10-Q 1 c64554e10-q.txt QUARTERLY REPORT 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 July 1, 2001 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 (I.R.S. Employer Identification No.) of 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 July 31, 2001: Class Outstanding July 31, 2001 ----- ------------------------- Common Stock, $0.001 Par Value 11,973,165 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 July 1, 2001 and December 31, 2000...................................... 3 Condensed Consolidated Statements of Operations for the Three Month and Six Month Periods ended July 1, 2001 and June 30, 2000........ 4 Condensed Consolidated Statements of Cash Flows for the Six Month Periods ended July 1, 2001 and June 30, 2000........................ 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......................... 13 PART II. OTHER INFORMATION................................................................. 14 Item 1. Legal Proceedings.................................................................. 14 Item 2. Changes in Securities.............................................................. 14 Item 3. Defaults upon Senior Securities.................................................... 14 Item 4. Submission of Matters to a Vote of Security Holders................................ 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 (in thousands except share and per share amounts)
July 1, December 31, 2001 2000 ------------ ------------ ASSETS (Unaudited) Current assets: Cash and cash equivalents $ 35,875 $ 30,938 Short-term investments 3,911 4,859 Accounts receivable, net 45,398 48,091 Inventories 15,113 10,588 Other current assets 4,499 3,112 -------- -------- Total current assets 104,796 97,588 -------- -------- Property and equipment, net 35,603 30,492 Investments in marketable securities -- 2,240 Deferred income taxes 5,264 5,123 Other assets, principally goodwill, net 128,229 130,264 -------- -------- $273,892 $265,707 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current installments of long-term debt $ 20,038 $ 37 Accounts payable 39,182 38,176 Accrued liabilities 5,791 6,171 Accrued restructuring charges 2,821 -- -------- -------- Total current liabilities 67,832 44,384 -------- -------- Long-term debt, excluding current installments 121 20,141 Other liabilities 3,612 3,001 Deferred income taxes 11,129 10,440 -------- -------- Total liabilities 82,694 77,966 -------- -------- 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 11,921,365 and 11,715,936 shares as of July 1, 2001 and December 31, 2000, respectively 12 12 Additional paid-in capital 139,893 136,962 Retained earnings 51,293 50,767 -------- -------- Total shareholders' equity 191,198 187,741 -------- -------- $273,892 $265,707 ======== ========
See accompanying notes to condensed consolidated financial statements. 3 4 INSURANCE AUTO AUCTIONS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Operations (in thousands except per share amounts)
THREE MONTH PERIODS ENDED SIX MONTH PERIODS ENDED ------------------------- ----------------------- JULY 1, JUNE 30, JULY 1, JUNE 30, 2001 2000 2001 2000 ------------------------- ----------------------- (UNAUDITED) (UNAUDITED) Net revenues: Vehicle sales $ 36,942 $ 50,845 $ 77,159 $ 105,809 Fee income 38,572 33,431 76,199 65,427 --------- --------- --------- --------- 75,514 84,276 153,358 171,236 Costs and expenses: Cost of sales 51,122 60,089 106,147 123,944 Direct operating expenses 19,550 14,409 38,017 29,427 Amortization of acquisition costs 1,005 985 2,011 1,933 Special charges -- -- 6,047 -- --------- --------- --------- --------- Earnings from operations 3,837 8,793 1,136 15,932 Other (income)expense: Interest expense 456 457 912 921 Interest income (315) (470) (683) (881) --------- --------- --------- --------- Earnings before income taxes 3,696 8,806 907 15,892 Income taxes 1,525 3,611 381 6,516 --------- --------- --------- --------- Net earnings $ 2,171 $ 5,195 $ 526 $ 9,376 ========= ========= ========= ========= Net earnings per share: Basic $ .18 $ .45 $ .04 $ .81 ========= ========= ========= ========= Diluted $ .18 $ .44 $ .04 $ .79 ========= ========= ========= ========= Weighted average shares outstanding: Basic 11,792 11,634 11,761 11,610 Effect of dilutive securities - stock options 148 252 208 218 --------- --------- --------- --------- Diluted 11,940 11,886 11,969 11,828 ========= ========= ========= =========
See accompanying notes to condensed consolidated financial statements. 4 5 INSURANCE AUTO AUCTIONS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (in thousands of dollars)
SIX MONTH PERIODS ENDED --------------------------- JULY 1, JUNE 30, 2001 2000 --------------------------- (UNAUDITED) Cash flows from operating activities: Net earnings $ 526 $ 9,376 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 4,975 4,790 Gain on disposal of fixed assets (388) (22) Special charges 6,047 -- Changes in assets and liabilities (excluding effects of acquired businesses): (Increase) decrease in: Investments, net 3,188 (2,596) Accounts receivable, net 2,756 (826) Inventories (4,525) 306 Other current assets (1,387) (628) Other assets 52 30 Increase (decrease) in: Accounts payable 952 4,274 Accrued liabilities (3,006) 419 Deferred income taxes, net 549 1,124 -------- -------- Total adjustments 9,213 6,871 -------- -------- Net cash provided by operating activities 9,739 16,247 -------- -------- Cash flows from investing activities: Capital expenditures (9,025) (6,432) Proceeds from disposal of fixed assets 1,416 88 Acquisitions of businesses, net of cash acquired (105) (6,925) -------- -------- Net cash used in investing activities (7,714) (13,269) -------- -------- Cash flows from financing activities: Proceeds from issuance of common stock 2,931 1,398 Principal payments of long-term debt (19) (114) -------- -------- Net cash provided by financing activities 2,912 1,284 -------- -------- Net increase in cash 4,937 4,262 Cash and cash equivalents at beginning of period 30,938 27,186 -------- -------- Cash and cash equivalents at end of period $ 35,875 $ 31,448 ======== ======== Supplemental disclosures of cash flow information: Cash paid during the periods for: Interest $ 860 $ 860 ======== ======== Income taxes $ 7 $ 5,154 ======== ========
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 annual audited consolidated financial statements and, in the opinion of the Company, reflect all adjustments (consisting of normal recurring adjustments, except as otherwise described in Note 2) necessary for a fair presentation for each of the periods presented. The results of operations for interim periods are not necessarily indicative of results for full fiscal years. As contemplated by the Securities and Exchange Commission ("SEC") under Rule 10-01 of Regulation S-X, the accompanying consolidated financial statements and related notes have been condensed and do not contain certain information that is included in the Company's annual consolidated financial statements and notes thereto. For further information, refer to the consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2000. Effective January 1, 2001, the Company adopted a fiscal year ending on the last Sunday in December of each year. Fiscal year 2001 will consist of 52 weeks and will end on December 30, 2001. 2. SPECIAL CHARGES In March 2001, the Company announced an organizational realignment. During the first quarter of 2001, the Company recorded pretax restructuring charges of $6.0 million. As part of this plan, the Company offered involuntary severance packages to approximately 30 staff employees primarily located at its headquarters and recognized $2.4 million in employee termination benefits associated with this workforce reduction. The Company also recorded approximately $1.7 million related to the abandonment of certain facilities including cancellation of a planned expansion at its headquarters building. The remaining balance includes amounts related to repositioning the Company's towing operations and other restructuring charges. The Company expects to substantially complete these restructuring activities by the end of 2001. The restructuring charges were determined based upon formal plans approved by the Company's management. The amounts the Company ultimately incurs may change as the reorganization is executed. The activity affecting the accrual for restructuring charges, which is included in Accrued Liabilities and Other Non-current Liabilities, for the six months ended July 1, 2001 is as follows: (000's) Workforce Facility Towing Reduction Closings and Other Total --------- -------- --------- --------- Balance at December 31, 2000 .... $ -- $ $ -- $ -- Charges to operations ........... 2,376 1,739 1,932 6,047 Utilization of accrual .......... (1,368) (378) (784) (2,530) ------- ------- ------- ------- Balance at July 1, 2001 ......... $ 1,008 $ 1,361 $ 1,148 $ 3,517 ======= ======= ======= ======= 6 7 3. 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. 4. ACQUISITION In February 2001, the Company acquired Pittsburgh Auto Salvage Service for $105,000 in cash. This acquisition was accounted for as a purchase, and the results of operations are included in the Company's consolidated financial statements from the date of acquisition. 5. NEW ACCOUNTING PRONOUNCEMENTS In June 2001, the FASB issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 addresses financial accounting and reporting for business combinations. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets. The Company is required to comply with SFAS No. 141 for all new acquisitions that occur beginning in the third quarter of fiscal year 2001. The Company is required to comply with SFAS No. 142 in the third quarter of fiscal year 2001 for new acquisitions and in the first quarter of fiscal year 2002 for previously acquired intangibles. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The discussion in this section contains forward-looking information that is subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those projected, expressed, or implied by such forward-looking information. In some cases, you can identify forward-looking statements by our use of words such as "may, will, should, anticipates, believes, expects, plans, future, intends, could, estimate, predict, targeting, potential or contingent," the negative of these terms or other similar expressions. The Company's actual results could differ materially from those discussed or implied herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in "Factors That May Affect Future Results" below and in the Company's annual report on Form 10-K for the fiscal year ended December 31, 2000. Among these risks are: conducting business pursuant to the purchase agreement method of sale; changes in the market value of salvage; fluctuations in the actual cash value of salvage vehicles; the ability to successfully renegotiate existing purchase agreement contracts; the quality and quantity of inventory available from suppliers; competition; the ability to pass through increased towing costs; dependence on key insurance company suppliers; delays or changes in state title processing; general weather conditions; legislative or regulatory acts; that vehicle processing time will improve; the availability of suitable acquisition candidates; the ability to bring new facilities to expected earnings targets; that the Company's towing business will reach forecasted levels of profitability and the level of energy and labor costs. 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 percentage of sale consignment and fixed fee 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 revenues. The percentage of sale consignment method offers potentially increased profits over fixed fee consignment by providing incentives to both the Company and the salvage provider to invest in vehicle enhancements thereby maximizing vehicle selling prices. Under the purchase agreement sales method, the vehicle is owned by the Company and the sales price of the vehicle is recorded in revenue. 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. 7 8 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. ACVs 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 ACVs or in the market or auction prices for salvage vehicles have an impact on the profitability of the sale of vehicles under the purchase agreement method. However, if increases in used car prices and ACVs 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. To mitigate these risks, 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. Since its initial public offering, the Company has grown primarily through a series of acquisitions to now include 58 locations as of July 1, 2001. 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 July 1, 2001 Compared to the Three Months Ended June 30, 2000 Net revenues of the Company decreased to $75.5 million for the three months ended July 1, 2001, from $84.3 million for the same three month period in 2000, a 10% decrease. The decline in net revenues is consistent with a planned strategic shift away from vehicles sold under the purchase agreement method. Under the purchase agreement method, the entire purchase price of the vehicle is recorded as revenue compared to only recording the fees collected on the sale of a car under the lower risk consignment fee based arrangements. This change in contract mix also contributed to the significant increase in fee income for the quarter. Fee income in the second quarter increased 15% to $38.6 million versus $33.4 million in the second quarter of last year. This increase is the result of both increased volume and pricing changes. Gross profit increased slightly to $24.4 million for the three months ended July 1, 2001, from $24.2 million for the comparable period in 2000. Direct operating expenses increased to $19.6 million for the three months ended July 1, 2001, from $14.4 million for the comparable period in 2000. Acquisitions and Company-developed new greenfield sites that were completed in 2000 and 2001 contributed to the significant increase in expenses. In addition, higher information technology expenses were recognized in 2001 as internal staffing costs were redirected from capitalized development cost efforts to maintenance. Interest expense decreased slightly to $456,000 for the three months ended July 1, 2001, from $457,000 for the comparable period in 2000. Interest income decreased to $315,000 for the 2001 second quarter versus $470,000 for the fiscal year 2000 second quarter. The Company's effective income tax rate for the quarter was 41.3% in 2001 versus 41% in 2000. Six Months Ended July 1, 2001 Compared to the Six Months Ended June 30, 2000 Net revenues of the Company decreased to $153.4 million for the six months ended July 1, 2001, from $171.2 million for the same six month period in 2000, a 10% decrease. Fee income in the second quarter increased 16% versus last year. This increase is the result of both increased volume and pricing changes. Gross profit decreased slightly to $47.2 million for the six months ended July 1, 2001, from $47.3 million for the same period in 2000. The decline in profitability reflects continued poor performance of 8 9 certain purchase agreement contracts during their phase-out period as well as inventory write-downs on certain purchase agreement cars still in inventory. Direct operating expenses increased to $38.0 million for the six months ended July 1, 2001, from $29.4 million for the comparable period in 2000. The increase is primarily related to acquisitions and greenfields that were completed in 2000 and 2001. Interest expense decreased slightly to $912,000 for the six months ended July 1, 2001, from $921,000 for the same period in 2000. Interest income decreased to $683,000 for the six month period ended July 1, 2001, from $881,000 for the comparable period in 2000. Income taxes decreased to $381,000 for the six months ended July 1, 2001, from $6.5 million for the comparable period in 2000. The Company's effective tax rate for the six months ended July 1, 2001 was 42% versus 41% for the comparable period in 2000. The effective tax rate reflects management's estimate of the applicable rate for the full year and is subject to ongoing review and evaluation by the Company. The Company's net earnings for the six months ended July 1, 2001, including special charges, is $526,000 with diluted earnings per share of $.04 compared to last year's six month period net earnings of $9.4 million and diluted earnings per share of $.79. Excluding the after-tax effect of special charges, the Company's net earnings for the first half of 2001 would have been $4.0 million with diluted earnings per share of $.34. FINANCIAL CONDITION AND LIQUIDITY At July 1, 2001, the Company had current assets of $104.8 million, including $35.9 million of cash and cash equivalents and $3.9 million of short-term investments. Current liabilities were $67.8 million. The Company had working capital of $37.0 million at July 1, 2001, a $16.2 million decrease from December 31, 2000. Current installments of long-term debt include $20.0 million of 8.6% Senior Notes that mature on February 15, 2002. These notes were reclassified to current liabilities in 2001 thus accounting for the decline in working capital since the end of the year. The Company plans to replace these notes with new external financing. Other long-term liabilities include a post-retirement benefits liability that relates to the acquisition in 1994 of Underwriters Salvage Company. The amount recorded at July 1, 2001 for the post-retirement benefits liability is approximately $2.9 million. The remaining balance within other long-term liabilities represents expenditures related to the restructuring charge that will be made more than one year beyond July 1, 2001. Capital expenditures were approximately $9.0 million for the six months ended July 1, 2001. These capital expenditures primarily included upgrading and expanding the Company's facilities including the purchase of land at its new facility in Albuquerque, New Mexico and the opening of its new Los Angeles, California facility. The Los Angeles facility consolidates and replaces two previous sites within the Los Angeles area. The Company currently leases most of its facilities and other properties. In February 2001, the Company acquired Pittsburgh Auto Salvage Service for $105,000 in cash. This acquisition was accounted for as a purchase, and the results of operations are included in the Company's consolidated financial statements from the date of acquisition. In September 2000, the Company's Board of Directors authorized the purchase of up to 1,500,000 shares of its common stock. Purchases may be made from time to time in the open market, subject to the requirements of applicable laws, and, if made will be financed with existing cash and cash equivalents, marketable securities, and cash from operations. As of July 1, 2001, the Company had not purchased any shares pursuant to this authorization and has no immediate plans to do so. 9 10 The Company believes that cash generated from operations will be sufficient to fund capital expenditures and provide adequate working capital for operations for the next twelve months. Part of the Company's plan is 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. In June 2001, the FASB issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 addresses financial accounting and reporting for business combinations. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets. The Company is required to comply with SFAS No. 141 for all new acquisitions that occur beginning in the third quarter of fiscal year 2001. The Company is required to comply with SFAS No. 142 in the third quarter of fiscal year 2001 for new acquisitions and in the first quarter of fiscal year 2002 for previously acquired intangibles. FACTORS THAT MAY AFFECT FUTURE RESULTS The Company operates in a changing environment that involves a number of risks, some of which are beyond the Company's control. The following discussion highlights some of these risks. Quarterly Fluctuations. The Company's operating results have in the past and may in the future fluctuate significantly depending on a number of factors, some of which are more significant for sales under the purchase agreement method. These factors include: fluctuations in ACVs of salvage vehicles, changes in the market value of salvage vehicles, delays or changes in state title processing, general weather conditions, changes in regulations governing the processing of salvage vehicles, the availability and quality of salvage vehicles and attendance at salvage auctions. The Company is also dependent upon receiving a sufficient number of total loss vehicles as well as recovered theft vehicles to sustain its profit margins. Factors 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. 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, 10 11 however, and the Company believes its principal publicly-held competitor is Copart, Inc. ("Copart"). Copart 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 end users. There can be no assurance that the Company will be able to compete successfully against current or future competitors or that competitive pressures faced by the Company will not have a material adverse effect on its operating results and financial condition. Dependence on Key Insurance Company Suppliers. Historically, a limited number of insurance companies has accounted for a substantial portion of the Company's revenues. For example, in 2000, vehicles supplied by the Company's three largest suppliers accounted for approximately 40% of the Company's unit sales. The largest suppliers, State Farm Insurance, Farmers Insurance, and Allstate, each accounted for approximately 14%, 14%, and 12%, respectively, of the Company's unit sales. A loss or reduction in the number of vehicles from any of these suppliers, or adverse changes in the agreements that such suppliers have with the Company, could have a material adverse effect on the Company's operating results and financial condition. Purchase Agreement Method of Sale. Under the purchase agreement method of sale, the Company is required to purchase, and the insurance company and other non-insurance company suppliers are required to sell to the Company, virtually all total loss and recovered theft vehicles generated by the supplier in a designated geographic area. The agreements are customized to each supplier's needs, but typically require the Company to pay a specified percentage of a vehicle's ACV, depending on the vehicle's age and certain other conditions including whether the vehicle is a total loss or recovered theft vehicle. IAA assumes the risk of market price variation for vehicles sold under a purchase agreement and therefore works to enhance the value of purchased vehicles in the selling process. Because the Company's purchase price is fixed by contract, changes in ACVs or in the market or auction prices for salvage vehicles have an impact on the profitability of the sale of vehicles under the purchase agreement method. If increases in used car prices and ACVs 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. Revenue recorded from the sale of a purchase agreement vehicle is the actual selling price of the vehicle. From 1993 to 1996, increased ACVs reduced the profitability that the Company realized on purchase agreement contracts. Beginning late in the second quarter of 2000 and continuing into early 2001, purchase agreement profitability was impaired by a combination of rising ACVs and flat to lower sale prices at auction in certain parts of the country. Further increases in ACVs or declines in the market or auction prices for salvage vehicles could have a material adverse effect on the Company's operating results and financial condition. The Company has included adjustment and risk-sharing clauses in certain of its purchase agreement contracts to provide some protection to the Company and its customers from unexpected, significant changes in ACVs that are not accompanied by a comparable increase in sales prices. In addition, the Company has renegotiated certain purchase agreements, converting them to either the Percent of Sale or Fixed Fee Consignment method of sale. In 2000 and 1999 respectively, approximately 26% and 28% of the units processed by IAA were processed through the purchase agreement method of sale. The Company expects that approximately 20% of total units sold in 2001 will be sold under the purchase agreement method of sale. Governmental Regulation. The Company's operations are subject to regulation, supervision and licensing under various federal, state and local statutes, ordinances and regulations. The acquisition and sale of totaled and recovered theft vehicles is regulated by state motor vehicle departments in each of the locations in which the Company operates. Changes in law or governmental regulations or interpretations of existing law or regulations can result in increased costs, reduced salvage vehicle prices and decreased 11 12 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 operating results and financial condition. Provision of Services as a National or Regional Supplier. The provision of services to insurance company suppliers on a national or regional basis requires that the Company expend resources and dedicate management to a small number of individual accounts, resulting in a significant amount of fixed costs. The development of a referral based national network service, in particular, has required the devotion of financial resources without immediate reimbursement of such expenses by the insurance company suppliers. Expansion and Integration of Facilities. The Company seeks to increase sales and profitability through acquisition of other salvage auction facilities, new site expansion and the increase of salvage vehicle volume at existing facilities. There can be no assurance that the Company will continue to acquire new facilities 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 operating results and financial condition. Furthermore, the Company has limited sources of additional capital available for acquisitions, expansions and start-ups. The Company's ability to integrate and expand its facilities will depend on its ability to identify and obtain additional sources of capital to finance such integration and expansion. In the future, the Company will be required to continue to improve its financial and management controls, reporting systems and procedures on a timely basis and expand, train and manage its employee work force. The failure to improve these systems on a timely basis and to successfully expand and train the Company's work force could have a material adverse effect on the Company's operating results and financial condition. Volatility of Stock Price. The market price of the Company's common stock has been and could continue to be subject to significant fluctuations in response to various factors and events, including variations in the Company's operating results, the timing and size of acquisitions and facility openings, the loss of vehicle suppliers or buyers, the announcement of new vehicle supply agreements by the Company or its competitors, changes in regulations governing the Company's operations or its vehicle suppliers, environmental problems or litigation. Environmental Regulation. The Company's operations are subject to federal, state and local laws and regulations regarding the protection of the environment. In the salvage vehicle auction industry, large numbers of wrecked vehicles are stored at auction facilities for short periods of time. Minor spills of gasoline, motor oils and other fluids may occur from time to time at the Company's facilities and may result in soil, surface water or groundwater contamination. Petroleum products and other hazardous materials are contained in aboveground or underground storage tanks located at certain of the Company's facilities. Waste materials such as waste solvents or used oils are generated at some of the Company's facilities and are disposed of as 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 operating results or financial condition. The contamination that could occur at the Company's facilities and the potential contamination by previous users of certain acquired facilities create the risk, however, that the Company could incur substantial expenditures for preventive or remedial action, as well as potential liability arising as a consequence of 12 13 hazardous material contamination, which could have a material adverse effect on the Company's operating results and financial condition. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Company had approximately $3.9 million of investments as of July 1, 2001. These investments largely consisted of state government obligations and had either variable rates of interest or stated interest rates ranging from 3.55% to 6.55%. The Company's 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 $20 million at an interest rate of 8.6% that mature on February 15, 2002. 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. 13 14 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. At the Annual Meeting of Shareholders of the Company held June 13, 2001 the shareholders (i) elected eight directors to serve on the Company's Board of Directors, (ii) approved the adoption of an amendment to the Company's Employee Stock Purchase Plan increasing the number of shares of common stock reserved for issuance thereunder by 75,000 shares, and (iii) ratified the Company's appointment of KPMG LLP to serve as the Company's independent auditors for the fiscal year ending December 31, 2001. Shareholders holding 10,477,156 shares of Common Stock, representing 89.0% of the total number of shares outstanding and entitled to vote at the meeting, were present in person or by proxy at the meeting. The vote for nominated directors was as follows: Director Votes for Votes Withheld -------- --------- -------------- Joseph F. Mazzella 10,430,552 46,604 Thomas C. O'Brien 10,430,552 46,604 Maurice A. Cocca 10,451,852 25,304 Susan B. Gould 10,451,852 25,304 Peter H. Kamin 10,430,552 46,604 Melvin R. Martin 10,415,467 61,689 Jeffrey W. Ubben 10,430,552 46,604 John K. Wilcox 10,451,852 25,304 The vote to approve the adoption of an amendment to the Company's Employee Stock Purchase Plan was as follows: For: 10,123,689; Against: 346,161; Abstain: 7,306. The vote for ratifying the appointment of KPMG LLP was as follows: For: 10,466,913; Against: 25,804; and Abstain: 4,439. ITEM 5. OTHER INFORMATION. Inapplicable ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) EXHIBITS. 10 Amended and Restated Employee Stock Purchase Plan (b) REPORTS ON FORM 8-K. No reports on Form 8-K were filed during the fiscal quarter ending July 1, 2001. 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: August 14, 2001 By: /s/ Scott P. Pettit --------------------------------- Name: Scott P. Pettit Title: Senior Vice President and Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer) 15 16 EXHIBIT INDEX EXHIBIT NO. ----------- 10 Amended and Restated Employee Stock Purchase Plan 16