filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CAUTION REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K for the fiscal year ended July 31, 2016, or this Form 10-K, including the information incorporated by reference herein, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). All statements other than statements of historical facts are statements that could be deemed forward-looking statements. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue” or the negative of these terms or other comparable terminology. The forward-looking statements contained in this Form 10-K involve known and unknown risks, uncertainties and situations that may cause our or our industry’s actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements. These forward-looking statements are made in reliance upon the safe harbor provision of the Private Securities Litigation Reform Act of 1995. These factors include those listed in Part I, Item 1A under the caption entitled “Risk Factors” in this Form 10-K and those discussed elsewhere in this Form 10-K. Unless the context otherwise requires, references in this Form 10-K to “Copart,” the “Company,” “we,” “us,” or “our” refer to Copart, Inc. We encourage investors to review these factors carefully together with the other matters referred to herein, as well as in the other documents we file with the Securities and Exchange Commission (the SEC). We may from time to time make additional written and oral forward-looking statements, including statements contained in our filings with the SEC. We do not undertake to update any forward-looking statement that may be made from time to time by or on behalf of us.
All references to numbered Notes are to specific Notes to our Consolidated Financial Statements included in this Annual Report on Form 10-K and which descriptions are incorporated into the applicable response by reference. Capitalized terms used, but not defined, in this Management’s Discussion and Analysis of Financial Condition and Results of Operation (“MD&A”) have the same meanings as in such Notes.
Overview
We are a leading provider of online auctions and vehicle remarketing services in the United States (U.S.), Canada, the United Kingdom (U.K.), Brazil, the United Arab Emirates (U.A.E.), Oman, Bahrain, Ireland, Spain and India. We also provide vehicle remarketing services in Germany and Spain.
We provide vehicle sellers with a full range of services to process and sell vehicles primarily over the Internet through our Virtual Bidding Third Generation Internet auction-style sales technology, which we refer to as VB3. Vehicle sellers consist primarily of insurance companies, but also include banks and financial institutions, charities, car dealerships, fleet operators and vehicle rental companies. We sell the vehicles principally to licensed vehicle dismantlers, rebuilders, repair licensees, used vehicle dealers and exporters and, at certain locations, to the general public. The majority of the vehicles sold on behalf of insurance companies are either damaged vehicles deemed a total loss or not economically repairable by the insurance companies, or are recovered stolen vehicles for which an insurance settlement with the vehicle owner has already been made. We offer vehicle sellers a full range of services that expedite each stage of the vehicle sales process, minimize administrative and processing costs, and maximize the ultimate sales price.
In the U.S., Canada, Brazil, the U.A.E., Oman, Bahrain, Ireland, Spain and India, we sell vehicles primarily as an agent and derive revenue primarily from fees paid by vehicle sellers and vehicle buyers as well as related fees for services, such as towing and storage. In the U.K., we operate both on a principal basis, purchasing the salvage vehicles outright from the insurance companies and reselling the vehicles for our own account, and as an agent. In Germany and Spain, we derive revenue from sales listing fees for listing vehicles on behalf of many insurance companies.
We monitor and analyze a number of key financial performance indicators in order to manage our business and evaluate our financial and operating performance. Such indicators include:
Service and Vehicle Sales Revenue: Our revenue consists of sales transaction fees charged to vehicle sellers and vehicle buyers, transportation revenue, purchased vehicle revenue, and other remarketing services. Revenues from sellers are generally generated either on a fixed fee contract basis, where our fees are fixed based on the sale of each vehicle regardless of the selling price of the vehicle or under our Percentage Incentive Program (PIP), where our fees are generally based on a predetermined percentage of the vehicle sales price. Under the consignment or fixed fee program, we generally charge an additional fee for title processing and special preparation. We may also charge additional fees for the cost of transporting the vehicle to our facility, storage of the vehicle, and other incidental costs not included in the consignment fee. Under the consignment program,
only the fees associated with vehicle processing are recorded in revenue, not the actual sales price (gross proceeds). Sales transaction fees also include fees charged to vehicle buyers for purchasing vehicles, storage, loading, and annual registration. Transportation revenue includes charges to sellers for towing vehicles under certain contracts and towing charges assessed to buyers for delivering vehicles. Purchased vehicle revenue includes the gross sales price of the vehicle which we have purchased or are otherwise considered to own, and is primarily generated in the U.K. We have certain contracts with insurance companies in which we act as a principal, purchasing vehicles and reselling them for our own account. We also purchase vehicles in the open market, primarily from individuals, and resell them for our own account.
Our revenue is impacted by several factors, including salvage frequency and the average vehicle auction selling price, as a significant amount of our service revenue is associated in some manner to the ultimate selling price of the vehicle. Vehicle auction selling prices are driven primarily by: (i) changes in commodity prices, particularly the per ton price for crushed car bodies, as we believe this has an impact on the ultimate selling price of vehicles sold for scrap and vehicles sold for dismantling; (ii) used car pricing, which we believe has an impact on salvage frequency; (iii) the mix of cars sold; and (iv) changes in the U.S. dollar exchange rate to foreign currencies, which we believe has an impact on auction participation by international buyers. We cannot specifically quantify the financial impact that commodity pricing, used car pricing, and product sales mix has on the selling price of vehicles, our service revenues or financial results. Salvage frequency is the percentage of cars involved in accidents which insurance companies salvage rather than repair and is driven by the relationship between repairs costs, used car values, and auction returns. Over the last several years, we believe there has been an increase in overall growth in the salvage market driven by an increase in salvage frequency. The increase in salvage frequency may have been driven by the decline in used car values relative to repair costs, which we believe are generally trending upward. Conversely, increases in used car prices, such as occurred during the most recent recession, may decrease salvage frequency and adversely affect our growth rate. Used car values are determined by many factors, including used car supply, which is tied directly to new car sales, and the average age of cars on the road. New car sales grew on a year over year basis, increasing the supply of used cars. Additionally, the average age of cars on the road continued to increase, growing from 9.6 years in 2002 to 11.5 years in 2015. The factors that influence repair costs, used car pricing, and auction returns are many and varied and we cannot predict their movements. Accordingly, we cannot predict future trends in salvage frequency.
Operating Costs and Expenses: Yard operations expenses consist primarily of operating personnel (which includes yard management, clerical and yard employees), rent, contract vehicle towing, insurance, fuel, equipment maintenance and repair, and costs of vehicles sold under the purchase contracts. General and administrative expenses consist primarily of executive management, accounting, data processing, sales personnel, human resources, professional fees, research and development, and marketing expenses.
Other Income and Expense: Other income primarily includes income from the rental of certain real property, foreign exchange rate gains and losses, and gains and losses from the disposal of assets, which will fluctuate based on the nature of these activities each period. Other expense consists primarily of interest expense on long-term debt. See Notes to Consolidated Financial Statements, Note 8 — Long-Term Debt.
Liquidity and Cash Flows: Our primary source of working capital is cash operating results and debt financing. The primary source of our liquidity is our cash and cash equivalents and Revolving Loan Facility. The primary factors affecting cash operating results are: (i) seasonality; (ii) market wins and losses; (iii) supplier mix; (iv) accident frequency; (v) salvage frequency; (vi) increased volume from our existing suppliers; (vii) commodity pricing; (viii) used car pricing; (ix) foreign currency exchange rates; (x) product mix; (xi) contract mix to the extent applicable; and (xii) our capital expenditures. These factors are further discussed in the Results of Operations and Risk Factors sections of this Annual Report on Form 10-K.
Potential internal sources of additional working capital are the sale of assets or the issuance of equity through option exercises and shares issued under our Employee Stock Purchase Plan. A potential external source of additional working capital is the issuance of debt and equity; however, we cannot predict if these sources will be available in the future and, if available, if they can be issued under terms commercially acceptable to us.
Acquisitions and New Operations
As part of our overall expansion strategy of offering integrated services to vehicle sellers, we anticipate acquiring and developing facilities in new regions, as well as the regions currently served by our facilities. We believe that these acquisitions and openings will strengthen our coverage, as we have facilities located in the U.S., Canada, the U.K., Brazil, the U.A.E., Oman, Bahrain, Germany, Spain, Ireland and India with the intention of providing national coverage for our sellers. All of these acquisitions have been accounted for using the purchase method of accounting.
The following table sets forth facilities that we have acquired or opened from August 1, 2013 through July 31, 2016:
| Locations | Acquisition or Greenfield | Date | Geographic Service Area | |||
| Seaford, Delaware | Greenfield | July 2014 | United States | |||
| Dallas, Texas | Greenfield | March 2016 | United States | |||
| Wilmer, Texas | Greenfield | April 2016 | United States | |||
| Temple, Texas | Greenfield | April 2016 | United States | |||
| Colorado Springs, Colorado | Greenfield | May 2016 | United States | |||
| Denver, Colorado | Greenfield | July 2016 | United States | |||
| Cartersville, Georgia | Greenfield | July 2016 | United States | |||
| Montreal, Quebec | Acquisition | November 2013 | Canada | |||
| Moncton, New Brunswick | Greenfield | July 2015 | Canada | |||
| Itaquaquecetuba, Brazil (São Paulo) | Greenfield | January 2014 | Brazil | |||
| Algete, Spain (Madrid) | Greenfield | July 2016 | Spain | |||
| Manama, Bahrain | Greenfield | May 2015 | Bahrain | |||
| Muscat, Oman | Greenfield | June 2015 | Oman | |||
| Sonepat, India (New Delhi) | Greenfield | October 2015 | India | |||
| Castledermot, Ireland | Greenfield | April 2016 | Ireland |
The period-to-period comparability of our consolidated operating results and financial position is affected by business acquisitions, new openings, weather and product introductions during such periods. In particular, we have certain contracts inherited through our U.K. acquisitions that require us to act as a principal, purchasing vehicles from the insurance companies and reselling them for our own account. It has been our practice and remains our intention, where possible, to migrate these contracts to the agency model in future periods. Changes in the amount of revenue derived in a period from principal transactions relative to total revenue will impact revenue growth and margin percentages.
In addition to growth through business acquisitions, we seek to increase revenues and profitability by, among other things, (i) acquiring and developing additional vehicle storage facilities in key markets; (ii) pursuing national and regional vehicle seller agreements; (iii) increasing our service offerings to sellers and members; and (iv) expanding the application of VB3 into new markets. In addition, we implement our pricing structure and auction procedures, and attempt to introduce cost efficiencies at each of our acquired facilities by implementing our operational procedures, integrating our management information systems, and redeploying personnel, when necessary.
Results of Operations
The following table shows certain data from our consolidated statements of income expressed as a percentage of total service revenues and vehicle sales for fiscal 2016, 2015 and 2014:
| Year Ended July 31, | ||||||||
| (In percentages) | 2016 | 2015 | 2014 | |||||
| Service revenues and vehicle sales: | ||||||||
| Service revenues | 87 | % | 86 | % | 82 | % | ||
| Vehicle sales | 13 | % | 14 | % | 18 | % | ||
| Total service revenues and vehicle sales | 100 | % | 100 | % | 100 | % | ||
| Operating expenses: | ||||||||
| Yard operations | 46 | % | 46 | % | 45 | % | ||
| Cost of vehicle sales | 11 | % | 12 | % | 15 | % | ||
| General and administrative | 11 | % | 12 | % | 14 | % | ||
| Impairment of long-lived assets | — | % | — | % | 3 | % | ||
| Total operating expenses | 68 | % | 70 | % | 77 | % | ||
| Operating income | 32 | % | 30 | % | 23 | % | ||
| Other (expense) income | (1 | )% | (1 | )% | — | % | ||
| Income before income taxes | 31 | % | 29 | % | 23 | % | ||
| Income taxes | 10 | % | 10 | % | 8 | % | ||
| Net income | 21 | % | 19 | % | 15 | % |
Comparison of Fiscal Years ended July 31, 2016, 2015 and 2014
The following table presents a comparison of service revenues for fiscal 2016, 2015 and 2014:
| Year Ended July 31, | 2016 vs. 2015 | 2015 vs. 2014 | ||||||||||||||||||||||||
| (In thousands) | 2016 | 2015 | 2014 | Change | % Change | Change | % Change | |||||||||||||||||||
| Service revenues | ||||||||||||||||||||||||||
| United States | $ | 958,558 | $ | 848,149 | $ | 830,561 | $ | 110,409 | 13.0 | % | $ | 17,588 | 2.1 | % | ||||||||||||
| International | 145,821 | 137,214 | 127,852 | 8,607 | 6.3 | % | 9,362 | 7.3 | % | |||||||||||||||||
| Total service revenues | $ | 1,104,379 | $ | 985,363 | $ | 958,413 | $ | 119,016 | 12.1 | % | $ | 26,950 | 2.8 | % |
Service Revenues. The increase in service revenues for fiscal 2016 of $119.0 million, or 12.1% as compared to fiscal 2015 came from (i) growth in the U.S. of $110.4 million and (ii) growth in International of $8.6 million. The growth in the U.S. was driven primarily by increased volume, partially offset by lower average auction selling prices, which we believe is due to lower commodity prices. The increase in volume in the U.S. was derived from (i) growth from existing suppliers, driven by what we believe was an increase in salvage frequency, and (ii) growth in the number of units sold from new and expanded contracts with insurance companies. Excluding a detrimental impact of $11.8 million due to changes in foreign currency exchange rates, primarily from changes in the British pound and the Brazilian real to U.S. dollar exchange rates, the growth in International of $20.4 million was driven primarily by increased volume in the U.K. as we increased our market share and a marginal increase in revenue per car.
The increase in service revenues for fiscal 2015 of $27.0 million, or 2.8% as compared to fiscal 2014 came from (i) growth in the U.S. of $17.6 million and (ii) growth in International of $9.4 million. The growth in the U.S. was driven primarily by increased volume, partially offset by a decrease in revenue per car due to lower average auction selling prices, which we believe is due to lower commodity prices. The increase in volume in the U.S. primarily came from existing suppliers as we believe there may have been an increase in the overall growth in the salvage market driven by increased salvage frequency. Excluding a detrimental impact of $8.9 million due to changes in foreign currency exchange rates, primarily from changes in the British pound and the Brazilian real to U.S. dollar exchange rates, the growth in International of $18.3 million was driven primarily by increased volume in the U.K. as we increased our market share and a marginal increase in revenue per car.
The following table presents a comparison of vehicle sales for fiscal 2016, 2015 and 2014:
| Year Ended July 31, | 2016 vs. 2015 | 2015 vs. 2014 | ||||||||||||||||||||||||
| (In thousands) | 2016 | 2015 | 2014 | Change | % Change | Change | % Change | |||||||||||||||||||
| Vehicle sales | ||||||||||||||||||||||||||
| United States | $ | 57,478 | $ | 54,730 | $ | 63,098 | $ | 2,748 | 5.0 | % | $ | (8,368 | ) | (13.3 | )% | |||||||||||
| International | 106,592 | 105,986 | 141,978 | 606 | 0.6 | % | (35,992 | ) | (25.4 | )% | ||||||||||||||||
| Total vehicle sales | $ | 164,070 | $ | 160,716 | $ | 205,076 | $ | 3,354 | 2.1 | % | $ | (44,360 | ) | (21.6 | )% |
Vehicle Sales. The increase in vehicle sales for fiscal 2016 of $3.4 million, or 2.1% as compared to fiscal 2015 came from (i) an increase in the U.S. of $2.7 million and (ii) an increase in International of $0.6 million. The growth in the U.S. was primarily the result of increased volume, partially offset by lower average auction selling prices, which we believe is due to lower commodity prices and a change in the mix of vehicles sold. The growth in International was primarily the result of increased volume, partially offset by a $7.0 million detrimental impact due to changes in foreign currency exchange rates, primarily from the change in the British pound to U.S. dollar exchange rate, and lower average selling prices driven by increased open market purchase activity from the general public.
The decrease in vehicle sales for fiscal 2015 of $44.4 million, or 21.6% as compared to fiscal 2014 came from (i) a decline in International of $36.0 million and (ii) a decline in the U.S. of $8.4 million. The decline in International was primarily the result of decreased volume in the U.K. from insurance sellers and lower average auction selling prices, driven by decreased insurance volume and increased open market purchase activity from the general public, and included a $5.1 million detrimental impact due to changes in foreign currency exchanges rates, primarily from the change in the British pound to U.S. dollar exchange rate. The decline in the U.S. was primarily the result of decreased open market purchase activity from the general public and lower average auction selling prices, which we believe is due to lower commodity prices.
The following table presents a comparison of yard operations expense for fiscal 2016, 2015 and 2014:
| Year Ended July 31, | 2016 vs. 2015 | 2015 vs. 2014 | ||||||||||||||||||||||||
| (In thousands) | 2016 | 2015 | 2014 | Change | % Change | Change | % Change | |||||||||||||||||||
| Yard operations expenses | ||||||||||||||||||||||||||
| United States | $ | 494,146 | $ | 440,517 | $ | 437,744 | $ | 53,629 | 12.2 | % | $ | 2,773 | 0.6 | % | ||||||||||||
| International | 88,758 | 85,774 | 82,679 | 2,984 | 3.5 | % | 3,095 | 3.7 | % | |||||||||||||||||
| Total yard operations expenses | $ | 582,904 | $ | 526,291 | $ | 520,423 | $ | 56,613 | 10.8 | % | $ | 5,868 | 1.1 | % | ||||||||||||
| Yard operations expenses, excluding depreciation and amortization | ||||||||||||||||||||||||||
| United States | $ | 468,528 | $ | 413,985 | $ | 408,442 | $ | 54,543 | 13.2 | % | $ | 5,543 | 1.4 | % | ||||||||||||
| International | 80,718 | 77,389 | 75,765 | 3,329 | 4.3 | % | 1,624 | 2.1 | % | |||||||||||||||||
| Yard depreciation and amortization | ||||||||||||||||||||||||||
| United States | $ | 25,618 | $ | 26,532 | $ | 29,301 | $ | (914 | ) | (3.4 | )% | $ | (2,769 | ) | (9.5 | )% | ||||||||||
| International | 8,040 | 8,385 | 6,915 | (345 | ) | (4.1 | )% | 1,470 | 21.3 | % |
Yard Operations Expenses. The increase in yard operations expenses for fiscal 2016 of $56.6 million, or 10.8% as compared to fiscal 2015 came from (i) an increase in the U.S. of $53.6 million, primarily from growth in volume and a marginal increase in the cost to process each car; (ii) an increase in International of $3.0 million related primarily to growth in volume in the U.K., partially offset by the beneficial impact of $7.0 million due to changes in foreign currency exchange rates, primarily from changes in the British pound and the Brazilian real to U.S. dollar exchange rates. Included in yard operations expenses were depreciation and amortization expenses. The decreases in yard operations depreciation and amortization expenses resulted primarily from certain assets becoming fully depreciated in the U.S.
The increase in yard operations expenses for fiscal 2015 of $5.9 million, or 1.1% as compared to fiscal 2014 was the result of (i) an increase in the U.S. of $2.8 million, primarily from growth in volume in the U.S. and partially offset by a decrease in the cost to process each car in the U.S., primarily driven by operational efficiencies and the integration of the Salvage Parent, Inc., acquisition which closed in the fourth quarter of fiscal 2013; (ii) a $3.1 million increase in International primarily due to growth in volume, partially offset by the beneficial impact of $4.8 million due to changes in foreign currency exchange rates, primarily from changes in the British pound and the Brazilian real to U.S. dollar exchange rates. Included in our U.S. yard operations expenses for fiscal 2014 were severance and lease termination costs of $4.0 million, primarily associated with the integration of the Salvage Parent, Inc. acquisition.
The following table presents a comparison of cost of vehicle sales for fiscal 2016, 2015 and 2014:
| Year Ended July 31, | 2016 vs. 2015 | 2015 vs. 2014 | ||||||||||||||||||||||||
| (In thousands) | 2016 | 2015 | 2014 | Change | % Change | Change | % Change | |||||||||||||||||||
| Cost of vehicle sales | ||||||||||||||||||||||||||
| United States | $ | 55,866 | $ | 52,232 | $ | 59,902 | $ | 3,634 | 7.0 | % | $ | (7,670 | ) | (12.8 | )% | |||||||||||
| International | 85,093 | 84,180 | 114,591 | 913 | 1.1 | % | (30,411 | ) | (26.5 | )% | ||||||||||||||||
| Total cost of vehicle sales | $ | 140,959 | $ | 136,412 | $ | 174,493 | $ | 4,547 | 3.3 | % | $ | (38,081 | ) | (21.8 | )% |
Cost of Vehicle Sales. The increase in cost of vehicle sales for fiscal 2016 of $4.5 million, or 3.3% as compared to fiscal 2015 was the result of (i) an increase in the U.S. of $3.6 million and (ii) an increase in International of $0.9 million. The increase in the U.S. was primarily the result of increased volume, partially offset by lower average purchase prices, which we believe is due to lower commodity prices and a change in the mix of vehicles sold. The increase in International was primarily the result of increased volume, partially offset by the beneficial impact of $5.6 million due to changes in foreign currency exchange rates, primarily from changes in the British pound and the Brazilian real to U.S. dollar exchange rates, and lower average purchases prices driven by increased open market purchase activity from the general public.
The decrease in cost of vehicle sales for fiscal 2015 of $38.1 million, or 21.8% as compared to fiscal 2014 came from (i) a decline in International of $30.4 million, which included the beneficial impact of $4.1 million due to changes in foreign currency exchange rates, primarily from the change in the British pound to U.S. dollar exchange rate, and (ii) a decline in the U.S. of $7.7 million. The decline in International resulted primarily from decreased volume in the U.K. from insurance sellers and lower average purchase prices, driven by decreased insurance volume and increased open market purchase activity from the general public. The decline in the U.S. was primarily the result of decreased open market purchase activity from the general public and lower average purchase prices.
The following table presents a comparison of general and administrative expenses for fiscal 2016, 2015 and 2014:
| Year Ended July 31, | 2016 vs. 2015 | 2015 vs. 2014 | ||||||||||||||||||||||||
| (In thousands) | 2016 | 2015 | 2014 | Change | % Change | Change | % Change | |||||||||||||||||||
| General and administrative expenses | ||||||||||||||||||||||||||
| United States | $ | 118,315 | $ | 120,140 | $ | 143,525 | $ | (1,825 | ) | (1.5 | )% | $ | (23,385 | ) | (16.3 | )% | ||||||||||
| International | 19,801 | 18,835 | 21,010 | 966 | 5.1 | % | (2,175 | ) | (10.4 | )% | ||||||||||||||||
| Total vehicle sales | $ | 138,116 | $ | 138,975 | $ | 164,535 | $ | (859 | ) | (0.6 | )% | $ | (25,560 | ) | (15.5 | )% | ||||||||||
| General and administrative expenses, excluding depreciation and amortization | ||||||||||||||||||||||||||
| United States | $ | 104,850 | $ | 110,433 | $ | 128,312 | $ | (5,583 | ) | (5.1 | )% | $ | (17,879 | ) | (13.9 | )% | ||||||||||
| International | 18,349 | 16,886 | 18,713 | 1,463 | 8.7 | % | (1,827 | ) | (9.8 | )% | ||||||||||||||||
| General and administrative depreciation and amortization | ||||||||||||||||||||||||||
| United States | $ | 13,465 | $ | 9,707 | $ | 15,213 | $ | 3,758 | 38.7 | % | $ | (5,506 | ) | (36.2 | )% | |||||||||||
| International | 1,452 | 1,949 | 2,297 | (497 | ) | (25.5 | )% | (348 | ) | (15.2 | )% |
General and Administrative Expenses. The decrease in general and administrative expenses for fiscal 2016 of $0.9 million, or 0.6% as compared to fiscal 2015 came primarily from a decrease in the U.S. of $1.8 million, partially offset by an increase in International of $1.0 million as we continue to expand in these markets. The decrease in the U.S. of $5.6 million, excluding depreciation and amortization, resulted from decreased expenditures on technology development; partially offset by the overall growth in labor costs and professional services associated with domestic expansion, increased stock-based payment compensation and increased depreciation and amortization expenses. The increases in depreciation and amortization expenses came primarily from depreciating certain technology assets placed into service in the U.S.
The decrease in general and administrative expenses for fiscal 2015 of $25.6 million, or 15.5% as compared to fiscal 2014 came primarily from a decrease in the U.S. of $23.4 million as a result of the integration of the Salvage Parent, Inc. acquisition, the relocation of our technology department being completed in fiscal 2014, decreased expenditures on technology development, a decrease in stock-based payment compensation and a decrease in depreciation and amortization expenses. Included in fiscal 2014 was $7.5 million in lease termination, severance and relocation costs associated with the integration of the Salvage Parent, Inc. acquisition, which was finalized in fiscal 2014, and the relocation of our technology department from California to our Dallas, Texas corporate headquarters. The decrease in depreciation and amortization expenses came primarily from a decrease in the U.S. as a result of certain assets becoming fully amortized.
The following table summarizes impairment, total other expenses and income taxes for fiscal 2016, 2015 and 2014:
| Year Ended July 31, | 2016 vs. 2015 | 2015 vs. 2014 | |||||||||||||||||||||
| (In thousands) | 2016 | 2015 | 2014 | Change | % Change | Change | % Change | ||||||||||||||||
| Impairment | $ | — | $ | — | $ | 29,104 | — | — | % | (29,104 | ) | (100.0 | )% | ||||||||||
| Total other expenses | (10,605 | ) | (12,332 | ) | (4,899 | ) | 1,727 | 14.0 | % | (7,433 | ) | (151.7 | )% | ||||||||||
| Income taxes | 125,505 | 112,286 | 91,348 | 13,219 | 11.8 | % | 20,938 | 22.9 | % |
Impairment. During fiscal 2014, we terminated a contract with KPIT (formerly known as Sparta Consulting, Inc.), whereby KPIT was engaged to design and implement an SAP-based replacement for our existing business operating software that, among other things, would address our international expansion needs. Following a review of KPIT’s work performed and an assessment of the cost to complete, deployment risk, and other factors, we ceased development of KPIT’s software and internally developed a proprietary solution in its place. As a result in fiscal 2014, we recognized a charge of $29.1 million resulting primarily from the impairment of costs previously capitalized in connection with the development of the software.
Other (Expense) Income. The decrease in total other expense for fiscal 2016 of $1.7 million, or 14.0% as compared to fiscal 2015 was primarily due to increased currency gains in International, primarily in the U.K. of $8.3 million, partially offset by an increase in interest expense of $5.5 million as a result of the additional long-term debt issued in December 2014, March 2016 and July 2016. See Notes to Consolidated Financial Statements, Note 8 — Long-Term Debt.
The increase in total other expense for fiscal 2015 of $7.4 million, or 151.7% as compared to fiscal 2014 was primarily due to an increase in interest expense of $9.4 million as a result of the additional long-term debt issued in December 2014, partially offset by increased currency gains in International, primarily in the U.K. of $2.1 million. See Notes to Consolidated Financial Statements, Note 8 — Long-Term Debt
Income Taxes. Our effective income tax rates were 31.7%, 33.8%, and 33.8% for fiscal 2016, 2015 and 2014, respectively. During the year ended July 31, 2016, we early adopted ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which impacts the accounting for share-based payments, including income tax consequences. As a result of the adoption, we recognized excess tax benefits of $14.7 million as a reduction to tax expense in the consolidated statements of income, as though ASU 2016-09 had been in effect since the beginning of fiscal 2016, instead of reflected in stockholders' equity. The decrease in the overall tax rate was driven by fluctuations in U.S. tax laws, the geographical allocation of our taxable income, and the adoption of ASU 2016-09.
Liquidity and Capital Resources
The following table presents a comparison of key components of our liquidity and capital resources for fiscal 2016, 2015 and 2014, excluding additional funds available to us through our Revolving Loan Facility:
| July 31, | 2016 vs. 2015 | 2015 vs. 2014 | |||||||||||||||||||||||
| (In thousands) | 2016 | 2015 | 2014 | Change | % Change | Change | % Change | ||||||||||||||||||
| Cash and cash equivalents | $ | 155,849 | $ | 456,012 | $ | 158,668 | $ | (300,163 | ) | (65.8 | )% | $ | 297,344 | 187.4 | % | ||||||||||
| Working capital | 220,523 | 521,456 | 168,007 | (300,933 | ) | (57.7 | )% | 353,449 | 210.4 | % |
| Year Ended July 31, | 2016 vs. 2015 | 2015 vs. 2014 | |||||||||||||||||||||||
| (In thousands) | 2016 | 2015 | 2014 | Change | % Change | Change | % Change | ||||||||||||||||||
| Operating cash flows | $ | 332,498 | $ | 265,076 | $ | 262,594 | $ | 67,422 | 25.4 | % | $ | 2,482 | 0.9 | % | |||||||||||
| Investing cash flows | (172,876 | ) | (81,915 | ) | (92,103 | ) | (90,961 | ) | (111.0 | )% | 10,188 | 11.1 | % | ||||||||||||
| Financing cash flows | (448,496 | ) | 120,362 | (76,823 | ) | (568,858 | ) | (472.6 | )% | 197,185 | 256.7 | % | |||||||||||||
| Capital expenditures, including acquisitions | $ | (173,917 | ) | $ | (79,153 | ) | $ | (95,810 | ) | $ | (94,764 | ) | (119.7 | )% | $ | 16,657 | 17.4 | % | |||||||
| Proceeds from revolving loan facility, net of repayments | 238,000 | — | — | 238,000 | 100.0 | % | — | — | % | ||||||||||||||||
| Principal payments on long-term debt | (337,500 | ) | (350,000 | ) | (75,000 | ) | 12,500 | 3.6 | % | (275,000 | ) | (366.7 | )% | ||||||||||||
| Acquisitions | — | — | (14,300 | ) | — | — | % | 14,300 | 100.0 | % |
Cash and cash equivalents and working capital decreased for fiscal 2016 as compared to fiscal 2015 primarily due to repurchases of common stock as part of our tender offer and stock repurchase program, capital expenditures, payments on long-term debt and changes in operating assets, partially offset by cash generated from operations and the proceeds from our Revolving Loan Facility. Cash equivalents consisted of bank deposits, domestic certificates of deposit, and funds invested in money market accounts, which bear interest at variable rates. Cash and cash equivalents and working capital increased for fiscal 2015 as compared to fiscal 2014 primarily due to issuance of long-term debt of $700.0 million, cash generated from operations and decreases in capital expenditures, partially offset by increases in payments on long-term debt and repurchases of common stock.
Historically, we have financed our growth through cash generated from operations, public offerings of common stock, equity issued in conjunction with certain acquisitions and debt financing. Our primary source of cash generated by operations is from the collection of sellers’ fees, members’ fees and reimbursable advances from the proceeds of vehicle sales. Our business is seasonal as inclement weather during the winter months increases the frequency of accidents and consequently, the number of cars involved in accidents which the insurance companies salvage rather than repair. During the winter months, most of our facilities process 10% to 30% more vehicles than at other times of the year. This increased volume requires the increased use of our cash to pay out advances and handling costs of the additional business.
We believe that our currently available cash and cash equivalents and cash generated from operations will be sufficient to satisfy our operating and working capital requirements for at least the next 12 months. We expect to acquire or develop additional locations and expand some of our current facilities in the foreseeable future. We may be required to raise additional cash through drawdowns on our Revolving Loan Facility or issuance of additional equity to fund this expansion. Although the timing and magnitude of growth through expansion and acquisitions are not predictable, the opening of new greenfield yards is contingent upon our ability to locate property that (i) is in an area in which we have a need for more capacity; (ii) has adequate size given the capacity needs; (iii) has the appropriate shape and topography for our operations; (iv) is reasonably close to a major road or highway; and (v) most importantly, has the appropriate zoning for our business. Costs to develop a new yard can range from $1.0 to $30.0 million, depending on size, location and developmental infrastructure requirements.
As of July 31, 2016, $111.2 million of the $155.8 million of cash and cash equivalents was held by our foreign subsidiaries. If these funds are needed for our operations in the U.S., we would be required to accrue and pay U.S. taxes to repatriate these funds. However, our intent is to permanently reinvest these funds outside of the U.S. and our current plans do not require repatriation to fund our U.S. operations.
Net cash used in operating activities increased for fiscal 2016 as compared to fiscal 2015 due to improved cash operating results from an increase in service revenues, partially offset by an increase in yard operations expenses, an increase in interest expense, and changes in operating assets and liabilities. The change in operating assets and liabilities was primarily the result of an increase in accounts payable of $52.3 million, a decrease in accounts receivable of $33.8 million, a decrease in income taxes receivable of $11.8 million and a decrease in other assets of $6.0 million.
Net cash used in operating activities increased for fiscal 2015 as compared to fiscal 2014 due to improved cash operating results from an increase in service revenues and a decrease in general and administrative expenses, partially offset by changes in operating assets and liabilities. The change in operating assets and liabilities was primarily the result of an increase in income taxes receivable of $10.1 million, a decrease in accounts payable of $9.4 million and an increase in accounts receivable of $7.5 million, partially offset by a decrease in other assets.
Net cash used in investing activities increased for fiscal 2016 as compared to fiscal 2015 due primarily to increases in capital expenditures. Our capital expenditures are primarily related to lease buyouts of certain facilities, opening and improving facilities, software development, and acquiring yard equipment. We continue to expand and invest in new and existing facilities and standardize the appearance of existing locations. We have no material non-cancelable commitments for future capital expenditures as of July 31, 2016. Included in capital expenditures were capitalized software development costs for new software for internal use and major software enhancements to existing software. The capitalized costs were $14.1 million, $8.8 million and $16.5 million for fiscal 2016, 2015 and 2014, respectively. If, at any time it is determined that capitalized software provides a reduced economic benefit, the unamortized portion of the capitalized development costs will be impaired. During fiscal 2014, we recognized a charge of $29.1 million resulting primarily from the impairment of costs previously capitalized in connection with the development of business operating software. See Notes to Consolidated Financial Statements, Capitalized Software Costs in Note 1 — Summary of Significant Accounting Policies.
Net cash used in investing activities decreased for fiscal 2015 as compared to fiscal 2014 due primarily to decreases in capital expenditures and cash used in acquisitions.
Net cash used in financing activities increased in fiscal 2016 as compared to fiscal 2015 primarily due to the repurchases of our common stock as part of our stock repurchase program and our tender offer as discussed in further detail under the subheading "Stock Repurchases", and a decrease in proceeds from the issuance of long-term debt. For further detail see Notes to Consolidated Financial Statements, Note 8 — Long-Term Debt and Note 11 — Stockholders’ Equity and under the subheadings "Credit Agreement" and "Note Purchase Agreement".
Net cash used in financing activities increased for fiscal 2015 as compared to fiscal 2014, primarily due to the issuance of long-term debt, and a $16.3 million change in bank overdraft, partially offset by repurchases of common stock as part of our stock repurchase program and our tender offer as discussed in further detail under the subheading "Stock Repurchases", and decreased proceeds of $6.8 million from the exercise of stock options. For further detail see Notes to Consolidated Financial Statements, Note 8 — Long-Term Debt and Note 11 — Stockholders’ Equity and under the subheadings "Credit Agreement" and "Note Purchase Agreement".
Stock Repurchases
On September 22, 2011, our Board of Directors approved a 40 million share increase in the stock repurchase program, bringing the total current authorization to 98 million shares. The repurchases may be effected through solicited or unsolicited transactions in the open market or in privately negotiated transactions. No time limit has been placed on the duration of the stock repurchase program. Subject to applicable securities laws, such repurchases will be made at such times and in such amounts as we deem appropriate and may be discontinued at any time. For fiscal 2016, we repurchased 2,938,519 shares of our common stock at a weighted average price of $40.13 per share totaling $117.9 million. For fiscal 2015, we repurchased 231,500 shares of our common stock at a weighted average price of $36.02 per share totaling $8.3 million. For fiscal 2014, we did not repurchase any shares of our common stock. As of July 31, 2016, the total number of shares repurchased under the program was 53,456,801 and 44,543,199 shares were available for repurchase under our program.
On July 9, 2015, we completed a modified "Dutch Auction" tender offer, or tender offer, to purchase up to 13,888,888 shares of our common stock at a purchase price not greater than $36.00 nor less than $34.75 per share. In connection with the tender offer, we accepted for payment an aggregate of 6,254,061 shares of our common stock at a purchase price of $36.00 per share for a total value of $225.1 million. Additionally, on December 30, 2015, we completed a modified "Dutch Auction" tender offer, or tender offer, to purchase up to 7,317,073 shares of our common stock at a price not greater than $41.00 nor less than $38.00 per share. In connection with the tender offer, we accepted for payment an aggregate of 8,333,333 shares of our common stock at a purchase price of $39.00 per share for a total value of $325.0 million. Our directors and executive officers did not participate in the tender offers. The shares purchased as a result of the tender offers were not part of our stock repurchase program.
During fiscal 2016, 2015 and 2014, certain executive officers and employees exercised stock options through cashless exercises. A portion of the options exercised were net settled in satisfaction of the exercise price and federal and state minimum statutory tax withholding requirements. We remitted $15.0 million, $3.8 million and $0.1 million for the years ended July 31, 2016, 2015 and 2014, respectively, to the proper taxing authorities in satisfaction of the employees’ minimum statutory withholding requirements.
The exercised stock options, utilizing a cashless exercise, are summarized in the following table:
| Period | Options Exercised | Exercise Price | Shares Net Settled for Exercise | Shares Withheld for Taxes(1) | Net Shares to Employee | Share Price for Withholding | Tax Withholding (in 000s) | |||||||||||||||||
| FY 2014—Q1 | 14,000 | $ | 16.43 | 7,241 | 2,519 | 4,240 | $ | 31.77 | $ | 80 | ||||||||||||||
| FY 2015—Q1 | 201,333 | 19.59 | 124,621 | 35,416 | 41,296 | 31.65 | 1,121 | |||||||||||||||||
| FY 2015—Q3 | 139,690 | 20.27 | 76,021 | 20,656 | 43,013 | 37.27 | 770 | |||||||||||||||||
| FY 2015—Q4 | 200,000 | 12.02 | 66,602 | 52,158 | 81,240 | 36.08 | 1,882 | |||||||||||||||||
| FY 2016—Q4 | 1,130,000 | 18.64 | 410,648 | 293,152 | 426,200 | 51.30 | 15,039 |
| (1) | Shares withheld for taxes are treated as a repurchase of shares for accounting purposes but do not count against our stock repurchase program. |
Contractual Obligations
We lease certain domestic and foreign facilities, and certain equipment under non-cancelable operating leases. In addition to the minimum future lease commitments presented, the leases generally require us to pay property taxes, insurance, maintenance and repair costs which are not included in the table because we have determined these items are not material. The following table summarizes our significant contractual obligations and commercial commitments as of July 31, 2016:
| Payments Due by Fiscal Year | |||||||||||||||||||||||
| (In thousands) | Less than 1 year | 1–3 Years | 3–5 Years | More than 5 Years | Other | Total | |||||||||||||||||
| Contractual Obligations | |||||||||||||||||||||||
| Long-term debt, revolving loan facility, including current portion (1) | $ | 75,000 | $ | 163,000 | $ | — | $ | 400,000 | $ | — | $ | 638,000 | |||||||||||
| Interest payments on long-term debt, revolving loan facility, including current portion (1) | 20,486 | 39,386 | 39,150 | 114,491 | — | 213,513 | |||||||||||||||||
| Operating leases (2) | 23,217 | 36,333 | 22,624 | 61,904 | — | 144,078 | |||||||||||||||||
| Capital leases (2) | 1,124 | 2,002 | — | — | — | 3,126 | |||||||||||||||||
| Tax liabilities (3) | — | — | — | — | 25,641 | 25,641 | |||||||||||||||||
| Total contractual obligations | $ | 119,827 | $ | 240,721 | $ | 61,774 | $ | 576,395 | $ | 25,641 | $ | 1,024,358 |
| Amount of Commitment Expiration Per Period | |||||||||||||||||||||||
| Commercial Commitments (4) | Less than 1 year | 1–3 Years | 3–5 Years | More than 5 Years | Other | Total | |||||||||||||||||
| Letters of Credit | $ | 15,310 | $ | — | $ | — | $ | — | $ | — | $ | 15,310 |
| (1) | Revolving loan facility payments of $75.0 million and $163.0 million and related interest payments reflect management's intent for the use of the Revolving Loan Facility, which may change on a quarter by quarter basis. |
| (2) | Contractual obligations consist of future non-cancelable minimum lease payments under capital and operating leases, used in the normal course of business. |
| (3) | Tax liabilities include the long-term liabilities in the consolidated balance sheet for unrecognized tax positions. At this time, we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing of tax audit outcomes. |
| (4) | Commercial commitments consist primarily of letters of credit provided for insurance programs and certain business transactions. |
Credit Facility
On December 14, 2010, we entered into an Amended and Restated Credit Facility Agreement (Credit Facility), with Bank of America, N.A. The Credit Facility was an unsecured credit agreement providing for (i) a $100.0 million revolving credit facility, including a $100.0 million alternative currency borrowing sublimit and a $50.0 million letter of credit sublimit and (ii) a term loan facility of $400.0 million. On September, 29, 2011, we amended the Credit Facility increasing the amount of the term loan facility from $400.0 million to $500.0 million.
Credit Agreement
On December 3, 2014, we entered into a Credit Agreement with Wells Fargo Bank, National Association, as administrative agent, and Bank of America, N.A., as syndication agent, which superseded the Credit Facility. The Credit Agreement provided for (a) a secured revolving loan facility in an aggregate principal amount of up to $300.0 million, none of which was outstanding at July 31, 2015 (Revolving Loan Facility), and (b) a secured term loan facility in an aggregate principal amount of $300.0 million (Term Loan), which was fully drawn at closing. The Term Loan amortized $18.8 million per quarter. Proceeds from the Credit Agreement were used to repay all outstanding amounts under the Credit Facility totaling $275.0 million at December 3, 2014.
On March 15, 2016, we entered into a First Amendment to Credit Agreement (the “Amendment to Credit Agreement”) with Wells Fargo Bank, National Association, as administrative agent and Bank of America, N.A. The Amendment to Credit Agreement amends certain terms of the Credit Agreement, dated as of December 3, 2014. The Amendment to Credit Agreement provides for (a) an increase in the secured revolving credit commitments by $50.0 million, bringing the aggregate principal amount of the revolving credit commitments under the Credit Agreement to $350.0 million, (b) a new secured term loan (Incremental Term Loan) in the aggregate principal amount of $93.8 million having a maturity date of March 15, 2021, and (c) an extension of the termination date of the Revolving Loan Facility and the maturity date of the Term Loan from December 3, 2019 to March 15, 2021. The Amendment to Credit Agreement extended the amortization period for the Term Loan, and decreased the quarterly amortization payments for that loan to $7.5 million per quarter. The Amendment to Credit Agreement additionally reduced the pricing levels under the Credit Agreement to a range of 0.15% to 0.30% in the case of the commitment fee, 1.125% to 2.0% in the case of the applicable margin for LIBOR loans, and 0.125% to 1.0% in the case of the applicable margin for base rate loans, based on our consolidated total net leverage ratio during the preceding fiscal quarter. We borrowed the entire $93.8 million principal amount of the Incremental Term Loan concurrent with the closing of the Amendment to Credit Agreement.
On July 21, 2016, the Company entered into a Second Amendment to Credit Agreement (the “Second Amendment to Credit Agreement”) with Wells Fargo Bank, National Association, SunTrust Bank, and Bank of America, N.A., as administrative agent (as successor in interest to Wells Fargo Bank). The Second Amendment to Credit Agreement amends certain terms of the Credit Agreement, dated as of December 3, 2014. The Second Amendment to Credit Agreement provides for, among other things, (a) an increase in the secured revolving credit commitments by $500.0 million, bringing the aggregate principal amount of the revolving credit commitments under the Credit Agreement to $850.0 million, (b) the repayment of existing term loans outstanding under the Credit Agreement, (c) an extension of the termination date of the revolving credit facility under the Credit Agreement from March 15, 2021 to July 21, 2021 and (d) increased covenant flexibility.
Concurrent with the closing of the Second Amendment to Credit Agreement, the Company prepaid in full the outstanding $242.5 million principal amount of the Term Loan and Incremental Term Loan under the Credit Agreement without premium or penalty. The Second Amendment to Credit Agreement reduced the pricing levels under the Credit Agreement to a range of 0.125% to 0.20% in the case of the commitment fee, 1.00% to 1.75% in the case of the applicable margin for LIBOR loans, and 0.0% to 0.75% in the case of the applicable margin for base rate loans, in each case depending on the Company’s consolidated total net leverage ratio. The principal purposes of these financing transactions were to increase the size and availability under our Revolving Loan Facility and to provide additional long-term financing. The proceeds are being used for general corporate purposes, including working capital and capital expenditures, potential share repurchases, acquisitions, or other investments relating to our expansion strategies in domestic and international markets.
The Revolving Loan Facility under the Credit Agreement bears interest, at our election, at either (a) the Base Rate, which is defined as a fluctuating rate per annum equal to the greatest of (i) the Prime Rate in effect on such day; (ii) the Federal Funds Rate in effect on such date plus 0.50%; or (iii) an adjusted LIBOR rate determined on the basis of a one-month interest period plus 1.0%, in each case plus an applicable margin ranging from 0.0% to 0.75% based on our consolidated total net leverage ratio during the preceding fiscal quarter; or (b) an adjusted LIBOR rate plus an applicable margin ranging from 1.00% to 1.75% depending on our consolidated total net leverage ratio during the preceding fiscal quarter. Interest is due and payable quarterly, in arrears, for loans bearing interest at the Base Rate, and at the end of an interest period (or at each three month interval in the case of loans with interest periods greater than three months) in the case of loans bearing interest at the adjusted LIBOR rate. The interest rate as of July 31, 2016 on our variable interest rate debt was the one month LIBOR rate of 0.49% plus an applicable margin of 1.25%. The carrying amount of the Credit Agreement is comprised of borrowings under which interest accrues under a fluctuating interest rate structure. Accordingly, the carrying value approximates fair value at July 31, 2016, and was classified within Level II of the fair value hierarchy.
Amounts borrowed under the Revolving Loan Facility may be repaid and reborrowed until the maturity date of July 21, 2021. We are obligated to pay a commitment fee on the unused portion of the Revolving Loan Facility. The commitment fee rate ranges from 0.125% to 0.20%, depending on our consolidated total net leverage ratio during the preceding fiscal quarter, on the average daily unused portion of the revolving credit commitment under the Credit Agreement. We had $238.0 million of outstanding borrowings under the Revolving Loan Facility as of July 31, 2016 and no outstanding borrowings as of July 31, 2015.
Our obligations under the Credit Agreement are guaranteed by certain of our domestic subsidiaries meeting materiality thresholds set forth in the Credit Agreement. Such obligations, including the guaranties, are secured by substantially all of our assets and the assets of the subsidiary guarantors pursuant to a Security Agreement, dated December 3, 2014, among us, the subsidiary guarantors from time to time party thereto, and Wells Fargo Bank, National Association, as collateral agent.
The Credit Agreement contains customary affirmative and negative covenants, including covenants that limit or restrict us and our subsidiaries’ ability to, among other things, incur indebtedness, grant liens, merge or consolidate, dispose of assets, make investments, make acquisitions, enter into transactions with affiliates, pay dividends, or make distributions on and repurchase stock, in each case subject to certain exceptions. We are also required to maintain compliance, measured at the end of each fiscal quarter, with a consolidated total net leverage ratio and a consolidated interest coverage ratio. We were in compliance with all covenants related to the Credit Agreement as of July 31, 2016.
Note Purchase Agreement
On December 3, 2014, we entered into a Note Purchase Agreement and sold to certain purchasers (collectively, the Purchasers) $400.0 million in aggregate principal amount of senior secured notes (Senior Notes) consisting of (i) $100.0 million aggregate principal amount of 4.07% Senior Notes, Series A, due December 3, 2024; (ii) $100.0 million aggregate principal amount of 4.19% Senior Notes, Series B, due December 3, 2026; (iii) $100.0 million aggregate principal amount of 4.25% Senior Notes, Series C, due December 3, 2027; and (iv) $100.0 million aggregate principal amount of 4.35% Senior Notes, Series D, due December 3, 2029. Interest is due and payable quarterly, in arrears, on each of the Senior Notes. Proceeds from the Note Purchase Agreement are being used for general corporate purposes.
On July 21, 2016, we entered into Amendment No. 1 to Note Purchase Agreement (the First Amendment to Note Purchase Agreement) which amended certain terms of the Note Purchase Agreement, including providing for increased flexibility substantially consistent with the changes included in the Second Amendment to Credit Agreement, including among other things increased covenant flexibility.
We may prepay the Senior Notes, in whole or in part, at any time, subject to certain conditions, including minimum amounts and payment of a make-whole amount equal to the discounted value of the remaining scheduled interest payments under the Senior Notes.
Our obligations under the Note Purchase Agreement are guaranteed by certain of our domestic subsidiaries meeting materiality thresholds set forth in the Note Purchase Agreement. Such obligations, including the guaranties, are secured by substantially all of our assets and the assets of the subsidiary guarantors. Our obligations and our subsidiary guarantors under the Note Purchase Agreement will be treated on a pari passu basis with the obligations of those entities under the Credit Agreement as well as any additional debt that we may obtain.
The Note Purchase Agreement contains customary affirmative and negative covenants, including covenants that limit or restrict us and our subsidiaries’ ability to, among other things, incur indebtedness, grant liens, merge or consolidate, dispose of assets, make investments, make acquisitions, enter into transactions with affiliates, pay dividends, or make distributions and repurchase stock, in each case subject to certain exceptions. We are also required to maintain compliance, measured at the end of each fiscal quarter, with a consolidated total net leverage ratio and a consolidated interest coverage ratio. We are in compliance with all covenants related to the Note Purchase Agreement as of July 31, 2016.
Related to the execution of the Credit Agreement, First Amendment to Credit Agreement, Second Amendment to Credit Agreement, and the Note Purchase Agreement, we incurred $3.4 million in costs, of which $2.0 million was capitalized as debt issuance fees and $1.4 million was recorded as a reduction of the long-term debt proceeds as a debt discount. During the year ended July 31, 2016, we recognized an expense of $0.6 million for prior capitalized costs into interest expense relating to the Second Amendment to Credit Agreement and payoff of the outstanding Term Loans. Both the debt issuance fees and debt discount are amortized to interest expense over the term of the respective debt instruments and are classified as reductions of the outstanding liability.
Off-Balance Sheet Arrangements
As of July 31, 2016, we had no off-balance sheet arrangements pursuant to Item 303(a)(4) of Regulation S-K promulgated under the Securities Exchange Act of 1934, as amended.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including costs related to vehicle pooling, self-insured reserves, allowance for doubtful accounts, income taxes, revenue recognition, stock-based payment compensation, purchase price allocations, long-lived asset impairment calculations and contingencies. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Management has discussed the selection of critical accounting policies and estimates with the Audit Committee of the Board of Directors and the Audit Committee has reviewed our disclosure relating to critical accounting policies and estimates in this Annual Report on Form 10-K. Our significant accounting policies are described in the Notes to Consolidated Financial Statements, Note 1 — Summary of Significant Accounting Policies. The following is a summary of the more significant judgments and estimates included in our critical accounting policies used in the preparation of our consolidated financial statements. We discuss, where appropriate, sensitivity to change based on other outcomes reasonably likely to occur.
The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements and related Notes in Part I., Item I., “Financial Statements.”
Revenue Recognition
We provide a portfolio of services to our sellers and buyers that facilitate the sale and delivery of a vehicle from seller to buyer. These services include the ability to use our Internet sales technology and vehicle delivery, loading, title processing, preparation and storage. We evaluate multiple-element arrangements relative to our member and seller agreements.
The services we provide to the seller of a vehicle involve disposing of a vehicle on the seller’s behalf and, under most of our current contracts, collecting the proceeds from the member. Pre-sale services, including towing, title processing,
preparation and storage, as well as sale fees and other enhancement service fees meet the criteria for separate units of accounting. The revenue associated with each service is recognized upon completion of the respective service, net of applicable rebates or allowances. For certain sellers who are charged a proportionate fee based on high bid of the vehicle, the revenue associated with the pre-sale services is recognized upon completion of the sale when the total arrangement is fixed and determinable. The selling price of each service is determined based on management’s best estimate and is allotted based on the relative selling price method.
Vehicle sales, where vehicles are purchased and remarketed on our own behalf, are recognized on the sale date, which is typically the point of high bid acceptance. Upon high bid acceptance, a legal binding contract is formed with the member, and we record the gross sales price as revenue.
We also provide a number of services to the buyer of the vehicle, charging a separate fee for each service. Each of these services has been assessed to determine whether we have met the requirements to separate them into units of accounting within a multiple-element arrangement. We have concluded that the sale and the post-sale services are separate units of accounting.
The fees for sale services are recognized upon completion of the sale. The fees for the post-sale services are recognized upon successful completion of those services using the relative selling price method.
We also charge members an annual registration fee for the right to participate in our vehicle sales program, which is recognized ratably over the term of the arrangement, and relist and late-payment fees, which are recognized upon receipt of payment by the member. No provision for returns has been established, as all sales are final with no right of return, although we provide for bad debt expense in the case of non-performance by our members or sellers.
We allocate arrangement consideration based on the relative estimated selling prices of the separate units of accounting containing multiple deliverables. Estimated selling prices are determined using management’s best estimate. Significant inputs in our estimates of the selling price of separate units of accounting include market and pricing trends, pricing customization and practices, and profit objectives for the services.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements in ASC 605, Revenue Recognition. ASU 2014-09 is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. We are currently evaluating the impact of implementing ASU 2014-09 on the consolidated financial statements, as well as evaluating the adoption date and transition alternatives.
Fair Value of Financial Instruments
We record our financial assets and liabilities at fair value in accordance with the framework for measuring fair value in U.S. GAAP. In accordance with ASC 820, Fair Value Measurements and Disclosures, as amended by Accounting Standards Update 2011-04, we consider fair value as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants under current market conditions. This framework establishes a fair value hierarchy that prioritizes the inputs used to measure fair value:
| Level I | Observable inputs that reflect unadjusted quoted prices for identical assets or liabilities traded in active markets. |
| Level II | Inputs other than quoted prices included within Level I that are observable for the asset or liability, either directly or indirectly. Interest rate hedges are valued at exit prices obtained from the counter-party. |
| Level III | Inputs that are generally unobservable. These inputs may be used with internally developed methodologies that result in management’s best estimate. |
The amounts recorded for financial instruments in our consolidated financial statements, which included cash, accounts receivable, accounts payable and accrued liabilities approximate their fair values for fiscal 2016 and 2015 due to the short-term nature of those instruments, and are classified within Level II of the fair value hierarchy. Cash equivalents are classified within Level II of the fair value hierarchy because they are valued using quoted market prices of the underlying investments. See Notes to Consolidated Financial Statements, Note 8 — Long-Term Debt for additional fair value disclosures.
Vehicle Pooling Costs
We defer in vehicle pooling costs certain yard operation expenses associated with vehicles consigned to and received by us, but not sold as of the balance sheet date. We quantify the deferred costs using a calculation that includes the number of vehicles at our facilities at the beginning and end of the period, the number of vehicles sold during the period and an allocation of certain yard operation expenses of the period. The primary expenses allocated and deferred are certain facility costs, labor, and vehicle processing. If our allocation factors change, then yard operation expenses could increase or decrease correspondingly in the future. These costs are expensed as vehicles are sold in subsequent periods on an average cost basis. Given the fixed cost nature of our business, there is not a direct correlation for an increase in expenses or units processed on vehicle pooling costs.
We apply the provisions of accounting guidance for subsequent measurement of inventory to our vehicle pooling costs. The provision requires that items such as idle facility expense, double freight and rehandling costs be recognized as current period charges, regardless of whether they meet the criteria of “abnormal” as provided in the guidance. In addition, the guidance requires that the allocation of fixed production overhead to the costs of conversion be based on the normal capacity of production facilities.
Long-lived Asset Valuation, Including Intangible Assets
We evaluate long-lived assets, including property and equipment, and certain identifiable intangibles, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets is measured by comparing the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the use of the asset. If the estimated undiscounted cash flows change in the future, we may be required to reduce the carrying amount of an asset.
Capitalized Software Costs
We capitalize system development costs and website development costs related to our enterprise computing services during the application development stage. Costs related to preliminary project activities and post implementation activities are expensed as incurred. Internal-use software is amortized on a straight-line basis over its estimated useful life, generally three years. Management evaluates the useful lives of these assets on an annual basis and tests for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets. Total gross capitalized software as of July 31, 2016 and 2015 was $49.4 million and $65.1 million, respectively. Accumulated amortization expense related to software as of July 31, 2016 and 2015 totaled $20.9 million and $42.6 million, respectively. During the year ended July 31, 2016, we retired fully amortized capitalized software of $29.8 million, which were no longer being utilized.
During fiscal 2014, we terminated a contract with KPIT (formerly known as Sparta Consulting, Inc.), whereby KPIT was engaged to design and implement an SAP-based replacement for our existing business operating software that, among other things, would address our international expansion needs. Following a review of KPIT’s work performed to date, and an assessment of the cost to complete, deployment risk, and other factors, we ceased development of KPIT’s software and internally developed a proprietary solution in its place.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts in order to provide for estimated losses resulting from disputed amounts billed to sellers or members and the inability of our sellers or members to make required payments. If billing disputes exceed expectations and/or if the financial condition of our sellers or members were to deteriorate, additional allowances may be required. The allowance is calculated by taking both seller and buyer accounts receivables written off during the previous 12 month period as a percentage of the total accounts receivable balance. A one percentage point adverse change to the write-off percentage would have resulted in an increase to the allowance for doubtful accounts balance of $2.3 million.
Valuation of Goodwill
We evaluate the impairment of goodwill for our reporting units annually or on an interim basis if certain indicators are present by comparing the fair value of the reporting unit to its carrying value. Future adverse changes in market conditions or poor operating results of the reporting units could result in an inability to recover the carrying value of the investment, thereby requiring impairment charges in the future.
Income Taxes and Deferred Tax Assets
We account for income tax exposures as required under ASC 740, Income Taxes. We are subject to income taxes in the U.S., Canada, the U.K., Brazil, Spain, Germany, and other emerging markets around the world. In arriving at a provision of income taxes, we first calculate taxes payable in accordance with the prevailing tax laws in the jurisdictions in which we operate. Then we analyze the timing differences between the financial reporting and tax basis of our assets and liabilities, such as various accruals, depreciation and amortization. The tax effects of the timing difference are presented as deferred tax assets and liabilities in the consolidated balance sheets. We assess the probability that the deferred tax assets will be realized based on our ability to generate future taxable income. In the event that it is more likely than not, the full benefit would not be realized from deferred tax assets, we record a valuation allowance to reduce the carrying value of the deferred tax assets to the amount expected to be realized. As of July 31, 2016, we have $5.4 million of valuation allowance arising from both our U.S. and International operations. To the extent we establish a valuation allowance or change the amount of valuation allowance in a period, we reflect the change with a corresponding increase or decrease in our income tax provision in the consolidated statements of income.
Historically, our income tax provision has been sufficient to cover our actual income tax liabilities among the jurisdictions in which we operate. Nonetheless, our future effective tax rate could still be adversely affected by several factors, including (i) the geographical allocation of our future earnings; (ii) the change in tax laws or our interpretation of tax laws; (iii) the changes in governing regulations and accounting principles; (iv) the changes in the valuation of our deferred tax assets and liabilities; and (v) the outcome of the income tax examinations. We routinely assess the possibilities of material changes resulting from the aforementioned factors to determine the adequacy of our income tax provision. The repatriation of our accumulated foreign earnings could also affect our effective tax rate, nevertheless, we intend to indefinitely reinvest these earnings in our foreign operations and do not anticipate the need for any of our foreign subsidiaries’ cash in the U.S. operations. Accordingly, we do not provide for U.S. federal income and foreign withholding tax on these earnings.
Based on our results for the twelve months ended July 31, 2016, a one percentage adverse change in our provision for income taxes as a percentage of income before taxes would have resulted in an increase in the income tax expense of $4.0 million.
We recognize and measure uncertain tax positions in accordance with ASC740, Income Taxes, pursuant to which we only recognize the tax benefit from an uncertain tax position if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. We report a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. ASC740 further requires that a change in judgment related to the expected ultimate resolution of uncertain tax positions be recognized in earnings in the quarter in which such change occurs. We recognize interest and penalties, if any, related to unrecognized tax benefits in income tax expense.
We file annual income tax returns in multiple taxing jurisdictions. A number of years may elapse before an uncertain tax position is audited by the relevant tax authorities and finally resolved. While it is often difficult to predict the final outcome or the timing of resolution of any particular uncertain tax position, we believe that our reserves for income taxes reflect the most likely outcome. We adjust these reserves, as well as the related interest, where appropriate in light of changing facts and circumstances. Settlement of any particular position could require the use of cash.
Stock-based Payment Compensation
We account for our stock-based awards to employees and non-employees using the fair value method. Compensation cost related to stock-based payment transactions are recognized based on the fair value of the equity or liability instruments issued. Determining the fair value of options using the Black-Scholes Merton option pricing model, or other currently accepted option valuation models, requires highly subjective assumptions, including future stock price volatility and expected time until exercise, which greatly affect the calculated fair value on the measurement date. If actual results are not consistent with our assumptions and judgments used in estimating the key assumptions, we may be required to record additional compensation or income tax expense, which could have a material impact on our consolidated results of operations and financial position. During the year ended July 31, 2016, we early adopted ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which impacts the accounting for share-based payments, including income tax consequences. As a result of the adoption, we recognized excess tax benefits of $14.7 million as a reduction to tax expense in the consolidated statements of income, as though ASU 2016-09 had been in effect since the beginning of fiscal 2016, instead of reflected in stockholders' equity.
Foreign Currency Translation
We record foreign currency translation adjustments from the process of translating the functional currency of the financial statements of our foreign subsidiaries into the U.S. dollar reporting currency. The Canadian dollar, British pound, U.A.E. dirham, Bahraini dinar, Omani rial, Brazilian real, Indian rupee, and Euro are the functional currencies of our foreign subsidiaries as they are the primary currencies within the economic environment in which each subsidiary operates. The original equity investment in the respective subsidiaries is translated at historical rates. Assets and liabilities of the respective subsidiary’s operations are translated into U.S. dollars at period-end exchange rates, and revenues and expenses are translated into U.S. dollars at average exchange rates in effect during each reporting period. Adjustments resulting from the translation of each subsidiary’s financial statements are reported in other comprehensive income.
Retained Insurance Liabilities
We are partially self-insured for certain losses related to medical, general liability, workers’ compensation and auto liability. Our insurance policies are subject to a $250,000 deductible per claim, with the exception of our medical policy which has a $500,000 stop loss per person. Our liability represents an estimate of the ultimate cost of claims incurred as of the balance sheet date, including an estimate for reported and unreported claims. The estimated liability is not discounted and is established based upon analysis of historical data and actuarial estimates. The primary estimates used in the actuarial analysis include total payroll and revenue. Historically, our estimates have not materially fluctuated from actual results. While we believe these estimates are reasonable based on the information currently available, if actual trends, including the severity of claims and medical cost inflation, differ from our estimates, our consolidated results of operations, financial position or cash flows could be impacted. The process of determining our insurance reserves requires estimates with various assumptions, each of which can positively or negatively impact those balances. The total amount reserved for all policies is $5.3 million as of July 31, 2016. If the total number of participants in the medical plan changed by 10%, we estimate that our annual medical expense would change by $1.8 million and our accrual for medical expenses would change by $0.4 million. If our total payroll changed by 10%, we estimate that our annual workers’ compensation expense and our accrual for workers’ compensation expenses would change by less than $0.2 million. A 10% change in revenue would change our insurance premium for the general liability and umbrella policy by an insignificant amount.
Accounting for Acquisitions
We recognize and measure identifiable assets acquired and liabilities assumed in acquired entities in accordance with ASC 805, Business Combinations. The accounting for acquisitions involves significant judgments and estimates, including the fair value of acquired intangible assets, which involve projections of future revenues, cash flows and terminal value, which are then either discounted at an estimated discount rate or measured at an estimated royalty rate, and the fair value of other acquired assets and assumed liabilities, including potential contingencies and the useful lives of the assets. The projections are developed using internal forecasts, available industry and market data and estimates of long-term growth rates of our business. Historical experience is additionally utilized, in which historical or current costs have approximated fair value for certain assets acquired.
Segment Reporting
Our U.S. and International regions are considered two separate operating segments and are disclosed as two reportable segments. The segments represent geographic areas and reflect how the chief operating decision maker allocates resources and measures results, including total revenues, operating income and income before income taxes. The segments continue to share similar business models, services and economic characteristics although recent changes in management structure and continued growth in our International region have resulted in the change in our reportable segments. Our revenues for the year ended July 31, 2016 were distributed as follows: U.S. 80.1% and International 19.9%. Geographic information as well as comparative segment revenues and related financial information pertaining to the U.S. and International segments for the years ended July 31, 2016, 2015 and 2014 are presented in the tables in Note 14 — Segments and Other Geographic Reporting, to the Notes to Consolidated Financial Statements, which are included under in Part II, Item 8 of this 10-K.
Recently Issued Accounting Standards
For a description of the new accounting standards that affect us, refer to the Notes to Consolidated Financial Statements — Note 1 — Summary of Significant Accounting Policies.
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