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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 31, 1998
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 (I.R.S. Employer
of incorporation or organization) identification Number)
850 EAST ALGONQUIN ROAD, SUITE 100
SCHAUMBURG, ILLINOIS 60173
(847) 839-3939
(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. [ ]
The aggregate market value of voting stock (based on the closing price as
reported by the Nasdaq National Market on March 15, 1999) held by non-affiliates
of the Registrant as of March 15, 1999 was approximately $46,900,000. For
purposes of this disclosure, shares of Common Stock known to be held by persons
who own 5% or more of the shares of outstanding common stock and shares of
common stock held by each officer and director have been excluded in that such
persons may be deemed to be "affiliates" as that term is defined under the Rules
and Regulations of the Act. This determination of affiliate status is not
necessarily conclusive. As of March 15, 1999, the Registrant had outstanding
11,338,858 shares of Common Stock, $0.001 par value.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Notice of Annual Meeting and Proxy Statement
for the Registrant's Annual Meeting of Shareholders are incorporated herein by
reference in Part III hereof.
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PART I
ITEM 1. BUSINESS.
The discussion in this section contains forward-looking information that is
subject to certain risks, trends and uncertainties that could cause actual
results to differ materially from those projected, expressed or implied by such
forward looking information. The Company's actual results could differ
materially from those discussed 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." Among these risks are
governmental regulation, weather conditions, market value of salvage,
competition, quality and quantity of inventory available from suppliers, and
dependence on key insurance company suppliers.
GENERAL
Insurance Auto Auctions, Inc., together with its subsidiaries
(collectively, "IAA" or the "Company"), offers 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 vehicles at live or closed bid
auctions on a competitive-bid basis at one of the Company's facilities.
The Company processes salvage vehicles under three methods: purchase
agreement, fixed fee consignment and percentage of sale consignment. Under the
purchase agreement method, IAA generally purchases vehicles from the insurance
companies upon clearance of title, under financial terms determined by contract
with the insurance company supplier and then resells these vehicles for IAA's
own account at IAA auctions. Under the fixed fee consignment and percentage of
sale consignment method, 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. Under all methods of sale, the Company
also charges the buyer of each vehicle various buyer-related fees.
Prior to 1992, the Company operated almost exclusively using the purchase
agreement system of salvage disposal. Since 1992, IAA has acquired additional
auto salvage pool operations, resulting in a network of 50 salvage pools in 22
states as of December 31, 1998. Most of these businesses operate primarily using
the fixed fee consignment method of sale. As a result of these site additions, a
majority of the vehicles currently processed by IAA are now sold under fixed fee
and percentage of sale consignment arrangements. In 1998, approximately 61% of
the vehicles processed by IAA were sold under the fixed fee consignment method,
9% were sold under the percentage of sale consignment method, and 30% were sold
under the purchase agreement method.
The Company obtains the majority of its supply of vehicles from a large
number of 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 1998, vehicles supplied by the
Company's three largest suppliers accounted for approximately 43% of the
Company's unit sales. The aggregate number of vehicles supplied in 1998 by the
Company's three largest suppliers increased from 1997. However, due to a
significant increase in vehicles supplied by other customers, the percent to
total units sold for the Company's three largest customers decreased. The
largest suppliers, State Farm Insurance, Allstate Insurance ("Allstate"), and
Farmers Insurance, each accounted for approximately 17%, 14%, and 13%
respectively, of the Company's unit sales.
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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 and its common stock is
traded on the Nasdaq National Market tier of The Nasdaq Stock Market under the
symbol IAAI. In 1997, the Company reincorporated in the state of Illinois.
IAA PERCENTAGE OF SALE CONSIGNMENT METHOD
Under the Percentage of Sale consignment method, the insurance company
receives a negotiated percentage of the vehicle-selling price. With this method
of sale, the Company acts as an agent for the insurance company. As agent, the
Company arranges for the salvage vehicle to be towed to its facility and
processes the car for sale. The percentage of sale consignment method provides
suppliers with potentially greater upside since IAA's fees are tied to selling
prices and IAA has, thus, more incentive to invest in improvements to salvage
vehicles to maximize sales prices. The Company offers two types of percentage of
sale agreements. The Percentage Plan is a straight percentage of sale agreement
that includes vehicle enhancements as part of the selling price-based fee. The
Percentage-Plus Plan offers a lower percentage of sale fee combined with
discounted pricing for enhancement services. Approximately 9% and 4% of the
vehicles processed by the Company were sold under the percentage of sale
consignment method in 1998 and 1997, respectively. The Company, in 1998,
designated the percentage of sale consignment method its preferred type of
salvage provider agreement. Accordingly, the Company expects the percent of
vehicles sold under this type of contract to total vehicles sold to increase.
IAA PURCHASE AGREEMENT METHOD
Under the purchase agreement method of sale, the Company is required to
purchase, and the insurance company and other non-insurance company suppliers
are required to sell to the Company, virtually all total loss and recovered
theft vehicles generated by the supplier in a designated geographic area. IAA
then works to enhance the value of purchased vehicles in the selling process and
assumes the risk of market price variation for vehicles so processed. Under the
purchase agreement method, insurance companies may outsource much of the salvage
administration workload and this potentially reduces their expenses accordingly.
The agreements are customized to each supplier's needs, but typically require
the Company to pay a specified percentage of a vehicle's Actual Cash Value
("ACV"), depending on the vehicle's age and certain other conditions including
whether the vehicle is a total loss or recovered theft vehicle. The Company's
revenue from the sale of a purchase agreement vehicle is the actual selling
price of the vehicle. The Company has added adjustment and risk-sharing clauses
to its new standard purchase agreement contracts designed to provide some
protection to the Company and its customers from certain unexpected, significant
changes in the ACV/salvage price relationship. In 1998 and 1997, approximately
30% of the units processed by IAA were processed through the purchase agreement
method of sale.
IAA FIXED FEE CONSIGNMENT SALE METHOD
Approximately 61% of the Company's vehicles for the year ended December 31,
1998 were sold on the fixed fee consignment method of sale, compared with 66% in
1997. As under the percentage of sale consignment method, the Company typically
acts as an agent for the insurance company rather than as a purchaser of salvage
vehicles. Under this method of disposal, the Company charges fees to the
insurance company supplier, typically including a towing fee, a title processing
fee and a storage and salvage sales fee. Since the Company does not own the
vehicle, the Company's revenues per vehicle from consignment sales are received
only from these fees rather than from the revenue from the sale of the vehicle.
As a result, revenue recognized per vehicle under the consignment method of sale
is approximately 5% to 15% of the revenue recognized per vehicle under the
purchase agreement method, where the sale price of the vehicle is also recorded.
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SERVICES PROVIDED TO ALL SUPPLIERS
The process of salvage disposition through the IAA system commences at the
time of loss, or when a stolen vehicle has been subsequently recovered. An
insurance company representative assigns the vehicle to the Company, either by
phone, facsimile or through the Company's on-line electronic DataLink(TM)
system. DataLink(TM) is the Company's proprietary computer order processing
system that enables insurance company suppliers to access their data
electronically and to retrieve information on a vehicle at any time during the
claims adjustment and disposal process.
The Company's FastTow(TM) service also provides towing services which
guarantee that vehicles will be delivered to a Company branch storage facility,
usually within one to two business days of assignment within a designated
service area. In retrieving a vehicle, the FastTow(TM) service will also
advance, on behalf of the supplier, any storage and towing charges incurred when
the vehicle was initially towed 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 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 (which can be
as high as $50 per day per car) and improve service time to the policyholder,
the Company and certain of its insurance company suppliers have established
vehicle inspection centers ("VICs") at many of the Company's facilities. A VIC
is a temporary storage and inspection facility located at an IAA 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 vehicle is totaled by the insurance company, the vehicle can easily be moved
to IAA's vehicle storage area. If the vehicle is not totaled, it is promptly
delivered to the insurer's selected repair facility. IAA also provides video
imaging as a service to its customers, digitizing pictures of the damaged cars
and electronically displaying them to insurance adjusters in their office.
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 IAA. For most vehicles stored on our facilities, no storage
charges accrue for a contractually specified period. The document processing
departments at the Company's facilities provide 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 and decreasing the suppliers' administrative costs and
expenses. The Company then processes the title documents in order to comply with
DMV requirements for such vehicles. This may involve re-registering the vehicle
and obtaining a salvage certificate, after which the Company is entitled to sell
the salvage vehicle. The company holds auctions every week or bi-weekly in all
of its locations. The auction is either live or sealed bid. Auction lists can be
viewed on line on the Company's Internet website where buyers can review all
vehicles at a location or search for specific vehicles.
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 generally 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 and detail of storage charges and other useful management data. The
Company also provides many of its suppliers with quarterly Comprehensive Salvage
Analysis of salvage trends.
OTHER SERVICES
IAA's BidFast(TM) service provides insurers with a binding bid for a
salvage vehicle which historically may have been owner-retained. The return on
such vehicles (owner-retained salvage vehicles) is, many times,
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measurably improved for the supplier using this service and enables compliance
with many state department of insurance regulations.
IAA also provides certain insurance company suppliers with anti-theft fraud
control programs for vehicle salvage processing. The Company's CarCrush(TM)
services 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. IAA 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.
IAA has also continued its support for consumer protection laws calling for the
nationwide mandatory use of salvage certificates for salvage vehicles.
The Company offers a National Salvage Network, based in Dallas, Texas, that
allows insurance company suppliers to call in all their salvage vehicle
assignments to a single location. This call center enables IAA to distribute
vehicle assignments throughout most of the United States, even in markets where
IAA does not currently have a facility, and is designed to minimize the
administrative workload for insurance companies and provide IAA with broader
geographic coverage. In certain areas where the Company does not have a
facility, such vehicles are distributed to IAA 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 offers insurance companies the
opportunity for better returns on units that typically do not sell for as much
at local salvage pools as a result of the limited number of local buyers. These
vehicles can be viewed on line through the Company's Internet website,
www.iaai.com.
GROWTH STRATEGIES
The Company seeks to increase sales on a profitable basis by offering to
insurance company suppliers a variety of methods of sale (including percentage
of sale consignment, purchase agreement and fixed fee consignment) and various
other services and by (i) increasing market share at existing sites; (ii)
continued market penetration through acquisitions; (iii) new site expansion;
(iv) development of national/regional supplier agreements, and (v) the offering
of new services to insurance companies to assist them in reducing time and cost
in the claims process.
Increasing Market Share and Profitability at Existing Sites
The Company's primary strategy for growth in its existing markets is to
contract for additional vehicles by promoting better returns on salvage vehicles
and 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 and results in more buyers attending auctions.
The Company's strategies for increasing profitability at existing sites
include efforts to shift more salvage providers to revenue sharing arrangements
such as the percentage of sale consignment method. The Company is also promoting
its "Run & Drive" service whereby certain salvage vehicles are driven during the
auction demonstrating to buyers that the major component parts of a vehicle
still operate. These product offerings are designed to maximize returns to 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 pool operations across the United States to offer better
national coverage to its insurance company customers. The Company currently
operates 50 salvage pools in 22 states.
IAA intends to continue to pursue acquisitions of strategically-located
salvage pools. Through such acquisitions, it seeks to enhance a geographically
broad-based relationship with key insurance company suppliers, as well as to
offer its specialized salvage services to new insurance companies and certain
non-insurance company 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 existing IAA
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operations. This will require continuing investment in infrastructure. See
"Factors That May Affect Future Results."
New Site Expansion
While the Company will continue to pursue growth through acquisitions, it
also will continue to seek growth through the opening of new sites. The opening
of new sites offers advantages in certain markets and capitalizes on regional
and national customer accounts.
Development of National/Regional Supplier Agreements
The Company's expanded geographic base of operations, plus its National
Network, facilitates its strategy of offering its customers and prospective
customers national and regional supplier agreements. These can provide a more
consistent reporting and control function to our customers, who benefit from a
reduction in the number of suppliers through which they must do business.
Offering of New 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.
MARKETING
The Company markets its services to insurance company and non-insurance
company salvage suppliers. Based upon historical data supplied by a prospective
supplier, the Company can provide prospective suppliers with a detailed analysis
of their current salvage returns and a proposal setting forth ways in which the
Company can improve salvage returns, reduce administrative costs and expenses
and provide proprietary turnkey claims processing services.
In addition to providing insurance companies and certain non-insurance
company suppliers with a means for disposing of salvage vehicles, the Company
provides services that are intended to increase the net amount of salvage sale
proceeds received by the suppliers and reduce the time in which the suppliers
receive net proceeds. The Company seeks to become an integral part of its
suppliers' salvage process. The Company views such mutually beneficial
relationships as an essential component of its effort to retain existing
suppliers and attract new suppliers.
The Company also seeks to expand its supply relationships through
recommendations from individual branch offices of an insurance company supplier
to other offices of the same insurance company. The Company believes that its
existing relationships and the recommendations of branch offices currently play
a significant role in its marketing of services to national insurance companies
from its growing network of salvage locations. Indeed, as the Company has
expanded its geographic coverage, it has been able to market its services to
insurance suppliers offering to handle salvage on a national basis or for a
large geographic area.
The Company sells the majority of its vehicles through live auctions. IAA
maintains databases which currently contain information regarding nearly 20,000
registered buyers. No single buyer accounted for more than 10% of the Company's
net sales in 1998. The Company generally accepts cash, money orders, cashier's
checks, wire transfers, credit cards, and pre-approved checks, at the time the
vehicle is picked up. Vehicles are sold "as is" and "where is." Sales notices
listing the vehicles to be auctioned on a particular day at a particular
location are generally mailed, faxed or available online on the Company's
Internet website to the Company's buyers in advance of the auction. Such notices
list the rules of the auction and details about the vehicle, including the year
and make of the vehicle, 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 Internet site at www.iaai.com.
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COMPETITION
Historically, the automotive salvage industry has been highly fragmented.
As a result, the Company faces intense competition for the supply of salvage
vehicles from vehicle suppliers, as well as competition for processors of
vehicles from other regional salvage pools. These regional salvage pools
generally process vehicles under the fixed fee consignment method and generally
do not offer the full range of services provided by the Company. The salvage
industry went through a period of consolidation, however, and the Company
believes its principal publicly-held competitor is Copart, Inc. Copart, Inc. has
completed a number of acquisitions of regional salvage pools and competes with
IAA in most of IAA's geographic markets. Due to the limited number of vehicle
suppliers, competition is intense for salvage vehicles from Copart and regional
suppliers. The Company attempts to differentiate itself from its competition
through the wide range and quality of services it provides to its insurance
customers and buyers. It is also possible that the Company may encounter further
competition from existing competitors and new market entrants that are
significantly larger and have greater financial and marketing resources. Other
potential competitors could include used car auction companies, providers of
claims processing software to insurance companies, certain salvage buyer groups
and insurance companies, some of which presently supply auto salvage to IAA.
While many insurance companies have abandoned or reduced efforts to sell salvage
without the use of service providers such as the Company, they may in the future
decide to dispose of their salvage directly to customers. There can be no
assurance that the Company will be able to compete successfully against current
or future competitors or that competitive pressures faced by the Company will
not have a material adverse effect on its business, operating results and
financial condition.
GOVERNMENT REGULATION
The Company's operations are subject to regulation, supervision and
licensing under various federal, state and local statutes, ordinances and
regulations. The acquisition and sale of totaled and recovered theft vehicles is
regulated by governmental agencies in each of the locations in which the Company
operates. In many of these states, regulations require that the title of a
salvage vehicle be forever "branded" with a salvage notice in order to notify
prospective purchasers of the vehicle's previous salvage status. 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 and
operation of its auction and storage facilities. Some state and local
regulations also limit who can purchase salvage vehicles, as well as determine
whether a salvage vehicle can be sold as rebuildable or must be sold for parts
only. Such regulations can reduce the number of potential buyers of vehicles at
Company auctions. The Company is also subject to environmental regulations. The
Company believes that it is in compliance with all applicable material
regulatory requirements. The Company will be subject to similar types of
regulations by federal, state and local governmental agencies in new markets and
to continuing legislation in existing markets.
ENVIRONMENTAL MATTERS
The Company's operations are subject to federal, state and local laws and
regulations governing, among other things, the handling, storage, transportation
and disposal of waste and other materials. The Company believes that its
business, operations and facilities have been and are being operated in
compliance in all material respects with applicable environmental laws and
regulations. The Company believes the overall impact of compliance with laws and
regulations protecting the environment will not have a material adverse effect
on its operating results and financial condition, although no assurance can be
given in this regard.
EMPLOYEES
At December 31, 1998, the Company employed 625 full-time persons. The
Company is not subject to any collective bargaining agreements and believes that
its relationship with its employees is good.
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FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company operates in a changing environment that involves a number of
risks, some of which are beyond the Company's control. The following discussion
highlights some of these risks.
Quarterly Fluctuations. The Company's operating results have in the past
and may in the future fluctuate significantly depending on a number of factors,
some of which are more significant for sales under the purchase agreement
method. These factors include changes in the market value of salvage vehicles,
attendance at salvage auctions, delays or changes in state title processing,
fluctuations in Actual Cash Values ("ACVs") of salvage vehicles, changes in
regulations governing the processing of salvage vehicles, general weather
conditions and the availability and quality of salvage vehicles. 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 which can
effect the number of vehicles received include: reduction of policy writing by
insurance providers which would affect the number of claims over a period of
time and changes in direct repair procedures that would reduce the number of
newer less damaged total loss vehicles that tend to have the higher salvage
values. Additionally in the last few years there has been a declining trend in
theft occurrences. These factors are further aggravated in the event the Company
fails to renegotiate purchase agreement contracts that are volume and mix
dependent on availability of these types of sales. 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. In addition, revenues for any future quarter are not predictable
with any significant degree of accuracy, while the Company's expense levels are
relatively fixed. If revenue levels are below expectations, operating results
are likely to be adversely affected. Due to all of the foregoing factors, it is
likely that in some future quarters the Company's operating results will be
below the expectations of public market analysts and investors.
Quality and Quantity of Inventory Available from Suppliers. The Company is
dependent upon receiving a sufficient number of total loss vehicles as well as
recovered theft vehicles to sustain its profit margins. Factors which can effect
the number of salvage vehicles received include the 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 that tend to have higher salvage values.
The decreases in the quality and quantity of inventory, and in particular the
availability of newer and less-damaged vehicles, are further aggravated under
the purchase agreement method of salvage and can have a material adverse effect
on the operating results and financial condition of the Company.
Competition. Historically, the automotive salvage industry has been highly
fragmented. As a result, the Company faces intense competition for the supply of
salvage vehicles from vehicle suppliers, as well as competition from processors
of vehicles from other regional salvage pools. These regional salvage pools
generally process vehicles under the fixed fee consignment method and generally
do not offer the full range of services provided by the Company. The salvage
industry has recently experienced consolidation, however, and the Company
believes its principal publicly-held competitor is Copart, Inc. Copart, Inc. has
completed a number of acquisitions of regional salvage pools and competes with
IAA in most of IAA's geographic markets. Due to the limited number of vehicle
suppliers, competition is intense for salvage vehicles from Copart and regional
suppliers. It is also possible that the Company may encounter further
competition from existing competitors and new market entrants that are
significantly larger and have greater financial and marketing resources. Other
potential competitors could include used car auction companies, providers of
claims software to insurance companies, certain salvage buyer groups and
insurance companies, some of which presently supply auto salvage to IAA. While
most insurance companies have abandoned or reduced efforts to sell salvage
without the use of service providers such as the Company, they may in the future
decide to dispose of their salvage directly to customers. There can be no
assurance that the Company will be able to compete successfully against current
or future competitors or that competitive pressures faced by the Company will
not have a material adverse effect on its operating results and financial
condition.
Dependence on Key Insurance Company Suppliers. Historically, a limited
number of insurance companies has accounted for a substantial portion of the
Company's revenues. For example, in 1998, vehicles supplied by the Company's
three largest suppliers accounted for approximately 44% of the Company's unit
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sales. The largest suppliers, State Farm Insurance, Allstate Insurance
("Allstate"), and Farmers Insurance, each accounted for approximately 17%, 14%,
and 13%, , respectively, of the Company's unit sales. A loss or reduction in the
number of vehicles from any of these suppliers, or adverse change in the
agreements that such suppliers have with the Company, could have a material
adverse effect on the Company's operating results and financial condition.
Purchase Agreement Method of Sale. The Company has entered into a number of
purchase agreements, including agreements with its most significant insurance
suppliers, that obligate the Company to purchase most salvage vehicles offered
to it at a formula percentage of ACV. From 1993 to 1996, increased ACVs on which
the Company's costs are based reduced the profitability that the Company
realizes on purchase agreement contracts. This could occur again if used car
prices increase faster than selling prices. The Company has renegotiated most of
its agreements with certain of these suppliers. Further increases in ACVs or
declines in the market or auction prices for salvage vehicles could have a
material adverse effect on the Company's business, operating results and
financial condition. The Company has added adjustment and risk-sharing clauses
to its new standard purchase agreement contracts designed to provide some
protection to the Company and its customers from certain unexpected, significant
changes in ACV's that are not accompanied by a comparable increase in sales
prices.
Governmental Regulation. The Company's operations are subject to
regulation, supervision and licensing under various federal, state and local
statutes, ordinances and regulations. The acquisition and sale of totaled and
recovered theft vehicles is regulated by state motor vehicle departments in each
of the locations in which the Company operates. Changes in governmental
regulations or interpretations of existing regulations can result in increased
costs, reduced salvage vehicle prices and decreased profitability for the
Company. For example, the Company believes legislation currently being
considered by Congress could have a negative impact on the number of buyers
attending an auction as well as increase some of the costs to those buyers. This
legislation could increase governmental regulation of certain operations of 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 of 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 expends 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
such expenses by the insurance company suppliers.
Integration and Expansion of Facilities. The Company seeks to increase
sales and profitability through acquisition of other salvage auction facilities,
new site expansion and the increase of salvage vehicle volume at existing
facilities. There can be no assurance that the Company will continue to acquire
new facilities on terms economical to the Company or that the Company will be
able to add additional facilities on terms economical to the Company or that the
Company will be able to increase revenues at newly acquired facilities above
levels realized prior to acquisition. The Company's ability to achieve these
objectives is dependent, among other things, on the integration of new
facilities, and their information systems, into its existing operations, the
identification and lease of suitable premises and the availability of capital.
There can be no assurance that this integration will occur, that suitable
premises will be identified or that additional capital will be available to fund
expansion and integration of the Company's business. Any delays or obstacles in
this integration process could have a material adverse effect on the Company's
business, operating results and financial condition. Furthermore, the Company
has limited sources of additional capital available for acquisitions, expansions
and start-ups. The Company's ability to integrate and expand its facilities will
depend on its ability to identify and obtain additional sources of capital to
finance such integration and expansion. In the future, the Company will be
required to continue to improve its financial and management controls, reporting
systems and procedures on a timely basis and expand, train and manage its
employee work force. The failure to improve these systems on a timely basis and
to successfully expand and train the Company's work force could have a material
adverse effect on the Company's operating results and financial condition.
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Volatility of Stock Price. The market price of the Company's common stock
has been and could continue to be subject to significant fluctuations in
response to various factors and events, including variations in the Company's
operating results, the timing and size of acquisitions and facility openings,
the loss of vehicle suppliers or buyers, the announcement of new vehicle supply
agreements by the Company or its competitors, changes in regulations governing
the Company's operations or its vehicle suppliers, environmental problems or
litigation.
Environmental Regulation. The Company's operations are subject to federal,
state and local laws and regulations regarding the protection of the
environment. In the salvage vehicle auction industry, large numbers of wrecked
vehicles are stored at auction facilities for short periods of time. Minor
spills of gasoline, motor oils and other fluids may occur from time to time at
the Company's facilities and may result in soil, surface water or groundwater
contamination. Petroleum products and other hazardous materials are contained in
aboveground or underground storage tanks located at certain of the Company's
facilities. Waste materials such as waste solvents or used oils are generated at
some of the Company's facilities and are disposed of as nonhazardous or
hazardous wastes. The Company believes that it is in compliance in all-material
respects with applicable environmental regulations and does not anticipate any
material capital expenditure for environmental compliance or remediation.
Environmental laws and regulations, however, could become more stringent over
time and there can be no assurance that the Company or its operations will not
be subject to significant compliance costs in the future. To date, the Company
has not incurred expenditures for preventive or remedial action with respect to
contamination or the use of hazardous materials that have had a material adverse
effect on the Company's results of operations or financial condition. The
contamination that could occur at the Company's facilities and the potential
contamination by previous users of certain acquired facilities create the risk,
however, that the Company could incur substantial expenditures for preventive or
remedial action, as well as potential liability arising as a consequence of
hazardous material contamination, which could have a material adverse effect on
the Company's operating results and financial condition.
ITEM 2. PROPERTIES.
The Company's principal administrative, sales, marketing and support
functions are located in Schaumburg, Illinois. The Company moved to Schaumburg
in mid 1997 to a building providing approximately 26,000 square feet of
available space. The lease on the office space in Schaumburg expires in May
2004. The Company and its subsidiaries also lease approximately 43 properties in
Alabama, Arizona, California, Florida, Georgia, Hawaii, Illinois, Maryland,
Massachusetts, Michigan, Minnesota, Nebraska, New Jersey, New York, North
Carolina, Oregon, Texas, Virginia and Washington. The Company owns 8 properties
located in Illinois, Kansas, Massachusetts and New York. Most of these
properties are used primarily for auction and storage purposes. Management
believes that the Registrant's properties are adequate for its current needs and
that suitable additional space will be available as required.
ITEM 3. LEGAL PROCEEDINGS.
Not applicable
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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 31, 1998.
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 31, 1999:
NAME AGE OFFICE HELD
---- --- -----------
Christopher G. Knowles............... 56 Chief Executive Officer
Senior Vice President, Chief Financial Officer and
Linda C. Larrabee.................... 51 Secretary
Gerald C. Comis...................... 50 Vice President, Customer Service and Industry Relations
Donald J. Comis...................... 40 Vice President, Central Division
Peter B. Doder....................... 38 Vice President, Western Division
Stephen L. Green..................... 43 Vice President, Finance
Marcia A. McAllister................. 47 Vice President, Government Affairs
Gaspare G. Ruggirello................ 41 Vice President, General Counsel
Patrick T. Walsh..................... 36 Vice President, Eastern Division
CHRISTOPHER G. KNOWLES became Chief Executive Officer of the Company in
December 1998 and. has been a Director of the Company since June 1994. As Chief
Executive Officer, Mr. Knowles oversees the Company's overall corporate
administration as well as strategic planning. Mr. Knowles was President and
Chief Operating Officer of the Company from April 1994 to March 1996. Mr.
Knowles previously served as Senior Vice President, Operations East of the
Company from January 1994 to April 1994. Prior to joining the Company, Mr.
Knowles was Chairman and Chief Executive Officer from 1980 to 1994 of
Underwriters Salvage Company, a multi-location salvage operation that the
Company acquired in January 1994.
LINDA C. LARRABEE became Senior Vice President, New Business Development,
Chief Financial Officer and Secretary in January 1999. Prior to that she served
as Senior Vice President, Finance, Chief Financial Officer and Secretary since
June 1996. Ms. Larrabee is responsible for the implementation and development of
information systems and evaluating and establishing new business opportunities
for IAA. Prior to joining the Company, Ms. Larrabee served as Vice President,
Information Systems of Van Waters & Rogers Inc. from 1992 to 1996. Prior to that
time, Ms. Larrabee served as Vice President, Information Systems for Hitachi
Data Systems from 1989 to 1992 and as Vice President, Finance for National
Advanced Systems from 1982 to 1989.
GERALD C. COMIS became Vice President Customer Service and Industry
Relations in February 1997. Mr. Comis is responsible for overseeing operational
procedures and customer service consistencies across all branch operations as
well as the management of the corporate accounts sales group. From October 1996
to February 1997 Mr. Comis served as Vice President, Western Division. From
April 1994 to October 1996, Mr. Comis served as Vice President, Field Operations
of the Company. From January 1994 to April 1994, Mr. Comis served as a Vice
President of Underwriters Salvage Company, a wholly owned subsidiary of the
Company, which was merged into the Company. From 1968 to January 1994, Mr. Comis
held various positions with Underwriters, prior to the January 1994 acquisition
by the Company, including Branch Manager, Vice President and Executive Vice
President.
DONALD J. COMIS has been Vice President of the Central Division since
October 1996. Mr. Comis is responsible for the sales and operational functions
of the Central Division. From January 1994 to October 1996, Mr. Comis served as
Regional General Manager of the Company. From 1979-1994, Mr. Comis served
Underwriters Salvage Company in many capacities, including Director of
Operations, Asst. Vice President of Operations and Vice President of Operations.
PETER B. DODER became Vice President of the Western Division in February
1997. Mr. Doder is responsible for the sales and operational functions of the
Western Division. From February 1996 to
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February 1997 Mr. Doder was Vice President, Financial Planning & Analysis of the
Company. From June 1992 through February 1996, Mr. Doder held various positions
with the Company, including Regional Sales Manager, Manager of Marketing Support
& Analysis and Director of Marketing.
STEPHEN L. GREEN became Vice President, Finance in January 1999. Prior to
that he served as Vice President, Corporate Controller, and Assistant Secretary
of the Company since February 1997. Mr. Green is responsible for cash management
and cash control as well as financial accounting, planning and reporting, taxes
and risk management. Prior to joining the Company, Mr. Green served as Manager
of Operations Accounting of Van Waters & Rogers Inc. from 1989 to February 1997.
MARCIA A. MCALLISTER has been Vice President, Government Affairs of the
Company since February 1995. Ms. McAllister is responsible for monitoring
legislation and participating on behalf of the Company with a variety of
industry and agency groups. From March 1994 to February 1995, Ms. McAllister was
a consultant to the Company. From June 1986 to January 1994, Ms. McAllister held
a variety of positions with Underwriters including Vice Chairman and General
Counsel.
GASPARE G. RUGGIRELLO has been Vice President and General Counsel of the
Company since July 1997. 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. Ruggirello
served as Senior Attorney & Assistant Secretary of Borg-Warner Automotive, Inc.
from 1993 to 1997. Prior to that time, Mr. Ruggirello served as Senior Attorney
for Borg-Warner Corporation from 1989 to 1993.
PATRICK T. WALSH has been Vice President, Eastern Division since October
1996. Mr. Walsh is responsible for the sales and operational functions of the
Eastern Division. From November 1994 to October 1996, Mr. Walsh was responsible
for operational planning. From January 1994 to November 1994, Mr. Walsh served
as Vice President, Operations West of the Company and from September 1991
through January 1994, Mr. Walsh served as Vice President, Operations. From April
1988 to September 1991, Mr. Walsh held various positions in the Company,
including Branch Operations Manager.
Officers are appointed to serve, at the discretion of the Board of
Directors, until their successors are appointed. Ms. McAllister is the wife of
Mr. Christopher G. Knowles; Chief Executive Officer and a member of the Board of
Directors, and Donald J. Comis is the brother of Gerald C. Comis.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
The Registrant's Common Stock is traded on the Nasdaq National Market tier
of The Nasdaq Stock Market under the symbol IAAI. The following table sets forth
the range of high and low per share bid information, as reported on the Nasdaq
National Market for each quarter of fiscal 1998 and 1997. At March 15, 1999, the
Registrant had 199 holders of record of its Common Stock, approximately 500
beneficial owners and 11,338,858 shares outstanding.
FISCAL 1998 FISCAL 1997
---------------- ----------------
HIGH LOW HIGH LOW
---- --- ---- ---
First Quarter................................. $12.75 $ 8.38 $10.63 $ 6.50
Second Quarter................................ 14.88 10.88 9.50 6.50
Third Quarter................................. 14.75 10.75 14.25 8.00
Fourth Quarter................................ 12.94 10.00 13.63 10.00
During the past two fiscal years, the Registrant did not declare or pay any
cash dividends on its Common Stock. The Registrant currently plans to retain all
of its earnings to support the development and expansion of its business and has
no present intention of paying any dividends on the Common Stock in the
foreseeable future. In addition, the Registrant's credit agreements between the
Registrant and its bank limit the Registrant's ability to pay cash dividends.
The Board of Directors of the Registrant reviews the dividend policy
periodically to determine whether the declaration of dividends is appropriate.
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ITEM 6. SELECTED FINANCIAL DATA.
The tables below summarize the Selected Consolidated Financial Data of the
Registrant 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 selected consolidated financial data presented
below have been derived from the Company's Consolidated Financial Statements
that have been audited by KPMG LLP, independent auditors, whose report is
included herein covering the Consolidated Financial Statements as of December
31, 1998 and 1997 and for each of the years in the three year period ended
December 31, 1998. The statement of earnings for the year ended December 31,
1995 and 1994 and the balance sheet data as of December 31, 1996, 1995 and 1994
are derived from audited Consolidated Financial Statements not included herein.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
Selected Statement of Earnings Data
Net sales................................. $287,063 $259,325 $281,893 $257,996 $172,125
Earnings from operations(1)............... 14,081 9,756 7,190 6,885 19,145
Earnings.................................. 7,181 4,495 3,102 3,136 10,985
Net earnings per common share(2).......... .63 .40 .27 .27 .98
Weighted average common shares
outstanding(2).......................... 11,437 11,337 11,333 11,421 11,225
AS OF DECEMBER 31,
--------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Selected Balance Sheet Data
Working capital........................... $ 35,306 $ 25,708 $ 21,665 $ 12,187 $ 12,055
Total assets.............................. 227,344 224,777 226,981 219,030 173,641
Long-term debt, excluding current
installments............................ 20,116 20,246 26,670 28,973 4,409
Total shareholders' equity................ 158,755 151,212 146,589 143,381 139,897
- -------------------------
(1) Amount includes special charges of $1,564,000, $750,000, and $1,395,000 in
1998, 1997 and 1996, respectively.
(2) Earnings per share and weighted average common shares outstanding are
presented on a diluted basis.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The discussion in this section contains forward-looking information that is
subject to certain risks, trends and uncertainties that could cause actual
results to differ materially from those projected, expressed or implied by such
forward looking information. The Company's actual results could differ
materially from those discussed 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" above. Among these risks are legislative acts,
weather conditions, changes in the market value of salvage, outcome of
litigation, competition, quality and quantity of inventory available from
suppliers, and dependence on key insurance company suppliers.
OVERVIEW
The Company offers insurance companies and other vehicle suppliers
cost-effective salvage processing solutions through a variety of different
methods of sale, including percentage of sale consignment, fixed fee consignment
and purchase agreement. Under the purchase agreement sales method, the vehicle
is owned by the Company and the sales price of the vehicle is recorded in
revenue. Under the fixed fee and percentage of sale consignment sales methods,
the vehicle is not owned by the Company and only the fees associated with the
processing and sale of the vehicle are recorded in net sales. By assuming some
of the risk inherent in owning the salvage vehicle instead of selling on a
consignment basis, the Company is potentially able to increase profits by
improving the value of the salvage vehicle prior to the sale. The percentage of
sale consignment method offers potentially increased profits over fixed fee
consignment by providing incentive to both the Company and the salvage provider
to invest in vehicle enhancements thereby maximizing the vehicle selling prices.
Under the purchase agreement method, IAA generally pays the insurance
company a pre-determined percentage of the Actual Cash Value ("ACV") to purchase
the vehicle, pursuant to the purchase agreement. ACV's are the estimated
pre-accident fair value of a vehicle, adjusted for additional equipment, mileage
and other factors. Until the significant rise in used car prices and ACV's from
1993 to 1996, the conversion from consignment sales to purchase agreement sales
generally benefited the Company. During this period, however, used car prices
and ACV's rose significantly. Despite the increase in used car prices and ACV's,
prices at salvage auctions did not increase correspondingly. Because the
Company's purchase price is fixed by contract, the increased ACV's can and has
reduced profitability on the sale of vehicles under the purchase agreement
method.
The Company has renegotiated most of its purchase agreement contracts and
seeks to renegotiate certain others. The Company has added adjustment and
risk-sharing clauses to its new standard purchase agreement contracts designed
to provide some protection to the Company and its customers from certain
unexpected, significant changes in the ACV/salvage price relationship.
Since its initial public offering, the Company has grown primarily through
a series of acquisitions to now include 50 locations as of December 31, 1998. In
February of 1998, the Company acquired Auto Disposal Company, Inc. which
operated two pools in Alabama. The Company also added a site in Northern
California in 1998.
The Company's operating results are subject to fluctuations, including
quarterly fluctuations, that can result from a number of factors, some of which
are more significant for sales under the purchase agreement method. See "Factors
That May Affect Future Results" above for a further discussion of some of the
factors that affect or could affect the Company's business, operating results
and financial condition.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE YEAR ENDED DECEMBER 31, 1997
Net sales of the Company increased to $287,063,000 for the year ended
December 31, 1998, from $259,325,000 in 1997, an 11% increase. An 8% increase in
unit volume to 474,000 units in 1998, versus
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440,000 units in 1997, accounted for a major portion of the increased sales
dollars. The number of vehicles processed through purchase agreements
represented 30% of all vehicles for both 1998 and 1997.
Gross profit was $70,309,000 for the year ended December 31, 1998, compared
to $59,342,000 in 1997, an 18% increase. Gross profit per unit of $148 for the
year ended December 31, 1998 was 10% higher than for the comparable period of
1997. The increased profitability was due to the implementation of fee
increases, the acquisition of two locations in Alabama and the impact of El Nino
on weather conditions on the West Coast during the first half of 1998, which
resulted in higher-value cars being available for sale.
Direct operating expenses were $50,885,000 for the year ended December 31,
1998, versus $45,046,000 in 1997, a 13% increase. This increase reflects a
general increase in operating expenses and the funding commitment made by the
Company to identify, develop and pilot new services that will streamline the
automobile total loss claims process, resulting in reduced costs for insurance
companies. The Alabama acquisition also contributed to the increase in expense.
Amortization of acquisition costs of $3,779,000 for the year ended December 31,
1998 were flat as compared to 1997.
During the first quarter of 1998 a settlement agreement was entered into by
the Company resolving all outstanding differences between Insurance Auto
Auctions, Inc. and Bradley Scott, who has resigned as a director and Chairman of
the Board. In the settlement agreement, various agreements were terminated
(including agreements providing for compensation and certain benefits through
September 30, 1999, and all outstanding stock options). Per the settlement
agreement, the Company made a lump-sum payment of $700,000 to Scott. This
included a bonus payment for 1997 of $126,000 pursuant to a 1996 agreement
between the Company and Scott. The difference of $574,000 was recorded as a
special charge in first quarter 1998.
McKinsey & Co. was retained by the Company to assist it in identifying and
developing additional customer-valued services, focusing on opportunities to add
value to the insurance industry's automobile claims process and reduce costs for
these organizations. The scope of the work completed also included the
evaluation and development of new business offerings that leverage the Company's
current competencies, geographic presence and assets. The cost of the project of
$990,000 was recorded as a special charge in first quarter 1998.
Interest expense decreased to $2,055,000 for the year ended December 31,
1998, from $2,253,000 in 1997. The decrease in interest expense was attributable
to the repayment of the proceeds of several notes payable to sellers related to
certain acquisitions. Interest income decreased to $797,000 for the year ended
December 31, 1998, from $821,000 in 1997.
The effective income tax rate of the Company was 44% in 1998 versus 46% in
1997. The decrease in the effective income tax rate was largely due to higher
pre-tax earnings reducing the impact of permanent book versus tax differences.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996
Net sales of the Company were $259,325,000 for the year ended December 31,
1997, from $281,893,000 in 1996, an 8% decrease. This is largely the result of
the change in mix of unit volume from purchase agreement to the consignment
method due to the company's decision to renegotiate or terminate specific,
unprofitable purchase agreements. Unit volume decreased 1%, as compared to the
same period in 1996, while existing facilities volume decreased by the same 1%.
Net sales and unit volume growth from existing facilities were the same as for
the Company overall as there were no significant acquisitions or new facility
startups in 1996 or 1997. The purchase agreement sales method of processing
accounted for 134,000 vehicles or 30% of total volume, down 10% from 1996.
Gross profit was $59,342,000 for the year ended December 31, 1997, compared
to 58,749,000 in 1996, a 1% increase. Gross profit per unit of $135 for the year
ended December 31, 1997 was 2% higher than for the comparable period of 1996,
largely due to the Company's decision to renegotiate or terminate specific,
unprofitable purchase agreements.
Direct operating expenses decreased to $45,046,000 for the year ended
December 31, 1997, from $46,386,000 in 1996, a 3% decrease. The decrease in
direct operating expenses was the result of management's
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focus on process enhancements and expense control during 1997. Direct operating
expenses as a percentage of net sales were 1% higher than for the same period in
1996, due to fewer units sold. Amortization of acquisition costs of $3,790,000
for the year ended December 31, 1997 were flat as compared to $3,778,000 for the
comparable period in 1996.
During 1997, the Company settled a securities class action lawsuit that had
been pending against the Company and certain of its present and former officers
and directors, in the United States District Court for the Central District of
California. The litigation was settled for $3.75 million, the substantial
portion of which was paid by the Company's directors' and officers' liability
insurance company. The difference of $750,000 was recognized as a special charge
in 1997. In February 1998, the settlement was approved the court.
Interest expense decreased to $2,253,000 for the year ended December 31,
1997, from $2,638,000 in 1996. The decrease in interest expense is mostly
attributable to the repayment of several notes payable to sellers of certain
acquisitions.
Interest income decreased to $821,000 for the year ended December 31, 1997,
from $890,000 in 1996. The change in interest income was attributable to a
decrease in interest-bearing investments liquidated during 1996 to repay several
notes payable to sellers of certain acquisitions and the proceeds from long-term
borrowings under the Company's $15,000,000 revolving line of credit facility.
Income taxes increased to $3,829,000 for the year ended December 31, 1997,
from the $2,340,000 in 1996. The increase of $1,489,000 was the result of a
higher tax rate incurred by the Company in 1997 and increased net earnings
before taxes.
FINANCIAL CONDITION AND LIQUIDITY
At December 31, 1998, the Company had current assets of $73,140,000,
including $11,682,000 of cash and cash equivalents, current liabilities of
$37,834,000 and working capital of $35,306,000. The $9,598,000 increase in
working capital from December 31, 1997 primarily consisted of an increase in
advance charges on vehicles in inventory reflecting strong vehicle assignments
in the fourth quarter of 1998. These advance charges are recorded as receivables
when vehicles are picked up and deducted from proceeds from vehicle sales
remitted to the salvage providers.
At December 31, 1998, the Company's indebtedness included 8.6% Senior Notes
approximating $19,801,000 that mature in 2002 and amounts due to the sellers
related to an acquisition aggregating $288,000, with imputed interest at 7.5%
and amounts due to the sellers of smaller acquisitions aggregating $243,000,
which bear interest at 8.0%. The Company also has a $15,000,000 revolving credit
facility. At December 31, 1998, there were no outstanding borrowings under the
facility.
Long-term liabilities also include a post-retirement benefits liability
relating to the Underwriters Salvage Company acquisition of approximately
$3,485,000.
Capital expenditures were approximately $6,607,000 for the year ended
December 31, 1998. These capital expenditures included upgrading and expanding
the Company's facilities and management information systems. The Company also
spent $1,806,000 on acquisitions in 1998. The Company currently leases most of
its facilities and other properties.
The Company believes that cash generated from operations and its borrowing
capacity 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 continued growth possibly through new facility start-ups, acquisitions,
and the development of new claims processing services. At some time in the
future, the Company may require additional financing. There can be no assurance
that additional financing, if required, will be available on favorable terms.
The Company's operating results have not historically been materially
affected by inflation.
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RECENT DEVELOPMENTS
Effective December 1, 1993, the Company entered into a national sales
agreement with Allstate Insurance Company (Allstate) (a shareholder of the
Company). The agreement expired as of December 31, 1998. At Allstate's
invitation, the Company submitted a proposal to provide automobile salvage
services for Allstate locations across the country. Allstate requested this
proposal as part of a comprehensive review of Allstate's automobile salvage
disposition practices. Several other providers of automobile salvage services
are believed to have submitted proposals to Allstate. Allstate recently advised
the Company that it had decided to not award all of its salvage business to a
single vendor at this time.
Allstate further advised the Company that it intends to conduct pilots at
selected Allstate locations of a single vendor approach for all of its salvage
disposition needs, although it does not know if the pilots will result in the
awarding of a single source contract. Although the Company is not currently
involved in the pilots, the Company is continuing its efforts to offer Allstate
a single source salvage solution. Allstate indicated the pilots would not have a
material impact on the volume of vehicles supplied to the Company by Allstate.
However, no assurance can be given as to the results of Allstate's pilot of a
single source solution or the interim impact on the volumes of vehicles supplied
by Allstate to the Company.
Under the original agreement, local Allstate management was, as it
continues to be in most Allstate locations, ultimately responsible for deciding
who will be the provider of automotive salvage services for their geographic
area of responsibility. As such, the Company continues to work with local
Allstate management and personnel to meet Allstate's customer service level
requirements and intends to work aggressively to maintain and increase the
amount of business it receives from Allstate, as well as to maintain the
profitability of that business. However, no assurance can be given as to the
results of these efforts and the Company may receive less, or less profitable
business from Allstate than it currently does.
Volumes of vehicles received from Allstate has decreased from 90,000 units
in 1996 to 64,500 units in 1998, part of which was due to the termination by the
Company of unprofitable purchase agreement contracts. Given the above, and the
significant decline in the volume of vehicles received from Allstate, the
Company is reviewing all aspects of its relationship with Allstate. The Company
intent has been and continues to be to maintain a profitable relationship with
Allstate. However, no assurances can be given in this matter. A significant
reduction in Allstate business could have a material, adverse impact on the
Company's financial condition and results of operations.
The Company undertook an initiative, ("the Project"), in mid 1997, the
objective of which is to determine and assess the risks of the Year 2000 issue,
and plan and institute mitigating actions to minimize those risks. The Project
team is being led by the Company's Senior Vice President and Chief Financial
Officer. The scope of the Project includes both IT based systems and non IT
systems. Modifications required to bring the Company's IT systems into Year 2000
compliance were identified by the Project team. Based on work completed by the
Project team, the Company does not believe its non-IT system Year 2000
compliance issues represent a significant risk to the Company.
The required modifications to the Company's standard transaction processing
system ("ESPS") have been completed. Based on the findings of the Project team
and the successful implementation of these required modifications, the Company
believes this system is currently Year 2000 compliant in all material respects.
However, certain of the Company's operations have yet to be converted from
non-Year 2000 compliant legacy systems currently in use to ESPS. These
operations are scheduled for conversion by October 1, 1999, although no
assurances can be given the conversion will be completed on schedule. Failure to
convert these operations on a timely basis could have a material adverse impact
on the company's financial position, results of operations or liquidity.
The Company may be impacted by the effect the Year 2000 issue has on the
ability of the Company's Insurance customers to process automobile claims and
state departments of motor vehicles ("DMV's") to process titles on a timely
basis. Any delay in the timely processing of automobile claims that
significantly reduces the number of units the Company has available for sale
would have a material adverse affect on the Company's financial position,
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results of operations or liquidity. In addition, the Company relies on state
DMV's to timely process titles to vehicles. Because the Company must generally
obtain title prior to selling a vehicle, a significant delay in title processing
would impact the Company's ability to sell vehicles from inventory and have a
material adverse impact on the company's financial position, results of
operations or liquidity.
The Company has been, and will continue to be, in communication with its
principal insurance customers and the DMV's with regard to their Year 2000
readiness. None of the responses received to date suggests there will be any
interruption in their operations which would have a material adverse impact on
the Company although there can be no assurances given in this regard.
Contingency plans will be completed during the second quarter of 1999.
The cost to the Company of dealing with the Year 2000 issue is not expected
to be material. Although a portion of the time of IT personnel and related
management has been and will be employed in evaluating the problem, taking
corrective actions and preparing contingency plans, the Company does not believe
other IT projects or operations have been or will be adversely affected. Costs
of review, analysis and corrective action are expected to total less than
$100,000.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company had approximately $11,138,000 of short-term investments as of
December 31, 1998. These investments largely consisted of state government
obligations and had either variable rates of interest or stated interest rates
ranging from 3 1/4% to 7%. The Company's short-term investments are exposed to
certain market risks inherent with such assets. This risk is mitigated by the
Company's policy of investing in securities with high credit ratings and
investing through major financial institutions with high credit ratings.
The Company has senior notes payable of $19,801,000 at an interest rate of
8.6%. The terms of the note agreement are such that pre-payment of such debt
may not be advantageous to the Company in the event that funds may be available
to the Company at a lower rate of interest.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Item 14(a) for an index to the financial statements and supplementary
financial information, which are attached hereto.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
19
20
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information with respect to Directors is included under the caption
"Nominees" in the Registrant's Proxy Statement (the "Proxy Statement") to be
filed with the Securities and Exchange Commission and incorporated herein by
reference. The information under the caption "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Proxy Statement to be filed with the Securities and
Exchange Commission is incorporated herein by reference. Information with
respect to Executive Officers may be found on pages 11 to 12 herein, under the
caption "Executive Officers of the Registrant."
ITEM 11. EXECUTIVE COMPENSATION.
Information required by this item is included under the captions
"Compensation of Directors," "Executive Compensation," "Stock Options,"
"Employment Contracts and Change-in-Control Arrangements" and "Compensation
Committee Interlocks and Insider Participation" in the Registrant's Proxy
Statement to be filed with the Securities and Exchange Commission and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information required by this item is included under the caption "Ownership
of Securities" in the Registrant's Proxy Statement to be filed with the
Securities and Exchange Commission and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information required by this item is included under the caption "Certain
Relationships and Related Transactions" in the Registrant's Proxy Statement to
be filed with the Securities and Exchange Commission and is incorporated herein
by reference.
20
21
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(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 report on Form 10-K:
PAGE
----
Independent Auditors' Report................................ 25
Consolidated Balance Sheets -- December 31, 1998 and
December 31, 1997......................................... 26
Consolidated Statements of Earnings -- Years ended December
31, 1998, 1997 and 1996................................... 27
Consolidated Statements of Shareholders' Equity -- Years
ended December 31, 1998, 1997 and 1996.................... 28
Consolidated Statements of Cash Flows -- Years ended
December 31, 1998, 1997 and 1996.......................... 29
Notes to Consolidated Financial Statements.................. 30
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 14(c) below.
(B) REPORTS ON FORM 8-K. No reports on Form 8-K were filed by the Company
during the three-month period ended December 31, 1998.
(C) EXHIBITS
EXHIBIT
NO DESCRIPTION
------- -----------
3.1 Articles of Incorporation of the Registrant, as filed with
the Illinois Secretary of State on August 7, 1997.
3.2 Bylaws of the Registrant.
4.1(9) Fifth Amended and Restated Registration Rights Agreement,
dated September 23, 1994, by and among the Registrant,
William W. Liebeck, Bradley S. Scott, Bob F. Spence, Corinne
Spence, Jimmie A. Dougherty, Patricia L. Dougherty and
Midwest Auto Pool Corporation.
4.2(1) Warrant, dated January 18, 1990, issued by Registrant to
Westinghouse Credit Corporation ("WCC") to purchase 176,056
shares of Series A Common Stock of Registrant ("WCC
Warrant").
4.3(1) Specimen Stock Certificate.
4.4(5) Stockholder Agreement dated December 1, 1993, by and among
the Registrant, Tech-Cor, Inc., Bradley S. Scott, Bob F.
Spence and William L. Liebeck.
4.5(5) Registration Agreement dated December 1, 1993, by and among
the Registrant and Tech-Cor.
4.5(8) Note Agreement, dated as of December 1, 1994 among the
Registrant and the purchasers listed therein.
10.35(4)* Insurance Auto Auctions, Inc. 1991 Stock Option Plan, as
amended and restated.
10.36(6)* Form of Notice of Grant of Stock Option -- employee,
officer.
21
22
EXHIBIT
NO DESCRIPTION
------- -----------
10.37(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.
10.38(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).
10.39(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.
10.40(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.
10.41(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.
10.66(2) Facilities Lease Agreement dated January 17, 1992, by and
between Melvin R. Martin and MASP.
10.122(5) Asset Purchase Agreement dated December 1, 1993, by and
between the Registrant, BC Acquisition Corp. (a wholly owned
subsidiary of Registrant ("BCAC") and Tech-Cor, Inc.
("Tech-Cor").
10.124(5) License Agreement, dated December 1, 1993, by and between
BCAC and Allstate Insurance Company.
10.125(5) Transition Agreement dated December 1, 1993, by and between
BCAC and Tech-Cor.
10.126(5) Lease, dated December 1, 1993, by and between Allstate
Insurance Company and BCAC.
10.127(5) Guaranty, dated December 1, 1993, by Allstate Insurance
Company and delivered to the Registrant and BCAC.
10.134(7) Registration Rights Agreement dated January 20, 1994, by and
among, the Registrant, Christopher G. Knowles, Gerald C.
Comis, F. Peter Haake and Donald J. Comis.
10.146(10)+ Revised Salvage Agreement by and between the Registrant and
Allstate Insurance Company dated April 29, 1996.
10.147(10)* Employment Agreement by and between the Registrant and James
P. Alampi dated March 11, 1996.
10.149(12)* Form of Change of Control Employment Agreement by and
between the Company and certain of its executive officers.
10.150(11) Revolving Credit Agreement between the Registrant and
LaSalle National Bank dated as of April 4, 1997.
10.151(12) Amendment to Revolving Credit Agreement dated as of December
1, 1997.
10.152*(11) Insurance Auto Auctions, Inc. Employee Stock Purchase Plan,
as amended as of June 18, 1997.
10.153 Form of Indemnification Agreement dated as of February 24,
1999 by and between the Company and its Directors and
Executive Officers.
22
23
EXHIBIT
NO DESCRIPTION
------- -----------
10.154* Consulting Agreement dated as of December 1, 1998 by and
between the Company and Thomas J. O'Malia
10.155* Agreement dated December 16, 1998 by and between the Company
and James P. Alampi.
21.1 Subsidiaries of the Registrant.
23.1 Consent of KPMG LLP.
24.1 Power of Attorney.
27.1 Financial Data Schedule.
- -------------------------
(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. O-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. O-19594) for the fiscal year ended
December 31, 1992.
(4) Incorporated by reference from an exhibit included in the Registrant's
Quarterly Report on Form 10-Q (File No. O-19594) for the fiscal quarter
ended June 30, 1993.
(5) Incorporated by reference from an exhibit included in the Registrant's
Current Report on Form 8-K (File No. O-19594) filed with the SEC on
December 15, 1993.
(6) Incorporated by reference from an exhibit included in the Registrant's
Annual Report on Form 10-K (File No. O-19594) for the fiscal year ended
December 31, 1993.
(7) Incorporated by reference from an exhibit included in the Registrant's
Current Report on Form 8-K (File No. O-19594) filed with the SEC on
February 3, 1994.
(8) Incorporated by reference from an exhibit included in the Registrant's
Current Report on Form 8-K (File No. O-19594) filed with the SEC on
February 10, 1995.
(9) 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, 1994.
(10) (15) Incorporated by reference from an exhibit included in the Registrant's
Quarterly Report on Form 10-Q (File No. O-19594) filed with the SEC on
August 5, 1996 as amended.
(11) Incorporated by reference from an exhibit included in the Registrant's
Quarterly Report on Form 10-Q (File No. O-19594) for the fiscal quarter
ended June 30, 1997.
(12) Incorporated by reference from an exhibit included in the Registrant's
Annual Report on Form 10K (File No. O-19594) for the fiscal year ended
December 31, 1997.
+ Certain portions of this document were granted confidential treatment
pursuant to an order from the SEC.
* 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.
23
24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
INSURANCE AUTO AUCTIONS, INC.
By: /s/ CHRISTOPHER G. KNOWLES
------------------------------------
Date: March 31, 1999 Chief Executive Officer
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 31st day of March, 1999
/s/ CHRISTOPHER G. KNOWLES Chief Executive Officer, Director
- ----------------------------------------------------- (Principal Executive Officer)
Christopher G. Knowles
/s/ LINDA C. LARRABEE Senior Vice President, Business Development,
- ----------------------------------------------------- Chief Financial Officer and Secretary
Linda C. Larrabee (Principal Financial Officer)
/s/ STEPHEN L. GREEN Vice President, Finance and Assistant
- ----------------------------------------------------- Secretary (Principal Accounting Officer)
Stephen L. Green
* Chairman of the Board of Directors
- -----------------------------------------------------
Thomas J. O'Malia
* Director
- -----------------------------------------------------
Maurice A. Cocca
* Director
- -----------------------------------------------------
Susan B. Gould
* Director
- -----------------------------------------------------
Peter H. Kamin
* Director
- -----------------------------------------------------
Melvin R. Martin
* Director
- -----------------------------------------------------
Joseph F. Mazzella
* Director
- -----------------------------------------------------
Glen E. Tullman
* Director
- -----------------------------------------------------
John K. Wilcox
* As attorney-in-fact.
24
25
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Insurance Auto Auctions, Inc.:
We have audited the Consolidated Financial Statements of Insurance Auto
Auctions, Inc. and subsidiaries, as listed in the accompanying index. 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 generally accepted auditing
standards. 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 financial position of Insurance
Auto Auctions, Inc. and subsidiaries as of December 31, 1998 and 1997 and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1998 in conformity with generally accepted
accounting principles.
KPMG LLP
Chicago, Illinois
February 15, 1999
25
26
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31
1998 1997
---- ----
ASSETS
Current assets:
Cash and cash equivalents................................. $ 11,682,000 $ 25,972,000
Short-term investments.................................... 11,138,000 1,367,000
Accounts receivable, net.................................. 37,415,000 28,992,000
Inventories............................................... 11,229,000 11,762,000
Other current assets...................................... 1,676,000 1,868,000
------------ ------------
Total current assets................................. 73,140,000 69,961,000
------------ ------------
Property and equipment, at cost:
Land and buildings........................................ 6,266,000 6,128,000
Furniture and fixtures.................................... 1,578,000 1,481,000
Machinery and equipment................................... 19,126,000 16,830,000
Leasehold improvements.................................... 14,007,000 13,268,000
------------ ------------
40,977,000 37,707,000
Less accumulated depreciation and amortization............ 18,665,000 16,929,000
------------ ------------
Net property and equipment........................... 22,312,000 20,778,000
Deferred income taxes....................................... 2,976,000 2,603,000
Intangible assets, principally goodwill, net................ 128,916,000 131,435,000
------------ ------------
$227,344,000 $224,777,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current installments of long-term debt.................... $ 216,000 $ 2,034,000
Accounts payable.......................................... 30,939,000 34,024,000
Accrued liabilities....................................... 6,097,000 7,698,000
Income taxes.............................................. 582,000 497,000
------------ ------------
Total current liabilities............................ 37,834,000 44,253,000
------------ ------------
Long-term debt, excluding current installments.............. 20,116,000 20,246,000
Accumulated postretirement benefits obligation.............. 3,485,000 3,831,000
Deferred income taxes....................................... 7,154,000 5,235,000
------------ ------------
Total liabilities.................................... 68,589,000 73,565,000
------------ ------------
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; issued and outstanding
11,327,169 and 11,299,561 shares as of December 31,
1998 and December 31, 1997, respectively............... 11,000 11,000
Additional paid-in capital.................................. 132,171,000 131,809,000
Retained earnings........................................... 26,573,000 19,392,000
------------ ------------
Total shareholders' equity............................. 158,755,000 151,212,000
------------ ------------
$227,344,000 $224,777,000
============ ============
See accompanying Notes to Consolidated Financial Statements.
26
27
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE YEARS ENDED DECEMBER 31
1998 1997 1996
---- ---- ----
Net sales:
Vehicle sales.................................... $191,312,000 $175,733,000 $201,104,000
Fee income....................................... 95,751,000 83,592,000 80,789,000
------------ ------------ ------------
287,063,000 259,325,000 281,893,000
Costs and expenses:
Cost of sales.................................... 216,754,000 199,983,000 223,144,000
Direct operating expenses........................ 50,885,000 45,046,000 46,386,000
Amortization of acquisition costs................ 3,779,000 3,790,000 3,778,000
Special charges.................................. 1,564,000 750,000 1,395,000
------------ ------------ ------------
Earnings from operations...................... 14,081,000 9,756,000 7,190,000
Other (income) expense:
Interest expense................................. 2,055,000 2,253,000 2,638,000
Interest income.................................. (797,000) (821,000) (890,000)
------------ ------------ ------------
Earnings before income taxes.................. 12,823,000 8,324,000 5,442,000
Income taxes....................................... 5,642,000 3,829,000 2,340,000
------------ ------------ ------------
Net earnings.................................. $ 7,181,000 $ 4,495,000 $ 3,102,000
============ ============ ============
Earnings per share
Basic............................................ $ .63 $ .40 $ 28
============ ============ ============
Diluted.......................................... $ .63 $ .40 $ .27
============ ============ ============
Weighted average shares outstanding:
Basic............................................ 11,316,000 11,294,000 11,279,000
============ ============ ============
Diluted.......................................... 11,437,000 11,337,000 11,333,000
============ ============ ============
See accompanying Notes to Consolidated Financial Statements
27
28
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK
--------------------- ADDITIONAL TOTAL
NUMBER PAID-IN RETAINED SHAREHOLDERS'
OF SHARES AMOUNT CAPITAL EARNINGS EQUITY
--------- ------ ---------- -------- -------------
Balance at December 31, 1995.... 11,270,141 $11,000 $131,575,000 $11,795,000 $143,381,000
Issuance of common stock in
connection with exercise of
common stock options.......... 2,000 -- 13,000 -- 13,000
Issuance of common stock in
connection with the employee
stock purchase plan........... 10,697 -- 93,000 -- 93,000
Net earnings.................... -- -- -- 3,102,000 3,102,000
---------- ------- ------------ ----------- ------------
Balance at December 31, 1996.... 11,282,838 11,000 131,681,000 14,897,000 146,589,000
Issuance of common stock in
connection with exercise of
common stock options.......... 8,600 -- 49,000 -- 49,000
Issuance of common stock in
connection with the employee
stock purchase plan........... 8,123 -- 79,000 -- 79,000
Net earnings.................... -- -- -- 4,495,000 4,495,000
---------- ------- ------------ ----------- ------------
Balance at December 31, 1997.... 11,299,561 11,000 131,809,000 19,392,000 151,212,000
Issuance of common stock in
connection with exercise of
common stock options.......... 16,400 -- 198,000 -- 198,000
Issuance of common stock in
connection with the employee
stock purchase plan........... 11,208 -- 164,000 -- 164,000
Net earnings.................... -- -- -- 7,181,000 7,181,000
---------- ------- ------------ ----------- ------------
Balance at December 31, 1998.... 11,327,169 $11,000 $132,171,000 $26,573,000 $158,755,000
========== ======= ============ =========== ============
See accompanying notes to Consolidated Financial Statements
28
29
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31
1998 1997 1996
---- ---- ----
Cash flows from operating activities:
Net earnings....................................... $ 7,181,000 $ 4,495,000 $ 3,102,000
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization................... 8,765,000 8,671,000 8,579,000
Loss (gain) on disposal of fixed assets......... 136,000 (151,000) --
Noncash special charges......................... -- 465,000
Changes in assets and liabilities (net of
effects of acquired companies):
(Increase) decrease in:
Short-term investments..................... (9,771,000) 337,000 (1,443,000)
Accounts receivable, net................... (7,985,000) 5,379,000 (3,998,000)
Inventories................................ 533,000 (1,600,000) (667,000)
Other current assets....................... 192,000 1,762,000 (39,000)
Other assets............................... 60,000 932,000 287,000
Increase (decrease) in:
Accounts payable........................... (3,085,000) 3,055,000 1,967,000
Accrued liabilities........................ (1,753,000) (3,792,000) 403,000
Income taxes............................... 1,631,000 1,143,000 (441,000)
------------ ----------- -----------
Total adjustments........................ (11,277,000) 15,736,000 5,113,000
------------ ----------- -----------
Net cash provided by operating activities....... (4,096,000) 20,231,000 8,215,000
------------ ----------- -----------
Cash flows from investing activities:
Proceeds from disposition of property and
equipment....................................... 151,000 696,000 698,000
Capital expenditures............................... (6,607,000) (4,608,000) (5,910,000)
Payments made in connection with acquisitions (net
of cash acquired)............................... (1,806,000) (311,000) (1,969,000)
------------ ----------- -----------
Net cash used in investing activities......... (8,262,000) (4,223,000) (7,181,000)
------------ ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock............. 362,000 128,000 107,000
Principal payments of long-term debt............... (2,294,000) (7,303,000) (3,909,000)
Proceeds from line of credit....................... -- -- 4,589,000
------------ ----------- -----------
Net cash provided by (used in) financing
activities................................. (1,932,000) (7,175,000) 787,000
------------ ----------- -----------
Net increase (decrease) in cash and cash
equivalents................................ (14,290,000) 8,833,000 1,821,000
Cash and cash equivalents at beginning of year....... 25,972,000 17,139,000 15,318,000
------------ ----------- -----------
Cash and cash equivalents at end of year............. $ 11,682,000 $25,972,000 $17,139,000
============ =========== ===========
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest........................................ $ 1,836,000 $ 4,411,000 $ 2,793,000
Income taxes.................................... $ 4,028,000 $ 2,364,000 $ 3,570,000
See accompanying notes to consolidated financial statements.
29
30
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES
BACKGROUND
Insurance Auto Auctions, Inc. (the Company) provides insurance companies
and other vehicle suppliers cost-effective salvage processing solutions
including selling total loss and recovered theft vehicles. The Company operates
as a single operating segment.
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.
REVENUE RECOGNITION
Revenue (including vehicle sales and fee income) are recognized upon
payment by the buyer for the auctioned vehicle.
CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Cash equivalents consist principally of commercial paper. For purposes of
the consolidated statements of cash flows, the Company considers all highly
liquid investments with original maturities of three months or less to be cash
equivalents.
The Company's short-term investment securities are principally instruments
of state governments, agencies and municipalities. All short-term investment
securities are classified as trading securities and are carried at fair value.
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 are charged to operations based upon the
specific-identification method.
The Company has agreements to purchase total loss and recovered theft
vehicles from insurance companies for a percentage of the vehicle's actual cash
value. The Company has acquired the majority of its inventory pursuant to these
contracts.
ASSET IMPAIRMENT
As part of an ongoing review of the valuation and amortization of assets,
management assesses the carrying value of the Company's assets if facts and
circumstances suggest that such assets may be impaired. If this review indicates
that the assets will not be recoverable, as determined by an undiscounted cash
flow analysis over the remaining amortization period, the carrying value of the
Company's assets would be reduced to their estimated fair market 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 assets and
liabilities to prepare these Consolidated Financial
30
31
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
Statements in conformity with generally accepted accounting principles. Actual
results could differ from these estimates.
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 ten 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.
Intangible assets, principally goodwill, are amortized over periods of 15
to 40 years on a straight-line basis. Accumulated amortization at December 31,
1998 and 1997 was $18,854,000 and 15,075,000, respectively.
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.
CREDIT RISK
The Company sells its vehicles principally to customers throughout the
United States under the purchase-agreement method, the fixed-fee-consignment
method and the percentage-of-sale-consignment method. Actual sales of 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 the vehicle supplier, most of which are insurance companies, are generally
satisfied from the net proceeds payable to the insurance company. 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
insurance company. 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.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments approximate fair value as of
December 31, 1998 and 1997. The carrying amounts related to cash and cash
equivalents, accounts receivable, other current assets and accounts payable
approximate fair value due to the relatively short maturity of such instruments.
The fair value of long-term debt is estimated by discounting the future cash
flows of each instrument at rates currently available to the Company for similar
debt instruments of comparable maturities by the Company's bankers. Short-term
investments are classified as trading securities and are carried at fair value
based on quoted market prices.
STOCK COMPENSATION
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" (Statement No. 123), issued in October 1995 and
effective for fiscal years beginning after December 15, 1995, permits, but does
not require, a fair-value based method of accounting for employee stock options
or similar equity instruments. Statement No. 123 allows an entity to elect to
continue to measure compensation cost under Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees'
(APBO No. 25), but requires pro forma disclosures of net earnings and net
earnings per share as if the fair-value based method of accounting had been
applied. Effective January 1, 1996, the Company elected to continue to measure
compensation cost under APBO No. 25 and comply with the pro forma disclosure
31
32
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
requirements. Accordingly, the adoption of Statement No. 123 had no material
impact on the Company's consolidated financial position or results of
operations.
EARNINGS PER SHARE
Statement of Financial Accounting Standards ("S.F.A.S.") No. 128, "Earnings
per Share", issued in March 1997 and effective for fiscal years ending after
December 15, 1997, requires the presentation of "Basic" earnings per share,
which represents net earnings divided by the weighted average number of shares
outstanding. Presentation of "Diluted" earnings per share, which reflects the
dilutive effects of potentially issuable common stock equivalents as determined
by the treasury stock method, is also required. The Diluted presentation is
similar to the historical presentation of fully diluted earnings per share. The
Company has adopted Statement No. 128, effective January 1, 1997. Adoption of
the Statement had no material impact on the Company's consolidated financial
position or results of operations.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1997 and 1996 financial
statements and footnotes to conform with the current year presentation.
(2) LONG-TERM DEBT
Long-term debt is summarized as follows:
1998 1997
---- ----
Senior notes payable, net of related loan fees, unsecured,
interest payable in semiannual installments commencing
August 15, 1995 through maturity at February 15, 2002, at
8.60%, principal due at maturity.......................... $19,801,000 $19,715,000
Notes payable issued in connection with the acquisition of a
subsidiary, secured by capital stock purchased in the
acquisition, interest payable quarterly at 7.5%, principal
payable in three annual installments beginning June 30,
1996...................................................... -- 1,833,000
Notes payable issued in connection with a consulting
agreement related to the acquisition of a subsidiary,
unsecured, payable in monthly installments of $16,666,
including interest at 7.5%, with final payment due June
30, 2000.................................................. 288,000 460,000
Notes payable issued in connection with the acquisition of a
certain subsidiary, unsecured, payable in monthly
installments, including interest at 8%, with final payment
due April 1, 2005......................................... 243,000 272,000
----------- -----------
20,332,000 22,280,000
Less current installments................................... 216,000 2,034,000
----------- -----------
$20,116,000 $20,246,000
=========== ===========
32
33
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
Total principal repayments required for each of the next five years under
all long-term debt agreements are summarized as follows:
1999........................................................ $ 216,000
2000........................................................ 138,000
2001........................................................ 37,000
2002........................................................ 19,841,000
2003........................................................ 44,000
Thereafter.................................................. 56,000
-----------
$20,332,000
===========
The Senior Notes and line of credit require the Company to comply with
certain covenants such as maintenance of net worth and limitations on debt. As
of December 31, 1998, the Company was in compliance with these covenants.
The Company has a revolving line of credit facility with LaSalle National
Bank. The $15,000,000 facility is unsecured, bears interest at the bank's prime
rate or LIBOR, as defined, and expires on April 1, 2000.
(3) SHORT-TERM INVESTMENTS
At December 31, 1998 and 1997, the Company has classified all investment
securities as trading securities. The investments are carried at fair value
which is not materially different from amortized cost.
Maturities of investment securities classified as trading securities were
as follows:
1998 1997
---- ----
STATE GOVERNMENT OBLIGATIONS:
Due within one year........................................ $ 1,173 --
Due after one year through ten years....................... 1,562 $ 410
Due after ten years........................................ 4,451 957
------- -------
Total...................................................... 7,186 1,367
------- -------
OTHER:
Due within one year........................................ 1,252 --
Due after one year through ten years....................... -- --
Due after ten years........................................ 2,700 --
------- -------
Total...................................................... 3,952 --
------- -------
Total Investments.......................................... $11,138 $ 1,367
======= =======
33
34
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(4) INCOME TAXES
Income taxes are summarized as follows:
1998 1997 1996
---- ---- ----
Current:
Federal.................................. $3,528,000 $2,853,000 $ 794,000
State.................................... 569,000 329,000 187,000
---------- ---------- ----------
4,097,000 3,182,000 981,000
---------- ---------- ----------
Deferred:
Federal.................................. 1,318,000 427,000 1,788,000
State.................................... 227,000 220,000 (429,000)
---------- ---------- ----------
1,545,000 647,000 1,359,000
---------- ---------- ----------
$5,642,000 $3,829,000 $2,340,000
========== ========== ==========
Deferred income taxes are comprised of the effects of the components listed
below. A valuation allowance has been recorded to reduce 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 31,
1998 and 1997 are presented below:
1998 1997
---- ----
Deferred tax assets attributable to:
Depreciation........................................ $ 1,778,000 $ 1,609,000
State Net Operating Loss............................ 866,000 690,000
Inventories......................................... 447,000 385,000
Special charges..................................... 152,000 248,000
State income taxes.................................. -- 61,000
Other............................................... 451,000 215,000
Valuation Allowance................................. (718,000) (605,000)
----------- -----------
Net deferred tax assets............................. 2,976,000 2,603,000
Deferred tax liabilities attributable to:
Intangible assets................................... (7,154,000) (5,235,000)
----------- -----------
Net deferred tax liabilities........................ $(4,178,000) $(2,632,000)
=========== ===========
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:
1998 1997 1996
---- ---- ----
"Expected" income taxes.................... $4,360,000 $2,830,000 $1,850,000
State income taxes, net of Federal
benefit.................................. 484,000 254,000 288,000
Amortization of intangible assets.......... 354,000 353,000 406,000
Other...................................... 444,000 392,000 (204,000)
---------- ---------- ----------
$5,642,000 $3,829,000 $2,340,000
========== ========== ==========
34
35
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(5) EMPLOYEE BENEFIT PLANS
The Company adopted the Insurance Auto Auctions, Inc. 1991 Stock Option
Plan (the 1991 Plan), as amended, presently covering 1,350,000 shares of the
Company's common stock. The 1991 Plan provides for the grant of incentive stock
options to key employees and nonqualified stock options and stock appreciation
rights to key employees, directors, consultants and independent contractors. The
1991 Plan expires September 26, 2001. In general, new nonemployee directors will
automatically receive grants of nonqualified options to purchase 10,000 shares
and subsequent grants to purchase 2,000 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, and consultants and
other independent advisors who provide services to the Company. The 1995 Plan
will expire on October 1, 2005.
Under both plans, as of December 31, 1998, options to purchase an aggregate
of 1,129,000 shares were outstanding at a weighted average exercise price of
$14.35 per share and 311,000 shares remained available for future grant.
Activity under the plans for the years ended December 31, 1998 and 1997 is
as follows:
1998 1997 1996
---- ---- ----
Balance at beginning of year............ 1,086,000 1,082,000 1,061,000
Options granted....................... 546,000 43,000 270,000
Options canceled...................... (487,000) (30,000) (247,000)
Options exercised..................... (16,000) (9,000) (2,000)
------------ ----------- -----------
Balance at end of year.................. 1,129,000 1,086,000 1,082,000
============ =========== ===========
Options exercisable at end of year...... 572,000 770,000 588,000
============ =========== ===========
Price range of options outstanding at
end of year........................... $ 7.00-37.50 $7.00-37.50 $7.00-37.50
============ =========== ===========
Price range of options granted during
the year.............................. $10.50-14.25 $8.25- 9.44 $9.25-12.63
============ =========== ===========
The Company applies APB Opinion No. 25 in accounting for its plans, and
accordingly, no compensation cost has been recognized for any stock options in
the accompanying Consolidated Financial Statements. Had the Company determined
compensation expense based upon the fair value at the date of grant, as
determined under Statement No. 123, the Company's net earnings and net earnings
per share would have been reduced to the pro forma amounts as summarized below:
1998 1997 1996
---- ---- ----
Pro forma Earnings......................... $6,554,000 $4,170,000 $2,829,000
========== ========== ==========
Pro forma Earnings per share
Basic.................................... $ .58 $ .37 $ .25
========== ========== ==========
Diluted.................................. $ .57 $ .37 $ .25
========== ========== ==========
The per share weighted average fair value of stock options granted during
1998, 1997 and 1996 was $5.86, $4.60 and $5.25, respectively, based upon a grant
date valuation using the Black-Scholes option pricing model with the following
weighted average assumptions in 1998, 1997 and 1996 -- expected dividend yield
of 0.0%, expected volatility of .61, .64, and .61, respectively; risk-free
interest rate of 5.5%, 5.7% and 6.2%, respectively; and an average expected
option life of 5.7, 4.5 and 4 years, respectively.
35
36
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
The pro forma net earnings and earnings per share reflect only those
options granted since January 1, 1995. Therefore, the full impact of calculating
compensation cost for stock options under Statement No. 123 is not reflected in
the pro forma net earnings and earnings per share presented above because
compensation cost is generally recorded over the options' vesting period,
generally four years, and compensation cost for options granted prior to January
1, 1995 is not considered.
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 and during the years ended December 31, 1998, 1997 and 1996, were
matched 100% up to 4% of eligible earnings. Company contributions to the plan
during the years ended December 31, 1998, 1997 and 1996 were approximately
$479,000, $381,000, and $482,000, respectively.
(6) RELATED PARTY TRANSACTIONS
Effective December 1, 1993, the Company entered into a national sales
agreement with Allstate Insurance Company (Allstate) (a shareholder of the
Company). The agreement expired as of December 31, 1998. At Allstate's
invitation, the Company submitted a proposal to provide automobile salvage
services for Allstate locations across the country. Allstate requested this
proposal as part of a comprehensive review of Allstate's automobile salvage
disposition practices. Several other providers of automobile salvage services
are believed to have submitted proposals to Allstate. Allstate recently advised
the Company that it had decided to not award all of its salvage business to a
single vendor at this time.
Allstate further advised the Company that it intends to conduct pilots at
selected Allstate locations of a single vendor approach for all of its salvage
disposition needs, although it does not know if the pilots will result in the
awarding of a single source contract. Although the Company is not currently
involved in the pilots, the Company is continuing its efforts to offer Allstate
a single source salvage solution. Allstate indicated the pilots would not have a
material impact on the volume of vehicles supplied to the Company by Allstate.
However, no assurance can be given as to the results of Allstate's pilot of a
single source solution or the interim impact on the volumes of vehicles supplied
by Allstate to the Company.
Under the original agreement, local Allstate management was, as it
continues to be in most Allstate locations, ultimately responsible for deciding
who will be the provider of automotive salvage services for their geographic
area of responsibility. As such, the Company continues to work with local
Allstate management and personnel to meet Allstate's customer service level
requirements and intends to work aggressively to maintain and increase the
amount of business it receives from Allstate, as well as to maintain the
profitability of that business. However, no assurance can be given as to the
results of these efforts and the Company may receive less, or less profitable
business from Allstate than it currently does.
Volumes of vehicles received from Allstate has decreased from 90,000 units
in 1996 to 64,500 units in 1998, part of which was due to the termination by the
Company of unprofitable purchase agreement contracts. Given the above, and the
significant decline in the volume of vehicles received from Allstate, the
Company is reviewing all aspects of its relationship with Allstate. The Company
intent has been and continues to be to maintain a profitable relationship with
Allstate. However, no assurances can be given in this matter. A significant
reduction in Allstate business could have a material, adverse impact on the
Company's financial condition and results of operations.
During the years ended December 31, 1998 and 1997, the Company recorded fee
income of $4,700,000 and $7,000,000, respectively, related to the consignment
sale of Allstate-insured vehicles and recorded sales of $35,700,000 and
$34,700,000, respectively, and cost of sales of $32,500,000 and $32,800,000,
respectively, related to the purchase of Allstate-insured vehicles under the
purchase-agreement method.
36
37
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(7) COMMITMENTS AND CONTINGENCIES
The Company leases its facilities and certain equipment under operating
leases with related and nonrelated parties, which expire through August 2007.
Rental expense for the years ended December 31, 1998, 1997 and 1996 aggregated
$9,935,000, $10,035,000 and $8,681,000 (of which $954,000, $966,000 and $884,000
pertained to leases with related parties in 1998, 1997 and 1996, respectively),
respectively.
Minimum annual rental commitments for the next five years under
noncancelable leases at December 31, 1998 are as follows:
UNRELATED RELATED
PARTY PARTY
--------- -------
Year ending December 31:
1999............................................... $ 8,014,000 $1,047,000
2000............................................... 7,803,000 702,000
2001............................................... 6,541,000 702,000
2002............................................... 7,007,000 264,000
2003............................................... 4,966,000 --
Thereafter......................................... 4,842,000 --
----------- ----------
$39,173,000 $2,715,000
=========== ==========
The Company has purchase agreements with certain insurance company
suppliers, which expire at various intervals over the next two years. The
Company's largest supplier accounted for 17% of the Company's supply of vehicles
sold in 1998 and 19% in 1997 and 1996. The second largest supplier accounted for
14%, 17% and 20% of the Company's supply of vehicles sold in 1998, 1997 and
1996, respectively. A third supplier accounted for 13% and 10% of the Company's
supply of vehicles sold in 1998 and 1997, respectively.
The Company has compensation agreements with certain officers and other key
employees.
The Company is subject to certain other miscellaneous legal claims, which
have arisen during the ordinary course of its business. None of these claims are
expected to have material adverse effect on the Company's financial condition or
operating results.
(8) ACCUMULATED POSTRETIREMENT BENEFIT OBLIGATIONS
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 Statement of Financial Accounting Standards No. 106, "Employers'
Accounting for Postretirement Benefits Other than Pensions," costs related to
the benefits are accrued over an employee's service life.
A one-percentage point increase or decrease in the assumed health care cost
trend rate for each future year would not have a material impact on the
Accumulated Postretirement Benefit Obligation or the income recognized relative
to the Plan in 1998. The assumed discount rate used to determine the Accumulated
Postretirement Benefit Obligation (APBO) as of December 31, 1998 and 1997 was
6.5% and 7%, respectively.
The Accumulated Postretirement Benefit Obligation (APBO) is a measure of
the plan's liability, equivalent to the Projected Benefit Obligation used in
pension accounting. The APBO is a factor in the expense calculation and is
included in the footnote disclosure. For retirees, it is the present value of
all benefits expected to be paid from the plan.
37
38
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
Reconciliation of funded status as of December 31,
1998 1997
---- ----
Medical............................................. $ (927,000) $ (972,000)
Life Insurance...................................... (361,000 (385,000)
----------- -----------
Total APBO.......................................... (1,288,000) (1,357,000)
Plan assets......................................... -- --
----------- -----------
Funded status....................................... (1,288,000) (1,357,000)
Unrecognized net loss from past experience.......... (2,197,000) (2,474,000)
----------- -----------
Accrued postretirement benefit cost................. $(3,485,000) $(3,831,000)
=========== ===========
Reconciliation of accumulated postretirement benefit
cost:
Accrued benefit cost.............................. $(3,831,000) $(4,173,000)
Income............................................ 168,000 162,000
Contributions/premium paid........................ 178,000 180,000
----------- -----------
Accumulated postretirement benefit cost, December
31,............................................ $(3,485,000) $(3,831,000)
=========== ===========
Effective January 20, 1994, the date of acquisition, the Company
discontinued future participation for active employees.
(9) SPECIAL CHARGES
During the first quarter of 1998, a settlement agreement was entered into
by the Company resolving all outstanding differences between Insurance Auto
Auctions, Inc. and a former director, who resigned as a director and Chairman of
the Board. In the settlement agreement, various agreements were terminated
(including agreements providing for compensation and certain benefits through
June 30, 1999, and all outstanding stock options). Per the settlement agreement,
the Company made a lump-sum payment of $700,000 to the former director. This
included a bonus payment for 1997 of $126,000 pursuant to a 1996 agreement
between the Company and the former director. The difference of $574,000 was
recorded as a special charge in first quarter 1998.
In addition, McKinsey & Co. had been retained to assist the Company in
identifying and developing additional customer-valued services, focusing on
opportunities to add value to the insurance industry's automobile claims process
and reduce costs for these organizations. The scope of the work completed also
included current competencies, geographic presence and assets. The cost of the
project of $990,000 was recorded as a special charge in first quarter 1998.
During the second quarter of 1997, the Company settled a securities class
action lawsuit that had been pending against the Company and certain of its
present and former officers and directors, in the United States District Court
for the Central District of California. The litigation was settled for $3.75
million, the substantial portion of which was paid by the Company's directors
and officers liability insurance company. The difference of $750,000 was
recognized as a special charge to earnings in the second quarter of 1997. In
February 1998, the settlement was approved by the court.
During 1996, the Company recorded special charges aggregating $1,395,000 as
a result of further repositioning to achieve its strategic plans. In
implementing these strategic plans, the Company decided to establish its
corporate headquarters in Illinois resulting in severance costs of $210,000
related to corporate employees not relocating to the Illinois corporate
headquarters. Additionally, the Company incurred costs amounting to $670,000 to
terminate an employment agreement with the Company's former Chairman of the
Board and Chief Executive Officer. After evaluating past contracts entered into,
the Company incurred a
38
39
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
charge of $880,000 for agreements determined to no longer have value to the
current corporate strategy. Additionally, the Company recorded an offsetting
gain of $365,000 related to the negotiation of a buyout of a long-term lease.
(10) EARNINGS PER SHARE
Reconciliations of the numerators and denominators of the basic and diluted
earnings per share computations for the years ended December 31, 1998, 1997 and
1996 are as follows:
1998
-------------------------------------
PER SHARE
EARNINGS SHARES AMOUNT
-------- ------ ---------
Basic Earnings per Share
Net earnings............................... $7,181,000 11,316,000 $.63
----
Effect of Dilutive Securities -- Stock
Options.................................... -- 121,000
---------- ----------
Diluted Earnings per Share $7,181,000 11,437,000 $.63
========== ========== ====
1997
-------------------------------------
PER SHARE
EARNINGS SHARES AMOUNT
-------- ------ ---------
Basic Earnings per Share
Net earnings............................... $4,495,000 11,294,000 $.40
----
Effect of Dilutive Securities -- Stock
Options.................................... -- 43,000
---------- ----------
Diluted Earnings per Share................... $4,495,000 11,337,000 $.40
========== ========== ====
1996
-------------------------------------
PER SHARE
EARNINGS SHARES AMOUNT
-------- ------ ---------
Basic Earnings per Share
Net earnings............................... $3,102,000 11,279,000 $.28
----
Effect of Dilutive Securities -- Stock
Options.................................... -- 54,000
---------- ----------
Diluted Earnings per Share................... $3,102,000 11,333,000 $.27
========== ========== ====
39
40
INSURANCE AUTO AUCTIONS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
(11) QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized unaudited financial data for 1998 and 1997 are as follows:
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
1998:
Net sales............................... $68,558,000 $75,400,000 $70,047,000 $73,058,000
Gross profit............................ 16,466,000 19,026,000 16,782,000 18,035,000
Earnings from operations................ 1,963,000 4,938,000 3,197,000 3,983,000
Net earnings............................ 869,000 2,497,000 1,563,000 2,252,000
Diluted earnings per share(1)........... $ .08 $ .22 $ .14 $ .20
=========== =========== =========== ===========
1997:
Net sales............................... $67,885,000 $65,978,000 $61,403,000 $64,059,000
Gross profit............................ 13,832,000 16,295,000 14,289,000 14,926,000
Earnings from operations................ 1,426,000 2,993,000 2,322,000 3,015,000
Net earnings............................ 530,000 1,520,000 971,000 1,474,000
Diluted earnings per share(1)........... $ .05 $ .13 $ .09 $ .13
=========== =========== =========== ===========
- -------------------------
(1) Basic earnings per share is not presented separately as it is the same as
diluted earnings per share for each quarter of 1997 and 1998.
40
41
INDEX TO EXHIBITS
SEQUENTIALLY
EXHIBIT NUMBERED
NO. PAGE
- ------- ------------
10.153 Form of Indemnification Agreement dated as of February 24,
1999 by and between the Company and its Directors and
Executive Officers.
10.154* Consulting Agreement dated as of December 1, 1998 by and
between the Company and Thomas J. O'Malia.
10.155* Agreement dated December 16, 1988 by and between the Company
and James P. Alampi.
21.1 Subsidiaries of the Registrant
23.1 Consent of Independent Auditors.
24.1 Power of Attorney
27.1 Financial Data Schedule
41