-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, O+maHTAT5BoIv+KEFKhQ7x8QjnM4Z8BKx0qsx3mMoxwzmY7DTAwUSW2k/Bgmwij6 SCdpzW5rEmkv8CT6TVuvbg== 0000950124-98-006777.txt : 19981118 0000950124-98-006777.hdr.sgml : 19981118 ACCESSION NUMBER: 0000950124-98-006777 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INSURANCE AUTO AUCTIONS INC /CA CENTRAL INDEX KEY: 0000880026 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-MOTOR VEHICLES & MOTOR VEHICLE PARTS & SUPPLIES [5010] IRS NUMBER: 953790111 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-19594 FILM NUMBER: 98752544 BUSINESS ADDRESS: STREET 1: 850 E ALGONQUIN RD STREET 2: STE 100 CITY: SCHAUMGURG STATE: IL ZIP: 60173 BUSINESS PHONE: 847839-3939 MAIL ADDRESS: STREET 1: 1270 WEST NORTHWEST HIGHWAY CITY: PALATINE STATE: IL ZIP: 60067 10-Q 1 FORM 10-Q 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________________ to ______________________ Commission File Number: 0-19594 ------- INSURANCE AUTO AUCTIONS, INC. ----------------------------- (Exact name of registrant as specified in its charter) Illinois 95-3790111 - ------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 850 East Algonquin Road, Suite 100, Schaumburg, Illinois 60173-3855 - ------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (847) 839-3939 - ------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No APPLICABLE ONLY TO CORPORATE ISSUERS Number of shares outstanding of each of the issuer's classes of common stock, as of September 30, 1998: Class Outstanding September 30, 1998 ----- ------------------------------ Common Stock, $0.001 Par Value 11,320,419 shares 2 INDEX INSURANCE AUTO AUCTIONS, INC.
PAGE NUMBER ----------- PART I. FINANCIAL INFORMATION................................... 3 Item 1. Financial Statements (Unaudited)........................ 3 Condensed Consolidated Balance Sheets as of September 30, 1998 and December 31, 1997...... 3 Condensed Consolidated Statements of Operations for the Three Month and Nine Month Periods ended September 30, 1998 and September 30, 1997........... 4 Condensed Consolidated Statements of Cash Flows for the Nine Month Periods ended September 30, 1998 and September 30, 1997.............................. 5 Notes to Condensed Consolidated Financial Statements.... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................. 7 Item 3. Quantitative and Qualitative Disclosures about Market Risk................................... 14 PART II. OTHER INFORMATION....................................... 14 Item 1. Legal Proceedings....................................... 14 Item 2. Changes in Securities................................... 14 Item 3. Defaults upon Senior Securities......................... 14 Item 5. Other Information....................................... 14 Item 6. Exhibits and Reports on Form 8-K........................ 14 SIGNATURES .................................................... 15
2 3 INSURANCE AUTO AUCTIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31, 1998 1997 ---- ---- (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 10,407,000 $ 9,634,000 Accounts receivable, net 34,472,000 28,992,000 Inventories 10,156,000 11,762,000 Other current assets 1,762,000 1,868,000 ------------ ------------ Total current assets 56,797,000 52,256,000 ------------ ------------ Property and equipment, at cost, net 21,510,000 20,778,000 Deferred income taxes 2,603,000 2,603,000 Other assets, principally goodwill, net 129,866,000 131,435,000 ------------ ------------ $210,776,000 $207,072,000 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current installments of long-term debt $ 200,000 $ 2,034,000 Accounts payable 17,981,000 16,319,000 Accrued liabilities 5,998,000 7,698,000 Income taxes 1,208,000 497,000 ------------ ------------ Total current liabilities 25,387,000 26,548,000 ------------ ------------ Long-term debt, excluding current installments 20,161,000 20,246,000 Accumulated postretirement benefit obligation 3,570,000 3,831,000 Deferred income taxes 5,235,000 5,235,000 ------------ ------------ Total liabilities 54,353,000 55,860,000 ------------ ------------ 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 11,320,419 and 11,299,561 shares as of September 30, 1998 and December 31, 1997, respectively 11,000 11,000 Additional paid-in capital 132,091,000 131,809,000 Retained earnings 24,321,000 19,392,000 ------------ ------------ Total shareholders' equity 156,423,000 151,212,000 ------------ ------------ $210,776,000 $207,072,000 ============ ============
See accompanying notes to condensed consolidated financial statements 3 4 INSURANCE AUTO AUCTIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Month Periods Nine Month Periods Ended September 30, Ended September 30, ------------------- ------------------- (Unaudited) (Unaudited) 1998 1997 1998 1997 ---- ---- ---- ---- Net Sales: Vehicle sales $ 45,726,000 $ 42,095,000 $ 144,789,000 $ 132,241,000 Fee income 24,321,000 19,308,000 69,216,000 63,025,000 ------------- ------------- ------------- ------------- 70,047,000 61,403,000 214,005,000 195,266,000 Cost and expenses: Cost of sales 53,265,000 47,114,000 161,731,000 150,850,000 Direct operating expenses 12,650,000 10,887,000 37,779,000 33,766,000 Amortization of acquisition costs 935,000 945,000 2,833,000 2,840,000 Special charges - - 1,564,000 750,000 ------------- ------------- ------------- ------------- Earnings from operations 3,197,000 2,457,000 10,098,000 7,060,000 Other (income) expense: Interest expense 496,000 668,000 1,560,000 2,073,000 Interest (income) (193,000) (210,000) (589,000) (609,000) ------------- ------------- ------------- ------------- Earnings before income taxes 2,894,000 1,999,000 9,127,000 5,596,000 Income taxes 1,331,000 1,028,000 4,198,000 2,575,000 ------------- ------------- ------------- ------------- Net earnings $ 1,563,000 $ 971,000 $ 4,929,000 $ 3,021,000 ============= ============= ============= ============= Earnings per share: Basic $ .14 $ .09 $ .44 $ .27 ============= ============= ============= ============= Diluted $ .14 $ .09 $ .43 $ .27 ============= ============= ============= ============= Weighted average shares outstanding: Basic 11,320,000 11,298,000 11,313,000 11,293,000 ============= ============= ============= ============= Diluted 11,474,000 11,373,000 11,432,000 11,318,000 ============= ============= ============= =============
See accompanying notes to condensed consolidated financial statements. 4 5 INSURANCE AUTO AUCTIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Month Periods Ended September 30, ------------------------- 1998 1997 ---- ---- Cash flows from operating activities: Net earnings $ 4,929,000 $ 3,021,000 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 6,539,000 5,930,000 Loss on disposal of fixed assets 79,000 0 Change in assets and liabilities (net of effects of acquired companies): (Increase) decrease in: Accounts receivable, net (5,042,000) 4,009,000 Inventories 1,606,000 (859,000) Other current assets 106,000 1,350,000 Other assets 56,000 (188,000) Increase (decrease) in: Accounts payable 1,662,000 824,000 Accrued liabilities (1,852,000) (2,136,000) Income taxes payable 711,000 948,000 ----------- ----------- Total adjustments 3,865,000 9,878,000 ----------- ----------- Net cash provided by operating activities 8,794,000 12,899,000 ----------- ----------- Cash flows from investing activities: Proceeds from disposal of fixed assets 22,000 0 Capital expenditures (4,338,000) (2,501,000) Payments made in connection with acquired companies, (1,806,000) (196,000) ----------- ----------- net of cash acquired Net cash used in investing activities (6,122,000) (2,697,000) ----------- ----------- Cash flows from financing activities: Payment of line of credit and notes payable to acquired companies (2,180,000) (2,541,000) Net proceeds (payment) of line of credit and notes payable (4,657,000) Proceeds from issuance of common stock 282,000 90,000 ----------- ----------- Net cash provided by (used in) financing activities 1,898,000 (7,108,000) ----------- ----------- Net increase in cash 773,000 3,094,000 Cash and cash equivalents at beginning of period 9,634,000 5,888,000 ----------- ----------- Cash and cash equivalents at end of period $10,407,000 $ 8,982,000 =========== =========== Supplemental disclosures of cash flow information: Cash paid during the year for: Interest $ 1,793,000 $ 4,205,000 Income taxes 3,500,000 1,627,000 =========== ===========
See accompanying notes to condensed consolidated financial statements. 5 6 INSURANCE AUTO AUCTIONS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. GENERAL The unaudited condensed consolidated financial statements of Insurance Auto Auctions, Inc. and its subsidiaries (collectively, the "Company") have been prepared on the same basis as the audited consolidated financial statements and, in the opinion of the Company, reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation for each of the periods presented. The results of operations for interim periods are not necessarily indicative of results for full fiscal years. As contemplated by the Securities and Exchange Commission ("SEC") under Rule 10-01 of Regulation S-X, the accompanying consolidated financial statements and related notes have been condensed and do not contain certain information that will be included in the Company's annual consolidated financial statements and notes thereto. For further information, refer to the consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 1997 2. INCOME TAXES Income taxes were computed using the effective tax rate estimated to be applicable for the full fiscal year, which is subject to ongoing review and evaluation by the Company. 3. NET EARNINGS PER SHARE Reconciliations of the numerators and denominators of the basic and diluted earnings per share computations for the three months and nine months ended September 30, 1998 and 1997 are as follows:
Three Month Period Ended September 30, 1998 Three Month Period Ended September 30, 1998 ------------------------------------------- ------------------------------------------- Per Share Per Share Earnings Shares Amount Earnings Shares Amount -------- ------ ------ -------- ------ ------ Basic Earnings per Share Net earnings $1,563,000 11,320,000 $0.14 $ 971,000 11,298,000 $0.09 ===== ===== Effect of Dilutive Securities Stock options - 154,000 - 75,000 ========== ========== ===== ========== ========== ===== Diluted Earnings per Share Income available to common stockholders plus assumed conversions $1,563,000 11,474,000 $0.14 $ 971,000 11,373,000 $0.09 ========== ========== ===== ========== ========== ===== Nine Month Period Ended September 30, 1998 Nine Month Period Ended September 30, 1997 ------------------------------------------ ------------------------------------------ Per Share Per Share Earnings Shares Amount Earnings Shares Amount -------- ------ ------ -------- ------ ------ Basic Earnings per Share Net earnings $4,929,000 11,313,000 $0.44 $3,021,000 11,293,000 $0.27 ===== ===== Effect of Dilutive Securities Stock options - 119,000 - 25,000 ========== ========== ===== ========== ========== ===== Diluted Earnings per Share Income available to common stockholders plus assumed conversions $4,929,000 11,432,000 $0.43 $3,021,000 11,318,000 $0.27 ========== ========== ===== ========== ========== =====
6 7 4. COMPREHENSIVE INCOME In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. SFAS 130 is effective for financial statements for fiscal years beginning after December 15, 1997 and was adopted by the Company in the three months ended March 31, 1998. Adoption of SFAS 130 did not have a material impact on the Company's consolidated financial position, results of operations, or liquidity. 5. 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 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 June 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. 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 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. 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. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The discussion in this section contains forward-looking information that is subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those projected, expressed or implied by such forward looking information. 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. Among these risks are quality and quantity of inventory available from suppliers, competition, dependence on key insurance company suppliers, governmental regulation, weather conditions and market value of salvage. OVERVIEW The Company offers insurance companies and other vehicle suppliers cost-effective salvage processing solutions through a variety of different methods of sale, including fixed fee consignment, purchase agreement and percentage of sale consignment. 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. 7 8 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. 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 a purchase agreement. ACV's are the estimated pre-accident fair value of a vehicle, adjusted for additional equipment, mileage and other factors. Because the Company's purchase price is fixed by contract, changes in ACV's or in the market or auction prices for salvage vehicles have an impact on the profitability of the sale of vehicles under the purchase agreement method. If increases in used car prices and ACV's are not associated with a corresponding increase in prices at salvage auctions, there can be a negative impact on the profitability of purchase agreement sales. The Company has adjustment and risk-sharing clauses in its standard purchase agreement contracts designed to provide protection to the Company and its customers from certain unexpected, significant changes in the ACV/salvage price relationship. The Company has renegotiated or terminated all significant purchase agreement contracts not conforming to the Company's standards for this type of agreement, converting customers to either a fixed fee consignment or percent of sale consignment contract whenever possible. However, the Company continues to offer purchase agreements to those customers who select it. Since its initial public offering, the Company has grown primarily through a series of acquisitions to now include 49 locations as of September 30, 1998. In February of 1998, the Company acquired Auto Disposal Company ("ADC"). ADC operated two pools in Alabama. In October of 1998, the Company opened a new greenfield location in Bay Point, California. The Company's operating results are subject to fluctuations, including quarterly fluctuations, that can result from a number of factors, some of which are more significant for sales under the purchase agreement method. See "Factors That May Affect Future Results" below for a further discussion of some of the factors that affect or could affect the Company's business, operating results and financial condition. RESULTS OF OPERATIONS Three Months Ended September 30, 1998 Compared to the Three Months Ended September 30, 1997 Net sales of the Company increased to $70,047,000 for the three months ended September 30, 1998, from $61,403,000 for the same three month period in 1997. Unit volume increased 13%, compared to the same period in 1997. The volume increase is primarily the result of an increase in same store sales. The purchase agreement sales method of processing accounted for 30% of total volume, consistent with the same period in 1997. Gross profit increased 17% to $16,782,000 for the three months ended September 30, 1998, from $14,289,000 for the same period in 1997. Gross profit per unit of $146 for the three months ended September 30, 1998 was 4% higher than for the comparable period of 1997. The Company experienced a positive impact on margins during this period as a result of its continuing focus on increasing profitability by insuring its services are properly valued in the market place. However, at the same time, margins were negatively impacted by a decline in the marketplace of actual cash values and selling prices, traditional seasonal changes in the quality of salvage, and a decline of the price of scrap steel to a thirty year low, which decreased the selling prices of the Company's older car inventory. Direct operating expenses increased to $12,650,000 for the three months ended September 30, 1998, from $10,887,000 for the same period in 1997. Direct operating expenses per unit increased to $110 for the three months ended September 30, 1998, as compared to $107 for the same period in 1997. The increase reflects the funding commitment made for the piloting of several value-added services that will 8 9 streamline the automobile claims process, resulting in reduced costs for insurance companies and the acquisition of the two locations in Alabama. Amortization of acquisition costs of $935,000 for the three months ended September 30, 1998 were relatively flat as compared to $945,000 for the comparable period in 1997. Interest expense decreased to $496,000 for the three months ended September 30, 1998, from $668,000 for the same period in 1997. The change in interest expense was attributable to a decrease in long-term debt as a result of the Company's repayment of several notes payable to sellers related to certain acquisitions. Interest income decreased to $193,000 for the three month period ended September 30, 1998, from $ 210,000 for the comparable period in 1997. Income taxes increased to $1,331,000 for the three months ended September 30, 1998, from $1,028,000 for the comparable period in 1997. This increase is the result of the increase in earnings. The Company's effective tax rate for the three months ended September 30, 1998 was 46%. The effective tax rate is subject to ongoing review and evaluation by the Company. The Company's net earnings were $1,563,000 for the three months ended September 30, 1998, a 61% increase from $971,000 for the comparable period in 1997. Nine Months Ended September 30, 1998 Compared to the Nine Months Ended September 30, 1997 Net sales of the Company increased to $214,005,000 for the nine months ended September 30, 1998, from $195,266,000 for the same Nine month period in 1997, a 10% increase. Unit volume for the nine months ended September 30, 1998, was 345,000, as compared to 333,000 for the same period in 1997. The increase in volume is the result of an increase in same store sales from the prior period and the acquisition of the two locations in Alabama. The purchase agreement sales method of processing accounted for 30% of total volume, compared with 31% for the same period in 1997. Gross profit increased to $52,274,000 for the nine months ended September 30, 1998, from $44,416,000 for the same period in 1997, an 18% increase. Gross profit per unit of $152 for the nine months ended September 30, 1998 was 14% higher than for the comparable period of 1997. Direct operating expenses increased to $37,779,000 for the nine months ended September 30, 1998, from $33,766,000 in 1997, a 12% increase. The increase reflects a general increase in operating expenses, the funding commitment made by the Company to identify, develop and pilot new services that will streamline the automobile claims process, resulting in reduced costs for insurance companies, and the acquisition of two locations in Alabama. Amortization of acquisition costs decreased slightly to $2,833,000 for the nine month period ended September 30, 1998 from $2,840,000 for the comparable period in 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. 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 9 10 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 $1,560,000 for the nine months ended September 30, 1998, from $2,073,000 for the same period in 1997. The change in interest expense was mostly attributable to a decrease in long-term debt as a result of the Company's repayment of the proceeds of several notes payable to sellers related to certain acquisitions. Interest income was $589,000 for the nine month period ended September 30, 1998, versus $609,000 for the comparable period in 1997. Income taxes increased to $4,198,000 for the nine months ended September 30, 1998, from $2,575,000 for the comparable period in 1997. This increase is the result of the increase in earnings. The Company's effective tax rate for the nine months ended September 30, 1998 was 46%. The effective tax rate is subject to ongoing review and evaluation by Management. The Company's net earnings were $4,929,000 for the nine months ended September 30, 1997, a 63% increase from the comparable period in 1997 of $3,021,000. Net earnings per diluted common share increased to 43 cents per share in 1998 versus 27 cents per share in 1997. Net earnings excluding the special charge were $5,774,000, or 51 cents per share, for the first nine months of 1998. FINANCIAL CONDITION AND LIQUIDITY At September 30, 1998, the Company had current assets of $56,797,000, including $10,407,000 of cash and cash equivalents and current liabilities of $25,387,000. The Company had working capital of $31,410,000 at September 30, 1998, a $5,702,000 increase from December 31, 1997. At September 30, 1998, the Company's indebtedness consisted mostly of 8.6% Senior Notes approximating $20,000,000. There were no borrowings outstanding on the Revolving Line of Credit Facility at September 30, 1998. Capital expenditures were approximately $4,338,000 for the nine months ended September 30, 1998. These capital expenditures primarily included upgrading and expanding the Company's management information system and the Company's facilities. 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. RECENT DEVELOPMENTS Statement of Financial Accounting Standards ("S.F.A.S.") No. 131, "Disclosures about Segments of an Enterprise and Related Information", was issued in September 1997 and is effective for fiscal years beginning after December 15, 1997. S.F.A.S. No. 131 establishes new standards for disclosing information about operating segments. Adoption of this statement did not have a material impact on the Company's financial position, results of operations, or liquidity. 10 11 In February 1998, the FASB issued Statement of Financial Accounting Standards No. 132, "Employers' Disclosures about Pensions and Others Postretirement Benefits" ("SFAS 132") which amends the disclosure requirements of SFAS No. 87, "Employers' Accounting for Pensions", SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits", SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." SFAS No. 132 is effective for fiscal years beginning after December 15, 1997. Adoption of this statement did not have a material impact on the Company's financial position, results of operations, or liquidity. 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 Vice President - Information Systems. 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. Those modifications have been completed and implemented. Based on the findings of the Project team and the successful implementation of these required modifications, the Company believes its IT based systems are currently Year 2000 compliant in all material respects. Based on work completed by the Project team, the Company believes its non IT system Year 2000 compliance issues do not represent a significant risk to the Company. 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, 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 result in 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 manner. Formal contingency plans will be developed by March 31, 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. Effective December 1, 1993, the Company entered into a national sales agreement with Allstate Insurance Company ("Allstate") that, as subsequently modified, established the Company as Allstate's preferred provider of salvage processing services. The Company agreed to purchase salvage and theft recovered vehicles from Allstate, or sell such vehicles on behalf of Allstate, in various geographic markets throughout the Country. Local Allstate management is responsible for deciding who will be the provider of automotive salvage services for their geographic area of responsibility. The national agreement provides specific guidelines as to the general terms and structure to which any local agreement must conform. These agreements typically have terms of one or two years, but are generally subject to termination by either party upon 30 days notice. For the fiscal year ended December 31, 1997, vehicles purchased from, or sold on behalf of, Allstate accounted for approximately 17% of the Company's total unit sales, making Allstate the Company's second largest supplier of vehicles for auction. 11 12 Allstate has recently invited the Company to submit a proposal to provide automobile salvage services for Allstate locations across the country, effective January 1, 1999. The Company understands that Allstate has requested this proposal as part of a comprehensive review of Allstate's automobile salvage disposition practices. The Company is working aggressively to maintain and increase the amount of business it receives from Allstate and to maintain the profitability of that business. However, no assurance can be given as to the results of Allstate's review, and the Company may receive less, or less profitable, business from Allstate than it currently does. A significant reduction of Allstate business, or a significant reduction in the profitability of that business, would have a material adverse affect or could affect the Company's business, operating results and financial condition. 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 ("ACV's") 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 affect the number of vehicles received include (a) reduction of policy writing by insurance providers which would affect the number of claims over a period of time and (b) 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. 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 operating expense levels do not vary significantly with changes in volume. 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 affect the number of salvage vehicles received include reduction of policy writing by insurance providers which would affect the number of claims over a period of time, the changes in direct repair procedures that would reduce the number of newer less damaged total loss vehicles that tend to have higher salvage values and general weather conditions. For example, a comparatively mild winter can result in fewer "total loss" accidents, causing fewer vehicles to be available for sale by the Company. 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 negative impact 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 effected 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 for salvage vehicles from Copart and regional suppliers is intense. It is also possible that the Company may encounter further 12 13 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 business, operating results and financial condition. Dependence on Key Insurance Company Suppliers. Historically, a limited number of insurance companies have accounted for a substantial portion of the Company's revenues. For example, in 1997, vehicles supplied by the Company's three largest suppliers accounted for approximately 46% of the Company's unit sales. The largest suppliers, State Farm Insurance, Allstate Insurance ("Allstate"), and Farmers Insurance, each accounted for approximately 19%, 17%, and 10%, respectively, of the Company's unit sales. A number of other insurance company suppliers, including 20th Century Insurance, have also contributed to the profitability of the Company. 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 business, 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. Increases in ACV's associated with flat or declining 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 adjustment and risk-sharing clauses in its 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. 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. 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 business, 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 require 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 13 14 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 business, operating results and financial condition. Volatility of Stock Price. The market price of the Company's common stock has been and could continue to be subject to significant fluctuations in response to various factors and events, including variations in the Company's operating results, the timing and size of acquisitions and facility openings, the loss of vehicle suppliers or buyers, the announcement of new vehicle supply agreements by the Company or its competitors, changes in regulations governing the Company's operations or its vehicle suppliers, environmental problems or litigation. Environmental Regulation. The Company's operations are subject to federal, state and local laws and regulations regarding the protection of the environment. In the salvage vehicle auction industry, large numbers of wrecked vehicles are stored at auction facilities for short periods of time. Minor spills of gasoline, motor oils and other fluids may occur from time to time at the Company's facilities and may result in soil, surface water or groundwater contamination. Petroleum products and other hazardous materials are contained in aboveground or underground storage tanks located at certain of the Company's facilities. Waste materials such as waste solvents or used oils are generated at some of the Company's facilities and are disposed of as 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. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. INAPPLICABLE PART II. OTHER INFORMATION. ------------------ ITEM 1. LEGAL PROCEEDINGS. INAPPLICABLE ------------------ ITEM 2. CHANGES IN SECURITIES. INAPPLICABLE ---------------------- ITEM 3. DEFAULTS UPON SENIOR SECURITIES. INAPPLICABLE -------------------------------- ITEM 4. SUBMISSION OF MATTERS TO A VOTE ON SECURITY HOLDERS. INAPPLICABLE ---------------------------------------------------- ITEM 5. OTHER INFORMATION. INAPPLICABLE ------------------ ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. --------------------------------- (a) EXHIBITS. --------- 27.1 Financial Data Schedule 14 15 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. INSURANCE AUTO AUCTIONS, INC. Date: November 16, 1998 By: /s/ Linda C. Larrabee ----------------- -------------------------------------- Name: Linda C. Larrabee Title: Senior Vice President, Chief Financial Officer and Secretary (Duly Authorized Officer and Principal Financial Officer) 15 16 EXHIBIT INDEX EXHIBIT NO. - ----------- 27.1 Financial Data Schedule 16 EX-27 2 FINANCIAL DATA SCHEDULE
5 3-MOS 9-MOS DEC-31-1998 DEC-31-1998 JUL-01-1998 JAN-01-1998 SEP-30-1998 SEP-30-1998 10,407,000 0 0 0 34,472,000 0 0 0 10,156,000 0 56,797,000 0 40,956,000 0 (19,446,000) 0 210,776,000 0 25,387,000 0 20,161,000 0 0 0 0 0 11,000 0 132,091,000 0 210,776,000 0 70,047,000 214,005,000 70,047,000 214,005,000 53,265,000 161,731,000 53,265,000 161,731,000 13,585,000 42,176,000 0 0 496,000 1,560,000 2,894,000 9,127,000 1,331,000 4,198,000 1,563,000 4,929,000 0 0 0 0 0 0 1,563,000 4,929,000 0.14 0.44 0.14 0.43
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