0000950137-01-504321.txt : 20011128 0000950137-01-504321.hdr.sgml : 20011128 ACCESSION NUMBER: 0000950137-01-504321 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011107 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: IL FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-19594 FILM NUMBER: 1776787 BUSINESS ADDRESS: STREET 1: 850 E ALGONQUIN RD STREET 2: STE 100 CITY: SCHAUMGURG STATE: IL ZIP: 60173 BUSINESS PHONE: 8478393939 MAIL ADDRESS: STREET 1: 850 E ALGONQUIN RD STREET 2: STE 100 CITY: SCHAUMGURG STATE: IL ZIP: 60173 10-Q 1 c65840e10-q.txt QUARTERLY REPORT 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, 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 of (I.R.S. Employer incorporation or organization) Identification No.) 850 East Algonquin Road, Suite 100, Schaumburg, Illinois 60173-3855 -------------------------------------------------------- ---------- (Address of principal executive offices) (Zip Code) (847) 839-3939 -------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. |X| Yes |_| No APPLICABLE ONLY TO CORPORATE ISSUERS Number of shares outstanding of each of the issuer's classes of common stock, as of October 31, 2001: Class Outstanding October 31, 2001 ----- ---------------------------- Common Stock, $0.001 Par Value 12,134,290 shares 1 INDEX INSURANCE AUTO AUCTIONS, INC. PAGE NUMBER ----------- PART I. FINANCIAL INFORMATION....................................... 3 Item 1. Financial Statements (Unaudited)............................ 3 Condensed Consolidated Statements of Operations for the Three Month and Nine Month Periods ended September 30, 2001 and September 30, 2000.............. 3 Condensed Consolidated Balance Sheets as of September 30, 2001 and December 31, 2000......... 4 Condensed Consolidated Statements of Cash Flows for the Nine Month Periods ended September 30, 2001 and September 30, 2000...................................... 5 Notes to Condensed Consolidated Financial Statements........ 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.............................. 8 Item 3. Quantitative and Qualitative Disclosures about Market Risk.. 14 PART II. OTHER INFORMATION.......................................... 15 Item 1. Legal Proceedings........................................... 15 Item 2. Changes in Securities....................................... 15 Item 3. Defaults upon Senior Securities............................. 15 Item 4. Submission of Matters to a Vote of Security Holders......... 15 Item 5. Other Information........................................... 15 Item 6. Exhibits and Reports on Form 8-K............................ 15 SIGNATURES ................................................... 16 2 INSURANCE AUTO AUCTIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands except per share amounts)
THREE MONTH PERIODS NINE MONTH PERIODS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, 2001 2000 2001 2000 ----------------------- ---------------------- (UNAUDITED) (UNAUDITED) Net sales: Vehicle sales $ 32,618 $ 47,307 $ 109,777 $ 153,116 Fee income 38,348 32,825 114,547 98,252 --------- --------- --------- --------- 70,966 80,132 224,324 251,368 Cost and expenses: Cost of sales 49,072 58,525 155,219 182,469 Direct operating expenses 20,188 16,587 58,121 46,014 Business transformation costs 668 -- 752 -- Amortization of acquisition costs 1,013 1,003 3,024 2,936 Special charges -- -- 6,047 -- --------- --------- --------- --------- Earnings from operations 25 4,017 1,161 19,949 Other (income) expense: Interest expense 441 455 1,353 1,376 Interest income (205) (436) (888) (1,317) --------- --------- --------- --------- Earnings (loss) before income taxes (211) 3,998 696 19,890 Provision (benefit) for income taxes (5) 1,639 376 8,155 --------- --------- --------- --------- Net earnings (loss) $ (206) $ 2,359 $ 320 $ 11,735 ========= ========= ========= ========= Earnings (loss) per share: Basic $ (.02) $ .20 $ .03 $ 1.01 ========= ========= ========= ========= Diluted $ (.02) $ .20 $ .03 $ .99 ========= ========= ========= ========= Weighted average shares outstanding: Basic 12,077 11,704 11,868 11,632 Effect of dilutive securities - stock options -- 262 158 227 --------- --------- --------- --------- Diluted 12,077 11,966 12,026 11,859 ========= ========= ========= =========
See accompanying notes to condensed consolidated financial statements. 3 INSURANCE AUTO AUCTIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands except share amounts)
SEPTEMBER 30, DECEMBER 31, 2001 2000 ------------- ------------ (UNAUDITED) ASSETS Current assets: Cash and cash equivalents $ 29,875 $ 30,938 Short-term investments 4,376 4,859 Accounts receivable, net 52,445 48,091 Inventories 15,581 10,588 Other current assets 4,607 3,112 -------- -------- Total current assets 106,884 97,588 -------- -------- Property and equipment, net 38,215 30,492 Investments in marketable securities 534 2,240 Deferred income taxes 5,366 5,123 Other assets, principally goodwill, net 127,181 130,264 -------- -------- $278,180 $265,707 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current installments of long-term debt $ 20,039 $ 37 Accounts payable 42,107 38,176 Accrued liabilities 5,645 6,171 Accrued restructuring charges 2,053 -- -------- -------- Total current liabilities 69,844 44,384 -------- -------- Long-term debt, excluding current installments 111 20,141 Other liabilities 3,366 3,001 Deferred income taxes 11,714 10,440 -------- -------- Total liabilities 85,035 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 12,133,165 and 11,715,936 and shares as of September 30, 2001 and December 31, 2000, respectively 12 12 Additional paid-in capital 142,046 136,962 Retained earnings 51,087 50,767 -------- -------- Total shareholders' equity 193,145 187,741 -------- -------- $278,180 $265,707 ======== ========
See accompanying notes to condensed consolidated financial statements. 4 INSURANCE AUTO AUCTIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars)
NINE MONTH PERIODS ENDED SEPTEMBER 30, 2001 2000 ------------- (UNAUDITED) Cash flows from operating activities: Net earnings $ 320 $ 11,735 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 7,663 7,241 Gain on disposal of fixed assets (411) (31) Special charges 6,047 -- Changes in assets and liabilities (excluding effects of acquired businesses): (Increase) decrease in: Investments, net 2,189 1,375 Accounts receivable, net (4,291) (4,288) Inventories (4,993) (619) Other current assets (1,495) (822) Other assets 85 (204) Increase (decrease) in: Accounts payable 3,877 4,765 Accrued liabilities (4,167) (279) Deferred income taxes, net 1,032 1,187 -------- -------- Total adjustments 5,536 8,325 -------- -------- Net cash provided by operating activities 5,856 20,060 -------- -------- Cash flows from investing activities: Capital expenditures (15,845) (8,762) Proceeds from disposal of property and equipment 3,975 670 Payments made in connection with acquired companies, net of cash acquired (105) (9,925) -------- -------- Net cash used in investing activities (11,975) (18,017) -------- -------- Cash flows from financing activities: Proceeds from issuance of common stock 5,084 1,959 Principal payments on long-term debt (28) (136) -------- -------- Net cash provided by financing activities 5,056 1,823 -------- -------- Net increase (decrease) in cash and cash equivalents (1,063) 3,866 Cash and cash equivalents at beginning of period 30,938 27,186 -------- -------- Cash and cash equivalents at end of period $ 29,875 $ 31,052 ======== ======== Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 1,720 $ 1,720 ======== ======== Income taxes $ 7 $ 6,584 ======== ========
See accompanying notes to condensed consolidated financial statements. 5 INSURANCE AUTO AUCTIONS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. GENERAL The unaudited condensed consolidated financial statements of Insurance Auto Auctions, Inc. and its subsidiaries (collectively, the "Company") have been prepared on the same basis as the annual audited consolidated financial statements and, in the opinion of the Company, reflect all adjustments (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 plans are executed. The activity affecting the accrual for restructuring charges, which is included in Accrued Liabilities and Other Non-current Liabilities, for the nine months ended September 30, 2001 is as follows (in thousands of dollars):
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................ (1,741) (728) (1,034) (3,503) --------- -------- --------- ------- Balance at September 30, 2001...... $ 635 $ 1,011 $ 898 $ 2,544 ========= ======== ========= =======
6 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. EARNINGS PER SHARE For the three months ended September 30, 2001, the Company would have reported an additional 195,000 dilutive shares outstanding in the form of stock options assumed exercised. However, the Company incurred a net loss for the period; therefore, those options were excluded from the calculation of diluted earnings per share amounts because the effect would have been anti-dilutive. 5. ACQUISITIONS In February 2001, the Company acquired Pittsburgh Auto Salvage Service. 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 October 2001, the Company acquired Austin Salvage Pool. The acquisition will be accounted for as a purchase in the Company's fourth quarter financial statements. 6. NEW ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations and SFAS No. 142, Goodwill and Intangible Assets. In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method of accounting and prohibits the use of the pooling-of-interests method for such transactions. SFAS No. 141 also requires identified intangible assets acquired in a business combination to be recognized as an asset apart from goodwill if they meet certain criteria. Management has adopted SFAS 141, which has had no material impact on its condensed consolidated financial statements. SFAS No. 142 applies to all goodwill and identified intangible assets acquired in a business combination. Under the new standard, all goodwill, including that acquired before initial application of the standard, should not be amortized but should be tested for impairment at least annually. Identified intangible assets should be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 144. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001, (although early adoption would be permitted in certain circumstances) and must be adopted as of the beginning of a fiscal year. Retroactive application is not permitted. The Company is in the process of evaluating the impact that adoption of SFAS No. 142 may have on the financial statements; however, such impact, if any, is not known or reasonably estimable at this time. SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, it retains many of the fundamental provisions of that Statement. SFAS No. 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. However, it retains the requirement in Opinion 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The Company is in the process of evaluating the impact that adoption of SFAS No. 144 may have on the financial statements; however, such impact, if any, is not known or reasonably estimable at this time. 7 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 the Company's annual report on Form 10-K for the fiscal year ended December 31, 2000. Among these risks are: accelerated departure from conducting business pursuant to the purchase agreement method of sale which could adversely affect the Company's client base; the ability to successfully renegotiate existing purchase agreement contracts; fluctuations in the actual cash value of salvage vehicles; the quality and quantity of inventory available from suppliers; the ability to pass through increased towing costs; that vehicle processing time will improve; that the Company's towing business will reach forecasted levels of profitability; legislative or regulatory acts; changes in the market value of salvage; competition; the availability of suitable acquisition candidates; the ability to bring new facilities to expected earnings targets and the dependence on key insurance company suppliers; the ability of Synergetics to successfully implement standardized key processes throughout the Company's operations as well as the ability of SEI Information Technology's ability to successfully complete the re-design of the Company's information systems, both in a timely manner and according to costs and operational specifications; and the level of energy and labor costs. OVERVIEW 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. In October 2001, the Company announced that it intends to accelerate its plan to discontinue offering the purchase agreement method of sale. Given the overall economics and risks associated with purchase agreement contracts, their level of performance has been unacceptable. The Company expects that the percentage of vehicle assignments received under the purchase agreement method will be less than 8 percent by the beginning of 2002. Insurance Auto Auctions began advising its significant purchase agreement customers of this decision in September 2001. The Company intends to convert these customers to more manageable consignment-based contracts. Although the Company has found that these customers have been open to this change, there can be no guarantee that the Company will not lose some of its volume as a result of this effort. Since its initial public offering in 1991, the Company has grown primarily through a series of acquisitions to now include 60 locations as of October 31, 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. 8 RESULTS OF OPERATIONS Three Months Ended September 30, 2001 Compared to the Three Months Ended September 30, 2000 Third quarter earnings from operations were $25,000 in 2001 versus $4.0 million in 2000. Earnings from operations reflected $668,000 of business transformation costs that encompass the enterprise-wide system re-design and business process re-engineering. Net earnings for the quarter, before business transformation costs, would have been $210,000, or $0.02 per diluted share, versus net earnings of $2.4 million, or $0.20 per diluted share, for the third quarter of 2000. Net revenues of the Company decreased to $71.0 million for the three months ended September 30, 2001, from $80.1 million for the same three month period in 2000, an 11.4% decrease. The decline in net revenues is primarily due to the plan to exit the purchase agreement method of sale. Under the purchase agreement method, the entire purchase price of the vehicle is recorded as revenue compared to only recording the fees collected on the sale of a vehicle under the lower risk consignment fee based arrangements. This change in contract mix also contributed to the significant increase in fee income for the quarter. Fee income in the third quarter increased 16.8% to $38.3 million versus $32.8 million in the third quarter of last year. This increase is the result of both increased volume and pricing changes. Gross profit increased slightly to $21.9 million for the three months ended September 30, 2001, from $21.6 million for the comparable period in 2000. The increase in fee income contributed to the increase in gross profit, however, the underlying economics on purchase agreement contracts had an adverse effect on gross profit dollars in 2001. Direct operating expenses increased to $20.2 million for the three months ended September 30, 2001, from $16.6 million for the comparable period in 2000. The increase in operating expenses is due in large part to new facilities, the Houston flood and expenses related to maintaining the Company's existing IT infrastructure. Interest expense decreased slightly to $441,000 for the three months ended September 30, 2001, from $455,000 for the comparable period in 2000. Interest income decreased to $205,000 for the 2001 third quarter versus $436,000 for the fiscal year 2000 third quarter. The Company recorded a small income tax benefit of $5,000 for the third quarter 2001 versus and income tax expense of $1.6 million in the third quarter of fiscal year 2000. The Company adjusted its cumulative effective tax rate for fiscal 2001 to be 54%. As a result of this adjustment, the effective tax rate for the third quarter 2001 resulted in a rate of 2.4% versus 41% in the third quarter of 2000. Nine Months Ended September 30, 2001 Compared to the Nine Months Ended September 30, 2000 Net revenues of the Company decreased to $224.3 million for the nine months ended September 30, 2001, from $251.4 million for the same nine month period in 2000, a 10.8% decrease. Fee income for the nine months increased 16.6% versus last year. This increase is the result of both increased volume and pricing changes. Gross profit increased slightly to $69.1 million for the nine months ended September 30, 2001, from $68.9 million for the same period in 2000. The increase in fee income contributed to the increased gross profit, however, continued weakness in purchase agreement profitability has had a negative impact on gross profit growth in 2001. Direct operating expenses increased to $58.1 million for the nine months ended September 30, 2001, from $46.0 million for the comparable period in 2000. The increase is primarily related to acquisitions and greenfields that were completed in 2000 and 2001. Direct operating expenses were also affected by costs related to the Houston flood and maintaining the Company's existing IT infrastructure including related labor costs. 9 Interest expense was flat at $1.4 million for the nine months ended September 30, 2001 versus the same period in 2000. Interest income decreased to $888,000 for the nine month period ended September 30, 2001, from $1.3 million for the comparable period in 2000. Income taxes decreased to $376,000 for the nine months ended September 30, 2001, from $8.2 million for the comparable period in 2000. The Company's effective tax rate for the nine months ended September 30, 2001 was 54% 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 nine months ended September 30, 2001, including special charges, were $320,000 with diluted earnings per share of $0.03 compared to last year's nine month period net earnings of $11.7 million and diluted earnings per share of $0.99. Excluding the after-tax effect of special charges and business transformation costs, which encompass the enterprise-wide system re-design and the business process re-engineering effort, the Company's net earnings for the nine months ended September 30, 2001 would have been $3.4 million with diluted earnings per share of $0.29. FINANCIAL CONDITION AND LIQUIDITY At September 30, 2001, the Company had current assets of $106.9 million, including $29.9 million of cash and cash equivalents and $4.4 million of short-term investments. Current liabilities were $69.8 million. The Company had working capital of $37.0 million at September 30, 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 September 30, 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 September 30, 2001. Capital expenditures were approximately $15.8 million for the nine months ended September 30, 2001. These capital expenditures primarily represented facility costs related to expansion into new markets and upgrading current facilities. The Company has begun operations this year in Philadelphia; Pennsylvania, Albuquerque, New Mexico and Hartford, Connecticut and has opened a new facility in Los Angeles, California. Expenditures have also been made toward two additional facilities that are expected to open late in 2001 or in early 2002. In February 2001, the Company acquired Pittsburgh Auto Salvage Service in a cash transaction. 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 October 2001, the Company acquired Austin Salvage Pool in a cash transaction. This acquisition was accounted for as a purchase. The results of Austin Salvage Pool will be included in the Company's fourth quarter financial statements as of 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 October 31, 2001, the Company had not purchased any shares pursuant to this authorization and has no immediate plans to do so. 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 and acquisitions. At some 10 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 July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations and SFAS No. 142, Goodwill and Intangible Assets. In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method of accounting and prohibits the use of the pooling-of-interests method for such transactions. SFAS No. 141 also requires identified intangible assets acquired in a business combination to be recognized as an asset apart from goodwill if they meet certain criteria. Management has adopted SFAS 141, which has had no material impact on its condensed consolidated financial statements. SFAS No. 142 applies to all goodwill and identified intangible assets acquired in a business combination. Under the new standard, all goodwill, including that acquired before initial application of the standard, should not be amortized but should be tested for impairment at least annually. Identified intangible assets should be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 144. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001, (although early adoption would be permitted in certain circumstances) and must be adopted as of the beginning of a fiscal year. Retroactive application is not permitted. The Company is in the process of evaluating the impact that adoption of SFAS No. 142 may have on the financial statements; however, such impact, if any, is not known or reasonably estimable at this time. SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, it retains many of the fundamental provisions of that Statement. SFAS No. 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. However, it retains the requirement in Opinion 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The Company is in the process of evaluating the impact that adoption of SFAS No. 144 may have on the financial statements; however, such impact, if any, is not known or reasonably estimable at this time. 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 11 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"). 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 2001, 12 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. For the nine months ended September 30, 2001, approximately 20% of total units sold were sold under the purchase agreement method of sale. In October 2001, the Company announced that it intends to accelerate its plan to discontinue offering the purchase agreement method of sale. Given the overall economics and risks associated with purchase agreement contracts, their level of performance has been unacceptable. The Company expects that the percentage of vehicle assignments received under the purchase agreement method will be less than 8 percent by the beginning of 2002. Insurance Auto Auctions began advising its significant purchase agreement customers of this decision in September 2001. The Company intends to convert these customers to more manageable consignment-based contracts. Although the Company has found that these customers have been open to this change, there can be no guarantee that the Company will not lose some of its volume as a result of this effort. Governmental Regulation. The Company's operations are subject to regulation, supervision and licensing under various federal, state and local statutes, ordinances and regulations. The acquisition and sale of totaled and recovered theft vehicles is regulated by state motor vehicle departments in each of the locations in which the Company operates. Changes in law or governmental regulations or interpretations of existing law or regulations can result in increased costs, reduced salvage vehicle prices and decreased profitability for the Company. In addition to the regulation of sales and acquisitions of vehicles, the Company is also subject to various local zoning requirements with regard to the location of its auction and storage facilities. These zoning requirements vary from location to location. Failure to comply with present or future regulations or changes in existing regulations could have a material adverse effect 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 13 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 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 $4.9 million of investments as of September 30, 2001. These investments largely consisted of state government obligations and had either variable rates of interest or stated interest rates ranging from 2.20% 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. 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. Inapplicable ITEM 5. OTHER INFORMATION. Inapplicable ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (A) EXHIBITS. Inapplicable (B) REPORTS ON FORM 8-K. No reports on Form 8-K were filed during the fiscal quarter ended September 30, 2001. 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 7, 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) 16 EXHIBIT INDEX EXHIBIT NO. ----------- None