-----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, IWp2uAW8aSGgDxCqnUoHezgLJodgYrMP54EpcW42n/fA6rc+2oEs556hLsgNdqSV R4lW6gnxg53EIVw2GwJlPg== 0000950137-99-004165.txt : 19991117 0000950137-99-004165.hdr.sgml : 19991117 ACCESSION NUMBER: 0000950137-99-004165 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991115 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: 99755468 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, 1999 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 of 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 September 30, 1999: Class Outstanding September 30, 1999 - ------------------------------ ------------------------------ Common Stock, $0.001 Par Value 11,568,300 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, 1999 and December 31, 1998................................ 3 Condensed Consolidated Statements of Operations for the Three Month and Nine Month Periods ended September 30, 1999 and September 30, 1998..................................... 4 Condensed Consolidated Statements of Cash Flows for the Nine Month Periods ended September 30, 1999 and September 30, 1998............ 5 Notes to Condensed Consolidated Financial Statements............................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..................................................... 6 Item 3. Quantitative and Qualitative Disclosures about Market Risk......................... 13 PART II. OTHER INFORMATION................................................................. 13 Item 1. Legal Proceedings.................................................................. 13 Item 2. Changes in Securities.............................................................. 13 Item 3. Defaults upon Senior Securities.................................................... 13 Item 4. Submission of Matters to a Vote of Security Holders................................ 13 Item 5. Other Information.................................................................. 13 Item 6. Exhibits and Reports on Form 8-K................................................... 13 SIGNATURES.................................................................................. 14
3 INSURANCE AUTO AUCTIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31, 1999 1998 ------------ ------------ (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 13,777,000 $ 11,682,000 Short-term investments 19,718,000 11,138,000 Accounts receivable, net 35,619,000 37,415,000 Inventories 12,263,000 11,229,000 Other current assets 2,263,000 1,676,000 ------------ ------------ Total current assets 83,640,000 73,140,000 ------------ ------------ Property and equipment, at cost, net 24,292,000 22,312,000 Deferred income taxes 3,637,000 2,976,000 Other assets, principally goodwill, net 126,074,000 128,916,000 ------------ ------------ $237,643,000 $227,344,000 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current installments of long-term debt $ 216,000 $ 216,000 Accounts payable 27,756,000 30,939,000 Accrued liabilities 6,118,000 6,097,000 Income taxes 692,000 582,000 ------------ ------------ Total current liabilities 34,782,000 37,834,000 ------------ ------------ Long-term debt, excluding current installments 20,020,000 20,116,000 Accumulated postretirement benefits obligation 3,261,000 3,485,000 Deferred income taxes 8,260,000 7,154,000 ------------ ------------ Total liabilities 66,323,000 68,589,000 ------------ ------------ 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 11,568,300 and 11,320,419 shares as of September 30, 1999 and December 31, 1998, respectively 12,000 11,000 Additional paid-in capital 134,439,000 132,171,000 Retained earnings 36,869,000 26,573,000 ------------ ------------ Total shareholders' equity 171,320,000 158,755,000 ------------ ------------ $237,643,000 $227,344,000 ============ ============
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) 1999 1998 1999 1998 ------------- ------------- ------------- ------------- Net Sales: Vehicle sales $ 49,562,000 $ 45,726,000 $ 155,231,000 $ 144,789,000 Fee income 27,452,000 24,321,000 84,192,000 69,216,000 ------------- ------------- ------------- ------------- 77,014,000 70,047,000 239,423,000 214,005,000 Cost and expenses: Cost of sales 56,465,000 53,265,000 176,242,000 161,731,000 Direct operating expenses 14,195,000 12,650,000 42,018,000 37,779,000 Amortization of acquisition costs 949,000 935,000 2,848,000 2,833,000 Special charges -- -- -- 1,564,000 ------------- ------------- ------------- ------------- Earnings from operations 5,405,000 3,197,000 18,315,000 10,098,000 Other (income) expense: Interest expense 492,000 496,000 1,479,000 1,560,000 Interest (income) (365,000) (193,000) (916,000) (589,000) ------------- ------------- ------------- ------------- Earnings before income taxes 5,278,000 2,894,000 17,752,000 9,127,000 Income taxes 2,092,000 1,331,000 7,456,000 4,198,000 ------------- ------------- ------------- ------------- Net earnings $ 3,186,000 $ 1,563,000 $ 10,296,000 $ 4,929,000 ============= ============= ============= ============= Earnings per share: Basic $ .28 $ .14 $ 90 $ .44 ============= ============= ============= ============= Diluted $ .27 $ .14 $ 89 $ .43 ============= ============= ============= ============= Weighted average shares outstanding: Basic 11,530,000 11,320,000 11,432,000 11,313,000 ============= ============= ============= ============= Diluted 11,830,000 11,474,000 11,605,000 11,432,000 ============= ============= ============= =============
4 5 INSURANCE AUTO AUCTIONS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTH PERIODS ENDED SEPTEMBER 30, ---------------------------- 1999 1998 ------------ ------------ Cash flows from operating activities: Net earnings $ 10,296,000 $ 4,929,000 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 6,791,000 6,539,000 (Gain) loss on disposal of fixed assets (79,000) 79,000 Change in assets and liabilities (net of effects of acquired companies): (Increase) decrease in: Short-term investments (8,580,000) (9,595,000) Accounts receivable, net 1,796,000 (5,042,000) Inventories (1,034,000) 1,606,000 Other current assets (587,000) 106,000 Other assets (6,000) 56,000 Increase (decrease) in: Accounts payable (3,183,000) (3,981,000) Accrued liabilities 21,000 (1,852,000) Income taxes payable 555,000 711,000 ------------ ------------ Total adjustments (4,306,000) (11,373,000) ------------ ------------ Net cash provided by (used in) operating activities 5,990,000 (6,444,000) ------------ ------------ Cash flows from investing activities: Capital expenditures (5,951,000) (4,339,000) Proceeds from disposal of fixed assets 107,000 22,000 Payments made in connection with acquired companies, net of cash acquired -- (1,806,000) ------------ ------------ Net cash used in investing activities (5,844,000) (6,123,000) ------------ ------------ Cash flows from financing activities: Proceeds from issuance of common stock 2,269,000 282,000 Principal payments of long-term debt (320,000) (2,180,000) ------------ ------------ Net cash provided by (used in) financing activities 1,949,000 (1,898,000) ------------ ------------ Net increase (decrease) in cash 2,095,000 (14,465,000) Cash and cash equivalents at beginning of period 11,682,000 25,972,000 ------------ ------------ Cash and cash equivalents at end of period $ 13,777,000 $ 11,507,000 ============ ============ Supplemental disclosures of cash flow information: Cash paid during the year for: Interest $ 1,720,000 $ 1,793,000 ============ ============ Income taxes $ 7,001,000 $ 3,500,000 ============ ============
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, 1998 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. SPECIAL CHARGES During the first quarter of 1998, a settlement agreement was entered into by the Company resolving all outstanding differences between Insurance Auto Auctions, Inc. and a former director, who resigned as a director and Chairman of the Board. In the settlement agreement, various agreements were terminated (including agreements providing for compensation and certain benefits through June 30, 1999, and all outstanding stock options). Per the settlement agreement, the Company made a lump-sum payment of $700,000 to the former director. This included a bonus payment for 1997 of $126,000 pursuant to a 1996 agreement between the Company and the former director. The difference of $574,000 was recorded as a special charge in first quarter 1998. In addition, McKinsey & Co. had been retained to assist the Company in identifying and developing additional customer-valued services, focusing on opportunities to add value to the insurance industry's automobile claims process and reduce costs for these organizations. The scope of the work completed also included 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 the first quarter of 1998. 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 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, 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, Form 10-K for the fiscal year ended December 31, 1998, or subsequent quarterly 6 7 reports. Among these risks are legislative acts, changes in the market value of salvage, competition, quality and quantity of inventory available from suppliers, and dependence on key insurance company suppliers. OVERVIEW The Company offers insurance companies and other vehicle suppliers cost-effective salvage processing solutions through a variety of different methods of sale, including 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. 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. However, 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. 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 50 locations as of September 30, 1999. In February of 1998, the Company acquired Auto Disposal Company. ADC operated two pools in Alabama. 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, 1999 Compared to the Three Months Ended September 30, 1998 Net sales of the Company increased to $77,014,000 for the three months ended September 30, 1999, from $70,047,000 for the same three month period in 1998. Unit volume increased 3%, compared to the same period in 1998. Gross profit increased 22% to $20,549,000 for the three months ended September 30, 1999, from $16,782,000 for the same period in 1998. Gross profit per unit of $173 for the three months ended September 30, 1999 was 18% higher than for the comparable period of 1998. The increase in gross profit per unit has been primarily the result of (i) the implementation and faster than expected rollout of the 7 8 Company's gross profit enhancement initiatives, including the conversion of fixed-fee consignment contracts to the generally more profitable percent of sale contract type, and (ii) the Company's focus on increasing the number and variety of vehicle enhancement services. Approximately 18% of vehicles sold in the third quarter of 1999 were sold under the percent of sale method versus 10% for the same period last year. The purchase agreement sales method of processing accounted for 28% of total volume, compared with 30% for the same period in 1998. Direct operating expenses increased to $14,195,000 for the three months ended September 30, 1999, from $12,650,000 for the same period in 1998. Direct operating expenses per unit increased to $119 for the three months ended September 30, 1999, as compared to $110 for the same period in 1998. The increase reflects higher earned management incentives due to the improved earnings as well as increased salary and labor costs largely associated with the increased number of vehicle enhancement services. Interest expense decreased to $492,000 for the three months ended September 30, 1999, from $496,000 for the same period in 1998. Interest income increased to $365,000 for the three month period ended September 30, 1999, from $193,000 for the comparable period in 1998 reflecting higher levels of cash equivalents and short-term investments due to strong cash flow from operations in 1999. Income taxes increased to $2,092,000 for the three months ended September 30, 1999, from $1,331,000 for the comparable period in 1998. This increase is the result of the increase in earnings, offset by a decrease in the Company's effective tax rate from 46% in 1998 to an anticipated 42% for the full fiscal year of 1999. The third quarter income tax provision included a retroactive application of the new lower 1999 effective rate. The effective tax rate is subject to ongoing review and evaluation by the Company. The Company's net earnings were $3,186,000 for the three months ended September 30, 1999, a 104% increase from $1,563,000 for the comparable period in 1998. Nine Months Ended September 30, 1999 Compared to the Nine Months Ended September 30, 1998 Net sales of the Company increased to $239,423,000 for the nine months ended September 30, 1999, from $214,005,000 for the same nine month period in 1998, a 12% increase. This is the result of an increase in the number of units sold, as compared to the same period in 1998, and increased fee revenues including increased buyer fees and the continued roll out of our profitability enhancement initiatives. Unit volume for the nine months ended September 30, 1999 increased 7%, as compared to the same period in 1998. The increase was the result of more units being available for sale due to strong vehicle assignments taken in the fourth quarter of 1998 and early in the first quarter of 1999. The vehicle assignments reflect an increase in same store sales due in part to severe winter storms in select areas of the country and an increase in the charity business. Flooding in certain east coast markets during September is expected to have a slight favorable impact on units sold during the fourth quarter. The purchase agreement sales method of processing accounted for 29% of total volume, down from 30% for the same period in 1998. The percent of sale agreement sales method of processing accounted for 16% of total volume, up 7 percentage points from the same period in 1998. The Company continues to focus on converting fixed fee consignment contracts to the generally more profitable percent of sale contract type. Gross profit increased 21% to $63,181,000 for the nine months ended September 30, 1999, from $52,274,000 for the same period in 1998. Gross profit per unit of $171 for the nine months ended September 30, 1999 was 13% higher than for the comparable period of 1998. The increase in gross profit per unit is the result of the quicker than anticipated implementation of several gross profit enhancement initiatives and a continued focus on price management. A key emphasis of the gross profit enhancement initiatives has been on increasing the number and variety of vehicle enhancement services which increase fee revenue and the value of auctioned vehicles, both of which improve the Company's gross profit per unit. The 8 9 price management initiative includes an ongoing evaluation of the Company's services and corresponding fee structures to ensure the Company's service offerings are properly valued in the market place. Direct operating expenses increased to $42,018,000 for the nine months ended September 30, 1999, from $37,779,000 for the same period in 1998. Direct operating expenses per unit increased to $114 for the nine months ended September 30, 1999, as compared to $110 for the same period in 1998. The increase is the result of higher earned management incentives, increased facility related costs and a general increase in operating expenses due to increased vehicle enhancement services. Interest expense decreased to $1,479,000 for the nine months ended September 30, 1999, from $1,560,000 for the same period in 1998. The change in interest expense was attributable to a decrease in long-term debt as a result of the Company's repayment in 1998 of several notes payable to sellers related to certain acquisitions. Interest income increased to $916,000 for the nine month period ended September 30, 1999, from $589,000 for the comparable period in 1998. The increase is the result of an increase in cash equivalents and short-term investments. Income taxes increased to $7,456,000 for the nine months ended September 30, 1999, from $4,198,000 for the comparable period in 1998. This increase is the result of the increase in earnings. The Company's effective tax rate for the nine months ended September 30, 1999 was 42% versus 46% for the comparable period in 1998. The effective tax rate is subject to ongoing review and evaluation by the Company. The Company's net earnings were $10,296,000 for the nine months ended September 30, 1999, a 78% increase from $5,774,000, before special charges, for the comparable period in 1998. FINANCIAL CONDITION AND LIQUIDITY At September 30, 1999, the Company had current assets of $83,640,000, including $13,777,000 of cash and cash equivalents and $19,718,000 of short-term investments. Current liabilities were $34,782,000. The Company had working capital of $48,858,000 at September 30, 1999, a $13,552,000 increase from December 31, 1998. At September 30, 1999, the Company's indebtedness consisted mostly of 8.6% Senior Notes approximating $20,000,000, a post-retirement benefits liability relating to the Underwriters Salvage Company acquisition of approximately $3,261,000 and amounts due to the sellers related to certain acquisitions. There were no borrowings outstanding on the Revolving Line of Credit Facility at September 30, 1999. Capital expenditures were approximately $5,951,000 for the nine months ended September 30, 1999. 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. 9 10 RECENT DEVELOPMENTS 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 lead by the Company's Vice President and Chief Information Officer. The scope of the Project includes both IT based systems and non IT systems. Modifications required to bring the Company's IT systems into Year 2000 compliance were identified by the Project team. Based on work completed by the Project team, the Company does not believe its non-IT system Year 2000 compliance issues represent a significant risk to the Company. The required modifications to the Company's standard transaction processing system ("ESPS") have been completed. Based on the findings of the Project team and the successful implementation of these required modifications, the Company believes this system is Year 2000 compliant in all material respects. In addition, the required Year 2000 modifications to the only remaining legacy transaction processing system have been completed. The changes will be implemented in the fourth quarter of 1999. Failure to implement the required changes to the legacy system on a timely basis could have a material adverse effect on the Company's financial position or results of operations. 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 or results of operations. In addition, the Company relies on state DMV's to timely process titles to vehicles. Because the Company must generally obtain title prior to selling a vehicle, a significant delay in title processing would impact the Company's ability to sell vehicles from inventory and have a material adverse effect on the Company's financial position or results of operations. The Company has been, and will continue to be, in communication with its principal insurance customers and the DMV's with regard to their Year 2000 readiness. None of the responses received to date suggests there will be any interruption in their operations which would have a material adverse impact on the Company, although there can be no assurances given in this regard. Contingency plans will continue to be developed during the fourth quarter of 1999. The cost to the Company of dealing with the Year 2000 issue is not expected to be material. Although a portion of the 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 the IT projects or operations have been or will be adversely affected. Costs of review, analysis and corrective action are expected to total less than $250,000. 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 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; 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. 10 11 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 affect 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") 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 including companies which are consolidating the dismantling industry 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 has accounted for a substantial portion of the Company's revenues. For example, in 1998, vehicles supplied by the Company's three largest suppliers accounted for approximately 44% of the Company's unit sales. The largest suppliers, State Farm Insurance, Allstate Insurance ("Allstate"), and Farmers Insurance, each accounted for approximately 17%, 14%, and 13%, respectively, of the Company's unit sales. A loss or reduction in the number of vehicles from any of these suppliers, or adverse change in the agreements that such suppliers have with the Company, could have a material adverse effect on the Company's operating results and financial condition. Purchase Agreement Method of Sale. The Company has entered into a number of purchase agreements, including agreements with its most significant insurance suppliers, that obligate the Company to purchase most salvage vehicles offered to it at a formula percentage of ACV. From 1993 to 1996, increased ACV's, on which the Company's costs are based, reduced the profitability that the Company realizes on purchase agreement contracts. This could occur again if used car prices increase faster than selling prices. Further increases in ACV's or declines in the market or auction prices for salvage vehicles could have a material adverse effect on the Company's business, operating results and financial condition. To mitigate these risks, the Company has added adjustment and risk-sharing clauses to its new standard purchase agreement contracts designed to provide some protection to the Company and its customers from certain unexpected, significant changes in 11 12 the ACV's that are not accompanied by a comparable increase in sales price. 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 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 capital. There can be no assurance that this integration will occur, that suitable premises will be identified or that additional capital will be available to fund expansion and integration of the Company's business. Any delays or obstacles in this integration process could have a material adverse effect on the Company's business, operating results and financial condition. Furthermore, the Company has limited sources of additional capital available for acquisitions, expansions and start-ups. The Company's ability to integrate and expand its facilities will depend on its ability to identify and obtain additional sources of capital to finance such integration and expansion. In the future, the Company will be required to continue to improve its financial and management controls, reporting systems and procedures on a timely basis and expand, train and manage its employee work force. The failure to improve these systems on a timely basis and to successfully expand and train the Company's work force could have a material adverse effect on the Company's operating results and financial condition. 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 12 13 materials such as waste solvents or used oils are generated at some of the Company's facilities and are disposed of as nonhazardous or hazardous wastes. The Company believes that it is in compliance in all material respects with applicable environmental regulations and does not anticipate any material capital expenditure for environmental compliance or remediation. Environmental laws and regulations, however, could become more stringent over time and there can be no assurance that the Company or its operations will not be subject to significant compliance costs in the future. To date, the Company has not incurred expenditures for preventive or remedial action with respect to contamination or the use of hazardous materials that have had a material adverse effect on the Company's results of operations or financial condition. The contamination that could occur at the Company's facilities and the potential contamination by previous users of certain acquired facilities create the risk, however, that the Company could incur substantial expenditures for preventive or remedial action, as well as potential liability arising as a consequence of hazardous material contamination, which could have a material adverse effect on the Company's operating results and financial condition. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Company had approximately $19,718,000 of short-term investments as of September 30, 1999. These investments largely consisted of state government obligations and had either variable rates of interest or stated interest rates ranging from 3.3% to 5.5%. The Company's short-term investments are exposed to certain market risks inherent with such assets. This risk is mitigated by the Company's policy of investing in securities with high credit ratings and investing through major financial institutions with high credit ratings. The Company has senior notes payable of $20,000,000 at an interest rate of 8.6%. The terms of the note agreement are such that pre-payment of such debt may not be advantageous to the Company in the event that funds may be available to the Company at a lower rate of interest. 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 (b) REPORTS ON FORM 8-K. No reports on Form 8-K were filed during the fiscal quarter ending September 30, 1999. 13 14 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 15, 1999 By: /s/ Stephen L. Green ----------------- --------------------------------- Name: Stephen L. Green Title: Vice President - Finance, Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer) 14 15 EXHIBIT INDEX EXHIBIT NO. - ----------- 27.1 Financial Data Schedule 15 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 3-MOS 9-MOS DEC-31-1999 DEC-31-1999 JUL-01-1999 JAN-01-1999 SEP-30-1999 SEP-30-1999 13,777,000 0 19,718,000 0 35,619,000 0 0 0 12,263,000 0 83,640,000 0 46,446,000 0 (22,154,000) 0 237,643,000 0 34,782,000 0 20,020,000 0 0 0 0 0 12,000 0 134,439,000 0 237,643,000 0 77,014,000 239,423,000 77,014,000 239,423,000 56,465,000 176,242,000 56,465,000 176,242,000 15,144,000 44,866,000 0 0 492,000 1,479,000 5,278,000 17,752,000 2,092,000 7,456,000 3,186,000 10,296,000 0 0 0 0 0 0 3,186,000 10,296,000 0.28 0.90 0.27 0.89
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