OPENLANE, INC.
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the "Selected Financial Data" and
the consolidated financial statements and notes thereto included elsewhere in
this Annual Report on Form 10-K.
Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995 and which are
subject to certain risks, trends and uncertainties. In particular, statements
made in this report on Form 10-K that are not historical facts (including, but
not limited to, expectations, estimates, assumptions and projections regarding
the industry, business, future operating results, potential acquisitions and
anticipated cash requirements) may be forward-looking statements. Words such as
"should," "may," "will," "anticipates," "expects," "intends," "plans,"
"believes," "seeks," "estimates" and similar expressions identify
forward-looking statements. Such statements, including statements regarding the
impact of COVID-19; our future growth; anticipated cost savings, revenue
increases, credit losses and capital expenditures; dividend declarations and
payments; common stock repurchases; tax rates and assumptions; strategic
initiatives, greenfields and acquisitions; our competitive position and
retention of customers; and our continued investment in information technology,
are not guarantees of future performance and are subject to risks and
uncertainties that could cause actual results to differ materially from the
results projected, expressed or implied by these forward-looking statements.
Factors that could cause or contribute to such differences include, but are not
limited to, those discussed in Item 1A. "Risk Factors" of this Annual Report on
Form 10-K. Some of these factors include:
•the evolving impact of the COVID-19 pandemic on our business and the economy
generally;
•our ability to effectively maintain or update information and technology
systems;
•our ability to implement and maintain measures to protect against
cyber-attacks;
•significant current competition and the introduction of new competitors;
•competitive pricing pressures;
•our ability to successfully implement our business strategies or realize
expected cost savings and revenue enhancements;
•our ability to meet or exceed customers' expectations, as well as develop and
implement information systems responsive to customer needs;
•business development activities, including greenfields, acquisitions and
integration of acquired businesses;
•costs associated with the acquisition of businesses or technologies;
•fluctuations in consumer demand for and in the supply of used, leased and
salvage vehicles and the resulting impact on auction sales volumes, conversion
rates and loan transaction volumes;
•any losses of key personnel;
•our ability to obtain land or renew/enter into new leases at commercially
reasonable rates;
•decreases in the number of used vehicles sold at on-premise marketplaces;
•changes in the market value of vehicles auctioned;
•trends in new and used vehicle sales and incentives, including wholesale used
vehicle pricing;
•the ability of consumers to lease or finance the purchase of new and/or used
vehicles;
•the ability to recover or collect from delinquent or bankrupt customers;
•economic conditions including fuel prices, commodity prices, foreign exchange
rates and interest rate fluctuations;
•trends in the vehicle remarketing industry;
•trends in the number of commercial vehicles being brought to auction, in
particular off-lease volumes;
•changes in the volume of vehicle production, including capacity reductions at
the major original equipment manufacturers;
•laws, regulations and industry standards, including changes in regulations
governing the sale of used vehicles and commercial lending activities;
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•our ability to maintain our brand and protect our intellectual property;
•the costs of environmental compliance and/or the imposition of liabilities
under environmental laws and regulations;
•weather, including increased expenses as a result of catastrophic events;
•general business conditions;
•our substantial amount of debt;
•restrictive covenants in our debt agreements;
•our assumption of the settlement risk for vehicles sold;
•litigation developments;
•our self-insurance for certain risks;
•interruptions to service from our workforce;
•any impairment to our goodwill or other intangible assets;
•changes in effective tax rates;
•the taxable nature of the spin-off of our former salvage auction business;
•changes to accounting standards; and
•other risks described from time to time in our filings with the SEC , including
the Quarterly Reports on Form 10-Q to be filed by us in 2021.
Many of these risk factors are outside of our control, and as such, they involve
risks which are not currently known that could cause actual results to differ
materially from those discussed or implied herein. The forward-looking
statements in this document are made as of the date on which they are made and
we do not undertake to update our forward-looking statements.
Our future growth depends on a variety of factors, including our ability to
increase vehicle sold volumes and loan transaction volumes, expand our product
and service offerings, including information systems development, acquire and
integrate additional business entities, manage expansion, control costs in our
operations, introduce fee increases, and retain our executive officers and key
employees. We cannot predict whether our growth strategy will be successful. In
addition, we cannot predict what portion of overall sales will be conducted
through online auctions or other remarketing methods in the future and what
impact this may have on our auction business.
Impact of COVID-19
On March 11, 2020 , the World Health Organization ("WHO") designated COVID-19 as
a pandemic. Governments in various jurisdictions we operate have mandated, and
continue to introduce, numerous and varying measures to slow the spread of
COVID-19, including travel bans and restrictions, quarantines, curfews,
shelter-in-place and safer-at-home orders, business shutdowns and closures.
Certain jurisdictions began easing restrictions only to return to tighter
restrictions in the face of increases in new COVID-19 cases. The COVID-19
pandemic and the related preventative measures taken to help slow the spread
have caused, and may continue to cause, significant volatility, uncertainty and
economic disruption.
In response to these measures and for the protection of our employees and
customers, on March 20, 2020 we temporarily suspended on-premise sale
operations, including Simulcast-only sales, across North America . We began
operating Simulcast-only sales in select markets on April 6, 2020 and expanded
the Simulcast-only sales each week, where possible and as permitted by
government directives. We also held Simulcast+ auctions at select locations, a
fully digital auction operated remotely with an automated auctioneer, sequential
sales, audio and visual cues to simulate the live auction experience and all
buyers and sellers interacting virtually through the Simulcast platform.
All ADESA auction locations in the U.S. and Canada are offering vehicles for
sale via ADESA Simulcast, DealerBlock and Simulcast+. Auction locations have
resumed offering ancillary and related services, where possible and as permitted
by government directives. Given the evolving health, economic, social and
governmental environments, the potential impact that COVID-19 could have on our
business remains uncertain.
As a result, we proactively took a number of significant steps to help secure
our business and preserve available cash during the second, third and fourth
quarters of 2020, including but not limited to reducing our compensation expense
(including a reduction of base salaries across many levels of the organization,
including the elimination of base salaries for our Chief Executive Officer,
Chief Financial Officer and President and 50% reduction of base salaries for our
other executive officers
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during the second quarter of 2020, furloughs and a reduction in force, among
others), prohibiting non-essential business travel, suspending non-essential
services provided by certain third parties at our locations, delaying or
canceling capital projects at our on-premise marketplace locations and
temporarily suspending the Company's quarterly dividend.
In addition, in June 2020 we issued and sold an aggregate of 550,000 shares of
Series A Preferred Stock of the Company in private placements for net proceeds
of approximately $528.2 million , as described in Note 14, "Convertible Preferred
Stock."
We have also taken advantage of legislation introduced to assist companies
during this time. In the second, third and fourth quarters of 2020, we recorded
a total of approximately $8.3 million of employee retention credits taken under
the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") and
approximately $16.0 million under the Canada Emergency Wage Subsidy. These
credits partially offset salaries and medical costs recorded in the U.S. and
Canada . We will continue to monitor and assess the impact the CARES Act and
similar legislation in other countries may have on our business and financial
results.
While we have developed and implemented and continue to develop and implement
health and safety protocols, business continuity plans and crisis management
protocols in an effort to try to mitigate the negative impact of COVID-19 on our
employees, customers and our business, the extent of the impact of the pandemic
on our business and financial results will continue to depend on future
developments that are uncertain and unpredictable, including new information
that may emerge concerning the severity and duration of the COVID-19 pandemic
and the effectiveness of actions taken to contain the COVID-19 outbreak or treat
its impact.
The broader implications for our business and results of operations remain
uncertain and will depend on many factors outside our control, including,
without limitation, the timing, extent, trajectory and duration of the pandemic,
the development and availability of effective treatments and vaccines, the
imposition of protective public safety measures, and the timing to which normal
economic and operating conditions resumes. Even after the COVID-19 outbreak has
subsided, we may continue to experience materially adverse impacts to our
business as a result of its impact.
Overview
We provide whole car auction services in North America and Europe . Our business
is divided into two reportable business segments, each of which is an integral
part of the vehicle remarketing industry: ADESA Auctions and AFC.
•The ADESA Auctions segment serves a domestic and international customer base
through online auctions and it provides services from 74 facilities in North
America that are developed and strategically located to draw professional
sellers and buyers together and allow the buyers to inspect and compare vehicles
remotely or in person. Through ADESA.com, ADESA offers comprehensive private
label remarketing solutions to automobile manufacturers, captive finance
companies and other institutions to offer vehicles via the Internet prior to
arrival at on-premise marketplaces. Vehicles sold on ADESA's digital platforms
are typically sold by commercial fleet operators, financial institutions, rental
car companies, new and used vehicle dealers and vehicle manufacturers and their
captive finance companies to franchise and independent used vehicle dealers.
ADESA also provides value-added ancillary services including inbound and
outbound transportation logistics, reconditioning, vehicle inspection and
certification, titling, administrative and collateral recovery services. ADESA
also includes TradeRev, an online automotive remarketing platform where dealers
can launch and participate in real-time vehicle auctions at any time,
BacklotCars, an app and web-based dealer-to-dealer wholesale vehicle platform,
ADESA Remarketing Limited , an online whole car vehicle remarketing business in
the United Kingdom and ADESA Europe (formerly known as CarsOnTheWeb), an online
wholesale vehicle auction marketplace in Continental Europe.
•The AFC segment provides short-term, inventory-secured financing, known as
floorplan financing, primarily to independent used vehicle dealers. At December
31, 2020 , AFC conducted business at 115 locations in the United States and
Canada . Prior to December 2020 , the Company also sold vehicle service contracts
through Preferred Warranties, Inc. ("PWI").
Historically, the costs and expenses of the holding company were reported
separately from the reportable segments and included expenses associated with
the corporate offices, such as salaries, benefits and travel costs for the
corporate management team, certain human resources, information technology and
accounting costs, and certain insurance, treasury, legal and risk management
costs. Holding company interest expense included the interest expense incurred
on finance leases and the corporate debt structure. Intercompany charges related
primarily to interest on intercompany debt or receivables and certain
administrative costs allocated by the holding company. Due to the spin-off of
IAA in 2019 and the Company's transition from physical marketplaces to digital
marketplaces, the Company has simplified its business and operations. Corporate
expenses, previously reported as holding company expenses, are now included in
the segments. Certain known expenses (e.g., information technology costs) were
recorded directly to the ADESA and AFC segments. Interest expense previously
reported
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by the holding company has been recorded in the ADESA segment. The residual
shared services expenses were recorded at ADESA and allocated to AFC based on
revenue and employee headcount. Holding company amounts reported in the segment
results in the consolidated financial statements prior to December 31, 2020 have
been reclassified to conform to the current presentation.
Industry Trends
Whole Car
Used vehicles sold in North America through whole car auctions, including
off-premise volumes and mobile application volumes, were approximately
12.0 million and 11.5 million in 2019 and 2018, respectively. Data for the whole
car auction industry is collected by the NAAA through an annual survey. NAAA
industry volumes for 2020 have not yet been released, but we expect that volumes
in 2020 were substantially lower than in 2019. The NAAA industry volumes
collected by the annual survey do not include off-premise volumes or mobile
application volumes (e.g., Openlane , TradeRev, BacklotCars and their respective
competitors), but we have included these volumes in our totals. In addition to
the traditional whole car auction market and off-premise venues described above,
we believe mobile applications, such as TradeRev and BacklotCars, may provide an
opportunity to expand our total addressable market for dealer-to-dealer
transactions to as much as 15 million units from approximately 5 million units
in 2019. TradeRev and BacklotCars sold approximately 316,000 vehicles in the
digital dealer-to-dealer marketplace for the year ended December 31, 2020 ,
compared with approximately 210,000 vehicles for the year ended December 31,
2019 . This includes vehicles sold by BacklotCars prior to its acquisition in
November 2020 . The COVID-19 pandemic has had a material impact on the whole car
auction industry and we are unable to estimate future volumes.
Automotive Finance
AFC works with independent used vehicle dealers to improve their results by
providing a comprehensive set of business and financial solutions that leverages
its local branches, industry experience and scale, as well as KAR affiliations.
AFC's North American dealer base was comprised of approximately 13,600 dealers
in 2020, and loan transactions, which includes both loans paid off and loans
curtailed, were approximately 1.5 million in 2020.
Key challenges for the independent used vehicle dealer include demand for used
vehicles, disruptions in pricing of used vehicle inventory, lack of access to
consumer financing and increased used car retail activity of franchise and
public dealerships (most of which do not utilize AFC or its competitors for
floorplan financing), as well as the ability to operate in locations
experiencing pandemic shelter-in-place orders. These same challenges, to the
extent they occur, could result in a material negative impact on AFC's results
of operations. A significant decline in used vehicle sales would result in a
decrease in consumer auto loan originations and an increased number of dealers
defaulting on their loans. In addition, volatility in wholesale vehicle pricing
impacts the value of recovered collateral on defaulted loans and the resulting
severity of credit losses at AFC. A decrease in wholesale used car pricing could
lead to increased losses if dealers are unable to satisfy their obligations.
Seasonality
The volume of vehicles sold through our auctions generally fluctuates from
quarter-to-quarter. This seasonality is caused by several factors including
weather, the timing of used vehicles available for sale from selling customers,
holidays, and the seasonality of the retail market for used vehicles, which
affects the demand side of the auction industry. Used vehicle auction volumes
tend to decline during prolonged periods of winter weather conditions. As a
result, revenues and operating expenses related to volume will fluctuate
accordingly on a quarterly basis. The fourth calendar quarter typically
experiences lower used vehicle auction volume as well as additional costs
associated with the holidays and winter weather.
Sources of Revenues and Expenses
Our revenue is derived from auction fees and various on-premise and off-premise
services, and from dealer financing fees, interest income and other revenue at
AFC. 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 composed
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 and loan
offices. Cost of services excludes depreciation and amortization. Selling,
general and administrative expenses are composed of payroll and related costs,
sales and marketing, information technology services and professional fees.
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Results of Operations
Overview of Results of KAR Auction Services, Inc. for the Years Ended
December 31, 2020 and 2019:
Year Ended
December 31,
(Dollars in millions except per share amounts) 2020 2019
Revenues
Auction fees $ 887.7 $ 1,115.3
Service revenue 737.4 1,018.2
Purchased vehicle sales 295.0 295.5
Finance-related revenue 267.6 352.9
Total revenues 2,187.7 2,781.9
Cost of services* 1,284.8 1,617.1
Gross profit* 902.9 1,164.8
Selling, general and administrative 545.4 662.0
Depreciation and amortization 191.3
188.7
Goodwill and other intangibles impairment 29.8 - Operating profit 136.4 314.1 Interest expense 128.9 189.5 Other (income) expense, net 2.1 (7.7) Loss on extinguishment of debt -
2.2
Income from continuing operations before income taxes 5.4 130.1 Income taxes
4.9 37.7
Net income from continuing operations 0.5
92.4
Net income from discontinued operations -
96.1
Net income$ 0.5 $
188.5
Net income (loss) from continuing operations per share Basic$ (0.16) $ 0.70 Diluted$ (0.16) $ 0.70 * Exclusive of depreciation and amortization Overview For the year endedDecember 31, 2020 , we had revenue of$2,187.7 million compared with revenue of$2,781.9 million for the year endedDecember 31, 2019 , a decrease of 21%. Businesses acquired in 2019 and 2020 accounted for an increase in revenue of$26.8 million or 1% of revenue. For a further discussion of revenues, gross profit and selling, general and administrative expenses, see the segment results discussions below. Depreciation and Amortization Depreciation and amortization increased$2.6 million , or 1%, to$191.3 million for the year endedDecember 31, 2020 , compared with$188.7 million for the year endedDecember 31, 2019 . The increase in depreciation and amortization was primarily the result of certain assets placed in service over the last twelve months.Goodwill and Other Intangibles Impairment In light of the impact that the COVID-19 pandemic has had on the economy, forecasts for all reporting units were revised. These economic circumstances contributed to lower sales, operating profits and cash flows atADESA Remarketing Limited (doing business as ADESAU.K. ) through the first part of 2020 as compared to 2019, and the outlook for the business was significantly reduced. As a result of the updated forecasts, an impairment analysis of goodwill and intangibles was conducted. The change in circumstances resulted in the impairment of the goodwill balance totaling$25.5 million in ourADESA Remarketing Limited reporting unit and a non-cash goodwill impairment charge was recorded for this amount in the second quarter of 2020. 37
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In addition, in the second quarter of 2020, a non-cash customer relationship impairment charge of approximately$4.3 million was also recorded in theADESA Remarketing Limited reporting unit, representing the impairment in the value of this reporting unit's customer relationships. Interest Expense Interest expense decreased$60.6 million , or 32%, to$128.9 million for the year endedDecember 31, 2020 , compared with$189.5 million for the year endedDecember 31, 2019 . The decrease was primarily attributable to a decrease in the weighted average interest rate of approximately 1.0% and a decrease of$360.9 million in the average outstanding balance of corporate debt for the year endedDecember 31, 2020 , compared with the year endedDecember 31, 2019 , resulting from the pay down of debt of approximately$1.3 billion in connection with the spin-off of IAA onJune 28, 2019 and a net increase in term loan debt of approximately$0.5 billion in connection with the debt refinancing onSeptember 19, 2019 . In addition, there was a decrease in interest expense at AFC of$24.9 million , which resulted from a decrease in the average finance receivables balance and interest rates for the year endedDecember 31, 2020 , as compared with the year endedDecember 31, 2019 . Other (Income) Expense, Net For the year endedDecember 31, 2020 , we had other expenses of$2.1 million compared with other income of$7.7 million for the year endedDecember 31, 2019 . The decrease in other (income) expense was primarily attributable to an increase in foreign currency losses of$5.6 million and an increase in contingent consideration valuation of$4.7 million , partially offset by other miscellaneous items aggregating$0.5 million . Loss on Extinguishment of Debt InSeptember 2019 , we amended our Credit Agreement and recorded a$2.2 million pretax charge primarily resulting from the write-off of unamortized debt issue costs associated with Term Loan B-4 and Term Loan B-5. Income Taxes We had an effective tax rate of 90.7% for the year endedDecember 31, 2020 , compared with an effective tax rate of 29.0% for the year endedDecember 31, 2019 . The 2020 rate was unfavorably impacted by the goodwill and other intangibles impairment charge and expense for the increase in the estimated value of contingent consideration for which no tax benefits have been recorded, as well as significantly reduced earnings and a greater proportion of earnings in higher tax jurisdictions. These were partially offset by the tax benefit from law changes, deductions related to stock-based compensation expenses and other discrete benefits. Net Income from Discontinued Operations OnJune 28, 2019 , the Company completed the separation of its salvage auction business, IAA, through a spin-off, creating a new independent publicly traded salvage auction company. As such, the financial results of IAA have been accounted for as discontinued operations in the comparable 2019 results presented. For the year endedDecember 31, 2020 and 2019, the Company's financial statements included income from discontinued operations of$0.0 million and$96.1 million , respectively. For additional information on the IAA separation, see Note 4 of the Notes to Consolidated Financial Statements. Impact of Foreign Currency For the year endedDecember 31, 2020 , fluctuations in the Canadian exchange rate decreased revenue by$1.2 million , operating profit by$0.3 million , net income by$0.2 million and had no impact on net income per diluted share. For the year endedDecember 31, 2020 , fluctuations in the European exchange rate increased revenue by$5.2 million , increased operating profit by$0.1 million , decreased net income by$0.1 million and had no impact on net income per diluted share. In addition, for the year endedDecember 31, 2020 , as a result of the goodwill and other intangibles impairment in theU.K. , fluctuations in the British pound exchange rate decreased net income by$0.3 million . Impact of COVID-19 on Our OperationsThe Company has been subject to numerous orders and directives that have impacted our ability to operate our business throughoutNorth America and inEurope . As a result of restrictions on our operations, we have adjusted our business processes to meet the needs of our customers while complying with the various laws, regulations, mandates and directives in each individual market we operate. In many cases, we have had to limit the number of employees and customers within our physical locations at any given time and modify the delivery of services to our customers. However, we were able to make adjustments in our operations that have permitted us to improve performance. 38
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New and used car retail activity was reduced to unprecedented levels in earlyApril 2020 . Auto retail operations were required to temporarily close and supply and demand for used cars was disrupted. By mid-April, we were experiencing improved retail automobile sales and demand for used vehicle supply was beginning to improve. The Company was prepared to meet the needs of the wholesale used car marketplace with its technology-based auction platforms throughoutNorth America and inEurope . The Company believes that certain changes to its business processes that were necessitated by the COVID-19 outbreak are sustainable going forward. The Company has reduced the labor required to process wholesale auction transactions and reduced its selling, general and administrative expenses. InMarch 2020 , the Company had over 15,000 active employees. In earlyApril 2020 , the Company furloughed approximately 11,000 employees. Since then, we have called back approximately 6,000 of these furloughed employees. We notified approximately 5,000 furloughed employees that changes in our business processes have resulted in the elimination of their positions. ADESA Results Year Ended December
31,
(Dollars in millions, except per vehicle amounts) 2020 2019 Auction fees$ 887.7 $ 1,115.3 Service revenue 737.4 1,018.2 Purchased vehicle sales 295.0 295.5 Total ADESA revenue 1,920.1 2,429.0 Cost of services* 1,205.7 1,520.7 Gross profit* 714.4 908.3 Selling, general and administrative 508.8
621.1
Depreciation and amortization 178.8
175.5
Goodwill and other intangibles impairment 29.8 - Operating profit (loss)$ (3.0) $ 111.7 On-premise vehicles sold 1,511,000 2,137,000 Off-premise vehicles sold 1,551,000 1,647,000 Total vehicles sold 3,062,000 3,784,000 Auction fees per vehicle sold$ 290 $
295
Gross profit per vehicle sold$ 233 $
240
Gross profit percentage, excluding purchased vehicles 44.0% 42.6% Dealer consignment mix 26% 28% Commercial mix 74% 72% * Exclusive of depreciation and amortization Revenue Revenue from ADESA decreased$508.9 million , or 21%, to$1,920.1 million for the year endedDecember 31, 2020 , compared with$2,429.0 million for the year endedDecember 31, 2019 . The decrease in revenue was the result of a decrease in the number of vehicles sold and a decrease in average revenue per vehicle sold due to the mix of vehicles sold. Businesses acquired in 2019 accounted for an increase in revenue of$18.3 million , of which approximately$12.7 million was included in "Purchased vehicle sales." Businesses acquired in 2020 accounted for an increase in revenue of$8.5 million . The change in revenue included the impact of an increase in revenue of$5.2 million due to fluctuations in the European exchange rate and a decrease of$1.1 million due to fluctuations in the Canadian exchange rate. 39 -------------------------------------------------------------------------------- Table of Contents On-premise marketplace sales are initiated online for vehicles at one of our locations acrossNorth America and include Simulcast, Simulcast+ and DealerBlock sales. Off-premise marketplace sales are initiated online and includeOpenlane , TradeRev, BacklotCars andADESA Europe sales. The 19% decrease in the number of vehicles sold was comprised of a 29% decrease in on-premise vehicles sold and a 6% decrease in off-premise vehicles sold. Volumes sold for the year endedDecember 31, 2020 were materially impacted by the COVID-19 related restrictions placed on businesses throughout the world. Beginning the week ofMarch 16 , we experienced a significant decline in volumes, as customers began to cease operations in response to local, state and provincial directives. Throughout the second, third and fourth quarters, we held all sales through digital marketplaces to protect the health and well-being of our workforce and customers. All vehicles were offered online, cars were not driven through the auction lanes and we limited access to our physical locations to promote social distancing measures and help prevent the spread of COVID-19. Service revenue for the year endedDecember 31, 2020 decreased$280.8 million , or 28%, primarily as a result of the decrease in vehicles sold and COVID-19 restrictions in the second quarter that limited our on-premise service offerings. Typically consigned vehicles located at our facilities utilize our service offerings at a higher rate than off-premise vehicles. Gross Profit For the year endedDecember 31, 2020 , gross profit for ADESA decreased$193.9 million , or 21%, to$714.4 million , compared with$908.3 million for the year endedDecember 31, 2019 . Gross profit for ADESA was 37.2% of revenue for the year endedDecember 31, 2020 , compared with 37.4% of revenue for the year endedDecember 31, 2019 . Gross profit as a percentage of revenue decreased for the year endedDecember 31, 2020 as compared with the year endedDecember 31, 2019 , but we have taken measures to reduce expenses to help protect our business while our operations have been impacted by COVID-19, and vehicles sold online require less labor. In addition, our gross profit as a percentage of revenue is impacted by purchased vehicles. Excluding purchased vehicle sales, gross profit as a percentage of revenue was 44.0% and 42.6% for the years endedDecember 31, 2020 and 2019, respectively. The entire selling and purchase price of the vehicle is recorded as revenue and cost of services for purchased vehicles sold. Businesses acquired in 2019 and 2020 accounted for an increase in cost of services of$20.6 million for the year endedDecember 31, 2020 . Selling, General and Administrative Selling, general and administrative expenses for the ADESA segment decreased$112.3 million , or 18%, to$508.8 million for the year endedDecember 31, 2020 , compared with$621.1 million for the year endedDecember 31, 2019 , primarily due to decreases in compensation expense of$45.7 million , marketing costs of$16.4 million , travel expenses of$13.0 million , severance of$8.2 million , professional fees of$6.4 million , supplies expense of$5.9 million , stock-based compensation of$5.0 million , other employee related expenses of$4.9 million , telecom expenses of$4.8 million , other miscellaneous expenses aggregating$4.8 million and the recording of the Employee Retention Credit provided under the CARES Act and theCanada Emergency Wage Subsidy of$9.8 million , partially offset by increases in information technology costs of$5.7 million and costs associated with acquisitions of$6.9 million .Goodwill and Other Intangibles Impairment In light of the impact that the COVID-19 pandemic has had on the economy, forecasts for all reporting units were revised. These economic circumstances contributed to lower sales, operating profits and cash flows atADESA Remarketing Limited (doing business as ADESAU.K. ) through the first part of 2020 as compared to 2019, and the outlook for the business was significantly reduced. As a result of the updated forecasts, an impairment analysis of goodwill and intangibles was conducted. The change in circumstances resulted in the impairment of the goodwill balance totaling$25.5 million in ourADESA Remarketing Limited reporting unit and a non-cash goodwill impairment charge was recorded for this amount in the second quarter of 2020. In addition, in the second quarter of 2020, a non-cash customer relationship impairment charge of approximately$4.3 million was also recorded in theADESA Remarketing Limited reporting unit, representing the impairment in the value of this reporting unit's customer relationships. 40 --------------------------------------------------------------------------------
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AFC Results
Year Ended
December 31,
(Dollars in millions except volumes and per loan amounts) 2020 2019
Finance-related revenue
Interest and fee income $ 266.1 $ 342.1
Other revenue 8.7 10.9
Provision for credit losses (38.6) (35.3)
Warranty contract revenue 31.4 35.2
Total AFC revenue 267.6 352.9
Cost of services* 79.1 96.4
Gross profit* 188.5 256.5
Selling, general and administrative 36.6 40.9
Depreciation and amortization 12.5 13.2
Operating profit $ 139.4 $ 202.4
Loan transactions 1,519,000 1,783,000Revenue per loan transaction, excluding "Warranty contract revenue" $
156
* Exclusive of depreciation and amortization Revenue For the year endedDecember 31, 2020 , AFC revenue decreased$85.3 million , or 24%, to$267.6 million , compared with$352.9 million for the year endedDecember 31 , 2019.The decrease in revenue was primarily the result of a 12% decrease in revenue per loan transaction and an 15% decrease in loan transactions. Revenue per loan transaction, which includes both loans paid off and loans curtailed, decreased$22 , or 12%, primarily as a result of an increase in provision for credit losses for the year endedDecember 31, 2020 , as well as decreases in interest yield. Revenue per loan transaction excludes "Warranty contract revenue." The provision for credit losses increased to 2.1% of the average managed receivables for the year endedDecember 31, 2020 from 1.7% for the year endedDecember 31, 2019 . Gross Profit For the year endedDecember 31, 2020 , gross profit for the AFC segment decreased$68.0 million , or 27%, to$188.5 million , or 70.4% of revenue, compared with$256.5 million , or 72.7% of revenue, for the year endedDecember 31, 2019 . The decrease in gross profit as a percent of revenue was primarily the result of a 24% decrease in revenue and an 18% decrease in cost of services. The decrease in cost of services was primarily the result of decreases in compensation expense of$7.9 million , PWI expenses of$5.6 million , lot audits of$1.8 million , travel expenses of$1.1 million , incentive-based compensation of$0.5 million and other miscellaneous expenses aggregating$0.4 million . Selling, General and Administrative Selling, general and administrative expenses at AFC decreased$4.3 million , or 11%, to$36.6 million for the year endedDecember 31, 2020 , compared with$40.9 million for the year endedDecember 31, 2019 primarily as a result of decreases in compensation expense of$1.1 million , travel expenses of$1.0 million , PWI expenses of$0.5 million , stock-based compensation of$0.5 million , severance of$0.5 million , promotion expenses of$0.5 million and other miscellaneous expenses aggregating$0.8 million , partially offset by an increase in information technology costs of$0.6 million . 41 -------------------------------------------------------------------------------- Table of Contents Overview of Results ofKAR Auction Services, Inc. for the Year EndedDecember 31, 2018 : An overview of the results ofKAR Auction Services, Inc. for the year endedDecember 31, 2018 was included in Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the year endedDecember 31, 2019 , as filed with theSEC onFebruary 19, 2020 . Overview of Results ofKAR Auction Services, Inc. for the Three Months EndedDecember 31, 2020 and 2019: Three Months Ended December 31, (Dollars in millions except per share amounts) 2020 2019 Revenues Auction fees$ 207.0 $ 261.0 Service revenue 173.5 243.0 Purchased vehicle sales 83.7 79.3 Finance-related revenue 65.4 88.0 Total revenues 529.6 671.3 Cost of services* 325.4 394.9 Gross profit* 204.2 276.4 Selling, general and administrative 139.7 164.7 Depreciation and amortization 50.6 50.1 Operating profit 13.9 61.6 Interest expense 30.5 39.5 Other (income) expense, net 3.9 (2.5) Income (loss) from continuing operations before income taxes (20.5) 24.6 Income taxes (3.4) 9.3 Net income (loss) from continuing operations (17.1) 15.3 Net income from discontinued operations - 4.5 Net income (loss)$ (17.1) $ 19.8 Net income (loss) from continuing operations per share Basic$ (0.21) $ 0.12 Diluted$ (0.21) $ 0.12 * Exclusive of depreciation and amortization Overview For the three months endedDecember 31, 2020 , we had revenue of$529.6 million compared with revenue of$671.3 million for the three months endedDecember 31, 2019 , a decrease of 21%. Business acquired in 2020 accounted for an increase in revenue of$8.5 million or 2% of revenue. For a further discussion of revenues, gross profit and selling, general and administrative expenses, see the segment results discussions below. Depreciation and Amortization Depreciation and amortization increased$0.5 million , or 1%, to$50.6 million for the three months endedDecember 31, 2020 , compared with$50.1 million for the three months endedDecember 31, 2019 . The increase in depreciation and amortization was primarily the result of depreciation and amortization for the assets of businesses acquired. 42 -------------------------------------------------------------------------------- Table of Contents Interest Expense Interest expense decreased$9.0 million , or 23%, to$30.5 million for the three months endedDecember 31, 2020 , compared with$39.5 million for the three months endedDecember 31, 2019 . The decrease was attributable to a decrease in the weighted average interest rate of approximately 1% and a decrease of$9.5 million in the average outstanding balance of corporate debt for the three months endedDecember 31, 2020 compared with the three months endedDecember 31, 2019 . In addition, there was a decrease in interest expense at AFC of$6.3 million , which resulted from a decrease in the average finance receivables balance and interest rates for the three months endedDecember 31, 2020 , as compared with the three months endedDecember 31, 2019 . The decrease in interest expense was partially offset by an increase in interest expense on the interest rate swaps of approximately$1.6 million for the three months endedDecember 31, 2020 . Other (Income) Expense, Net For the three months endedDecember 31, 2020 , we had other expenses of$3.9 million compared with other income of$2.5 million for the three months endedDecember 31, 2019 . The decrease in other (income) expense was primarily attributable to an increase in contingent consideration valuation of$4.7 million , an increase in foreign currency losses of$1.4 million and other miscellaneous items aggregating$0.3 million . Income Taxes We had an effective tax rate of 16.6% on a pre-tax loss for the three months endedDecember 31, 2020 , compared with an effective tax rate of 37.8% for the three months endedDecember 31, 2019 . The 2020 rate was unfavorably impacted by expense for the increase in the estimated value of contingent consideration for which no tax benefit has been recorded, as well as a greater proportion of earnings in higher tax jurisdictions. These were partially offset by the tax benefit from deductions related to stock-based compensation expenses and other discrete benefits. Net Income from Discontinued Operations OnJune 28, 2019 , the Company completed the separation of its salvage auction business, IAA, through a spin-off, creating a new independent publicly traded salvage auction company. As such, the financial results of IAA have been accounted for as discontinued operations in the comparable 2019 results presented. For the three months endedDecember 31, 2020 and 2019, the Company's financial statements included income from discontinued operations of$0.0 million and$4.5 million , respectively. Impact of Foreign Currency For the three months endedDecember 31, 2020 , fluctuations in the Canadian exchange rate increased revenue by$0.8 million , operating profit by$0.2 million , net income by$0.1 million and had no impact on net income per diluted share. For the three months endedDecember 31, 2020 , fluctuations in the European exchange rate increased revenue by$4.0 million , increased operating profit by$0.3 million , decreased net income by$0.3 million and had no impact on net income per diluted share. 43 --------------------------------------------------------------------------------
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ADESA Results
Three Months Ended
December 31,
(Dollars in millions, except per vehicle amounts) 2020 2019
Auction fees $ 207.0 $ 261.0
Service revenue 173.5 243.0
Purchased vehicle sales 83.7 79.3
Total ADESA revenue 464.2 583.3
Cost of services* 308.4 370.9
Gross profit* 155.8 212.4
Selling, general and administrative 130.6 154.9
Depreciation and amortization 47.7 46.6
Operating profit (loss) $ (22.5) $ 10.9
On-premise vehicles sold 328,000 502,000
Off-premise vehicles sold 353,000 385,000
Total vehicles sold 681,000 887,000
Auction fees per vehicle sold $ 304 $ 294
Gross profit per vehicle sold $ 229 $ 239
Gross profit percentage, excluding purchased vehicles 40.9% 42.1%
Dealer consignment mix 31% 28%
Commercial mix 69% 72%
* Exclusive of depreciation and amortization
Revenue
Revenue from ADESA decreased $119.1 million , or 20%, to $464.2 million for the
three months ended December 31, 2020 , compared with $583.3 million for the three
months ended December 31, 2019 . The decrease in revenue was the result of a
decrease in the number of vehicles sold, partially offset by an increase in
purchase vehicle sales. Businesses acquired in 2020 accounted for an increase in
revenue of $8.5 million . The change in revenue included the impact of an
increase in revenue of $4.0 million due to fluctuations in the European exchange
rate and $0.7 million due to fluctuations in the Canadian exchange rate.
On-premise marketplace sales are initiated online for vehicles at one of our
locations across North America and include Simulcast, Simulcast+ and DealerBlock
sales. Off-premise marketplace sales are initiated online and include Openlane ,
TradeRev, BacklotCars and ADESA Europe sales. The 23% decrease in the number of
vehicles sold was primarily attributable to a 35% decrease in on-premise
vehicles sold and an 8% decrease in off-premise vehicles sold. Volumes sold for
the three months ended December 31, 2020 were materially impacted by the
COVID-19 related restrictions placed on businesses. For the three months ended
December 31, 2020 we held all sales through digital marketplaces to protect the
health and well-being of our workforce and customers. All vehicles were offered
online, cars were not driven through the auction lanes and we limited access to
our physical locations to promote social distancing measures and help prevent
the spread of COVID-19.
Service revenue for the quarter ended December 31, 2020 decreased $69.5 million ,
or 29%, primarily as a result of the decrease in vehicles sold. Typically
consigned vehicles located at our facilities utilize our service offerings at a
higher rate than off-premise vehicles.
Gross Profit
For the three months ended December 31, 2020 , gross profit for ADESA decreased
$56.6 million , or 27%, to $155.8 million , compared with $212.4 million for the
three months ended December 31, 2019 . Gross profit for ADESA was 33.6% of
revenue for the three months ended December 31, 2020 , compared with 36.4% of
revenue for the three months ended December 31, 2019 . Gross profit as a
percentage of revenue decreased for the three months ended December 31, 2020 as
compared with the three months ended December 31, 2019 primarily related to the
increase in purchase vehicle sales and the impact of lower volumes. The entire
selling and purchase price of the vehicle is recorded as revenue and cost of
services for
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purchased vehicles sold. Excluding purchased vehicle sales, gross profit as a
percentage of revenue was 40.9% and 42.1% for the three months ended
December 31, 2020 and 2019, respectively. Businesses acquired in 2020 accounted
for an increase in cost of services of $5.0 million for the quarter ended
December 31, 2020 . We have also taken measures to reduce expenses to help
protect our business while our operations have been impacted by COVID-19.
Selling, General and Administrative
Selling, general and administrative expenses for the ADESA segment decreased
$24.3 million , or 16%, to $130.6 million for the three months ended December 31,
2020 , compared with $154.9 million for the three months ended December 31, 2019 ,
primarily due to decreases in compensation expense of $12.4 million , severance
of $8.5 million , marketing costs of $4.0 million , travel expenses of $3.1
million , bad debt expense of $2.2 million , stock-based compensation of $2.1
million , other employee related expenses of $1.3 million , telecom expenses of
$1.2 million , supplies expense of $1.1 million and other miscellaneous expenses
aggregating $4.5 million , partially offset by increases in incentive-based
compensation of $7.8 million , costs associated with acquisitions of $5.0
million , professional fees of $2.2 million and information technology costs of
$1.1 million .
AFC Results
Three Months Ended
December 31,
(Dollars in millions except volumes and per loan amounts) 2020 2019
Finance-related revenue
Interest and fee income $ 61.4 $ 86.0
Other revenue 1.9 2.8
Provision for credit losses (2.7) (9.8)
Warranty contract revenue 4.8 9.0
Total AFC revenue 65.4 88.0
Cost of services* 17.0 24.0
Gross profit* 48.4 64.0
Selling, general and administrative 9.1 9.8
Depreciation and amortization 2.9 3.5
Operating profit $ 36.4 $ 50.7
Loan transactions 327,000 443,000Revenue per loan transaction, excluding "Warranty contract revenue" $
186 $ 178
* Exclusive of depreciation and amortization
Revenue
For the three months ended December 31, 2020 , AFC revenue decreased
$22.6 million , or 26%, to $65.4 million , compared with $88.0 million for the
three months ended December 31, 2019 . The decrease in revenue was primarily the
result of a 26% decrease in loan transactions, partially offset by a 4% increase
in revenue per loan transaction. Warranty contract revenue decreased $4.2
million for the three months ended December 31, 2020 , compared with the three
months ended December 31, 2019 , as PWI was sold in December 2020 .
Revenue per loan transaction, which includes both loans paid off and loans
curtailed, increased $8 , or 4%, primarily as a result of an increase in loan
values and a decrease in provision for credit losses for the three months ended
December 31, 2020 , partially offset by decreases in interest yield and average
portfolio duration. Revenue per loan transaction excludes "Warranty contract
revenue."
The provision for credit losses decreased to 0.6% of the average managed
receivables for the three months ended December 31, 2020 from 1.9% for the three
months ended December 31, 2019 .
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Gross Profit
For the three months ended December 31, 2020 , gross profit for the AFC segment
decreased $15.6 million , or 24%, to $48.4 million , or 74.0% of revenue, compared
with $64.0 million , or 72.7% of revenue, for the three months ended December 31,
2019 . The increase in gross profit as a percent of revenue was primarily the
result of a 26% decrease in revenue and an 29% decrease in cost of services. The
decrease in cost of services was primarily the result of decreases in PWI
expenses of $3.0 million , compensation expense of $2.8 million , lot audits of
$0.8 million and other miscellaneous expenses aggregating $0.4 million .
Selling, General and Administrative
Selling, general and administrative expenses at AFC decreased $0.7 million , or
7%, to $9.1 million for the three months ended December 31, 2020 , compared with
$9.8 million for the three months ended December 31, 2019 . The decrease in
selling, general and administrative expenses was primarily attributable to
decreases in compensation expense of $0.5 million , severance of $0.4 million ,
PWI expenses of $0.4 million and other miscellaneous expenses aggregating $0.4
million , partially offset by an increase in incentive-based compensation of $1.0
million .
LIQUIDITY AND CAPITAL RESOURCES
We believe that the significant indicators of liquidity for our business are
cash on hand, cash flow from operations, working capital and amounts available
under our Credit Facility. Our principal sources of liquidity consist of cash
generated by operations and borrowings under our Revolving Credit Facility.
December 31,
(Dollars in millions) 2020 2019
Cash and cash equivalents $ 752.1 $ 507.6
Restricted cash 60.2 53.3
Working capital 924.6 726.8Amounts available under the Revolving Credit Facility* 325.0 325.0 Cash flow from operations for the year ended
384.4 380.8
* There were related outstanding letters of credit totaling approximately$28.5 million and$27.4 million atDecember 31, 2020 and 2019, respectively, which reduced the amount available for borrowings under the Revolving Credit Facility. We regularly evaluate alternatives for our capital structure and liquidity given our expected cash flows, growth and operating capital requirements as well as capital market conditions. The COVID-19 pandemic has had, and is continuing to have, a significant impact on our business. As a result, we have implemented several measures that we believe will enhance liquidity for the foreseeable future. Some of these measures included reducing our compensation expense (including a reduction of base salaries across many levels of the organization, including the elimination of base salaries for our Chief Executive Officer, Chief Financial Officer and President and 50% reduction of base salaries for our other executive officers during the second quarter of 2020, furloughs and a reduction in force, among others), prohibiting non-essential business travel, suspending non-essential services provided by certain third parties at our locations, delaying or canceling capital projects at our on-premise marketplace locations and temporarily suspending the Company's quarterly dividend. In addition, inJune 2020 we issued and sold an aggregate of 550,000 shares Series A Preferred Stock of the Company in private placements for net proceeds of approximately$528.2 million , as described in Note 14, "Convertible Preferred Stock." We have also taken advantage of legislation introduced to assist companies during this time. In the second, third and fourth quarters of 2020, we recorded a total of approximately$8.3 million of employee retention credits taken under the CARES Act and approximately$16.0 million under theCanada Emergency Wage Subsidy. These credits partially offset salaries and medical costs recorded in theU.S. andCanada . We will continue to monitor and assess the impact the CARES Act and similar legislation in other countries may have on our business and financial results. As the impact of the COVID-19 pandemic on the economy and our operations evolves, we will continue to assess our liquidity needs. A continued disruption could materially affect our liquidity. 46 -------------------------------------------------------------------------------- Table of Contents 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 a week 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 in theU.S. 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$158.1 million of available cash was held by our foreign subsidiaries atDecember 31, 2020 . If funds held by our foreign subsidiaries were to be repatriated, we expect any applicable taxes to be minimal. AFC offers short-term inventory-secured financing, also known as floorplan financing, to independent used vehicle dealers. Financing is primarily provided for terms of 30 to 90 days. AFC principally generates its funding through the sale of its receivables. The receivables sold pursuant to the securitization agreements are accounted for as secured borrowings. For further discussion of AFC's securitization arrangements, see "Securitization Facilities." Credit Facilities OnSeptember 2, 2020 , we entered into the Fifth Amendment Agreement (the "Fifth Amendment") to the Credit Agreement. The Fifth Amendment (1) eliminated the financial covenant "holiday" provided by the Fourth Amendment Agreement, dated as ofMay 29, 2020 (the "Fourth Amendment"); (2) eliminated the changes to the calculation of Consolidated EBITDA for the purposes of the financial covenant compliance for the fiscal quarters endingSeptember 30, 2021 andDecember 31, 2021 , as provided by the Fourth Amendment; (3) removed the monthly minimum liquidity covenant provided by the Fourth Amendment; and (4) eliminated the limitations imposed by the Fourth Amendment on the Company's ability to make certain investments, junior debt repayments, acquisitions and restricted payments and to incur additional secured indebtedness. OnMay 29, 2020 , we entered into the Fourth Amendment to the Credit Agreement (the "Fourth Amendment"). The Fourth Amendment (1) provided a financial covenant "holiday" through and includingJune 30, 2021 ; (2) for purposes of determining compliance with the financial covenant for the fiscal quarters endingSeptember 30, 2021 andDecember 31, 2021 , permitted the Consolidated EBITDA for the applicable test period to be calculated on an annualized basis, excluding results prior toApril 1, 2021 ; (3) established a monthly minimum liquidity covenant of$225.0 million through and includingSeptember 30, 2021 ; and (4) effectively placed certain limitations on the ability to make certain investments, junior debt repayments, acquisitions and restricted payments and to incur additional secured indebtedness untilOctober 1, 2021 . OnSeptember 19, 2019 , we entered into the Third Amendment Agreement (the "Third Amendment") to the Credit Agreement. The Third Amendment provided for, among other things, (1) the refinancing of the existing Term Loan B-4 and Term Loan B-5 with the new Term Loan B-6, (2) repayment of the 2017 Revolving Credit Facility and (3) the$325 million Revolving Credit Facility. The Credit Facility is available for letters of credit, working capital, permitted acquisitions and general corporate purposes. The Revolving Credit Facility also includes a$50 million sub-limit for issuance of letters of credit and a$60 million sub-limit for swingline loans. Term Loan B-6 was issued at a discount of$2.4 million and the discount is being amortized using the effective interest method to interest expense over the term of the loan. Term Loan B-6 is payable in quarterly installments equal to 0.25% of the original aggregate principal amount, with the balance payable at the maturity date. As set forth in the Credit Agreement, Term Loan B-6 bears interest at an adjusted LIBOR rate plus 2.25% or at the Company's election, Base Rate (as defined in the Credit Agreement) plus 1.25%. Loans under the Revolving Credit Facility will bear interest at a rate calculated based on the type of borrowing (either adjusted LIBOR or Base Rate) and the Company's Consolidated Senior Secured Net Leverage Ratio (as defined in the Credit Agreement), with such rate ranging from 2.25% to 1.75% for adjusted LIBOR loans and from 1.25% to 0.75% for Base Rate loans. The Company also pays a commitment fee between 25 to 35 basis points, payable quarterly, on the average daily unused amount of the Revolving Facility based on the Company's Consolidated Senior Secured Net Leverage Ratio, from time to time. The interest rate applicable to Term Loan B-6 was 2.44% atDecember 31, 2020 . 47 -------------------------------------------------------------------------------- Table of Contents OnDecember 31, 2020 ,$938.1 million was outstanding on Term Loan B-6 and there were no borrowings on the Revolving Credit Facility. In addition, we had related outstanding letters of credit in the aggregate amount of$28.5 million and$27.4 million atDecember 31, 2020 andDecember 31, 2019 , respectively, which reduce the amount available for borrowings under the Revolving Credit Facility. Our European operations have lines of credit aggregating$36.6 million (€30 million) of which$14.8 million was drawn atDecember 31, 2020 . The obligations of the Company under the Credit Facility are guaranteed by certain of our domestic subsidiaries (the "Subsidiary Guarantors") and are secured by substantially all of the assets of the Company and the Subsidiary Guarantors, including but not limited to: (a) pledges of and first priority perfected security interests in 100% of the equity interests of certain of the Company's and the Subsidiary Guarantors' domestic subsidiaries and 65% of the equity interests of certain of the Company's and the Subsidiary Guarantors' first tier foreign subsidiaries and (b) perfected first priority security interests in substantially all other tangible and intangible assets of the Company and each Subsidiary Guarantor, subject to certain exceptions. Certain covenants contained within the Credit Agreement are critical to an investor's understanding of our financial liquidity, as the failure to maintain compliance with these covenants could result in a default and allow the lenders under the Credit Agreement to declare all amounts borrowed immediately due and payable. The Credit Agreement contains a financial covenant requiring compliance with a Consolidated Senior Secured Net Leverage Ratio not to exceed 3.5 as of the last day of each fiscal quarter if revolving loans are outstanding. The Consolidated Senior Secured Net Leverage Ratio is calculated as consolidated total debt (as defined in the Credit Agreement) divided by the last four quarters consolidated Adjusted EBITDA. Consolidated total debt includes term loan borrowings, revolving loans, finance lease liabilities and other obligations for borrowed money less unrestriced cash as defined in the Credit Agreement. Consolidated Adjusted EBITDA is EBITDA (earnings before interest expense, income taxes, depreciation and amortization) adjusted to exclude among other things (a) gains and losses from asset sales; (b) unrealized foreign currency translation gains and losses in respect of indebtedness; (c) certain non-recurring gains and losses; (d) stock-based compensation expense; (e) certain other non-cash amounts included in the determination of net income; (f) charges and revenue reductions resulting from purchase accounting; (g) minority interest; (h) consulting expenses incurred for cost reduction, operating restructuring and business improvement efforts; (i) expenses realized upon the termination of employees and the termination or cancellation of leases, software licenses or other contracts in connection with the operational restructuring and business improvement efforts; (j) expenses incurred in connection with permitted acquisitions; (k) any impairment charges or write-offs of intangibles; and (l) any extraordinary, unusual or non-recurring charges, expenses or losses. Our Consolidated Senior Secured Net Leverage Ratio was 0.7 atDecember 31, 2020 . In addition, the Credit Agreement and the indenture governing our senior notes (see Note 12, "Long-Term Debt" for additional information) contain certain limitations on our ability to pay dividends and other distributions, make certain acquisitions or investments, grant liens and sell assets, and the Credit Agreement contains certain limitations on our ability to incur indebtedness. The applicable covenants in the Credit Agreement affect our operating flexibility by, among other things, restricting our ability to incur expenses and indebtedness that could be used to grow the business, as well as to fund general corporate purposes. We were in compliance with the covenants in the Credit Agreement and the indenture governing our senior notes atDecember 31, 2020 . We believe our sources of liquidity from our cash and cash equivalents on hand, working capital, cash provided by operating activities, and availability under our Credit Facility are sufficient to meet our operating needs for the foreseeable future. In addition, we believe the previously mentioned sources of liquidity will be sufficient to fund our capital requirements and debt service payments for the foreseeable future. A lack of recovery in market conditions, or further deterioration in market conditions, could materially affect the Company's liquidity. Senior Notes OnMay 31, 2017 , we issued$950 million of 5.125% senior notes dueJune 1, 2025 . The Company pays interest on the senior notes semi-annually in arrears onJune 1 andDecember 1 of each year, which commenced onDecember 1, 2017 . We may redeem the senior notes, in whole or in part, at a premium that declines ratably to par in 2023. The senior notes are guaranteed by the Subsidiary Guarantors. 48 -------------------------------------------------------------------------------- Table of Contents Securitization Facilities AFC sells the majority of itsU.S. dollar denominated finance receivables on a revolving basis and without recourse toAFC Funding Corporation . A securitization agreement allows for the revolving sale byAFC Funding Corporation to a group of bank purchasers of undivided interests in certain finance receivables subject to committed liquidity. The agreement expires onJanuary 31, 2024 .AFC Funding Corporation had committed liquidity of$1.60 billion forU.S. finance receivables atDecember 31, 2020 . InSeptember 2020 ,AFC and AFC Funding Corporation entered into the Ninth Amended and Restated Receivables Purchase Agreement (the "Receivables Purchase Agreement"). The Receivables Purchase Agreement decreased AFC Funding'sU.S. committed liquidity from$1.70 billion to$1.60 billion and extended the facility's maturity date fromJanuary 28, 2022 toJanuary 31, 2024 . In addition, provisions designed to provide additional credit enhancement to the purchasers upon the occurrence of the certain events related to the payment rate and net spread on the receivables portfolio were added, certain portfolio performance metrics that could result in a requirement to increase the cash reserve or constitute a termination event were amended to the benefit of AFC Funding and provisions providing for a mechanism for determining an alternative rate of interest were added. We capitalized approximately$12.3 million of costs in connection with the Receivables Purchase Agreement. We also have an agreement for the securitization of AFCI's receivables. AFCI's committed facility is provided through a third-party conduit (separate from theU.S. facility) and wasC$175 million atDecember 31, 2020 . InSeptember 2020 , AFCI entered into the Fifth Amended and Restated Receivables Purchase Agreement (the "Canadian Receivable Purchase Agreement"). The Canadian Receivables Purchase Agreement extended the facility's maturity date fromJanuary 28, 2022 toJanuary 31, 2024 . In addition, provisions designed to provide additional credit enhancement to the purchasers upon the occurrence of the certain events related to the payment rate and net spread on the receivables portfolio were added, certain portfolio performance metrics that could result in a requirement to increase the cash reserve or constitute a termination event were amended to the benefit of AFC Funding and provisions providing for a mechanism for determining an alternative rate of interest were added. We capitalized approximately$1.0 million of costs in connection with the Canadian Receivables Purchase Agreement. The receivables sold pursuant to both theU.S. and Canadian securitization agreements are accounted for as secured borrowings. AFC managed total finance receivables of$1,911.0 million and$2,115.2 million atDecember 31, 2020 andDecember 31, 2019 , respectively. AFC's allowance for losses was$22.0 million and$15.0 million atDecember 31, 2020 andDecember 31, 2019 , respectively. As ofDecember 31, 2020 andDecember 31, 2019 ,$1,865.3 million and$2,061.6 million , respectively, of finance receivables and a cash reserve of 1 or 3 percent of the obligations collateralized by finance receivables served as security for the$1,261.2 million and$1,461.2 million of obligations collateralized by finance receivables atDecember 31, 2020 andDecember 31, 2019 , respectively. The amount of the cash reserve depends on circumstances which are set forth in the securitization agreements. There were unamortized securitization issuance costs of approximately$21.6 million and$13.2 million atDecember 31, 2020 andDecember 31, 2019 , respectively. After the occurrence of a termination event, as defined in theU.S. securitization agreement, the banks may, and could, cause the stock ofAFC Funding Corporation to be transferred to the bank facility, though as a practical matter the bank facility would look to the liquidation of the receivables under the transaction documents as their primary remedy. Proceeds from the revolving sale of receivables to the bank facilities are used to fund new loans to customers. AFC,AFC Funding Corporation and AFCI must maintain certain financial covenants including, among others, limits on the amount of debt AFC and AFCI can incur, minimum levels of tangible net worth, and other covenants tied to the performance of the finance receivables portfolio. The securitization agreements also incorporate the financial covenants of our Credit Facility. AtDecember 31, 2020 , we were in compliance with the covenants in the securitization agreements. In response to the COVID-19 pandemic and the related economic downturn, AFC amended itsU.S. and Canadian securitization agreements in March andMay 2020 , in order to provide temporary cash relief to its customers by launching a Customer Relief Program. Under this program, eligible customers were able to choose to defer curtailment payments (principal, fees and interest) due throughJune 30, 2020 , on eligible units. These transactions were permitted as eligible loans under the amended securitization agreements. TheMay 2020 amendments were also made to reflect the modifications to the Credit Facility. 49 -------------------------------------------------------------------------------- Table of Contents OnApril 30, 2020 , AFC amended itsU.S. and Canadian securitization agreements to modify certain definitions and to reduce the minimum net spread for April, May andJune 2020 . In addition, the one-month minimum payment rate test decreased for April, May andJune 2020 . OnJune 25, 2020 , AFC amended itsU.S. and Canadian securitization agreements to extend the modification of certain definitions through the end of September and to increase the minimum net spread for July, August, andSeptember 2020 above the April amendment requirement, but below the original agreement. An Over Collateralization floor was also implemented, and the restriction on payments being made to AFC fromAFC Funding Corporation was removed, thereby reducing AFC's restricted cash requirements. InSeptember 2020 , AFC amended itsU.S. and Canadian securitization agreements to remove provisions made in previous amendments to provide relief for the economic impact of the COVID-19 pandemic and to permit the Customer Relief Program. EBITDA and Adjusted EBITDA EBITDA and Adjusted EBITDA, as presented herein, are supplemental measures of our performance that are not required by, or presented in accordance with, generally accepted accounting principles inthe United States , or GAAP. They are not measurements of our financial performance under GAAP and should not be considered substitutes for net income (loss) or any other performance measures derived in accordance with GAAP. EBITDA is defined as net income (loss), plus interest expense net of interest income, income tax provision (benefit), depreciation and amortization. Adjusted EBITDA is EBITDA adjusted for the items of income and expense and expected incremental revenue and cost savings, as described above in the discussion of certain restrictive loan covenants under "Credit Facilities." Management believes that the inclusion of supplementary adjustments to EBITDA applied in presenting Adjusted EBITDA is appropriate to provide additional information to investors about one of the principal measures of performance used by our creditors. In addition, management uses EBITDA and Adjusted EBITDA to evaluate our performance. EBITDA and Adjusted EBITDA have limitations as analytical tools, and should not be considered in isolation or as a substitute for analysis of the results as reported under GAAP. These measures may not be comparable to similarly titled measures reported by other companies. The following tables reconcile EBITDA and Adjusted EBITDA to net income (loss) from continuing operations for the periods presented: Three Months Ended December 31, 2020 (Dollars in millions) ADESA AFC Consolidated Net income (loss) from continuing operations$ (38.5) $ 21.4 $ (17.1) Add back: Income taxes (9.7) 6.3 (3.4) Interest expense, net of interest income 21.5 8.8 30.3 Depreciation and amortization 47.7 2.9 50.6 Intercompany interest 0.1 (0.1) - EBITDA 21.1 39.3 60.4 Non-cash stock-based compensation 2.5 0.5 3.0 Acquisition related costs 4.1 - 4.1 Securitization interest - (6.2) (6.2) Loss on asset sales 0.2 - 0.2 Severance 0.9 - 0.9 Foreign currency (gains)/losses 1.7 - 1.7 Contingent consideration adjustment 4.7 - 4.7 Other (1.7) 0.4 (1.3) Total addbacks 12.4 (5.3) 7.1 Adjusted EBITDA$ 33.5 $ 34.0 $ 67.5 50
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Three Months Ended December 31, 2019
(Dollars in millions) ADESA AFC Consolidated
Net income (loss) from continuing operations $ (12.6) $ 27.9 $ 15.3
Add back:
Income taxes 0.6 8.7 9.3
Interest expense, net of interest income 23.3 15.0 38.3
Depreciation and amortization 46.6 3.5 50.1
Intercompany interest 0.9 (0.9) -
EBITDA 58.8 54.2 113.0
Non-cash stock-based compensation 4.6 0.6 5.2
Acquisition related costs 1.8 0.1 1.9
Securitization interest - (13.0) (13.0)
Loss on asset sales 0.4 - 0.4
Severance 8.9 0.7 9.6
Foreign currency (gains)/losses 0.3 - 0.3
Other 4.6 - 4.6
Total addbacks 20.6 (11.6) 9.0
Adjusted EBITDA $ 79.4 $ 42.6 $ 122.0
Year Ended December 31, 2020
(Dollars in millions) ADESA AFC Consolidated
Net income (loss) from continuing operations $ (79.1) $ 79.6 $ 0.5
Add back:
Income taxes (17.0) 21.9 4.9
Interest expense, net of interest income 88.3 39.0 127.3
Depreciation and amortization 178.8 12.5 191.3
Intercompany interest 1.1 (1.1) -
EBITDA 172.1 151.9 324.0
Non-cash stock-based compensation 12.8 2.3 15.1
Acquisition related costs 8.8 - 8.8
Securitization interest - (27.3) (27.3)
Loss on asset sales 1.3 - 1.3
Severance 11.1 0.4 11.5
Foreign currency (gains)/losses 4.9 - 4.9
Goodwill and other intangibles impairment 29.8 - 29.8
Contingent consideration adjustment 4.7 - 4.7
Other 2.1 0.4 2.5
Total addbacks 75.5 (24.2) 51.3
Adjusted EBITDA $ 247.6 $ 127.7 $ 375.3
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Year Ended December 31, 2019
(Dollars in millions) ADESA AFC Consolidated
Net income (loss) from continuing operations $ (13.6) $ 106.0 $ 92.4
Add back:
Income taxes (0.1) 37.8 37.7
Interest expense, net of interest income 122.9 63.5 186.4
Depreciation and amortization 175.5 13.2 188.7
Intercompany interest 5.0 (5.0) -
EBITDA 289.7 215.5 505.2
Non-cash stock-based compensation 17.6 2.7 20.3
Loss on extinguishment of debt 2.2 - 2.2
Acquisition related costs 11.6 0.6 12.2
Securitization interest - (54.9) (54.9)
Loss on asset sales 2.1 - 2.1
Severance 14.3 1.0 15.3
Foreign currency (gains)/losses (0.7) - (0.7)
IAA allocated costs 2.1 0.2 2.3
Other 6.0 - 6.0
Total addbacks 55.2 (50.4) 4.8
Adjusted EBITDA $ 344.9 $ 165.1 $ 510.0
Certain of our loan covenant calculations utilize financial results for the most
recent four consecutive fiscal quarters. The following table reconciles EBITDA
and Adjusted EBITDA to net income (loss) for the periods presented:
Twelve
Months
Three Months Ended Ended
March 31, June 30, September 30, December 31, December 31,
(Dollars in millions) 2020 2020 2020 2020 2020
Net income (loss) $ 2.8 $ (32.3) $ 47.1 $ (17.1) $ 0.5
Add back:
Income taxes 2.0 (4.6) 10.9 (3.4) 4.9
Interest expense, net of interest income 37.2 30.6 29.2 30.3 127.3
Depreciation and amortization 47.7 46.5 46.5 50.6 191.3
EBITDA 89.7 40.2 133.7 60.4 324.0
Non-cash stock-based compensation 5.3 2.9 3.9 3.0 15.1
Acquisition related costs 1.4 0.9 2.4 4.1 8.8
Securitization interest (11.4) (6.0) (3.7) (6.2) (27.3)
Loss on asset sales 0.5 0.5 0.1 0.2 1.3
Severance 1.8 6.5 2.3 0.9 11.5
Foreign currency (gains)/losses 0.4 2.7 0.1 1.7 4.9
Goodwill and other intangibles impairment - 29.8 - - 29.8
Contingent consideration adjustment - - - 4.7 4.7
Other 0.9 2.5 0.4 (1.3) 2.5
Total addbacks (1.1) 39.8 5.5 7.1 51.3
Adjusted EBITDA $ 88.6 $ 80.0 $ 139.2 $ 67.5 $ 375.3
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Summary of Cash Flows
Year Ended
December 31,
(Dollars in millions) 2020 2019
Net cash provided by (used by):
Operating activities - continuing operations $ 384.4 $ 380.8
Operating activities - discontinued operations -
161.2
Investing activities - continuing operations (326.6)
(415.0)
Investing activities - discontinued operations -
(37.4)
Financing activities - continuing operations 194.8
(1,163.8)
Financing activities - discontinued operations -
1,317.6
Effect of exchange rate on cash (1.2)
12.8
Net increase in cash, cash equivalents and restricted cash
256.2
Cash flow provided by operating activities (continuing operations) was$384.4 million for the year endedDecember 31, 2020 , compared with$380.8 million for the year endedDecember 31, 2019 . The increase in operating cash flow was primarily attributable to changes in operating assets and liabilities as a result of the timing of collections and the disbursement of funds to consignors for auctions held near period-ends, as well as a net increase in non-cash item adjustments, partially offset by decreased profitability attributable to reduced operations beginningMarch 20, 2020 , resulting from COVID-19 restrictions on our business. Net cash used by investing activities (continuing operations) was$326.6 million for the year endedDecember 31, 2020 , compared with$415.0 million for the year endedDecember 31, 2019 . The increase in net cash from investing activities was primarily attributable to: •a net decrease in finance receivables held for investment of approximately$303.3 million ; •a reduction in capital expenditures of approximately$60.2 million ; and •net proceeds from the sale of PWI of approximately$24.3 million ; partially offset by: •an increase in cash used for acquisitions of approximately$300.3 million . Net cash provided by financing activities (continuing operations) was$194.8 million for the year endedDecember 31, 2020 , compared with net cash used by financing activities of$1,163.8 million for the year endedDecember 31, 2019 . The increase in net cash from financing activities was primarily attributable to: •a decrease in net payments on long-term debt of$791.9 million . In the second quarter of 2019, the Company used net cash provided by financing activities from discontinued operations (cash received from IAA in the separation) to prepay its term loan debt. In addition, in the third quarter of 2019, the Company refinanced the outstanding Term Loan B-4 and Term Loan B-5 and repaid the remaining amount on the 2017 Revolving Credit Facility with the new Term Loan B-6; •net proceeds of approximately$528.2 million received from the issuance of the Series A Preferred Stock in the second quarter of 2020; •a decrease in dividends paid to stockholders of approximately$115.3 million ; •a decrease in the repurchase of common stock of$109.5 million ; and •a decrease in cash transferred to IAA of$50.9 million ; partially offset by: •a net decrease in the obligations collateralized by finance receivables of approximately$194.9 million ; •a net decrease in borrowings on lines of credit of approximately$33.3 million ; and •an increase in cash used for payments of contingent consideration of approximately$21.8 million . 53 -------------------------------------------------------------------------------- Table of Contents Capital Expenditures Capital expenditures for the years endedDecember 31, 2020 and 2019 approximated$101.4 million and$161.6 million , respectively. Capital expenditures were funded primarily from internally generated funds. We continue to invest in our core information technology capabilities and capacity expansion. Capital expenditures are expected to be approximately$125 million for fiscal year 2021. Future capital expenditures could vary substantially based on capital project timing, the opening of new auction facilities, capital expenditures related to acquired businesses and the initiation of new information systems projects to support our business strategies. Dividends The Series A Preferred Stock ranks senior to the shares of the Company's common stock, par value$0.01 per share, with respect to dividend rights and rights on the distribution of assets on any voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Company. The holders of the Series A Preferred Stock are entitled to a cumulative dividend at the rate of 7% per annum, payable quarterly in arrears. Dividends are payable in kind through the issuance of additional shares of Series A Preferred Stock for the first eight dividend payments, and thereafter, in cash or in kind, or in any combination of both, at the option of the Company. As ofDecember 31, 2020 , the holders of the Series A Preferred Stock had received dividends in kind with a value in the aggregate of approximately$21.6 million . The holders of the Series A Preferred Stock are also entitled to participate in dividends declared or paid on our common stock on an as-converted basis. The following common stock dividend information has been released for 2020: •OnFebruary 18, 2020 , the Company announced a cash dividend of$0.19 per share that was paid onApril 3, 2020 , to stockholders of record at the close of business onMarch 20, 2020 . •OnNovember 5, 2019 , the Company announced a cash dividend of$0.19 per share that was paid onJanuary 3, 2020 , to stockholders of record at the close of business onDecember 20, 2019 . The Company has temporarily suspended its quarterly common stock dividend in light of the impact of the COVID-19 pandemic on its operations. Future dividend decisions will be based on and affected by a variety of factors, including our financial condition and results of operations, contractual restrictions, including restrictive covenants contained in our Credit Agreement and AFC's securitization facilities and the indenture governing our senior notes, capital requirements and other factors that our board of directors deems relevant. No assurance can be given as to whether any future dividends may be declared by our board of directors or the amount thereof. Acquisition InNovember 2020 , ADESA completed the acquisition of BacklotCars for approximately$421.0 million , net of cash acquired. BacklotCars is an app and web-based dealer-to-dealer wholesale platform featuring a 24/7 "bid-ask" marketplace offering vehicles with comprehensive inspections performed by automobile mechanics. The acquisition is expected to further diversify the Company's broad portfolio of digital capabilities and accelerate the Company's strategy to be a leading digital dealer-to-dealer marketplace provider. The purchased assets included accounts receivable, property and equipment, software, customer relationships and tradenames. Financial results for BacklotCars have been included in our consolidated financial statements from the date of acquisition. In addition, as part of the acquisition of BacklotCars, we assumed line-of-credit debt of approximately$9.5 million which was paid off in the fourth quarter of 2020. The acquired assets and assumed liabilities of BacklotCars were recorded at fair value, including$78.8 million to intangible assets, representing the fair value of acquired customer relationships of$66.4 million , software of$8.3 million and tradenames of$4.1 million , which are being amortized over their expected useful lives. The multi-period excess earnings method was used to value the customer relationships and the relief from royalty method was used to value the software and tradenames. Both of these methods require forward looking estimates to determine fair value, including among other assumptions, forecasted revenue growth and estimated royalty rates. The purchase accounting associated with this acquisition is preliminary, subject to obtaining information to determine the fair value of certain assets and liabilities. The acquisition resulted in a preliminary estimate of$354.8 million of goodwill. The goodwill is recorded in the ADESA Auctions reportable segment. The financial impact of this acquisition, including pro forma financial results, was immaterial to the Company's consolidated results for the year endedDecember 31, 2020 . 54 -------------------------------------------------------------------------------- Table of Contents Contractual Obligations The table below sets forth a summary of our contractual debt and lease obligations as ofDecember 31, 2020 . Some of the figures included in this table are based on management's estimates and assumptions about these obligations, including their duration, the possibility of renewal and other factors. Because these estimates and assumptions are necessarily subjective, the obligations we may actually pay in future periods could vary from those reflected in the table. This table does not include the obligations related to our Series A Preferred Stock discussed in Note 14 of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K. The following summarizes our contractual cash obligations as ofDecember 31, 2020 (in millions):
Payments Due by Period
Less than More than
Contractual Obligations Total 1 year 1 - 3 Years 4 - 5 Years 5 Years
Long-term debt
$325 million Revolving Credit Facility $ - $ - $ - $ - $ -
Term Loan B-6 (a) 938.1 9.5 19.0 19.0 890.6
Senior notes (a) 950.0 - - 950.0 -
European lines of credit 14.8 14.8 - - -
Finance lease obligations (b) 17.3 9.4 7.7 0.2 -
Interest payments relating to long-term
debt (c) 345.8 72.4 143.8 113.4 16.2
Operating leases (d) 512.4 58.3 108.7 101.1 244.3
Other long-term liabilities 37.9 37.9 - - -
Total contractual cash obligations $ 2,816.3 $
202.3
________________________________________
(a)The table assumes the long-term debt is held to maturity. (b)We have entered into finance leases for furniture, fixtures, equipment and software. The amounts include the interest portion of the finance leases. Future finance lease obligations would change if we entered into additional finance lease agreements. (c)Interest payments on long-term debt are projected based on the contractual rates of the debt securities. Interest rates for the variable rate term debt instruments were held constant at rates as ofDecember 31, 2020 . (d)Operating leases are entered into in the normal course of business. We lease most of our auction facilities, as well as other property and equipment under operating leases. Some lease agreements contain options to renew the lease or purchase the leased property. Future operating lease obligations would change if the renewal options were exercised and/or if we entered into additional operating lease agreements. Critical Accounting Estimates In preparing the financial statements in accordance withU.S. generally accepted accounting principles, management must often make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the date of the financial statements and during the reporting period. Some of those judgments can be subjective and complex. Consequently, actual results could differ from those estimates. Accounting measurements that management believes are most critical to the reported results of our operations and financial condition include: (1) allowance for credit losses; (2) business combinations; (3) goodwill and other intangible assets; and (4) legal proceedings and other loss contingencies. In addition to the critical accounting estimates, there are other items used in the preparation of the consolidated financial statements that require estimation, but are not deemed critical. Changes in estimates used in these and other items could have a material impact on our financial statements. We continually evaluate the accounting policies and estimates used to prepare the consolidated financial statements. In cases where management estimates are used, they are based on historical experience, information from third-party professionals, and various other assumptions believed to be reasonable. In addition, our most significant accounting policies are discussed in Note 2 and elsewhere in the notes to the consolidated financial statements for the year endedDecember 31, 2020 , which are included in this Annual Report on Form 10-K. 55 -------------------------------------------------------------------------------- Table of Contents Allowance for Credit Losses We maintain an allowance for credit losses for estimated losses resulting from the inability of customers to make required payments. Delinquencies and losses are monitored on an ongoing basis and this historical experience provides the primary basis for estimating the allowance. The allowance for credit losses is also based on management's evaluation of the receivables portfolio under current economic conditions, the size of the portfolio, overall portfolio credit quality, review of specific collection matters and such other factors which, in management's judgment, deserve recognition in estimating losses. Specific collection matters can be impacted by the outcome of negotiations, litigation and bankruptcy proceedings with individual customers. AFC controls credit risk through credit approvals, credit limits, underwriting and collateral management monitoring procedures, including approximately 55,000 lot audits and holding vehicle titles where permitted. The estimates are based on management's evaluation of many factors, including AFC's historical credit loss experience, the value of the underlying collateral, delinquency trends and economic conditions. The estimates are based on information available as of each reporting date and reflect the expected credit losses over the entire expected term of the receivables. Actual losses may differ from the original estimates due to actual results varying from those assumed in our estimates. As a measure of sensitivity, if we had experienced a 10% increase in net charge-offs of finance receivables for the year endedDecember 31, 2020 , our provision for credit losses would have increased by approximately$3.7 million in 2020. Business Combinations When we acquire businesses, we estimate and recognize the fair values of tangible assets acquired, liabilities assumed and identifiable intangible assets acquired. The excess of the purchase consideration over the fair values of identifiable assets and liabilities is recorded as goodwill. The purchase accounting process requires management to make significant estimates and assumptions in determining the fair values of assets acquired and liabilities assumed, especially with respect to intangible assets and contingent consideration. Critical estimates are often developed using valuation models that are based on historical experience and information obtained from the management of the acquired companies. These estimates can include, but are not limited to, the cash flows that an asset is expected to generate in the future, growth rates, the appropriate weighted-average cost of capital and the cost savings expected to be derived from acquiring an asset. These estimates are inherently uncertain and unpredictable. In addition, unanticipated events and circumstances may occur which could affect the accuracy or validity of such estimates. Depending on the facts and circumstances, we may engage an independent valuation expert to assist in valuing significant assets and liabilities.Goodwill and Other Intangible Assets We assess goodwill for impairment annually during the second quarter or more frequently if events or changes in circumstances indicate that impairment may exist. Important factors that could trigger an impairment review include significant under-performance relative to historical or projected future operating results; significant negative industry or economic trends; and our market valuation relative to our book value. When evaluating goodwill for impairment, we may first perform a qualitative assessment to determine whether it is more likely than not that a reporting unit is impaired. If we do not perform a qualitative assessment, or if we determine that a reporting unit's fair value is not more likely than not greater than its carrying value, then we calculate the estimated fair value of the reporting unit using discounted cash flows and market approaches. When assessing goodwill for impairment, our decision to perform a qualitative impairment assessment for a reporting unit in a given year is influenced by a number of factors, including the size of the reporting unit's goodwill, the significance of the excess of the reporting unit's estimated fair value over carrying value at the last quantitative assessment date, the amount of time in between quantitative fair value assessments and the date of acquisition. If we perform a quantitative assessment of a reporting unit's goodwill, our impairment calculations contain uncertainties because they require management to make assumptions and apply judgment when estimating future cash flows and earnings, including projected revenue growth and operating expenses related to existing businesses, as well as utilizing valuation multiples of similar publicly traded companies and selecting an appropriate discount rate based on the estimated cost of capital that reflects the risk profile of the related business. Estimates of revenue growth and operating expenses are based on internal projections considering the reporting unit's past performance and forecasted growth, strategic initiatives and changes in economic conditions. These estimates, as well as the selection of comparable companies and valuation multiples used in the market approach are highly subjective, and our ability to realize the future cash flows used in our fair value calculations is affected by factors such as the success of strategic initiatives, changes in economic conditions, changes in our operating performance and changes in our business strategies. In 2020, we performed a quantitative impairment assessment for our reporting units. This assessment resulted in the impairment of goodwill totaling$25.5 million in ourADESA Remarketing Limited reporting unit (doing business as ADESAU.K. ). For additional information, see Note 9 of the Notes to Consolidated Financial Statements included in this Annual Report on Form 56 -------------------------------------------------------------------------------- Table of Contents 10-K. Based on our previous goodwill assessments, the Company did not identify a reporting unit for which the goodwill was impaired in 2019 or 2018. As with goodwill, we assess indefinite-lived tradenames for impairment annually during the second quarter or more frequently if events or changes in circumstances indicate that impairment may exist. When assessing indefinite-lived tradenames for impairment using a qualitative assessment, we evaluate if changes in events or circumstances have occurred that indicate that impairment may exist. If we do not perform a qualitative impairment assessment or if changes in events and circumstances indicate that a quantitative assessment should be performed, management is required to calculate the fair value of the tradename asset group. The fair value calculation includes estimates of revenue growth, which are based on past performance and internal projections for the tradename asset group's forecasted growth, and royalty rates, which are adjusted for our particular facts and circumstances. The discount rate is selected based on the estimated cost of capital that reflects the risk profile of the related business. These estimates are highly subjective, and our ability to achieve the forecasted cash flows used in our fair value calculations is affected by factors such as the success of strategic initiatives, changes in economic conditions, changes in our operating performance and changes in our business strategies. We review other intangible assets for possible impairment whenever circumstances indicate that their carrying amount may not be recoverable. If it is determined that the carrying amount of an other intangible asset exceeds the total amount of the estimated undiscounted future cash flows from that asset, we would recognize a loss to the extent that the carrying amount exceeds the fair value of the asset. Management judgment is involved in both deciding if testing for recovery is necessary and in estimating undiscounted cash flows. Our impairment analysis is based on the current business strategy, expected growth rates and estimated future economic conditions. In 2020, this analysis resulted in the impairment of customer relationships of approximately$4.3 million in ourADESA Remarketing Limited reporting unit (doing business as ADESAU.K. ). For additional information, see Note 9 of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K. Legal Proceedings and Other Loss Contingencies We are subject to the possibility of various legal proceedings and other loss contingencies, many involving litigation incidental to the business and a variety of environmental laws and regulations. Litigation and other loss contingencies are subject to inherent uncertainties and the outcomes of such matters are often very difficult to predict and generally are resolved over long periods of time. We consider the likelihood of loss or the incurrence of a liability, as well as the ability to reasonably estimate the amount of loss, in determining loss contingencies. Estimating probable losses requires the analysis of multiple possible outcomes that often are dependent on the judgment about potential actions by third parties. Contingencies are recorded in the consolidated financial statements, or otherwise disclosed, in accordance with ASC 450, Contingencies. We accrue for an estimated loss contingency when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. Management regularly evaluates current information available to determine whether accrual amounts should be adjusted. If the amount of an actual loss is greater than the amount accrued, this could have an adverse impact on our operating results in that period. Off-Balance Sheet Arrangements As ofDecember 31, 2020 , we had no off-balance sheet arrangements pursuant to Item 303(a)(4) of Regulation S-K under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). New Accounting Standards For a description of new accounting standards that could affect the Company, reference the "New Accounting Standards" section of Note 2 of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K. 57
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