IAA, INC. The following discussion and analysis contains forward-looking statements within the meaning of the federal securities laws, and should be read in conjunction with the disclosures we make concerning risks and other factors that may affect our business and operating results. See "Statement Regarding Forward-Looking Statements" preceding Part I, Item 1 in this Quarterly Report on Form 10-Q. Unless the context suggests otherwise, all reference in this Quarterly Report on Form 10-Q to the "Company," "we," "us," refer toIAA, Inc. together with its subsidiaries, and all references to "KAR Auction Services" and "KAR" refer to KAR Auction Services, Inc. Executive Overview Our Business We are a leading global marketplace connecting vehicle buyers and sellers. Leveraging leading-edge technology and focusing on innovation, our unique platform facilitates the marketing and sale of total-loss, damaged and low-value vehicles for a full spectrum of sellers. Headquartered inWestchester, IL , we have more than 200 facilities throughoutthe United States ,Canada and theUnited Kingdom . We serve a global buyer base and a full spectrum of sellers, including insurance companies, dealerships, fleet lease and rental car companies, and charitable organizations. We offer sellers a comprehensive suite of services aimed at maximizing vehicle value, reducing administrative costs, shortening selling cycle time and delivering the highest economic returns. Our solutions provide global buyers with the vehicles they need to, among other things, fulfill their vehicle rebuild requirements, replacement part inventory or scrap demand. We provide global buyers with multiple bidding/buying digital channels, innovative vehicle merchandising, efficient evaluation services and digital bidding tools, enhancing the overall purchasing experience. We completed the roll-out of our buyer digital transformation inthe United States inApril 2020 and inCanada inJuly 2020 . As a result, we have shifted to a fully online, digital auction model, resulting in a reduction of costs previously associated with the physical auctions. The Separation OnFebruary 27, 2018 , KAR Auction Services, Inc. ("KAR") announced a plan to pursue the separation and spin-off (the "Separation") of its salvage auction businesses into a separate public company. OnJune 28, 2019 (the "Separation Date"), KAR completed the distribution of 100% of the issued and outstanding shares of common stock of IAA to the holders of record of KAR's common stock onJune 18, 2019 , on a pro rata basis (the "Distribution"). On the Separation Date, each KAR common stockholder of record received one share of IAA common stock for every one share of KAR common stock held by such stockholder as of the record date. Following the Separation and Distribution, IAA became an independent publicly-traded company. See Note 1 - Basis of Presentation and Nature of Operations in the condensed notes to unaudited consolidated financial statements for additional information. 22 -------------------------------------------------------------------------------- Table of Contents COVID-19 Impact on our Business The outbreak of the coronavirus disease (COVID-19), which was declared by theWorld Health Organization to be a pandemic onMarch 11, 2020 , continues to severely impact worldwide economic activities. In an effort to contain and combat the spread of COVID-19, government and health authorities around the world took extraordinary and wide-ranging actions, including orders to close all business not deemed "essential", quarantines, "stay-at-home" orders, and the practice of social distancing. Although many of these governmental restrictions have since been lifted or scaled back, surges of COVID-19 infections in certain geographies have resulted in the re-imposition of certain restrictions from time to time and may lead to other restrictions being re-implemented in response to efforts to reduce the spread of COVID-19. Given our operations, we are classified as "essential" and have remained open for business and our branches continue to be operational. We have implemented strict health and sanitization protocols across all of our locations to keep our employees and customers safe including, but not limited to: the use of personal protective equipment; sanitizing our facilities; continuing to temporarily require employees to work remotely where possible; suspending all non-essential travel worldwide for our employees; and discouraging employee attendance at in-person work-related meetings. We have also activated contingency plans to ensure continued operations and business continuity across our global network. The significant decline in miles driven resulting from the stay-at-home orders that were executed in mid-March acrossNorth-America and theUnited Kingdom translated into a reduction in the number of car accidents and, in turn, a reduction in vehicle assignments. This decline in vehicle assignments significantly impacted our business during the second quarter of fiscal 2020 and, to a lesser extent, during the third quarter of fiscal 2020. Notwithstanding this reduction in vehicle assignments, our net revenue per vehicle sold increased due to lower supply of vehicles and strong demand from buyers, as well as benefits from our buyer digital transformation and enhanced service offerings. As certain economies began to re-open, we saw gradual improvements in miles driven that resulted in higher vehicle assignments through the third quarter of fiscal 2020 as compared to the second quarter. By the end ofSeptember 2020 and into October, vehicles assignments were only slightly lower than the pre-COVID-19 levels. Given that there is a lag before a change in vehicle assignments impacts the volume of vehicles sold, we are continuing to see an impact on units sold. In response to the uncertainty surrounding COVID-19, we took a series of actions during the second quarter of fiscal 2020 to reduce costs and cash outlays, including, but not limited to, a temporary reduction in salaries at the senior leadership level throughJune 2020 , a temporary reduction in the annual cash retainer payable in quarterly installments to directors throughSeptember 2020 , aggressive cost reductions across all departments, a temporary reduction in branch labor hours across most locations that generally lasted throughSeptember 2020 , employee furloughs in select international locations and a reduction or deferral of certain non-critical capital spending. In addition, we enhanced our liquidity position by: (i) entering into an amendment to our Credit Agreement inMay 2020 to increase the aggregate principal amount to be borrowed under our Revolving Credit Facility (as defined below) by$136.0 million to$361.0 million ; and (ii) entering into a credit agreement inJuly 2020 which provides for a revolving credit facility in an aggregate principal amount of$10.0 million Canadian dollars (the "Canadian Credit Facility"). We are continuing to actively monitor the rapidly evolving situation and guidance from the government and public health authorities and we may take additional actions that we determine are in the best interest of the Company and all our stakeholders. The COVID-19 pandemic had limited impact on our operations in the first quarter of fiscal 2020, but adversely affected our operations in the second and third quarters of fiscal 2020 and may continue to do so thereafter, particularly if the buyer demand declines or the stabilization in assignments and miles driven is not sustained. All of the factors described above may have far-reaching impacts on our business, operations, and financial results and conditions, directly and indirectly, including, but not limited to, impacts on vehicle assignments, branch operations, the health of our management and employees, and on the overall economy. Given the dynamic nature of these circumstances, the severity and duration of business disruption and the related financial effects cannot be reasonably estimated at this time. However, we expect COVID-19 and the efforts taken to reduce its spread to have a negative impact on our consolidated financial statements in fiscal 2020, the impact of which may continue to be material. See Item 1A, Risk Factors for additional information. Sources of Revenues and Expenses A significant portion of our revenue is derived from auction fees and related services associated with our salvage auctions. Our revenue earned from buyers represents fees charged based on a tiered structure that increases with the sales price of the vehicle as well as service fees for additional services. Our revenue earned from sellers represents the combination of the inbound tow, processing, storage, titling, enhancing and auctioning of the vehicle. We purchase only a small amount of vehicles as the majority of our business comprises auctioning vehicles on consignment. However, when we do purchase vehicles, we record the entire sale price as revenue and the purchase price as cost of services, which results in lower gross margin versus vehicles 23 -------------------------------------------------------------------------------- Table of Contents sold at auction on a consignment basis. Although auction revenues primarily include the auction services and related fees, our related receivables and payables include the gross value of the vehicles sold. Our operating expenses consist of cost of services, selling, general and administrative and depreciation and amortization. Cost of services is comprised of payroll and related costs, subcontract services, the cost of vehicles purchased, supplies, insurance, property taxes, utilities, service contract claims, maintenance and lease expense related to the auction sites. Cost of services excludes depreciation and amortization. Selling, general and administrative expenses are comprised of, among other things, payroll and related costs, sales and marketing, information technology services and professional fees. Factors Affecting Comparability of Financial Results Historical KAR Cost Allocations versus IAA as aStand-Alone Company : Our historical consolidated financial statements have been prepared in accordance with accounting principles generally accepted inthe United States ("GAAP"). The financial statements for periods prior to the Separation include certain expenses of KAR that were allocated to IAA for certain corporate functions including accounting, treasury, tax, internal audit, risk management, human resources, safety, and security, and information technology risk. These costs may not be representative of the costs IAA will incur as an independent, publicly traded company. In addition, our financial information for periods prior to the Separation does not reflect changes that IAA expects to experience as a result of IAA's separation from KAR, including changes in IAA's cost structure, personnel needs, tax structure, capital structure, financing and business operations. The consolidated financial statements also do not reflect the assignment of certain assets and liabilities between KAR and IAA. Consequently, the financial information included herein may not necessarily reflect IAA's financial position, results of operations and cash flows in the future or what IAA's financial position, results of operations and cash flows would have been had IAA been an independent, publicly traded company during the periods prior to the Separation. Debt Financing: In connection with the Separation, we entered into the Credit Agreement (as defined below) onJune 28, 2019 . We borrowed (i) an aggregate principal amount of$800 million under the Term Loan Facility (as defined below) and (ii) an aggregate principal amount of$225 million under the Revolving Credit Facility. In connection with the Separation, onJune 6, 2019 , we also issued$500.0 million aggregate principal amount of 5.50% Senior Notes due 2027 (the "Notes"). We used the net proceeds from the Notes offering, together with borrowings under the Term Loan Facility and the Revolving Credit Facility, to make a cash distribution to KAR and to pay fees and expenses related to the Separation and Distribution. We used the remaining proceeds from the Term Loan Facility and borrowings under the Revolving Credit Facility for our ongoing working capital needs and general corporate purposes. Acquisitions: OnJuly 31, 2019 , we acquiredDecision Dynamics, Inc. ("DDI"), a leading electronic lien and title technology firm located inLexington, South Carolina for$19.2 million , which includes the fair value of contingent consideration of$2.5 million . See Note 9 - Business Acquisition in the condensed notes to consolidated financial statements for additional information. COVID-19: The outbreak of COVID-19 pandemic and the efforts taken to reduce its spread had limited impact on our operations in the first quarter of fiscal 2020, but adversely affected our operations in the second and third quarters of fiscal 2020. See above under "COVID-19 Impact on our Business" for additional information. 24 --------------------------------------------------------------------------------
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Results of Operations
Three Months Ended Change Nine Months Ended Change
(Dollars in millions) Sep 27, 2020 Sep 29, 2019 $ % Sep 27, 2020 Sep 29, 2019 $ %
Revenues $ 338.0 $ 357.3 $ (19.3) (5.4) % $ 1,001.4 $ 1,080.9 $ (79.5) (7.4) %
Cost of services* 199.7 221.3 (21.6) (9.8) % 615.8 667.4 (51.6) (7.7) %
Gross profit* 138.3 136.0 2.3 1.7 % 385.6 413.5 (27.9) (6.7) %
Gross margin 40.9 % 38.1 % 280 bp 38.5 % 38.3 % 20 bp
Selling, general and
administrative 34.9 38.9 (4.0) (10.3) % 107.2 106.2 1.0 0.9 %
Depreciation and
amortization 19.4 22.1 (2.7) (12.2) % 61.5 66.0 (4.5) (6.8) %
Operating profit 84.0 75.0 9.0 12.0 % 216.9 241.3 (24.4) (10.1) %
Interest expense, net 13.3 17.5 (4.2) (24.0) % 43.1 39.1 4.0 10.2 %
Other expense (income),
net (0.2) - (0.2) NM** (0.8) (0.1) (0.7) NM**
Income before income
taxes 70.9 57.5 13.4 23.3 % 174.6 202.3 (27.7) (13.7) %
Income taxes 18.1 15.7 2.4 15.3 % 43.9 54.7 (10.8) (19.7) %
Net income $ 52.8 $ 41.8 $ 11.0 26.3 % $ 130.7 $ 147.6 $ (16.9) (11.4) %
Net income per share
Basic $ 0.39 $ 0.31 $ 0.08 25.8 % $ 0.98 $ 1.11 $ (0.13) (11.7) %
Diluted $ 0.39 $ 0.31 $ 0.08 25.8 % $ 0.97 $ 1.10 $ (0.13) (11.8) %
________________
* Exclusive of depreciation and amortization
** NM - Not meaningful
Revenues
Three Months Ended Change Nine Months Ended Change
(Dollars in millions) Sep 27, 2020 Sep 29, 2019 $ % Sep 27, 2020 Sep 29, 2019 $ %
United States $ 298.4 $ 318.1 $ (19.7) (6.2) % $ 885.4 $ 952.9 $ (67.5) (7.1) %
International 39.6 39.2 0.4 1.0 % 116.0 128.0 (12.0) (9.4) %
Total revenues $ 338.0 $ 357.3 $ (19.3) (5.4) % $ 1,001.4 $ 1,080.9 $ (79.5) (7.4) %
Three Months Ended September 27, 2020 versus September 29, 2019
United States revenues decreased $19.7 million due to lower volumes of 20% which
primarily resulted from the COVID-19 pandemic. This decrease in volume was
partially offset by an increase in revenue per vehicle sold of 18% primarily
resulting from: (i) additional revenue associated with the roll-out of our buyer
digital transformation; (ii) enhanced service offerings; (iii) higher used car
prices; and (iv) the positive impact that less supply had on bidding activity.
Additionally, the three months ended September 27, 2020 included $1.1 million of
revenue from the DDI acquisition and the three months ended September 29, 2019
benefited from a non-cash adjustment of $3.6 million relating to certain revenue
agreements.
International revenues increased $0.4 million primarily due an increase in
revenue per vehicle sold of 25% primarily resulting from higher purchased
vehicle revenue, additional revenue associated with the roll-out of our buyer
digital transformation in Canada and enhanced service offerings. These increases
were partially offset by lower volumes of 19% which primarily resulted from the
COVID-19 pandemic.
Nine Months Ended September 27, 2020 versus September 29, 2019
United States revenues decreased $67.5 million due to lower volumes of 17% which
primarily resulted from the COVID-19 pandemic. This decrease in volume was
partially offset by an increase in revenue per vehicle sold of 12% primarily
resulting from: (i) additional revenue associated with the roll-out of our buyer
digital transformation; (ii) enhanced service offerings; (iii)
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higher used car prices; and (iv) the positive impact that less supply had on
bidding activity. Additionally, the nine months ended September 27, 2020
included $5.9 million of revenue from the DDI acquisition and the nine months
ended September 29, 2019 benefited from a non-cash adjustment of $3.6 million
relating to certain revenue agreements.
International revenues decreased $12.0 million due to lower volumes of 17% which
primarily resulted from the COVID-19 pandemic and an unfavorable foreign
currency impact of $1.6 million . These decreases were partially offset by an
increase in revenue per vehicle sold of 9%, as well as benefits achieved from
the completion of our buyer digital transformation in Canada and enhanced
service offerings.
Gross profit
Three Months Ended Change Nine Months Ended Change
(Dollars in millions) Sep 27, 2020 Sep 29, 2019 $ % Sep 27, 2020 Sep 29, 2019 $ %
United States $ 126.1 $ 124.7 $ 1.4 1.1 % $ 352.7 $ 374.6 $ (21.9) (5.8) %
International 12.2 11.3 0.9 8.0 % 32.9 38.9 (6.0) (15.4) %
Total gross profit $ 138.3 $ 136.0 $ 2.3 1.7 % $ 385.6 $ 413.5 $ (27.9) (6.7) %
Gross profit is defined as total consolidated revenues minus cost of services and excludes depreciation and amortization.
Three Months EndedSeptember 27, 2020 versusSeptember 29, 2019 United States gross profit increased$1.4 million primarily due to higher revenue per vehicle sold, and cost reductions in response to the COVID-19 pandemic and from the buyer digital transformation, partially offset by lower volume and an increase in occupancy costs. International gross profit increased$0.9 million primarily due to higher revenue per vehicle sold and cost reductions in response to the COVID-19 pandemic, partially offset by lower volume and an increase in occupancy costs. Nine Months EndedSeptember 27, 2020 versusSeptember 29, 2019 United States gross profit decreased$21.9 million primarily due to lower volume and an increase in the cost of occupancy. These decreases were partially offset by higher revenue per vehicle sold, cost reductions in response to the COVID-19 pandemic, and benefits related to adopting a fully-digital auction model. International gross profit decreased$6.0 million primarily due to lower volume and an increase in occupancy costs. These decreases were partially offset by higher revenue per vehicle sold and cost reductions in response to the COVID-19 pandemic.
Selling, General and Administrative
Three Months Ended Change Nine Months Ended Change
(Dollars in millions) Sep 27, 2020 Sep 29, 2019 $ % Sep 27, 2020 Sep 29, 2019 $ %
United States $ 32.5 $ 36.5 $ (4.0) (11.0) % $ 100.5 $ 97.2 $ 3.3 3.4 %
International 2.4 2.4 - - % 6.7 9.0 (2.3) (25.6) %
Total selling, general and
administrative expenses $ 34.9 $ 38.9 $ (4.0) (10.3) % $ 107.2 $ 106.2 $ 1.0 0.9 %
Three Months Ended September 27, 2020 versus September 29, 2019
United States selling, general and administrative expenses decreased $4.0
million primarily due to a reduction in discretionary spending, including items
such as travel and meetings, as a result of the COVID-19 pandemic. These
decreases were partially offset by $0.6 million from the DDI acquisition.
International selling, general and administrative expenses remained relatively
flat compared to the prior year comparable period.
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Nine Months Ended September 27, 2020 versus September 29, 2019
International selling, general and administrative expenses decreased
Depreciation and Amortization
Three Months Ended Change Nine Months Ended Change
(Dollars in millions) Sep 27, 2020 Sep 29, 2019 $ % Sep 27, 2020 Sep 29, 2019 $ %
United States $ 17.7 $ 20.5 $ (2.8) (13.7) % $ 56.5 $ 61.0 $ (4.5) (7.4) %
International 1.7 1.6 0.1 6.3 % 5.0 5.0 - - %
Total depreciation and
amortization $ 19.4 $ 22.1 $ (2.7) (12.2) % $ 61.5 $ 66.0 $ (4.5) (6.8) %
Depreciation and amortization for the three months ended September 27, 2020
decreased $2.7 million compared to the prior year comparable period as there
were fewer intangible assets to amortize within the United States segment in the
third quarter of fiscal 2020.
Depreciation and amortization for the nine months ended September 27, 2020
decreased $4.5 million as compared to the prior year comparable period as there
were fewer intangible assets to amortize within the United States segment during
the first nine months of fiscal 2020.
Interest Expense
Interest expense for the three months endedSeptember 27, 2020 decreased$4.2 million as compared to the prior year comparable period primarily due to lower interest rates on our floating rate Term Loan Facility (as defined below), as well as a slightly lower average outstanding debt balance. Interest expense for the nine months endedSeptember 27, 2020 increased$4.0 million as compared to the prior year comparable period. This increase was primarily due to a higher average outstanding debt balance during the nine months endedSeptember 27, 2020 resulting from the Notes offering and borrowings under the Term Loan Facility inJune 2019 in connection with the Separation.
Income Taxes
The effective tax rate was 25.5% for the three months endedSeptember 27, 2020 as compared to 27.3% for the three months endedSeptember 29, 2019 . The three months endedSeptember 27, 2020 benefited from the implementation of certain tax optimization initiatives during fiscal 2020. The effective tax rate was 25.1% for the nine months endedSeptember 27, 2020 as compared to 27.0% for the nine months endedSeptember 29, 2019 . The effective tax rate for the nine months endedSeptember 29, 2019 was adversely impacted by certain discrete tax items of$1.4 million associated with the spin-off from KAR and other discrete items. The nine months endedSeptember 27, 2020 benefited from the implementation of certain tax optimization initiatives during fiscal 2020. Liquidity and Capital Resources We believe that the significant indicators of liquidity for our business are cash on hand, cash flow from operations and working capital. Prior to the Separation, we transferred the cash flow generated by our operations to KAR to support its overall cash management strategy. Cash was transferred daily, based on our balances, to centralized accounts maintained by KAR. As cash was disbursed or received by KAR, it was recognized through "Net Parent Investment " on our statements of stockholders' deficit and as "Net cash transfers to Parent and affiliates" on our statements of cash flows. 27
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Table of Contents On the Separation Date, our capital structure and sources of liquidity changed significantly. We no longer participate in cash management and funding arrangements with KAR. Subsequent to the Separation Date, our principal source of liquidity consists of cash generated by operations, and our revolving credit facilities provide another source of liquidity as needed. Our internally generated cash flow is used to invest in new products and services, fund capital expenditures and working capital requirements, and is expected to be adequate to service any future debt, and fund future acquisitions, if any. Our ability to fund these capital needs will depend on our ongoing ability to generate cash from operations and to access borrowings under our revolving credit facilities and the capital markets. We believe that our cash on hand, future cash from operations, borrowings available under our revolving credit facilities and access to the debt and capital markets will provide adequate resources to fund our operating and financing needs for at least the next twelve months. Working Capital A substantial amount of our working capital is generated from the payments received for services provided. The majority of our working capital needs are short-term in nature, usually less than three months in duration. Due to the decentralized nature of the business, payments for most vehicles purchased are received at each auction and branch. Most of the financial institutions place a temporary hold on the availability of the funds deposited that generally can range up to two business days, resulting in cash in our accounts and on our balance sheet that is unavailable for use until it is made available by the various financial institutions. There are outstanding checks (book overdrafts) to sellers and vendors included in current liabilities. Because a portion of these outstanding checks for operations are drawn upon bank accounts at financial institutions other than the financial institutions that hold the cash, we cannot offset all the cash and the outstanding checks on our balance sheet. Changes in working capital vary from quarter-to-quarter as a result of the timing of collections and disbursements of funds to consignors from auctions held near period end. Approximately$47.0 million of available cash was held by our foreign subsidiaries as ofSeptember 27, 2020 . If funds held by our foreign subsidiaries were to be repatriated, state and local income tax expense and foreign withholding tax expense would need to be recognized, net of any applicable foreign tax credits.
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