Fitch Ratings has affirmed IAA, Inc.'s Long-Term Issuer Default Ratings (IDR) at 'BB-' and has withdrawn the ratings due to commercial reasons.

Fitch has also affirmed and withdrawn IAA's senior secured credit facility at 'BB+'/'RR1' and its senior unsecured notes at 'BB-'/'RR4'.

The Rating Outlook is Positive.

Fitch reserves the right in its sole discretion to withdraw or maintain any rating at any time for any reason it deems sufficient.

Fitch has subsequently withdrawn IAA's IDR and Instrument ratings for commercial reasons.

Key Rating Drivers

Leading Market Position: IAA has a strong market position in the relatively stable salvage vehicle auction industry, controlling a significant share of the North American market. Its largest competitor, Copart, Inc., holds a similar share. The remaining market is somewhat fragmented and made up of smaller regional companies. Fitch does not believe there is a material risk of disruption from another competitor entering the market due to the geographic footprint and established market presence of the two incumbents. However, the company derives approximately 40% of its revenue from cars sourced through three insurance companies, which exposes the company to risk from the loss of an important customer.

High Profitability: Fitch attributes IAA's strong profitability to its asset-light business model and its investments in technology to support a shift towards online-only auctions. Actual EBITDA margins, based on Fitch's calculations, were approximately 29% in 2021, which was up from 28% in the prior year. Fitch expects margins to be in the 27% to 30% range over the next couple of years supported by further technology investments to reduce cycle times and administrative costs.

Strong FCF Generation: Fitch expects IAA's FCF margin to be in the 10% to 12% range over the next couple of years. Fitch expects an increase in cash interest costs as a result of rising interest rates and a sizeable proportion of debt that is floating rate. Fitch notes IAA's acquisition of SYNETIQ was funded with revolver borrowings the cash interest costs is priced on a floating rate. IAA's actual FCF margin declined to 9% in 2021 from 16% in the prior year due an increase in working capital to support higher sales and an increase in working capital to support investments in technology. Fitch expects capital intensity (capex/revenue) to be in the range of 7% of revenue over the next several years.

Moderating Adjusted Leverage: Fitch expects IAA's adjusted leverage (total lease adjusted debt/operating EBITDAR) to decline towards 3.5x by YE22 from approximately 3.7x at YE21. Lease-adjusted leverage is higher than gross EBITDA leverage (total debt/operating EBITDA, as calculated by Fitch) due to the company's relatively heavy use of operating leases. At YE 2021, gross EBITDA leverage was a Fitch-calculated 2.5x and Fitch expects IAA's gross leverage to be in the high-1x to low-2x range over the next couple of years. Fitch expects total debt to be about $1.1 billion throughout the forecast with debt reduction primarily as a result of term loan amortization.

Positive Medium-Term; Long-Term Concerns: Fitch views positively the medium-term trends affecting IAA's business. Fitch expects the growing vehicle car parc in North America, increasing vehicle complexity, and rising vehicle repair costs to support demand for IAA's products and services as certain end-users increase their participation in auto auctions. However, longer-term rating concerns include the impact on the inbound supply of damaged and total loss vehicles as a result of new vehicles being equipped with Advanced Driver-Assistance Systems technologies which seek to increase vehicle safety potentially reducing the number of vehicle crashes.

Derivation Summary

IAA's operating profile is similar to its largest competitor, Copart Inc., with comparable size and scale as well as a similar percentage of its revenue base tied to international markets. IAA's financial profile is relatively weaker than Copart's due to IAA's higher total debt outstanding as well as IAA's relatively heavy reliance on operating leases, which Fitch capitalizes at 8.0x and treats as debt.

Compared with auto retailer AutoNation, Inc. (BBB-/Stable) the company has significantly higher operating margins but also has materially higher adjusted leverage and is much smaller. No parent/subsidiary linkage, country ceiling or operating environment constraints were in effect for these ratings.

Key Assumptions

Revenues rise in the range of 10% in 2022 due to benefits from volume, price, and inorganic acquisitions completed in the prior year. Revenue grows in the mid-single digits range thereafter due to a rising vehicle car parc and increasing vehicle complexity which supports both volume and pricing;

EBITDA margins are in the 25% to 30% range throughout the forecast;

Capex as a percentage of revenue is in the mid- to high-single digits throughout the forecast;

FCF margins are in the low-teens throughout the forecast;

Total debt is approximately $1.1 billion throughout the forecast. Debt reduction is in the form of term loan amortization;

The company uses excess cash for acquisitions or shareholders return

RATING SENSITIVITIES

Ratings Sensitivities are no longer applicable given the ratings withdrawal.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Sufficient Liquidity: IAA's liquidity as of April 3, 2022 consists of $136 million of cash and roughly $398 million of availability on its $525 million revolving credit facility. Fitch's revolver availability incorporates $121 million of revolver borrowings and approximately $6 million of LOCs outstanding as of April 3, 2022. Fitch believes the company's internal liquidity and significant cash flow will allow them to meet debt servicing costs, working capital needs and investment priorities without additional funding.

Debt Structure: The company's capital structure consists of a $525 million revolving credit facility, a $650 million Term Loan B, and $500 million of unsecured notes.

Issuer Profile

IAA, Inc. is leading provider of total loss solutions and digital salvage vehicles auctions. The company was spun-off of KAR Auction Services in June 2019. Approximately 88% of 2021 revenue was generated in the United States with the largest international markets being Canada and the UK.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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