Item 1A. Risk Factors
Investing in our Company involves a high degree of risk. You should carefully consider the following risks, as well as all of the other information contained in this Annual Report on Form 10-K, before deciding to invest in our Company. The occurrence of any of the following risks could materially and adversely affect our business, financial condition, prospects, results of operations and cash flows. In such case, the trading price of our common stock could decline and you could lose all or part of your investment. However, these risks are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also materially affect our business, financial condition, results of operations and prospects.
Risks Related to Mergers with RBA
The announcement and pendency of the Mergers with RBA may have an adverse effect on our business, results of operations and stock price.
On November 7, 2022, we entered into the Original Merger Agreement, and on January 22, 2023, we entered into the Merger Agreement Amendment. Pursuant to the Merger Agreement, RBA will acquire the Company in a stock and cash transaction. We currently operate, and until completion of the Mergers will continue to operate, independently of RBA.
There are material uncertainties and risks associated with the Merger Agreement and the Mergers. If any of these uncertainties and risks develop into actual events, then our business, financial condition, results and ongoing operations, stock price or prospects could be materially adversely affected. These uncertainties and risks include, but are not limited to, the following:
• the announcement, pendency or consummation of the Mergers could adversely impact our ability to attract, retain or motivate employees and our relationships with third parties, including our current and prospective customers, suppliers, vendors, landlords and other business partners;
• we may forego opportunities we might otherwise pursue absent the Mergers with RBA, including as a result of the restrictions imposed on our business and operations pursuant to certain covenants set forth in the Merger Agreement, which may prevent us from pursuing certain business or other strategic opportunities or taking other non-ordinary course actions without RBA’s prior consent, even if those actions would be beneficial to us;
• matters relating to the Mergers, including integration planning, may require substantial commitments of time and resources by our management and employees and may otherwise divert the attention of management and employees, which could otherwise have been devoted to other opportunities that may have been beneficial to us;
• the pendency and outcome of any legal proceedings that may be instituted against us, our directors and others relating to the transactions contemplated by the Mergers, could result in significant costs of defense, indemnification or liability or prevent or delay the consummation of the Mergers; and
• our directors and executive officers have financial interests in the Mergers that may be different from, or in addition to, the interests of our stockholders generally, which could have influenced their decisions to support or approve the Mergers.
In addition, since a majority of the consideration that our stockholders will receive in the Mergers will consist of RBA Common Shares, prior to the closing of the Mergers our stock price will be impacted by changes in RBA’s share price (as discussed below).
In addition, we have incurred, and will continue to incur, significant costs, expenses and fees for professional services, other transaction costs and employee retention costs in connection with the Mergers, many of which fees and costs are payable by us regardless of whether the Mergers are consummated.
The Mergers are subject to various closing conditions, including approvals by our and RBA’s shareholders, as well as other uncertainties. There can be no assurances as to whether or when the Mergers will be completed.
Completion of the Mergers is subject to the satisfaction or waiver of a number of closing conditions. It is possible that such conditions may prevent, delay or otherwise materially impact the completion of the Mergers. The closing of the Mergers is subject to the satisfaction or waiver of certain conditions including, among other things, (a) in the case of RBA, the approval of the issuance of the RBA Common Shares in connection with the Mergers by the affirmative vote of a majority of the votes cast by holders of the outstanding RBA Common Shares at its shareholder meeting, (b) in the case of the Company, the adoption of the Merger Agreement by the holders of a majority of the outstanding shares of the Company’s common stock, (c) the approval for listing by the NYSE and TSX of the RBA Common Shares to be issued pursuant to the Merger Agreement, (d) subject to
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certain materiality exceptions, the accuracy of the representations and warranties of the other party contained in the Merger Agreement and the compliance by the other party with its covenants contained in the Merger Agreement, (e) the absence of a material adverse effect with respect to the other party, (f) the receipt by us of an opinion from tax counsel as to the Mergers qualifying as a “reorganization” and not resulting in gain recognition for certain Company stockholders under the applicable provisions of the Internal Revenue Code and (g) other customary closing conditions. As of December 20, 2022, the parties have received all necessary antitrust clearances required by the Merger Agreement.
Any delay in completing the Mergers may significantly reduce the synergies projected to result from the Mergers and other benefits that the parties expect to achieve if they successfully complete the Mergers. The parties are not obligated to consummate the Mergers under certain circumstances, including if the required approvals by our stockholders and RBA’s shareholders are not obtained. In addition, other factors, such as RBA’s ability to obtain the debt financing it needs to complete the Mergers on acceptable terms and other sources of cash to consummate the Mergers, and any litigation challenging the Merger, may affect when and whether the Mergers will occur. If the Mergers are not completed on or before 5:00 p.m. New York City time on August 7, 2023 (subject to extension as provided in the Merger Agreement), either RBA or we may choose to terminate the Merger Agreement. RBA or we may also elect to terminate the Merger Agreement in certain other circumstances, and the parties can mutually decide to terminate the Merger Agreement at any time prior to the closing, before or after the required stockholder and shareholder approvals, as applicable.
Failure to complete the Mergers, or a delay in the completion of the Mergers, could negatively impact our business, results of operations, financial condition and stock price.
If the Mergers or the other transactions contemplated by the Merger Agreement are not completed for any reason, including as a result of our stockholders failing to adopt the Merger Agreement or RBA’s shareholders failing to approve the issuance of RBA Common Shares in the Mergers, we will remain an independent public company, and our stockholders will not receive any payment for our common stock in connection with the Mergers. Our ongoing business may be materially and adversely affected by the failure to complete the Mergers, or by a delay in the completion of the Mergers, and we may suffer consequences that could adversely affect our business, results of operations, financial condition and stock price, including the following:
• we could be required to pay a termination fee of $189 million if the Merger Agreement is terminated in certain circumstances, including because our Board of Directors has changed its recommendation in favor of the Merger, if we terminate the Merger Agreement to accept a superior proposal or in certain circumstances if an alternative acquisition proposal is made prior to the termination of the Merger Agreement and we enter into a definitive agreement providing an alternative transaction within 12 months of such termination;
• we will be required to make certain changes to the composition of our Board of Directors pursuant to the terms of the Cooperation Agreement, which include, among other things: (i) the resignation of one of the current members of our Board of Directors and (ii) after completion of director information and interviews and in accordance with certain procedures described in the Cooperation Agreement, the appointment of (a) Timothy James O’Day, (b) a second independent director candidate identified by Ancora and (c) a third independent director candidate mutually agreed between the Company and Ancora, in each case, as observers to our Board of Directors and then as directors immediately following our 2023 annual meeting of stockholders;
• matters relating to the Mergers will require substantial commitments of time and resources by our management and the expenditure of significant funds in the form of fees and expenses, which would otherwise have been devoted to day-to-day operations and other opportunities that may have been beneficial to us as an independent company;
• we may be subject to legal proceedings related to the potential delay of or failure to consummate the Mergers;
• the failure of the Mergers to be consummated may result in negative publicity and a negative impression of us in the investment community, including as a result of the public criticism of the Company, its business and prospects by certain investors that oppose the consummation of the Mergers;
• disruptions to our business resulting from the announcement and pendency of the acquisition, including any adverse changes in our relationships with our customers, business partners and employees, may continue or intensify in the event the Mergers is delayed or not consummated;
• the Merger Agreement places certain restrictions on the conduct of our business, and such restrictions, the waiver of which is subject to the consent of RBA, may prevent us from making certain acquisitions, entering into or amending
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certain contracts, taking certain other specified actions or otherwise pursuing business opportunities during the pendency of the Mergers that we would have made, taken or pursued if these restrictions were not in place; and
• we may experience an increase in employee departures in the event the Mergers are delayed or not consummated.
Furthermore, on January 18, 2023, Luxor Capital Group, LP (together with its affiliates, “Luxor”) filed a preliminary proxy statement and on February 13, 2023 Luxor filed a definitive proxy statement with the SEC opposing the Mergers and soliciting votes of RBA shareholders in opposition to the recommendations of RBA’s board of directors at the RBA Special Meeting in connection with the Mergers. This proxy contest may cause RBA to incur additional solicitation and other costs, and may negatively impact RBA’s ability to obtain the votes required to approve the issuance of RBA Common Shares in connection with the Mergers at the RBA Special Meeting. If that vote is not obtained, then the Mergers and the other transactions contemplated by the Merger Agreement will not complete and, under certain circumstances, RBA will be required to pay us a maximum amount of $5.0 million in expense reimbursement.
In addition to the above risks, if the Merger Agreement is terminated and our Board of Directors seeks another merger or business combination, our stockholders cannot be certain that we will be able to find a party willing to offer equivalent or more attractive consideration than the consideration RBA has agreed to provide in the Mergers. If the Merger Agreement is terminated under certain circumstances, we or RBA may be required to pay the other a termination fee of $189 million.
In addition, we could be subject to litigation related to any failure to complete the Mergers or related to any proceeding to specifically enforce our performance obligations under the Merger Agreement. Similarly, delays in the completion of the Mergers could, among other things, result in additional transaction costs, loss of revenue or other negative effects associated with delay and uncertainty. If any of these risks materialize, they may materially and adversely affect our business, financial condition, financial results and stock price.
Our business could be negatively affected as a result of actions of activist stockholders, and such activism could impact the price of our common stock.
Stockholders may from time to time attempt to effect changes, engage in proxy solicitations or advance stockholder proposals. Certain activist stockholders have made, or have indicated they may make, strategic proposals related to our business, strategy, management or operations, and have requested, or have indicated they may request, changes to the composition of our Board of Directors. We cannot predict, and no assurances can be given as to, the outcome or timing of any such matters. In the event of a proxy contest, our business could be adversely affected. Responding to a proxy contest can be costly, time-consuming and disruptive, and can divert the attention of our management and employees from the operation of our business and execution of our strategic plan. Additionally, if individuals are elected to our Board of Directors with a specific agenda, it may adversely affect our ability to effectively implement our strategic plan and create additional value for our stockholders. Further, perceived uncertainties as to our future direction, including uncertainties related to the composition of our Board of Directors, may lead to the perception of instability or a change in the direction of our business, which may be exploited by our competitors, cause concern to current or potential customers, result in the loss of potential business opportunities, make it more difficult to attract and retain qualified personnel and/or affect our relationships with vendors, customers and other third parties. Moreover, a proxy contest could cause significant fluctuations in the price of our common stock based on temporary or speculative market perceptions or other factors that do not necessarily reflect the underlying fundamentals and prospects of our business.
Because the exchange ratio is fixed and the market price of RBA’s common shares has fluctuated and will continue to fluctuate, our stockholders cannot be certain of the ultimate value of the Merger Consideration (as defined below) they will receive in the Mergers.
Upon completion of the Mergers, each share of our common stock that is outstanding immediately prior to the Mergers will be automatically converted into the right to receive the Merger Consideration, which consists of (1) 0.5252 of an RBA Common Share and (2) $12.80 in cash, without interest and less any applicable withholding taxes. Our stockholders will receive cash in lieu of any fractional RBA common shares to which they would otherwise be entitled. The exchange ratio is fixed and will not be adjusted to reflect stock price changes of either our common stock or RBA Common Shares prior to the closing of the Mergers. As a result, the ultimate value of the share consideration will depend on the market price of RBA Common Shares at the time the Mergers are completed and our stockholders cannot be sure of the market value of the share component of the Merger Consideration they will receive upon completion of the Mergers.
The market price of RBA Common Shares has fluctuated since the date of the announcement of the Mergers and is expected to continue to fluctuate through and after the date the Mergers are completed, which could occur a considerable amount of time after the date hereof. Changes in the price of RBA’s Common Shares may result from a variety of factors, including, among others:
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• general market and economic conditions and other factors affecting the price of our common stock or RBA Common Shares;
• changes in RBA’s and our respective businesses, operations and prospects and the risks inherent in our respective businesses;
• changes in market assessments of the likelihood that the Mergers will be completed and/or the value that may be generated by the Mergers; and
• changes with respect to expectations regarding the timing of the Mergers and regulatory considerations.
In addition, the use of cash and incurrence of substantial indebtedness in connection with the financing of the Mergers may have an adverse impact on RBA’s liquidity, limit RBA’s flexibility in responding to other business opportunities and increase RBA’s vulnerability to adverse economic and industry conditions, each of which could adversely affect the price of RBA’s Common Shares prior to closing and that of the combined company following closing. Further, public advocacy by stockholders or other market participants against the Mergers and the terms or strategic rationale therefor could adversely affect the price of our common stock or RBA Common Shares prior to closing and that of the combined company following closing. Many of these factors are beyond our and RBA’s control. In addition, the use of cash and incurrence of substantial indebtedness in connection with the financing of the Mergers may have an adverse impact on RBA’s liquidity, limit RBA’s flexibility in responding to other business opportunities and increase RBA’ s vulnerability to adverse economic and industry conditions, each of which could adversely affect RBA’s share price prior to closing and that of the combined company following closing.
Potential litigation filed against us or RBA could prevent or delay the completion of the Mergers or result in the payment of damages following completion of the Mergers.
We and members of our Board of Directors or executive officers are currently parties, among others, to various claims and litigation related to or arising out of the Mergers. As of February 22, 2023, four complaints were filed in federal court by purported stockholders of the Company regarding the Company’s proposed Mergers. The first complaint was filed on December 15, 2022, in the United States District Court for the Southern District of New York and is captioned Shiva Stein v. IAA, Inc., et al. , Case No. 1:22-cv-10602. The second complaint was filed on February 14, 2023, in the United States District Court for the Southern District of New York and is captioned Christopher Taylor v. IAA, Inc., et al., Case No. 1:23-cv-1228. The third complaint was filed on February 14, 2023, in the United States District Court for the District of Delaware and is captioned William Johnson v. IAA, Inc., et al., Case No. 1:23-cv-165-UNA. The fourth complaint was filed on February 16, 2023, in the United States District Court for the Southern District of New York and is captioned Brian Jones v. IAA, Inc., et al., Case No. 1:23-cv-1357. The aforementioned four complaints are collectively referred to as the “Complaints.” The Complaints names us and the members of our Board of Directors as defendants. The Complaints asserts violations of Section 14(a) of the Exchange Act and Rule 14a-9 promulgated thereunder against all defendants and violations of Section 20(a) of the Exchange Act against members of our Board of Directors. The plaintiffs alleges that the registration statement on Form S-4 and joint proxy statement/prospectus filed with the SEC and applicable Canadian securities regulatory authorities in connection with the Mergers (the “Form S-4”) omitted or misrepresented material information regarding the Mergers. The Complaints seeks, among other relief, (i) injunctive relief preventing the consummation of the Mergers, unless and until certain information, as requested in the Complaint, is disclosed, (ii) rescission and/or rescissory damages in the event the Mergers are consummated, (iii) an order directing the defendants to file a Proxy Statement that does not contain any untrue statements of material fact, (iv) other damages purportedly suffered as a result of the alleged material omissions or misstatements, (v) an award of plaintiff's costs and disbursements in the action, including reasonable attorneys' and expert fees and expenses, and (vi) other and further equitable relief as the court may deem just and proper. In addition, as of February 22, 2023, we have received three demand letters from purported IAA stockholders, which generally seek that certain information allegedly omitted from the Form S-4 be disclosed. It is possible that additional lawsuits will be filed, or additional allegations will be received from IAA stockholders, with respect to the Mergers. RBA and its executive officers and members of its Board of Directors may also be the subject of potential claims and litigation related to or arising out of the Mergers, including claims similar to those asserted in the Complaint and seeking similar remedies, including requests to enjoin the Mergers. The results of complex legal proceedings, including those discussed above, are difficult to predict, and could delay or prevent the Mergers from becoming effective in a timely manner. The existence of litigation relating to the Mergers could impact the likelihood of obtaining the requisite approvals from our stockholders or RBA shareholders. Moreover, the litigation discussed above and any future litigation could be time consuming and expensive, could divert our attention away from regular business, and, if any one of these actual or potential lawsuits is adversely resolved, could have a material adverse effect on our or the combined company’s business, results of operations or financial condition.
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The Merger Agreement contains provisions that limit our ability to pursue alternatives to the Mergers and could discourage a potential competing acquirer of us or could result in any competing proposal being at a lower price than it might otherwise be.
The Merger Agreement contains certain restrictions on our ability to solicit alternative acquisition proposals from third parties, to provide information to third parties, to enter into or continue discussions or negotiations with third parties regarding alternative acquisition proposals, to enter into any commitment with respect to any alternative acquisition proposal or to recommend or approve any alternative acquisition proposal. In addition, subject to certain customary “fiduciary out” exceptions, our Board of Directors is required to recommend that our stockholders vote in favor of the adoption of the Merger Agreement at the special stockholder meeting we will hold in connection with the Mergers. In addition, we may be required to pay RBA a termination fee of $189 million in certain circumstances, including if the Merger Agreement is terminated in certain circumstances following our receipt of an alternative acquisition proposal.
These provisions might discourage an otherwise-interested third party from considering or proposing an acquisition to acquire all or a significant party of the Company, including proposals that may be deemed to offer greater value to our stockholders than the Merger Consideration. Furthermore, even if a third party elects to propose an acquisition, the requirement that we must pay a termination fee to accept any such proposal may cause that third party to offer a lower price to our stockholders than such third party might otherwise have offered.
While the Merger Agreement is in effect, we are subject to restrictions on our business activities.
While the Merger Agreement is in effect, we are generally required to use reasonable efforts to conduct our business in the ordinary course in all material respects and are restricted from taking certain actions set forth in the Merger Agreement without RBA’s prior consent. These limitations include, among other things, issuing stock or equity awards subject to specified carve-outs, hiring, promoting or terminating employees, incurring indebtedness other than certain revolving credit facility borrowings, engaging in capital expenditures beyond certain levels, terminating, materially modifying or materially amending certain material contracts or entering into certain material contracts. These restrictions could prevent us from pursuing strategic business opportunities and taking actions with respect to our business that we may consider advantageous and may, as a result, materially and adversely affect our business, results of operations and financial condition.
After completion of the Mergers, RBA may fail to realize the projected benefits and cost savings of the Mergers, which could adversely affect the value of RBA Common Shares.
The success of the Mergers will depend, in part, on RBA’s ability to realize the anticipated benefits and cost savings from combining the respective businesses of us and RBA, including operational and other synergies that we believe the combined company will be able to achieve. The anticipated benefits and cost savings of the Mergers may not be realized fully or at all, may take longer to realize than expected or could have other adverse effects that we do not currently foresee. Some of the assumptions that we have made, such as the achievement of operating synergies, may not be realized. The integration process may, for us and RBA, result in the loss of key employees, the disruption of ongoing businesses or inconsistencies in standards, controls, procedures and policies. There could be potential unknown liabilities and unforeseen expenses associated with the Mergers that were not discovered in the course of performing due diligence. Additionally, the integration will require significant time and focus from management following the Mergers.
In addition, in connection with the proposed Mergers, on November 7, 2022, RBA entered into a commitment letter pursuant to which the initial lenders thereunder committed to provide (i) a backstop senior secured revolving credit facility in an aggregate principal amount of up to $750 million (the “Backstop Revolving Facility”) and (ii) a senior secured 364-day bridge loan facility in an aggregate principal amount of up to $2.8 billion (the “Bridge Loan Facility,” and together with the Backstop Revolving Facility, the “Facilities”), which commitments were subsequently reduced to $886.1 million in connection with the sixth amendment to RBA's existing credit facility. On December 9, 2022, RBA entered into a sixth amendment to its existing credit agreement to terminate the backstop commitments (including the Backstop Revolving Facility and $88.9 million of bridge commitments that served as a backstop for RBA’s existing term loans) and replace $1.825 billion of commitments under the Bridge Loan Facility with term A loan commitments. RBA expects to replace remaining amount of the Bridge Loan Facility prior to the closing of the Mergers with permanent financing, which may include the issuance of debt securities and/or one or more senior term loan facilities. Taking on additional indebtedness in connection with the proposed Mergers, as a result of the borrowings under the Bridge Loan Facility and/or other permanent financing that replaces such facility, would increase the cash outlays to service RBA’s debt in future periods. If the combined company’s cash flows and capital resources are insufficient to fund debt service obligations, it could face substantial liquidity problems and could be forced to reduce or delay investments and capital expenditures or to dispose of material assets or operations, seek additional debt or equity capital or restructure or refinance its indebtedness.
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The Mergers also are expected to create revenue, growth, operational enhancement, expansion and other opportunities for the combined company, beyond the identified cost synergies, including through cross-selling opportunities, accelerated marketplace innovation, cross-utilization of yards, strengthening our catastrophic event response and insurance carrier relationships, and acceleration of our international expansion. The identification and scope of these opportunities is based on various assumptions, which may or may not prove to be accurate. These opportunities for the combined company may not arise as expected, or the combined company may not be able to realize the anticipated benefits from these opportunities, from the sources or in the amount manner or time frame expected, or at all. Failure to realize these opportunities could significantly reduce the expected benefits associated with the Mergers.
Risks Related to Supply, Demand and Competition
Our business and operating results would be adversely affected due to: loss of one or more significant suppliers, reduction in significant volume from suppliers, an adverse change in our supplier relationships, or a disruption to our supply of damaged, total loss and low-value vehicles.
Our business depends on suppliers of damaged, total loss and low-value vehicles. Approximately one-third of our revenue is associated with vehicles supplied by suppliers or sellers. Our vehicle suppliers include insurance companies, used-vehicle dealers, rental car and fleet lease companies, auto lenders and charitable organizations, among others. We have established long-term relationships with virtually all of the major automobile insurance companies. During fiscal 2022, approximately 40% of our revenues were associated with vehicles supplied by our four largest insurance customers in the United States segment. Our agreements with insurance company suppliers are generally subject to cancellation by either party upon 30 to 90 days’ notice. There can be no assurance that our existing agreements will not be canceled or that we will be able to enter into future agreements on favorable terms with these suppliers. We work to develop strong relationships with our suppliers to better understand their needs. From time to time, however, we experience the loss of suppliers or a reduction in volume from our suppliers, including our top vehicle suppliers. If we lose one or more of our significant suppliers, or if one or more of our large suppliers were to significantly reduce volume for any reason or favor competitors or new entrants, we may not be successful in replacing such business and our profitability and operating results could be materially adversely affected.
Generally, institutional and dealer suppliers make non-binding long-term commitments to us regarding consignment volumes. Changes in the consignment patterns of our key suppliers could have a material adverse effect on our business and operations. There are many factors that can adversely affect volume from suppliers, many of which are beyond our control. These factors include, but are not limited to, the following: a decrease in the number of vehicles in operation or miles driven; mild weather conditions that cause fewer traffic accidents; reduction of policy writing by insurance providers that would affect the number of claims over a period of time; increases in fuel prices that could lead to a reduction in the miles driven per vehicle, which may reduce the accident rate; changes in vehicle technology, an increase in autonomous vehicles and vehicles equipped with advanced driver-assistance systems (ADAS); a decrease in the percentage of claims resulting in a total loss or elimination of automotive collision coverage by consumers; delays or changes in state title processing; government regulations on the standards for producing vehicles; and changes in direct repair procedures that would reduce the number of newer, less damaged total loss vehicles, which tend to have higher salvage values. Furthermore, in periods when the supply of vehicles from the insurance sector declines, salvage operators have acquired and in the future may acquire vehicles on their own. Also, when used vehicle prices are high, used-vehicle dealers may retail more of their trade-in vehicles on their own rather than selling them at auction. If the supply or value of damaged, total loss and low-value vehicles coming to auction declines significantly, our revenues and profitability may be adversely affected.
Our business and operating results would be adversely affected if we are unable to meet or exceed our buyer customers’ demand and expectations or due to a disruption in demand of damaged, total loss and low-value vehicles.
We believe our future success depends in part on our ability to respond to changes in buyer requirements, our ability to meet service level expectations of both buyers and sellers and our ability to meet regulatory requirements for such customers. Our buyer customers include automotive body shops, rebuilders, used car dealers, automotive wholesalers, exporters, dismantlers, recyclers, brokers, and the general public, among others. We work to develop strong relationships and interactive dialogue with our customers to better understand current trends and customer needs. If we are not successful in meeting our customers’ expectations, our customer relationships could be negatively affected and result in a loss of future business, which would adversely affect our operating results and financial condition.
Our market position and competitive advantage could be threatened by our competitors and/or disruptive new entrants.
We face significant competition for the supply of damaged and total loss vehicles and the buyers of those vehicles. Our principal sources of competition historically have come from (1) direct competitors (e.g., Copart, Inc. and Total Resource Auctions, a subsidiary of Cox Enterprises, Inc.), (2) new entrants, including new vehicle remarketing venues, and (3) existing
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alternative vehicle remarketing venues, including used-vehicle auctions and certain salvage buyer groups. Due to the increasing use of the Internet and other technology as marketing and distribution channels, we may face increasing competition from online wholesale and retail marketplaces (generally without any meaningful physical presence) and from our own customers, including insurance companies, when they sell directly to end users through such platforms rather than remarket vehicles through our marketplaces. Increased competition could result in price reductions, reduced margins or loss of market share.
Our future success also depends on our ability to respond to evolving industry trends, changes in customer requirements and new technologies. Some of our competitors may have greater financial and marketing resources than we do, may be able to respond more quickly to evolving industry dynamics and changes in customer requirements, or may be able to devote greater resources to the development, promotion and sale of new or emerging services and technologies. Our ability to successfully grow through investments in the area of emerging opportunities depends on many factors, including advancements in technology, regulatory changes and other factors that are difficult to predict, or that may significantly affect the future of electrification, autonomy, and mobility. If we are unable to compete successfully or to successfully adapt to industry changes, our business, revenues and profitability could be materially adversely affected.
Also, see " The separation and distribution agreement (the "Separation Agreement") that we entered into with KAR limits our ability to compete in certain markets for a period of time following the Separation, and in certain instances, requires that we make revenue and profit sharing payments to KAR related to specific customer segments ."
If our facilities lack the capacity to accept additional vehicles, then our relationships with insurance companies or other vehicle suppliers could be adversely affected.
We regularly evaluate our capacity in all of our markets and, where appropriate, seek to increase capacity through the acquisition of additional land and facilities. Capacity at our facilities varies from period to period and by region as a result of various factors, including natural disasters. We may not be able to reach agreements to purchase or lease storage facilities in markets where we have limited available capacity, and zoning restrictions or difficulties obtaining use permits may limit our ability to expand our capacity through acquisitions of new land. If we fail to have sufficient capacity at one or more of our facilities, our relationships with insurance companies or other vehicle suppliers could be adversely affected, which could adversely affect our operating results and financial condition.
Risks Related to Our Business and Operations
The COVID-19 pandemic, or other future epidemic or pandemic diseases, and measures intended to reduce their spread, may adversely affect our business, results of operations and financial condition.
Current and future outbreaks of COVID-19, other epidemic or pandemic diseases pose the risk that we or our employees, suppliers, subhaulers and other partners may be prevented from conducting business activities at full capacity for an indefinite period of time, including due to spread of disease within these groups or due to shutdowns that may be requested or mandated by governmental authorities.
As we experienced in fiscal 2020, and to a lesser extent in fiscal 2021 and 2022, measures taken by governments to combat the spread of COVID-19, or other future epidemic or pandemic diseases may disrupt the supply of salvage vehicles. Shutdown or stay-at- home orders and other mandates implemented by federal, state and local governments may result in a significant decline in miles driven, reducing the supply of salvage vehicle assignments.
The further spread of COVID-19, including due to more contagious and/or vaccine resistant variants, or the outbreak of other future epidemic or pandemic diseases, and actions taken to limit and combat the spread, could have a material adverse impact our ability to carry out our business as normal, and may materially adversely impact our business, operating results and financial condition. The extent to which COVID-19 or other future epidemic or pandemic diseases impact our business and results of operations depends on future developments that are highly uncertain and cannot be predicted, including the duration and severity of COVID-19 or any such other future epidemic or pandemic and the actions taken to contain their impact and spread; resurgences of COVID-19 or variants thereof that may continue to occur; other actions taken by governments, businesses, and individuals in response to such epidemics or pandemics and any resulting economic disruption; and how quickly and to what extent normal economic and operating conditions resume.
Macroeconomic factors, including high fuel prices, high labor costs, rising inflation and changes in used car prices, may have an adverse effect on our revenues, gross profit and operating results.
Macroeconomic factors that affect oil prices and the vehicle and commodity markets can have adverse effects on our revenues and operating results. Significant increases in the cost of fuel, whether due to inflationary pressures, the current war between Ukraine and Russia or otherwise, could lead to a reduction in miles driven per car and a reduction in accident rates. A material
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reduction in accident rates, whether due to a reduction in miles driven or other factors, could reduce our vehicle assignment volumes which, in turn, could have a material adverse impact on our revenues. In addition, significant increases in the cost of fuel have resulted and could continue to result in an increase in the prices charged to us by our independent subhaulers and trucking fleet operators. Further, we have recently experienced labor shortages, which have resulted in an increase in associated costs, such as increased overtime to meet demand and increased wages to attract and retain employees. If these conditions or other inflationary pressures continue, our costs for towing and branch labor may continue to rise. To the extent we are unable to pass these costs on to our customers, the increase in prices charged by our independent subhaulers and trucking fleet operators and the increase in labor costs have negatively impacted and could continue to negatively impact our profitability.
Volatility in used car prices could have a material adverse effect on our revenues in future periods. While increased used vehicle prices have recently resulted in an increase in our revenue per unit, a sustained increase in used vehicle prices may result in vehicle owners holding on to their vehicles for longer periods of time, which could negatively impact our vehicle assignment volumes. See “A significant change in used-vehicle prices could impact the proceeds and revenue from the sale of damaged and total loss vehicles” below for additional information.
In addition, we continue to invest in capacity expansion, including the opening of new auction facilities. Adverse economic conditions, including increases in interest rates and lease rates, real estate values and real estate development and construction costs, may increase the costs required to invest in capacity expansion or delay our ability to open new facilities, both of which could have a material impact on our consolidated results of operations and financial position.
We may be unable to keep existing facilities or open new facilities in desirable locations and on favorable terms, which could materially and adversely affect our results of operations.
Local land use and zoning regulations, environmental regulations and other regulatory requirements may impact our ability to find suitable locations and influence the cost of our operations. The majority of our salvage auction vehicle facilities are leased. The termination or expiration of leases at existing facilities may adversely affect us if the renewal terms of those leases are unacceptable to us and we are forced to close the facilities. If we determine to close a location, we may remain obligated under the applicable lease for the remaining lease term and may have to expense the unamortized portion of the right-of-use assets, in part or in full, as an impairment which may have a material impact on our consolidated results of operations and financial position. Also, if we are unable to maintain our existing facilities or open new facilities in desirable locations and on favorable terms, our results of operations could be materially and adversely affected. Further, in an increasing number of markets where we experience significant capacity constraints together with pressing customer demand and a lack of viable alternatives for expansion due to zoning and land use restrictions, we may be required to purchase, lease or occupy industrial sites which may contain significant environmental impacts. See “Environmental, health and safety risks could adversely affect our operating results and financial condition.”
We may not be successful in the implementation of our business strategy or we may improperly align new strategies with our vision, which could lead to the misapplication of our resources.
Our business, results of operations, and financial condition depend on our ability to execute our business strategy. See “Our Business Strategy” under “Item 1. Business” included in this Annual Report on Form 10-K. There are significant risks involved with the execution of these initiatives, including significant business, economic and competitive uncertainties, many of which are outside of our control. Accordingly, we cannot predict whether or when we will succeed in implementing these strategic initiatives, and even if we do succeed, our strategy may not have the favorable impact on our business, results of operations, or financial condition that we anticipate. Additionally, our business strategy may change from time to time, which could delay our ability to implement initiatives that we believe are important to our business.
We may not properly leverage or make the appropriate investment in technology advancements, which could result in the loss of any sustainable competitive advantage in products, services and processes.
Our business is dependent on information technology. Robust information technology systems, platforms and products are critical to our operating environment, digital online products and competitive position. Rapid technology changes may render our technology obsolete and understanding technology innovation is necessary to remain at the forefront of our industry. While we continue to invest in our core information technology capabilities, we may not be successful in structuring our information technology or developing, acquiring or implementing information systems that are competitive and responsive to the needs of our customers. In addition, we might lack sufficient resources to continue to make the significant investments in information technology necessary to compete with our competitors. Certain information technology initiatives that management considers important to our long-term success will require capital investment, have significant risks associated with their execution, and could take several years to implement. If we are unable to develop/implement these initiatives in a cost-effective, timely manner or at all, it could damage our relationships with our customers and negatively impact our financial condition and results of operations.
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If we fail to identify, manage, complete and integrate acquisitions, our operating results, financial condition and growth prospects could be adversely affected.
Acquisitions are a part of our growth strategy and have enabled us to further broaden and diversify our service offerings. For example, we acquired Decision Dynamics, Inc. in July 2019, Auto Exchange in June 2021 and SYNETIQ in October 2021. Our strategy generally involves acquisitions of companies, products, services and technologies to expand our online, digital and mobile capabilities and the acquisition and integration of additional auction sites and personnel. Acquisition of businesses requires substantial time and attention of management personnel and may also require additional equity or debt financings. Further, integration of acquired businesses is often disruptive. There can be no assurance that we will identify appropriate targets, will acquire such businesses on favorable terms, or will be able to successfully integrate such organizations into our business. Because these new ventures are inherently risky, no assurance can be given that such strategies and offerings will be successful and they could materially adversely affect our business, financial condition and results of operations. Acquisitions may also have unanticipated tax, legal, regulatory and accounting ramifications, including as a result of recording goodwill and non-amortizable intangible assets that are subject to impairment testing on a regular basis and potential periodic impairment charges. In addition, we expect to compete against other auction groups or new industry consolidators for suitable acquisitions. If we are able to consummate acquisitions, such acquisitions could be dilutive to earnings, and we could overpay for such acquisitions.
In pursuing a strategy of acquiring other businesses, we face other risks including, but not limited to:
• incurring significantly higher capital expenditures, operating expenses and operating losses of the business acquired;
• entering new markets with which we are unfamiliar;
• incurring potential undiscovered liabilities at acquired businesses;
• failing to maintain uniform standards, controls and policies;
• incorporating acquired technology and rights into our offerings and unanticipated expenses related to such integration;
• impairing relationships with employees and customers as a result of management changes; and
• increasing expenses for accounting and computer systems, as well as integration difficulties.
Reliance on our subhaulers and trucking fleet operations could materially and adversely affect our business and reputation.
We rely on independent subhaulers and trucking fleet operations to pick up and deliver vehicles to and from our auction facilities. Consistent with the economy generally, we have recently experienced a shortage of towers and haulers, which has resulted in an increase in costs charged to us by towers and subhaulers for these services, and we cannot provide assurances that towers and subhaulers will be available in a timely manner to pick up and deliver vehicles. Failure to pick up and deliver vehicles in a timely manner could harm our brand and reputation, and adversely impact our overall business and results of operations. Further, an increase in fuel cost may lead to increased prices charged by our independent subhaulers and trucking fleet operators, which may significantly increase our cost. We may not be able to pass these costs on to our suppliers or buyers. We are also exposed to risks associated with inclement weather, disruptions in the transportation infrastructure and increase in the price of fuel, any of which could increase our operating costs. If we experience problems or are unable to negotiate or obtain favorable terms with our subhaulers, our results of operations could be materially and adversely affected .
Weather-related and other events beyond our control may adversely impact operations.
Extreme weather or other events, such as hurricanes, tornadoes, earthquakes, forest fires, floods, global pandemics or other health crises, terrorist attacks or war, may adversely affect the overall economic environment, the markets in which we compete, and our operations and profitability. These events , which may increase in frequency and magnitude as a result of climate change, may impact our physical auction facilities, causing a material increase in costs, or delays or cancellation of auction sales, which could have a material adverse impact on our revenues and profitability. In some instances, for example with the severe storms in August 2021 and September 2022 known as “Hurricane Ida” and “Hurricane Ian”, these events may result in a sharp influx in the available supply of damaged and total loss vehicles and there can be no assurance that our business will have sufficient resources to handle such extreme increases in supply. Our failure to meet our customers’ demands in such situations could negatively affect our relationships with such customers and result in a loss of future business, which would adversely affect our operating results and financial condition. In addition, revenues generated as a result of the total loss of vehicles associated with such a catastrophe are typically recognized subsequent to the incurrence of incremental costs and such revenues may not be sufficient to offset the costs incurred.
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Mild weather conditions tend to result in a decrease in the available supply of damaged and total loss vehicles because traffic accidents decrease and fewer vehicles are damaged. Accordingly, mild weather can have an adverse effect on our damaged and total loss vehicle inventories, which would be expected to have an adverse effect on our revenue and operating results and related growth rates.
An increase in the number of damaged and total loss vehicles we purchase could adversely affect our profitability.
In certain countries, the salvage market typically operates on a principal basis, in which a vehicle is purchased and then resold, rather than on an agent basis, in which the auction acts as a sales agent for the owner of the vehicle. Operating on a principal basis exposes us to inventory risks, including losses from theft, damage and obsolescence. If we purchase vehicles, the increased costs associated with acquiring the vehicles could have a material adverse effect on our gross profit margin and operating results. Vehicles sold under purchase agreements were approximately 6% of our vehicles sold both domestically and internationally for fiscal 2022. In addition, when vehicles are purchased, we are subject to changes in vehicle values, such as those caused by changes in commodity prices or changes in used car prices. Decreases in commodity prices, such as steel and platinum, may negatively affect vehicle values and demand at auctions. In addition, declines in used car prices, especially if they occur faster than anticipated, can lead to a significant gap between pre-accident value and sales price, which we recently experienced with respect to our UK business.
If we fail to attract and retain key personnel, have inadequate succession planning, or manage labor shortages, we may not be able to execute our business strategies and our financial results could be negatively affected.
Our success depends in large part on the performance of our senior executive team and other key employees, including key field, operations, sales and information technology personnel. If we lose the services of one or more of our executive officers or key employees, or if one or more of them decides to join a competitor or otherwise compete with us, we may not be able to effectively implement our business strategies, our business could suffer and the value of our common stock could be materially adversely affected. Our auction business is directly impacted by the business relationships our employees have established with customers and suppliers and, as a result, if we lose key personnel, we may have difficulty in retaining and attracting customers, developing new services, negotiating favorable agreements with customers and providing acceptable levels of customer service. Changes to our senior executive team and other key personnel will occur from time to time and we cannot predict whether significant resignations will occur or whether we will be able to recruit additional qualified personnel. We do not have nor do we currently expect to obtain key person insurance on any of our executive officers. Further, consistent with the economy generally, we have recently experienced labor shortages, which have resulted in an increase in associated costs, such as increased overtime to meet demand and increased wages to attract and retain employees. If we are unable to manage the impact of labor shortages, we may continue to experience higher labor costs and our results of operations could be materially and adversely affected .
A significant change in used-vehicle prices could impact the proceeds and revenue from the sale of damaged and total loss vehicles.
The volume of new vehicle production, accuracy of lease residual estimates, interest rate fluctuations, customer demand and changes in regulations, among other things, all potentially affect the pricing of used vehicles. A sustained reduction in used-vehicle pricing could result in lower proceeds from the sale of damaged and total loss vehicles and a related reduction in revenue per vehicle, a potential loss of consignors and decreased profitability. Conversely, when used vehicle prices are high, used-vehicle dealers may retail more of their trade-in vehicles on their own rather than selling them at auction, which could adversely affect our revenues and profitability.
We are partially self-insured for certain losses, and our self-insured costs could increase.
We self-insure a portion of employee medical benefits under the terms of our employee health insurance program, as well as a portion of our automobile, general liability and workers’ compensation claims. We record an accrual for the claims expense related to our employee medical benefits, automobile, general liability and workers’ compensation claims based upon the expected amount of all such claims. If actual trends, including the severity of claims and medical cost inflation above expectations were to occur, our self-insured costs would increase, which could have an adverse impact on our results of operations and financial position.
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We have a material amount of goodwill which, if it becomes impaired, would result in a reduction in our net income.
Goodwill represents the amount by which the cost of an acquisition accounted for using the purchase method exceeds the fair value of the net assets acquired. Current accounting standards require that goodwill be periodically evaluated for impairment based on the fair value of the reporting unit. Goodwill represents a significant percentage of our total assets. Declines in our profitability or the value of comparable companies may impact the fair value of our reporting units, which could result in a write-down of goodwill and a reduction in net income.
We assume the settlement risk for vehicles sold through our marketplaces.
Typically, following the sale of a vehicle, we do not release the vehicle to a buyer until such time as we have received full payment for the vehicle. We may be obligated, however, to remit payment to a seller before receiving payment from a buyer and in those circumstances, we may not have recourse against sellers for any buyer’s failure to satisfy its payment obligations. Because we retain possession of the vehicle, we can resell the vehicle to mitigate any potential losses. Since revenue for most vehicles does not include the gross sales proceeds, failure to collect the receivables in full may result in a net loss up to the amount of gross sales proceeds on a per vehicle basis in addition to any expenses incurred to collect the receivables and to provide the services associated with the vehicle. If we are unable to collect payments on a large number of vehicles and we are unable to resell them and recover our costs, the resulting payment obligations to the seller and decreased fee revenues may have a material adverse effect on our results of operations and financial condition.
If we are unable to protect our intellectual property, the value of our brand and other intangible assets may be diminished, and our business may be adversely affected. Also, we may be subject to patent or other intellectual property infringement claims, which could have an impact on our business or operating results due to a disruption in our business operations, the incurrence of significant costs and other factors.
We rely and expect to continue to rely on a combination of confidentiality and license agreements with our employees, consultants and third parties with whom we have relationships, as well as trademark, copyright, patent, trade secret, and domain name protection laws, to protect our proprietary rights. In the United States and internationally, we have filed various applications for protection of certain aspects of our intellectual property. However, third parties may knowingly or unknowingly infringe our proprietary rights, third parties may challenge proprietary rights held by us, and pending and future trademark and patent applications may not be approved. In addition, effective intellectual property protection may not be available in every country in which we operate or intend to operate our business. In any or all of these cases, we may be required to expend significant time and expense in order to prevent infringement or to enforce our rights. Although we have taken measures to protect our proprietary rights, there can be no assurance that others will not offer products or concepts that are substantially similar to ours and compete with our business. If the protection of our proprietary rights is inadequate to prevent unauthorized use or appropriation by third parties, the value of our brand and other intangible assets may be diminished and competitors may be able to more effectively mimic our service and methods of operations. Any of these events could have an adverse effect on our business and financial results.
From time to time, we may receive notices from others claiming that we infringed or otherwise violated their patent or intellectual property rights, and the number of these claims could increase in the future. Claims of intellectual property infringement or other intellectual property violations could require us to enter into licensing agreements on unfavorable terms, incur substantial monetary liability or be enjoined preliminarily or permanently from further use of the intellectual property in question, which could require us to change business practices and limit our ability to compete effectively. Even if we believe that the claims are without merit, the claims can be time-consuming and costly to defend and may divert management’s attention and resources away from our businesses. If we are required to take any of these actions, it could have an adverse impact on our business and operating results.
Risks Related to Data and Cyber Security
Significant disruptions of information technology systems, infrastructure and business information could adversely affect our business and reputation.
Our business involves the receipt and storage of information about our customers and employees and maintaining internal business data. We rely on information technology systems, some of which are managed by third parties, to process, transmit and store electronic information, and to manage or support a variety of our business processes and activities. The secure operation of these systems, and the processing, maintenance and storage of the information processed by these systems, is critical to our business operations and strategy. Information technology risks (including to the confidentiality, integrity and availability of digital assets) for companies have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. These threats may
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derive from fraud or malice on the part of third parties or our employees, or may result from human error, accidental technological failure or physical break-ins. In addition, our technology infrastructure, information systems, and data storage facilities are vulnerable to damage or interruption from events beyond our control, including, but not limited to, natural disasters, physical break-ins, power loss and telecommunications failures. Although we have technology and information security processes and disaster recovery plans in place to mitigate our risks to these vulnerabilities, these measures may not be adequate to ensure that our operations will not be significantly disrupted upon the occurrence of any of these events. Our customers and other parties in the payments value chain rely on our digital online products as well as other information technologies, computers, software and networks to conduct their operations. In addition, our customers increasingly use personal smartphones, tablet PCs and other mobile devices to access our online products and services and the security of these third party devices may be beyond our control. Any significant disruptions of our information technology systems or the theft of information from our data storage facilities could negatively impact our business, damage our reputation and materially adversely affect our consolidated financial position and results of operations.
Cyber attacks, including breaches of information technology systems and other cybersecurity incidents, could cause interruptions, malfunctions or other failures that could materially adversely affect our business and reputation and create data security risks.
We are highly dependent on information technology networks and systems, including the Internet, to securely process, transmit, and store electronic information. We have experienced cyber incidents and security breaches of varying degrees to our information technology infrastructure and systems. We believe we will continue to be a potential target of cyber threats and incidents in the future, which may result in unauthorized access to our computer systems and networks, including our cloud-based platforms and the data contained, any of which may materially adversely affect our business. The technology infrastructure and systems of our suppliers, vendors, service providers, cloud solution providers and partners have also in the past experienced cyber incidents and any future cyber incidents involving these third parties may materially adversely affect our business. Cyber incidents can include computer viruses, computer denial-of-service attacks, phishing attacks, ransomware, worms, and other malicious software programs, covert introduction of malware to computers and networks, impersonation of authorized users, and efforts to discover and exploit any design flaws, bugs, security vulnerabilities or security weaknesses, as well as intentional or unintentional acts by employees or other insiders with access privileges, intentional acts of vandalism or fraud by third parties and sabotage. We believe cyber attack attempts are increasing in number and that cyber attackers are developing increasingly sophisticated systems and means to not only attack systems, but also to evade detection or to obscure their activities.
Continuous cyber incidents or a sustained cyber attack could jeopardize data security, lead to service interruptions, malfunctions or other failures in the information technology that supports our business and customers (such as the lack of availability of our value-added systems), as well as the operations of our customers or other third parties. Cyber-incidents, including security breaches involving customer data, could also lead to damage to our reputation with our customers and other parties and the market, additional costs (such as repairing systems, adding new personnel or protection technologies, or compliance costs), regulatory penalties, financial losses to both us and our customers and partners and the loss of customers and business opportunities. If such cyber incidents are not detected in a timely manner, their effects could be compounded.
Although we have technology and information security processes and disaster recovery plans in place to mitigate our risks to these vulnerabilities, these measures may not be adequate to ensure that our operations will not be significantly compromised or disrupted upon the occurrence of any such events. If our information technology is compromised, becomes inoperable for extended periods of time or ceases to function properly, we may have to make a significant investment to fix or replace the information technology and our ability to provide many of our electronic and online solutions to our customers may be impaired, which would have a material adverse effect on our consolidated operating results and financial position. In some instances, efforts to correct vulnerabilities or prevent attacks may reduce the performance of our computer systems and networks, which could negatively impact our business. In addition, as cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities. Any of the risks described above could disrupt our business, damage our reputation and materially adversely affect our financial position and results of operations.
Our business is exposed to risks associated with online commerce security and credit card fraud.
We rely on encryption and authentication technology of third party partners to securely transmit confidential information such as customer credit card numbers. A compromise or breach of our own or our third party systems used to protect customer transaction data, whether due to viruses transmitted via the Internet and other points of access, employee error, malfeasance, insufficiency, or defective design, could cause a service disruption. We maintain an information security program and our processing systems incorporate multiple levels of protection in order to address or otherwise mitigate these risks. Despite these mitigation efforts, there can be no assurance that we will not suffer losses in the future. Under current credit card practices, we may be held liable for fraudulent credit card transactions and other payment disputes with customers. As such, we have
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implemented certain anti-fraud measures, including credit card verification procedures and limiting the acceptance of credit cards from certain newly acquired customers. However, a failure to adequately prevent fraudulent credit card transactions could adversely affect our consolidated financial position and results of operations.
Compliance with U.S. and global privacy and data security requirements could result in additional costs and liabilities to us or inhibit our ability to collect and store data, and the failure to comply with such requirements could subject us to significant fines and penalties, which could adversely affect our business, financial condition and reputation.
We collect and store sensitive and confidential data, including the intellectual property, proprietary business information, proprietary business information of our customers, as well as personally identifiable information of our customers and employees, in data centers and on information technology networks. Aspects of our operations and business are subject to privacy regulation in the United States, including the California Consumer Privacy Act (“CCPA”), California Privacy Rights Act (“CPRA”), and privacy regulations elsewhere around the globe, including the European Union’s General Data Protection Regulation (the “GDPR”). The CCPA, which came into effect beginning in January 2020, imposes notice and privacy policy requirements, and obligations to respond to requests to know and access to personal information, to delete personal information and to allow data subjects to opt out of the sale of their personal information. The CPRA was approved by voters in California in November 2020, and beginning in January 2023 impose additional data protection obligations on companies doing business in California, including creation of a data protection agency with the power to impose administrative fines, additional consumer rights processes and opt-outs for certain uses of sensitive data. Aspects of the CPRA and its interpretation and enforcement remain uncertain. Similar privacy laws have been and may in the future be enacted by other states. The potential effects of the CCPA, CRPA and other similar state laws, are far-reaching and may require us to modify our data processing practices and policies and to incur substantial costs and expenses in an effort to comply with these regulations. There is also the potential for increased regulatory enforcement by the state agencies empowered to enforce these laws. In addition, the GDPR, which took effect in May 2018, imposes strict rules on the transfer of personal data out of the European Union to the United States, enhances enforcement authority and imposes large penalties for noncompliance, including the potential for fines of up to €20 million or 4% of the annual global revenues of the infringer, whichever is greater.
In addition, a growing number of legislative and regulatory bodies have adopted consumer notification and other requirements in the event that consumer information is accessed by unauthorized persons, and additional regulations regarding the use, access, accuracy, and security of such data are possible. In the U.S., state laws provide for disparate notification regimes. If our practices or products are deemed to be an invasion of privacy, whether or not consistent with current or future regulations and industry practices, we may be subject to public criticism, private class actions, reputational harm, or claims by regulators, which could disrupt our business and expose us to increased liability. Our failure to comply with these laws, or any future laws or regulations of a similar nature, could result in substantial regulatory penalties, litigation expense, and loss of revenue.
These laws and regulations as well as laws and regulations in the various states or in other countries could limit our ability to pursue business opportunities we might otherwise consider engaging in, impose additional costs or restrictions on us, result in significant loss of revenue, impact the value of assets we hold, or otherwise significantly adversely affect our business. Any failure by us to comply with applicable laws or regulations could also result in significant liability to us, including liability to private plaintiffs as a result of individual or class action litigation, or may result in the cessation of our operations or portions of our operations or impositions of fines and restrictions on our ability to carry on or expand our operations. Our operations could also be negatively affected by changes to laws and regulations and enhanced regulatory oversight of our customers and us. These changes may limit the manner in which we conduct our business or otherwise may have a negative impact on our ability to generate revenues, earnings, and cash flows. If we are unable to adapt our products and services to conform to the new laws and regulations, or if these laws and regulations have a negative impact on our customers, we may experience customer losses or increased operating costs, and our business and results of operations could be negatively affected.
Risks Related to Laws and Regulations
Changes in laws affecting the import and export of damaged and total loss vehicles may have an adverse effect on our business and financial condition.
Our Internet-based auction services have allowed us to offer our products and services to international markets and have increased our international buyer base. As a result, foreign buyers of damaged and total loss vehicles now represent a significant part of our total buyer base. Changes in laws, regulations and treaties that restrict the importation of damaged and total loss vehicles into foreign countries may reduce the demand for damaged and total loss vehicles and impact our ability to maintain or increase our international buyer base. The adoption of such laws or regulations in other jurisdictions that have the effect of reducing or curtailing our activities abroad could have a material adverse effect on our results of operations and financial condition by reducing the demand for our products and services.
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We are subject to certain governmental regulations, including vehicle brokerage and auction laws and currency reporting obligations. Our business is subject to risks related to litigation and regulatory actions.
Our operations are subject to regulation, supervision and licensing under various federal, state, provincial and local authorities, agencies, statutes and ordinances, which, among other things, require us to obtain and maintain certain licenses, permits and qualifications and provide certain disclosures and notices. See Item 1. Business - Government Regulation for additional information.
Changes in law or governmental regulations or interpretations of existing law or regulations could result in increased costs, reduced vehicle prices and decreased profitability for us. In addition, failure to comply with present or future laws and regulations or changes in existing laws or regulations or in their interpretation could have a material adverse effect on our operating results and financial condition.
We are also subject from time to time to a variety of legal actions relating to our current and past business operations, including litigation relating to employment-related issues, the environment and personal injury claims. There is no guarantee that we will be successful in defending ourselves in legal and administrative actions or in asserting our rights under various laws. In addition, we could incur substantial costs in defending ourselves or in asserting our rights in such actions. The costs and other effects of pending litigation and administrative actions against us cannot be determined with certainty. Although we currently believe that no such proceedings will have a material adverse effect, there can be no assurance that the outcome of such proceedings will be as expected.
Environmental, health and safety risks could adversely affect our operating results and financial condition.
Our operations are subject to various foreign, federal, state and local environmental, health and safety laws and regulations, including those governing the emission or discharge of pollutants into the air or water, the generation, treatment, storage and release of hazardous materials and wastes and the investigation and remediation of contamination. Our failure to comply with current or future environmental, health or safety laws or to obtain and comply with permits required under such laws, could subject us to significant liability or require costly investigative, remedial or corrective actions.
Some of the facilities on which we operate are impacted by significant recognized environmental concerns and pollution conditions. We have incurred and may in the future incur expenditures relating to compliance and risk mitigation efforts, releases of hazardous materials, investigative, remedial or corrective actions, claims by third parties and other environmental issues, and such expenditures, individually or in the aggregate, could be significant. Federal and state environmental authorities are currently investigating our role in contributing to contamination at the Lower Duwamish Waterway Superfund Site in Seattle, Washington and our subsidiary ’ s role in contributing to the Pyrite Canyon Plume in Jurupa Valley, California. Our potential liability at these sites cannot be estimated at this time. See “ Business-Legal Proceedings. ”
Risks Related to International Operations
Our expansion into markets outside the U.S. and our non-U.S. based operations subject us to unique operational, competitive and regulatory risks.
Acquisitions and other strategies to expand our operations beyond North America subject us to additional significant risks and uncertainties. As we continue to explore opportunities to expand our business internationally, we will need to develop policies and procedures to manage our business on a global scale. There can be no assurance that we will identify appropriate international targets, acquire such businesses on favorable terms, or be able to successfully grow and integrate such organizations into our business. Operationally, acquired businesses typically depend on key relationships and our failure to develop or maintain those relationships could have an adverse effect on our operating results and financial condition.
In addition, we anticipate that our non-U.S.-based operations will continue to subject us to risks associated with operating on an international basis, including:
• exposure to foreign currency exchange rate risk, which may have an adverse impact on our revenues and profitability;
• exposure to the principal or purchase auction model rather than the agency or consignment model, which adversely impacts our margins and exposes us to inventory risks;
• restrictions on our ability to repatriate funds, as well as repatriation of funds currently held in foreign jurisdictions, which may result in higher effective tax rates;
• tariffs and trade barriers and other regulatory or contractual limitations on our ability to operate in certain foreign markets;
• compliance with the Foreign Corrupt Practices Act;
• compliance with the various privacy regulations, including the GDPR;
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• dealing with unfamiliar regulatory agencies and laws favoring local competitors;
• dealing with political and/or economic instability as well as armed conflict;
• the difficulty of managing and staffing foreign offices, as well as the increased travel, infrastructure, legal and compliance costs associated with international operations;
• localizing our product offerings; and
• adapting to different business cultures and market structures.
As we continue to explore opportunities to expand globally, our success will depend on our ability to anticipate and effectively manage these and other risks associated with operating on an international basis. Our failure to manage these risks could have an adverse effect on our operating results and financial condition.
A portion of our net income is derived from our international operations, primarily Canada and the United Kingdom, which exposes us to foreign exchange risks that may impact our financial statements. In addition, increases in the value of the U.S. dollar relative to certain foreign currencies may negatively impact foreign buyer participation in our marketplaces.
Fluctuations between U.S. and foreign currency values may adversely affect our results of operations and financial position. In addition, there may be tax inefficiencies in repatriating cash from our foreign subsidiaries. Approximately 19% of our revenues were attributable to our foreign operations for the fiscal year ended January 1, 2023. Changes in the value of foreign currencies, particularly Canadian dollar and pound sterling relative to the U.S. dollar, could negatively affect our profits from foreign operations and the value of the net assets of our foreign operations when reported in U.S. dollars in our financial statements. The strength of the U.S. dollar compared to foreign currencies over the past year has adversely affected our profits and may continue to do so. A 10% change in the average Canadian and U.K. exchange rate for the twelve months ended January 1, 2023 would have impacted net income by approximately $0.5 million.
In addition, fluctuations in exchange rates may make it more difficult to perform period-to-period comparisons of our reported results of operations. For purposes of accounting, the assets and liabilities of our foreign operations are translated using period-end exchange rates; such translation gains and losses are reported in “Accumulated other comprehensive income/loss” as a component of stockholders’ equity. The revenues and expenses of our foreign operations are translated using average exchange rates during each period.
Likewise, we have a significant number of non-U.S.-based buyers who participate in our marketplaces. Increases in the value of the U.S. dollar relative to these buyers’ local currencies may reduce the prices they are willing to pay at auction, which may negatively affect our revenues.
Risks Related to Our Separation and Distribution
The separation and distribution agreement (the “ Separation Agreement ” ) that we entered into with KAR limits our ability to compete in certain markets for a period of time following the Separation, and in certain instances, requires that we make revenue and profit sharing payments to KAR related to specific customer segments.
Prior to the Separation, we were a wholly-owned subsidiary of KAR. Accordingly, KAR possessed and exercised sole and absolute discretion to determine and change the terms of the Separation Agreement. The Separation Agreement contains a covenant not to compete, prohibiting us and our affiliates from engaging in certain non-salvage activities in competition with KAR’s business for a period of five years following the Separation in certain jurisdictions, subject to certain exceptions. We are expressly permitted to continue to conduct our salvage auction business as conducted immediately prior to the Separation. The exceptions also permit us to conduct certain non-salvage business, in some cases subject to a revenue sharing mechanic in the event such business exceeds specified volume limits or other thresholds. These restrictions may limit our ability to compete in certain markets and could materially and adversely affect our business, growth strategy, financial condition and results of operations.
Since the Separation, we also face competition from ADESA, Inc., a wholly-owned subsidiary of KAR (“ADESA”), for some of the services that we provide, and the Separation Agreement limits our ability to compete in certain markets for a period of time.
If the Separation and Distribution fail to qualify as a tax-free transaction for U.S. federal income tax purposes, then IAA, KAR and KAR’s stockholders could be subject to significant tax liability or tax indemnity obligations.
KAR received an IRS Ruling on certain issues relevant to the qualification of the Separation and Distribution as tax-free under Sections 368(a)(1)(D) and 355 of the Code, based on certain facts and representations. The IRS Ruling does not address all of the requirements for tax-free treatment of the Separation and Distribution.
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As a condition to the Distribution KAR received an opinion from its U.S. tax counsel, Skadden, Arps, Slate, Meagher & Flom LLP, on the basis of certain facts, representations, covenants and assumptions set forth in such opinion, substantially to the effect that, for U.S. federal income tax purposes, the Separation and Distribution, taken together, qualifies as a transaction that generally is tax-free to KAR and KAR’s stockholders, for U.S. federal income tax purposes, under Sections 355 and 368(a)(1)(D) of the Code. Notwithstanding the tax opinion, the IRS could determine on audit that the distribution should be treated as a taxable transaction if it determines that any of the facts, assumptions, representations or covenants set forth in the tax opinion is not correct or has been violated, or that the Distribution should be taxable for other reasons, including as a result of a significant change in stock or asset ownership after the Distribution, or if the IRS were to disagree with the conclusions of the tax opinion. If the Distribution is ultimately determined to be taxable, the Distribution could be treated as a taxable dividend to you for U.S. federal income tax purposes, and you could incur significant U.S. federal income tax liability. In addition, KAR and/or we could incur significant U.S. federal income tax liabilities or tax indemnification obligations, whether under applicable law or the tax matters agreement that we entered into with KAR, if it is ultimately determined that certain related transactions were undertaken in anticipation of the Distribution.
We may have received better terms from unaffiliated third parties than the terms we receive in our agreements with KAR.
The agreements we entered into with KAR in connection with the Separation and Distribution, including the Separation Agreement and the ancillary agreements, were prepared in the context of IAA’s separation from KAR while IAA was still a wholly-owned subsidiary of KAR. Accordingly, during the period in which the terms of those agreements were prepared, IAA did not have an independent board of directors or a management team that was independent of KAR and KAR possessed and exercised sole and absolute discretion in determining the terms of the agreements. As a result, the terms of those agreements may not reflect terms that would have resulted from arm’s length negotiations between unaffiliated third parties. We may have received better terms from third parties because, among other things, third parties may have competed with each other to win our business.
We will be required to satisfy certain indemnification obligations to KAR or we may not be able to collect on indemnification rights from KAR.
Under the terms of the Separation and Distribution, we are required to indemnify KAR from and with respect to (i) all debts, liabilities and obligations allocated or transferred to us in connection with the Separation and Distribution (including our failure to pay, perform or otherwise promptly discharge any such debts, liabilities or obligations after the Separation and Distribution), (ii) any breach by us of the Separation Agreement or any of the ancillary agreements, and (iii) any misstatement or omission of a material fact in our Registration Statement on Form 10. We are not aware of any existing indemnification obligations at this time, but any such indemnification obligations that may arise could be significant. Under the terms of the Separation Agreement, KAR is required to indemnify us from and after the Separation and Distribution with respect to (i) all debts, liabilities and obligations allocated to KAR after the Separation and Distribution (including its failure to pay, perform or otherwise promptly discharge any such debts, liabilities or obligations after the separation and distribution) and (ii) any breach by KAR of the Separation Agreement or any of the ancillary agreements. Our and KAR’s ability to satisfy these indemnities, if called upon to do so, will depend respectively upon our and KAR’s future financial strength. If we are required to indemnify KAR, or if we are not able to collect on indemnification rights from KAR, our financial condition, liquidity or results of operations could be materially and adversely affected. We cannot determine whether we will have to indemnify KAR, or if KAR will have to indemnify us, for any substantial obligations after the Distribution.
Risks Related to Our Capital Structure and Organization
We have a substantial amount of debt, which could impair our financial condition and adversely affect our ability to react to changes in our business.
As of January 1, 2023, our total corporate debt was $1.1 billion. Our indebtedness could have important consequences including:
• limiting our ability to borrow additional amounts to fund working capital, capital expenditures, debt-service requirements, execution of our business strategy, acquisitions and other purposes;
• requiring us to dedicate a substantial portion of our cash flow from operations to pay principal and interest on debt, which would reduce the funds available for other purposes, including funding future expansion;
• making us more vulnerable to adverse changes in general economic, industry and competitive conditions, in government regulation and in our business by limiting our flexibility in planning for, and making it more difficult to react quickly to, changing conditions; and
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• exposing us to risks inherent in interest rate fluctuations because the majority of our indebtedness is at variable rates of interest, which could result in higher interest expenses in the event of increases in interest rates.
In addition, if we are unable to generate sufficient cash from operations to service our debt and meet other cash needs, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our indebtedness. We may not be able to refinance our debt or sell additional debt or equity securities or our assets on favorable terms, if at all, particularly because of our high levels of debt and the restrictions imposed by the agreements governing our indebtedness. If we must sell certain of our assets, it may negatively affect our ability to generate revenue. The inability to obtain additional financing could have a material adverse effect on our financial condition.
If we cannot make scheduled payments on our debt, we would be in default and, as a result:
• our debt holders could declare all outstanding principal and interest to be due and payable;
• the lenders under our senior secured credit facilities could terminate their commitments to lend us money and foreclose against the assets securing their borrowings; and
• we could be forced into bankruptcy or liquidation.
Provisions in our amended and restated certificate of incorporation and by-laws, and of Delaware law, may prevent or delay an acquisition of us, which could decrease the trading price of our common stock.
Our amended and restated certificate of incorporation and by-laws contain, and Delaware law contains, provisions that may be considered to have an anti-takeover effect and may delay or prevent a tender offer or other corporate transaction that a stockholder might consider to be in its best interest, including those transactions that might result in payment of a premium over the market price for our stock.
These provisions include:
• rules regarding how stockholders may present proposals or nominate directors for election at stockholder meetings;
• permitting our Board to issue preferred stock without stockholder approval;
• granting to the Board, and not the stockholders, the sole power to set the number of directors;
• authorizing vacancies on our Board to be filled only by a vote of the majority of the directors then in office and specifically denying our stockholders the right to fill vacancies in the Board; and
• prohibiting stockholder action by written consent.
These provisions apply even if an offer may be considered beneficial by some stockholders. We believe these provisions will protect our stockholders from coercive or otherwise unfair takeover tactics. These provisions are not intended to make us immune from takeovers. However, these provisions will apply even if the offer may be considered beneficial by some stockholders and the provisions could delay or prevent an acquisition that our Board determines is not in the best interests of us and our stockholders. These provisions may also prevent or discourage attempts to remove and replace incumbent directors.
We are not subject to the provisions of Section 203 of the General Corporation Law of the State of Delaware (the “DGCL”). Section 203 of the DGCL provides that, subject to limited exceptions, persons that acquire, or are affiliated with a person that acquires, more than 15% of the outstanding voting stock of a Delaware corporation shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which that person or its affiliates becomes the holder of more than 15% of the corporation’s outstanding voting stock. Accordingly, we are not subject to any anti-takeover effects of Section 203.
Our amended and restated certificate of incorporation and by-laws contain exclusive forum provisions that could limit an IAA stockholder’s ability to choose a judicial forum that it finds favorable for certain disputes with IAA or its directors, officers, stockholders, employees or agents, and may discourage lawsuits with respect to such claims.
Our amended and restated certificate of incorporation and bylaws provide that unless the Board otherwise determines, the Court of Chancery of the State of Delaware will be the sole and exclusive forum for (i) any derivative action or proceeding brought on behalf of IAA, (ii) any action asserting a claim of breach of a fiduciary duty owed by any director, officer, stockholder, employee or agent of IAA to IAA or its stockholders, (iii) any action asserting a claim against IAA or any director, officer, stockholder, employee or agent of IAA arising out of or relating to any provision of the DGCL or IAA’s amended and restated certificate of incorporation or by-laws, or (iv) any action asserting a claim against IAA or any director, officer, stockholder, employee or agent of IAA governed by the internal affairs doctrine, in all cases subject to the court having subject matter jurisdiction and personal jurisdiction over an indispensable party named as a defendant (the “Delaware Exclusive Forum Provision”). The Delaware Exclusive Forum Provision does not apply to any actions arising under the Securities Act or the
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Securities Exchange Act of 1934, as amended (the “Exchange Act”), for which the U.S. federal courts have exclusive jurisdiction, except that if the Delaware Court of Chancery lacks subject matter jurisdiction over any such actions, the Delaware Exclusive Forum Provision would require, subject to the terms thereof, that the federal courts in the State of Delaware have exclusive jurisdiction over such action. In addition, our bylaws further provide that the federal district courts of the United States of America will, to the fullest extent permitted by law, be the exclusive forum for resolving any complaint asserting a cause of action under the Securities Act (the “Federal Forum Provision”). The Federal Forum Provision is intended to apply to claims arising under the Securities Act and would not apply to claims brought pursuant to the Exchange Act.
These exclusive forum provisions will not relieve us of our duties to comply with the federal securities laws and the rules and regulations thereunder and, accordingly, actions by our stockholders to enforce any duty or liability created by the Exchange Act or the rules and regulations thereunder must be brought in federal courts. The exclusive forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for such disputes and may discourage these types of lawsuits. Alternatively, if a court were to find the exclusive forum provisions inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions.
