defined contribution plan covering all full-time
employees. Plan participants can elect to contribute up to 15% of their
gross payroll. Company contributions are determined at the discretion of
the Board of Directors; during the years 2002 to 2004, the Company matched
100% of employee contributions up to 4% of eligible earnings. Company
contributions to the plan were $0.8 million in 2004, $0.8 million in 2003
and $0.8 million in 2002.
(8) RELATED PARTY TRANSACTIONS
The Company leases certain properties from a recently retired member of
its Board of Directors. The Company believes the terms of the leases are
no less favorable than those available from unaffiliated third party
lessors. Rental payments to the Related Party were $1.2 million in 2004,
and $0.8 million in 2003 and 2002. In 2004 and 2003, the Company incurred
$3.9 million and $2.7 million, respectively, in costs to upgrade
properties owned by the Related Party. A portion of the investment to
upgrade these facilities was funded by the Related Party. The Company
agreed to modify its future lease payments to take into consideration the
costs funded by the Related Party. The total of all future
56
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
rent payments related to the Related Party's funding is $2.8 million. The
Company also initiated a temporary license agreement in March 2004 to
expand the amount of property available at one of the leased facilities.
The temporary lease agreement does not have a specified term, can be
terminated by either party upon 30 days written notice, and has an annual
rental of less than $0.2 million.
(9) COMMITMENTS AND CONTINGENCIES
The Company leases its facilities and certain equipment under operating
leases with related and unrelated parties, which expire through August
2021. Rental expense for the years ended December 26, 2004, December 28,
2003 and December 29, 2002, was $24.1 million, $22.5 million and $22.1
million, respectively.
In 2004, the Company entered into a new lease agreement for 38,000 square
feet of space for use as its corporate offices in Westchester, Illinois.
This lease commenced in September 2004 and expires in August 2016. The
total future rent obligation associated with this new lease is $10.3
million. The Company used an allowance totaling $1.9 million from the
lessor to build-out the office space.
In 2002, the Company began leasing certain equipment under capital leases.
Equipment leased under these leases amounted to $1.8 in 2004, $3.4 million
in 2003 and $4.7 million in 2002.
Minimum annual rental commitments for the next five years under
noncancelable operating and capital leases at December 26, 2004 are as
follows:
OPERATING CAPITAL
LEASES LEASES
--------- --------
(dollars in thousands)
2005 $ 21,528 $ 1,203
2006 19,731 387
2007 16,355 316
2008 14,345 33
2009 12,178 -
Thereafter 67,623 -
--------- --------
$ 151,760 $ 1,939
=========
Less amount representing interest expense 184
--------
Future capital lease obligation $ 1,755
========
Assets as of December 26, 2004 and December 28, 2003 recorded under
capital leases are included in property and equipment, net as follows:
2004 2003
---- ----
(dollars in thousands)
Computer equipment $ 5,221 $ 6,654
Security fencing 1,441 1,441
-------- --------
6,662 8,095
Accumulated amortization (4,819) (3,378)
-------- --------
$ 1,843 $ 4,717
======== ========
The Company has compensation agreements with certain officers and other
key employees. In addition to base salary and bonus information, certain
agreements have change in control provisions that address compensation due
to the executive in the event of termination following a change of
control.
57
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
On September 16, 2003, the Company received notice from the King County
Wastewater Treatment Division, Department of Natural Resources, that King
County was in the process of building a water treatment facility and that
the Company's Woodinville, Washington branch was located within the
boundaries of the likely site for placement of this facility. On October
3, 2003, the Company received further notice from King County that it had
extended an offer to purchase the Woodinville site from Waterman
Properties and that, if the offer was accepted, the Company would be
expected to enter into a lease arrangement with King County until such
time as King County directed it to vacate the facility. In an open house
meeting on December 1, 2003, King County announced that it expected all
property owners and tenants to vacate the proposed water treatment site no
later than the end of 2004. On March 4, 2004, the Company filed a lawsuit
in Snohomish County Superior Court against King County and Waterman
Properties asking the Court to appoint a receiver to manage a portion of
the funds (up to $1.5 million) that Waterman Properties might receive from
King County and to award the Company a portion of the condemnation award
in an amount equal to the value of its leasehold improvements.
In 2004, the Company negotiated a settlement with King County whereby the
Company terminated its lease with Waterman Properties and dismissed its
complaint against King County to permit the sale and purchase of the
Woodinville property. The settlement further provided for $900,000 of the
purchase price to be placed into escrow for payment of any judgment that
might be awarded in the Company's on-going suit against Waterman
Properties. The outcome of this action remains uncertain at this time. At
year end, the Company exited the Woodinville facility wrote off its
leasehold improvements of approximately $991,000. The Company expects to
recover approximately $375,000 of which $200,000, that was recorded in
2004 as a reduction of the loss, is for branch re-establishment and
$175,000 is for relocation of inventory.
The Company is subject to certain miscellaneous legal claims, which have
arisen during the ordinary course of its business. None of these claims
are expected to have a material adverse effect on the Company's financial
condition or operating results.
(10) TREASURY STOCK
The Company records treasury stock purchases using the cost method of
accounting. In the third quarter of 2004, the Company repurchased 95,800
shares at an average price of $16.17 and in the fourth quarter the Company
repurchased 3,471 shares at an average price of $21.75. The Company did
not repurchase any shares during the first and second quarters of 2004. On
a full year basis, the Company has repurchased 99,271 shares at an average
price of $16.37 per share and a total cost of $1.6 million.
(11) ACCOUNTS RECEIVABLE
Accounts receivable consists of the following as of December 26, 2004 and
December 28, 2003:
2004 2003
---- ----
(dollars in thousands)
Unbilled receivables $ 35,555 $ 35,188
Trade accounts receivable 14,596 12,787
Other receivables 1,086 1,213
-------- --------
51,237 49,188
Less allowance for doubtful accounts (794) (813)
-------- --------
$ 50,443 $ 48,375
======== ========
58
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Unbilled receivables represent amounts paid to third parties on behalf of
insurance companies for which the Company will be reimbursed when the
vehicle is sold. Trade accounts receivable include fees and proceeds to be
collected from both insurance companies and buyers.
59
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(12) PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 26, 2004 and
December 28, 2003:
2004 2003
---- ----
(dollars in thousands)
Land $ 7,662 $ 7,582
Buildings and improvements 13,722 11,506
Equipment 49,645 39,302
Leasehold improvements 49,485 38,304
--------- ---------
120,514 96,694
Less accumulated depreciation and amortization (45,830) (36,507)
--------- ---------
$ 74,684 $ 60,187
========= =========
Depreciation expense was $12.4 million in 2004 and $10.2 million in 2003.
Amortization of intangibles was $0.6 million in 2004 and $0.5 million in
2003.
(13) EARNINGS PER SHARE
There were no adjustments to net income to calculate diluted earnings per
share. The table below reconciles basic weighted shares outstanding to
diluted weighted average shares outstanding for the years ended December
26, 2004, December 28, 2003 and December 29, 2002.
2004 2003 2002
------ ------ -------
(in thousands)
Basic weighted average shares outstanding 11,526 11,652 12,235
Effect of dilutive securities - stock options 288 80 296
------ ------ -------
Diluted weighted average shares outstanding 11,814 11,732 12,531
====== ====== =======
Options to purchase 0.1 million, 1.1 million and 0.1 million shares of
common stock at an average price of $18.61, $14.81 and $28.90 per share
were outstanding during the fiscal years ended 2004, 2003 and 2002,
respectively, but were not included in the Company's diluted earnings per
share calculations because the options' exercise prices were greater than
the average market price of the Company's shares for the period.
(14) ACCUMULATED POSTRETIREMENT BENEFIT OBLIGATION
In connection with the acquisition of the capital stock of Underwriters
Salvage Company ("USC"), the Company assumed the obligation for certain
health care and death benefits for retired employees of USC. In accordance
with the provisions of SFAS No. 106, "Employers Accounting for
Postretirement Benefits Other than Pensions," costs related to the
benefits are accrued over an employee's service life.
The accumulated post retirement benefit obligation was determined using a
discount rate of 5.75% at December 26, 2004, 6.25% at December 28, 2003
and 6.75% at December 29, 2002 and an average health care cost trend rate
of approximately 10.0%, progressively decreasing to approximately 5.0% in
the year 2009 and thereafter. A one percentage point change in the assumed
health care cost trend rate would not have a material effect on the
postretirement benefit obligation or on the aggregate service cost and
interest cost components.
60
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
A reconciliation of the funded status of this program as of December 26,
2004 and December 28, 2003 follows:
2004 2003
----- -----
(dollars in thousands)
Benefit Obligations and Funded Status
Change in accumulated postretirement benefit obligation
Accumulated postretirement benefit obligation at the beginning of the year $ 1,432 $ 1,506
Interest cost 47 95
Actuarial (gain) or loss (678) (69)
Benefits paid (57) (100)
-------- -----------
Accumulated postretirement benefit obligation at the end of the year 744 1,432
Change in plan assets
Benefits paid (56) (100)
Employer contributions 56 100
-------- -----------
Fair value of assets at the end of the year - -
Net amount recognized
Funded status (744) (1,432)
Unrecognized net (gain) or loss (1,620) (1,166)
-------- -----------
Net amount recognized $ (2,364) $ (2,598)
======== ===========
Amounts recognized in the statement of financial position
Accrued benefit liability $ (2,364) $ (2,598)
======== ===========
Weighted average assumptions at the end of the year
Discount rate 5.75% 6.25%
Assumed health care cost trend rates
Health care cost trend rate assumed for next year 10.00% 8.50%
Ultimate rate 5.00% 5.00%
Year that the ultimate rate is reached 2009 2010
61
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Net periodic benefit cost (income) is summarized as follows for the fiscal
years 2004, 2003, and 2002:
2004 2003 2002
---- ---- ----
NET PERIODIC BENEFIT COST (INCOME) (dollars in thousands)
Interest cost $ 47 $ 95 $ 103
Amortization of net (gain) or loss (224) (133) (130)
------ ------- -------
Total net periodic benefit cost (income) $ (177) $ (38) $ (27)
====== ======= =======
Estimated future benefit payments for the next five years as of December
26, 2004 are as follows:
(dollars in thousands)
2005 $ 126
2006 117
2007 118
2008 108
2009 97
Thereafter 259
-------
$ 825
=======
Effective January 20, 1994, the date of acquisition, the Company
discontinued future participation for active employees.
(15) ACQUISITIONS AND DIVESTITURES
In fiscal 2004, the Company acquired Mid-South Salvage LLC located in
Jackson, Mississippi. The acquisition leverages the Company's existing
regional coverage in this market. The acquisition was accounted for using
the purchase method of accounting. The results of operations of this
acquisition are included in the Company's consolidated financial
statements from the date of acquisition. The aggregate purchase price of
this acquisition was $1.9 million.
In fiscal 2004, the Company sold its West Bridgewater, Massachusetts
facility to Harvey Industries, Inc., a Massachusetts corporation, for $1.1
million. The Company recorded a gain on the sale of the West Bridgewater
facility of $0.3 million, net of taxes.
(16) SUBSEQUENT EVENT (UNAUDITED)
In January 2005, the Company announced the opening of a new greenfield
facility in Lincoln, Illinois. This new 15-acre facility will provide
needed coverage in the central part of the state. The new facility will
also improve the Company's regional coverage, complementing other existing
locations.
In February 2005, the Company entered into a definitive merger agreement
to be acquired by affiliates of Kelso & Company ("Kelso"), a New York
based private equity investment firm. The closing of the transaction is
subject to certain terms and conditions customary for transactions of this
type, including shareholder approval and the completion of financing.
62
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(17) QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized unaudited financial data for 2004 and 2003 are as follows:
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- ---------- ---------
(dollars in thousands except per share amounts)
2004
Revenues $ 57,191 $ 60,002 $ 60,752 $ 62,234
Earnings from operations 4,334 4,877 5,734 5,964
Net earnings 2,301 2,655 3,354 3,955
Basic earnings per share .20 .23 .29 .34
Diluted earnings per share .20 .22 .28 .33
2003
Revenues $ 56,040 $ 53,338 $ 49,127 $ 51,145
Earnings (loss) from operations 3,382 2,627 (520) (478)
Net earnings 1,976 1,280 (594) (330)
Basic earnings (loss) per share .16 .11 (.05) (.03)
Diluted earnings (loss) per share .16 .11 (.05) (.03)
The sum of earnings per share for the four quarters of 2004 and 2003 does
not equal the full year amount due to rounding and the impact of changes
in the average shares outstanding.
63
INDEX TO EXHIBITS
Exhibit No.
10.32 Employment Agreement dated October 6, 2004 by and between the
Company and Sidney L. Kerley.
10.33 Waiver dated March 3, 2005 to the Second Amended and Restated
Credit Agreement dated as of March 19, 2004 by and among the
Company and LaSalle Bank National Association.
10.34 Lease Agreement dated September 20, 2004 by and between the
Company and MCI.
10.35 Lease Agreement dated January 23, 2004 by and between the
Company and Savin Corporation.
21 Subsidiaries of the Registrant.
23 Consent Independent Registered Public Accounting Firm.
24 Power of Attorney (See signatures page).
31.1 Certification of Thomas C. O'Brien, Chief Executive Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Scott P. Pettit, Chief Financial Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Thomas C. O'Brien, Chief Executive Officer,
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Scott P. Pettit, Chief Financial Officer,
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.