ALLETE Inc (ALE) 2002 Q2 法說會逐字稿

Good day and welcome everyone to the Allete second quarter 2002 earnings results conference call. Today's call is being recorded. Your line will be muted for the presentation. Then we will conduct a question and answer session period. At that time you can press the star or asterisks key followed by the digit 1 to signal you have a question. This conference call may contain forward-looking statements within the meaning of Federal Securities law, including statements concerning business or strategies and results and similar statements concerning anticipated future events and expectations that are not historical facts. These forward-looking statements are made pursuant to the Safe Harbor Act and the Private Securities Litgation Reform Act of 1995. The forward-looking statements in the earnings release distributed this morning reflect management's best judgment at this time. But all such statements are subject to numerous risks and uncertainties which could cause actual results to differ materially from those expressed or applied by the statement therein. Additional information containing potential factors that could affect future financial results is included in the company's annual reports and from time to time in the company's filings with the SEC. At this time I would like to introduce the chairman, president and chief executive officer Mr. David Gartzke. Please go ahead, sir.

Thank you. Good morning, everyone. With me again this morning is Jim Vizanko, chief financial officer. Today we reported earnings per share for the second quarter of 47 cents. This includes charges associated with our exiting from the vehicle transport business, including these charges earnings per share for the quarter were 50 cents. Last year's quarterly earnings per share of 57 cents did include the largest real estate transaction we've ever had. Jim will now give you some details for the quarter.

Good morning. Energy services net income was about equal to last year's second quarter. Total kilo hour sales were up over last year. But were offset by weaker wholesale market prices. During the quarter our coal fired generating service at (inaudible) harbor and northern Minnesota (inaudible) outside of Chicago began operations. As a result, we had 2.8 million dollars of income from the mark-to-market of Kendall County long-term sales contracts. Net income from our automotive services business was up 8.7 million dollars or 42 percent from last year's second quarter due to EBITDA improvement, mandated accounting change relating to goodwill amortization and lower interest expense. EBITDA increased 13 percent from last year, due to a combination of fee increases, new services at process improvements. This offset a slight decrease in vehicles sold at auction from last year. In other words, vehicles sold at auctions declined and net income rose 42 percent. The number of vehicles sold at auction this quarter was below our expectations and reflects fewer cars brought to auction from car rental companies. We believe rental car volumes will increase during the second half of the year. Fleet and leased vehicles continue to be strong. AFC had another strong quarter. Its total portfolio was up 12 percent over last year and 536 million dollars and the credit quality remains solid. Units financed increased four percent over the same period last year. Net income from investments was down 14.9 million dollars from last year. 11 million of this difference is from reduced income at our real estate operations over last year's second quarter. Which included the Tarpon point sale. The securities portfolio included a one percent after tax loss versus a 2.4 percent tax gain, which resulted in four million dollars less net income than the same period last year. This continued operations include quarterly activity at water services and great rigs. Water services net income was over last year because of higher consumption rates and the discontinuance of depreciation expense. This quarter includes the final entry recording our exit from great rigs. Dave.

Before we take your questions, I would like to make some additional comments. Most importantly, I would like to provide an update on the planned sales of our water assets. The Florida governmental utility authority has recently announced that they plan to delay the approvals of the purchase until September. We're going to continue to work with them as we explore other sale opportunities. The closing of this transaction may not occur until early 2003. With regards to heater utilities we've recently hired UBS Warburg to facilitate that sales process. And we expect and anticipate that sale to be completed by early 2003 as well. The sale of the water assets has taken longer than we had anticipated when we first entered into the agreements. Some folks may say we should have expected these delays simply because of the number of public systems that are involved in this approval process. But I want you folks to be assured that the board of directors and myself are committed to selling these water assets to either the Florida governmental utility authority or to another party at an acceptable price. Looking ahead, we continue to be bullish about our two core competent sis. The second quarter performance of our automotive services business demonstrates ability to drive efficiencies at the auctions we're currently doing business in. We expect efficiency gains, fee increases, new products and services at these auctions to continue. And this is what gives us confidence that the earnings growth of automotive services will continue at the rates we've experienced into the future. We also expect that the rental car volumes that Jim was talking about earlier at our auctions will return to normal later this year. We remain comfortable with our previously stated goal of 30 percent earnings growth for 2001, or over 2001 for automotive services, which is 20 percent absent the goodwill accounting change. The third quarter is typically the highest net income quarter for energy services. And this year certainly won't be any exception. Our profitability will be impacted by wholesale power prices, as you know, during the next couple of months. Our base retail business remains strong. And this is very important to understand. And we continue to have the lowest cost generation in our region. In order to eliminate our future exposure to security market uncertainties that we've all experienced over the last month or last several months we made the conscious decision to liquidate our securities portfolio which has served this company quite well over the past ten years. We plan to use the proceeds to reduce our debt balance. And our balance sheet continues to be strong. We recently completed a mid-year review of our businesses. And based on that review we are revising our earnings per share guidance for the year to the two to $2.10 range, which excludes the five cent exit charge we've realized and any potential gain in the sale of water assets. This estimate takes into account our year to date performance, our revised expectations for the second half of the year, which will include the elimination of the securities portfolio, and lower wholesale power prices than originally anticipated at the beginning of the year. That concludes our formal comments. And now we would like to take your questions

Thank you. The question and answer session will be conducted electronically. If you would like to ask a question you may do so by pressing the star key followed by the digit 1 on your touch tone telephone. Again, ladies and gentlemen to ask a question, that's star 1 on your touch tone telephone. We'll pause for a moment to assemble our roster. Our first question comes from David Schanzer with David Montgomery.

Good morning. I know that it's probably difficult given market conditions in both kinds of markets, real estate and securities. But could you give us just a rough idea of when you expect to have finished exiting both the utility income portfolio and the real estate?

Speaking of the securities portfolio, the piece that's traded in-house will be liquidated in the next few days. The money that we have in partnerships, most of that money will be liquidated at the end of August and there's a slight piece that goes beyond that.

Does that include the venture capital stuff?

No, it doesn't. We're not liquidating the venture capital. And the real estate is on a regular time frame. Our regular time frame is five, seven year liquidation. And some of that is far along in that process, some of the things we've recently purchased are just starting that process. And venture capital, we have sold some venture capital pieces. But we're not liquidating the rest of the portfolio right now.

Okay. Thank you

We'll go next to Ron (Masherco) Winchester Capital.

In the same vain I just want to see if I had a handle on all the nonrecurrent items or items that could be construed as not operating, including any loss that - does the two to two.10 guidance include any loss of sale on securities and what other items might be in there, thanks?

What's in there is the exiting of our transportation businesses, which is great rigs and our Canadian transportation business.

That's five cents.

That excludes it, though.

Okay.

There's one other piece of that. That's the electric odyssey retail business. The sum of those are five cents. There will not be an exit charge with the portfolio. The portfolio is mark-to-market.

So they're already written down. Okay. Good. Thank you

We'll go next to John lan sa Robert Baird.

I think you covered this I apologize for missing it but you talked about the increase auction efficiency. Could you go over again exactly some of those efficiencies that were gained.

The efficiencies gained, we had some fee increases, we had some new services. And some of it is cutting costs, just really analyzing and looking at what it costs at various auctions to do some of the same processes. If it costs us a certain amount of money at one auction to do something, it's costing us more it's trying to ring that out auction by auction.

We've stated that when we acquired the auctions, the nine from the (Manheim) sale and also the Canadian auction group, the percentage of revenue or the EBITDA the percent of revenue from those auctions were substantially below our experience which is a major efficiency. And we have been continually improving those percentages year over year. And that certainly was the case this quarter, having a significant impact on the efficiencies of the whole company.

In fact, Dave mentions, this was not mentioned in our comments but if you look at the second quarter, if you look at EBITDA divided by revenues for the entire automotive services, that increased from 28 percent to slightly over 31 percent.

Okay. What were some of these services that you added?

Well, we provide remarketing services, reconditioning services. We recently acquired a new business last year that's called auto vend that provides inspection services. That's a service that's provided outside of, in addition to our captive auctions and our finance company to other companies as well.

Sounds good. Thanks, guys

We'll go next to George (Rubus) (Angela Gordon) and company.

Good morning. The mark-to-market amount you gave was 2.2 million.

2.8 million.

Is that pretax or after tax?

After tax.

That's after tax. Separately, the cost of your debt you'll be paying down.

In the short-term we are retiring commercial paper which is very low cost. As you know. But we also have first mortgage bonds that we'll be addressing as soon as we possibly can that are approximately eight percent interest cost debt.

Okay. Is it fairly safe to say that the amount of that portfolio was roughly 150 or 160?

Yes.

Is that the number we should be expecting for the debt to be paid down?

Yes.

In combination with long-term and short-term and total.

So as a result, I'm just trying to reconcile back a little bit here to the downward revision of five cents. It seems like that the portfolio loan would have been a little bit more than that. Is there something else that's doing better than the budget originally to have been revised only five cents?

It's more than five cents. I believe our guidance in the past was 213 to perhaps 215 to 216. Now we're seeing that the range is beginning at two dollars up to $2.10. To look at the low end of the range I think is giving full effect to the elimination of the securities portfolio and also a perhaps more pessimistic view of the power markets. But the power markets, as we go into August and September, as we see the prices improving, could be better than what history has given us this year. And also the volumes could return as the rental cars refleet to improve the performance in automotive services giving us the upside of that range.

Okay. And the sale of the water business, how is that reflected in the guidance for this year? , prior to -

We've never reflected the water sale as a part of the earnings performance for this company. In fact, the way we've viewed the earnings absent any gain recognition of the water sale for us is to be neutral to the company's earnings. So if sold, absent gain recognition and deployed either in debt retirement, hauling of equity securities redeployment of other assets our belief is we would be able to manage that to the same point we would be had we not sold it. In the short-term.

Just a little bit more. On energy services, if I look at energy services versus last year, the trading and marketing piece of that business appears to have been a lot more weaker, because if I sort of look at, listen to your comments about the utility business, which seems to be fairly flat, maybe slightly down, then the bulk of the weakness is it safe to assume it was trading?

The weakness has been in the prices, not so much the quantity of the power sold, but certainly the prices, which affect the margins. And keep in mind that this is for the first half of the year. The second half of the year we will have all of the LTV assets, capacity of energy available to be able to resold as well.

Can you just give me an update, this is my last question, on those assets as far as how much forward you've sold?

Kendall County we've sold 100 out of the 275 megawatts. In attack night harbor we have sold just a small relatively small piece of that. And Kendall County has been completely sold for the summer.

It's very important to keep in mind when answering that question the relative costs of the two facilities and the opportunity and/or exposure that we think we may have. The LTV assets, burn coal, base load facilities, and they dispatch at 16, 17 dollars or one and a half cents a kilowatt hour which is very, very low. So to the extent that power prices which are currently during peak periods at $40, that increment of 15 to 40 makes a significant contribution to the return on our investment in that asset, which is also relatively low. So given the current market situation, I think it would be foolish for us to lock into longer term contracts out of that asset. That is not the case with Kendall, however, because the investment and the cost characteristics are different.

Did you say sold entirely through the summer?

Kendall County, yes.

So does that mean that any up side in prices you've already locked in with Kendall County?

There's about 40 megawatts of energy to be sold.

The capacity is completely sold through the summer.

Okay. Thank you very much

We'll go next to Ed war Doe San DA with UBS Warburg.

I had a quick question. Can you break out the income from this discontinued operations of 5.6 million between great rigs and your Canadian transport?

I don't believe we disclosed that. If we haven't I don't believe that we can. You're asking for the breakout of the great rigs and Canada and U.S. separately?

Yes what's the components of the 5.6, since it's a lump sum number.

What we do break out obviously is the exit piece of that. The exit piece of, as you can see in the footnote with this discontinued operation, we break out that there's 3.1 million, four cents a share for the exit in the auto transport and the retail odyssey business year to date. And since there was two cents in the first quarter, we have an additional two cents this quarter. And there's white set from exiting the auto transport business. Obviously a big piece of this is water. I mean the only other piece that's really missing here is the operating losses of great rigs. And that certainly is a relatively small piece of that total 5.6 million.

Okay. Thank you

We'll go next to Walter Kirchberger with UBS Warburg.

We're sure gaining up on you. I'd like to sort of get your take a little bit on the auto unit volume issue. Certainly at least from our perspective the number of units that went through auction in the second quarter were probably a little lower than we had anticipated.

They were lower than we anticipated as well, Walt.

How significant, you mentioned rental fleets, how significant are rental fleets to your business?

Rental fleets do provide at least 20 to 30 percent of the vehicles that come to the auction. It is a significant source. And we've been told that they're at about 93 percent of what their normal, this is the rental fleets in general, of their normal levels are. So that tells us that there's still refleeting and their turnover of vehicles accelerates significantly once they get to 100 percent and the mileage accumulates. But they're in the refleeting mode and we expected this to have come to an end quicker than it did. But we're expecting that they will get there in the second half of the year and the turn overs which is what we depend on will kick in in the second half of the year. But we were surprised it took this long for that to refleet.

Maybe I'm somewhat confused. Help me on this. Aren't the rental fleets probably operating less vehicles than they were a year ago in line with the decline in air travel and more importantly business travel?

I'm sure they have.

And if the fleets in aggregate are somewhat lower than the normal turnover would bring a smaller number of cars into auction on a more or less continuing basis.

Well, that's true in the short-term. I think the 9- 11 event is still with us and has had that effect in the short-term. But relative to us, that certainly has impacted our volumes being off from what we had. But relative to second half relative to the first half we still expect our volumes to pick up. If we can hold out on our efficiency being in with those volume pickups we'll be still ahead in our plans but you're right in your observations.

But I think we believe that the rental fleets are not significantly off of where they were. I mean they're lower but they're not significantly off.

Okay.

But I would agree with you that you should expect or we would expect that they would be in the short-term on a run rate basis perhaps lower than they were a year before. How much that's going to affect our business we can't tell you.

All right. Now, the other part of this is basically if I've understood this correctly, I mean the auto business, the number of vehicles on a macro basis really isn't growing all that much. So your opportunity is efficiencies and market share as opposed to waiting for more vehicles from normal suppliers?

Absolutely. And we have had significant gains in that market share arena. Absolutely. And that's my point which would be in my closing comments that we continue to focus on the opportunity that we have for market share, especially given the entrance into the major markets that we're a part of the strategy when we acquired the nine locations that we have.

But there is some growth in total cars. We forecast growth of approximately three percent in the total cars, total car market going forward.

Thank you.

Next question comes from Jeff (inaudible) from (inaudible) capital.

Can you give us the goodwill contribution to the auto earnings and then what the same same growth rate would be for the quarter?

The breakout of the pieces the goodwill, the interest expense and the EBITDA piece for that 42 percent?

Yes.

About half of that is EBITDA and a quarter of that is goodwill and a quarter of that is lower interest expense. So that essentially is 20 percent of the 40 is EBITDA. 10 and 10 for the other two pieces.

Which I think is consistent with our expectations at the beginning of the year. And that is significant improvement in the line. So again we feel very good about the ability of our company through the fee increases, which is something that is a big part of the equation. Also the efficiencies, products and services to be able to bring this kind of growth even in a flat market.

So then does that growth rate compare, if I do the math, to about the same as the EBITDA growth rate for the quarter then, or perhaps a little better than that, I guess? The 13 percent?

EBITDA increased 13 percent over last year.

Okay. Can you give us any indication on wholesale pricing just over the last few weeks, where that's going.

Are you talking about the power pricing?

Yes.

The power pricing over the last month has certainly improved as the temperatures improve and the demand for power in our region on an incremental basis is priced outside of the base mode facilities that burn coal into the facilities that burn gas. So that has had the effect of moving the dispatch prices or wholesale prices from 26 to $40, just in one month. So to the extent that continues, it puts more pressure on the facilities that perhaps our peak is running more than they typically do could only serve to hopefully improve that price.

And can you just review what the composition of that investment portfolio was? I guess I'm a little confused. If you're paying down commercial paper, there was no opportunity to just reallocate that investment position and it sounds like either through the water sale or maybe additional cash flow is really when you would start to pay down the eight percent bond. So it just doesn't seem like a good after tax type of investment decision.

In the short-term it may appear that way. We will be calling bonds as soon as practically possible.

Of course that's not going to come from the investment portfolio liquidation?

Certainly.

And then does that affect, given the pushout of the water sale and the fact that you're going to liquidate the portfolio and pay down the paper, does that affect the ability to grow the auto business? Or where are they getting the cash to grow from an acquisition standpoint?

We will continue to focus on our capital expenditures to be able to generate positive cash flow as an organization to provide that liquidity to do so and as we approach our 2003 plans, that will even be more of a focus to be able to improve our cash flow liquid advertise and give us the flexibility absent the need to go to the market to fund our growth initiative. We expect, as we mentioned that the heater transaction to close early in 2003 and hopefully the Florida transaction will close prior to that.

Is auto on a free cash flow positive at this point?

None of the acquisitions and the large store build outs, they are.

Thank you very much.

Once again ladies and gentlemen to ask a question that's star 1 on your touch tone telephone. We do have a follow-up question from David Schanzer from David Montgomery Scott.

Would you be able to characterize what would be necessary to dispose of Florida water services should the part of the municipal government association not reach an agreement or for whatever reason the deal falls through, without going into the detail as to how you would go about selling it, or disposing of it, would you need some sort of letter or some assurance from Florida about eminent domain?

Eminent domain being condemnations from the counties?

Yeah.

I think it would depend upon who the buyer was. I mean some buyers might look towards having an asset that may be purchased from them by counties in the future. And some buyers may not. I think it depends on who the buyer is. I think obviously somebody coming in and buying this, if the FUA doesn't complete that transaction, would be aware of that what's happened and buy on those terms. And I think the whole idea of eminent domain or condemnation, I mean we've been very successful with those in the past. We've gotten a full purchase price for our assets when that has happened.

Okay.

We'll go next to Beth willing with wood land partners.

I have a bunch of questions. Good morning. As kind of a follow-up to the water sale issue. If I remember correctly you drew a line in the sand and you said okay if we don't have a deal by this date then we're going to pursue other parties; is that correct?

I don't know if we really have drawn a line in the sand. But I will tell you that, which is a fact that everybody knows, the exclusivity agreement has expired, so therefore we are free to explore alternatives and we certainly are doing that at the same time that we are continuing to negotiate with the GUA.

And have other interested parties approached you?

Certainly, yes.

So you're doing multiple negotiations at the same time?

I would think that's fair to say, yes.

And is your expectations for the price the same? I think you talked about 520 million, if that's correct.

That's a price that is public information. But certainly with the -

As far as other prices we're looking at other options we've not disclosed any other options or any other prices at this time.

I don't think we can be in a position to do so, Beth.

Okay. I guess what I just want to understand is that you're not just waiting to do the deal with Florida, in fact, you potentially could strike a deal with somebody else sooner?

That is true, yes.

But at the same time we're still continuing to work with them. We still continue to talk to them. We have not shut them out of the process either.

We appreciate the process that we're going through. We're disappointed no question about it about the delays we've had. But there are 12 to 13 public entities that have to agree to their respective parts of this transaction. And we're respectful of that process as to how much more time we can have the patience to be respectful of that process is the question. But at the same time we're pursuing other options.

Okay. And I want to make sure I understand better that the number, the revised number, the two to two.10 versus two, to 2.15, the two dollars is the number you're estimating if you don't get improved power markets and you don't get better volumes out of the car market; is that correct?

That's correct.

And when you talk about improved power markets, I want to better understand it. Are you talking about volumes or are you talking about pricing?

Pricing.

Now, it's been pretty hot recently.

Yes, it has.

So I'm struggling with your cautiousness about pricing when we all know how hot it's been.

And in saying that, it's important to note that what drives up prices is the cost of the generating units that are being dispatched into that market. And currently there are peaking facilities that are fueled by gas, therefore the current prices are a function of gas prices. And gas prices currently have come down, not moved north, which has had an impact to put somewhat of a cap on those prices at $40. So how long that can continue is I think the real question, because there is an inventory of gas that fuels these facilities that is causing the short-term damping on the prices at the current levels we're experiencing.

It doesn't matter it's been really hot because that doesn't -

If it continues then they'll continue to absorb more of that inventory and it will put pressure on gas prices.

And then in terms of - is any part of this revision - what part of this revision is due to the securities portfolio being sold? As you look at the 150 to 160 you're going to get and you're going to pay down debt and reduce interest expense, I mean that interest expense offsets the lost income from the securities portfolio.

To a certain extent. But I think if you look at the past experience that we've had with the securities portfolio, being conservatively invested, earning returns on an after tax basis in the five to six range, five to six percentage point range, given our current commercial paper rates are, you can easily do the math, I think, to determine what the impact on an earnings, related to that spread is to this company. And I would guess it's fair to say that it's approximately a dime. So it's a big part of the guidance reduction for our company.

Yes. And your decision to liquidate the securities portfolio at this point in time is what?

It's related to the performance, the first half of the year where we've not lost money but the amount of money made, which is pretty close to zero, relative to the perception of risk that the marketplace may think that we're taking puts us in a situation where we think it's prudent not to take that risk for that additional return going forward.

Right because here's the problem I'm having, Dave, which is if you look at your revision, it's related to - somewhat related to the tough economic environment. But it seems to me, based on what you just said, it's more related to the liquidation of the securities portfolio. Is that a correct statement?

That's correct. And perhaps a little bit affected slightly by the experience we've had year to date in the power market.

And the problem is, not that I need to tell you how to write your press releases, but I think if you had made it more clear that your revision is due to your desire to clean up the company and make it simpler to understand and your decision more to focus on power and auto, I mean as you read the press release it's not clear. So just in the interests of clarity in a rather challenging equity market environment where simpler and easier things to understand -

I appreciate what you're saying, Beth. It was our intention and our plan going into the year, based on many years of successful experience in the securities portfolio, to continue to have that form of liquidity until such time as we were to the point where the water assets were being sold and we were looking at larger acquisitions and then we would have much larger scale reallocation of our assets and the portfolio in general. So this was a premature liquidation.

It's the right decision, clearly, because although in the short-term it impacts earnings. In the long-term it makes - you're paying down debt and you're making the company easier to understand?

That's true.

My only thought I'll get off the subject. It's that's not clear in the press release. I think if you had said on a proactive business we're liquidating the securities portfolio, we're selling it in an effort to make this company simpler to understand and pay down debt, I think that would have been a better way to convey your strategic step. The other question I have, with your stock down $2.23, you and I have spoken about this at great length at what point does the board of directors step? Say okay we're finally going to start to buy back stock?

That's a very good question. I'm not in the position to answer that right. Now but it certainly is one of the alternatives going forward that we'll always consider.

So is it on the docket?

We will currently given the capital structure of the company for the next six months it's probably not on the docket, but as we approach the closing of the water dispositions, I'm sure it will be there.

Okay. Great. Thank you

We'll go next to Gary Steiner with A 1 asset management.

Good morning. I was wondering if you could comment a little bit on where conversion rates are today. What was the trend during the quarter, where it was during last year, and given the recent special finance deals offered by the big 3, whether you expect that to have any impact in the next few months or so.

The conversion rates for last year, for the second quarter, were 58 and a half percent. For this year, for second quarter, it was 59.7, which is much closer to normal for this time period. We expect around 60 percent. You could see the year to date numbers. These numbers are shown in the bottom of the last page of our press release. Year to date was 61 percent last year and 62.6 percent this year. They were much higher in the first quarter, but in our estimation that first quarter was more an unusual time period for that number. It's more back to what we would say to be a normal type number.

So the conversion rates were actually down year over year and I know the conversion rates do tend to have some impact on your margins.

They're actually up slightly.

I'm sorry, you're right. 59.7 versus 58.5. Did that have a meaningfully positive effect on the margin in the quarter which was really a nice positive?

Yes, certainly.

Because I guess in the second quarter your auto results, your income growth was meaningfully better than in the first quarter. How much of that was driven by conversion rates versus some of the other factors you mentioned before?

We don't have that breakdown. It certainly was a piece of it. I don't know if we can take a stab at that.

I don't think we can.

I don't think it's a large, very large piece of that. But certainly a contributing piece.

Okay. And your thoughts on conversion rates going forward, given - I guess it was last year where you had the special finance programs offered by the big 3, which really had an impact on your conversion rates in the near term. What are you guys seeing so far and what are your thoughts on the third quarter?

I think we're returning to quote, unquote what is average. I was going to use the word normal. But what is average for the mix of vehicles that we run through our auctions. It depends on the mix that you have. If you have mostly a consignment type sale your conversion rates are going to be lower. If you have more of an institutional type of a sale, they're going to be higher. Our blended average, typically, in the normal market is about 60 percent. When we have unusual activity like we did in the first quarter of this year, it was high. It was 69 percent. And then when things hit us like they did in September 11, it was substantially less than that. But we're seeing now, and you can see statistically that we're recovering and we're returning back to what we would consider normal conversion, which is good.

Gartzke. Now what we need is a return to what we would consider to be the normal growth in the volume that comes through our auctions.

You don't expect any material change in the conversion rates?

No, we don't.

I was wondering, there's not really been much conversation about the salvage operations, and I was wondering, when you guys talk about doing 66s acquisitions for a while you've been relatively quiet for a while, have you been slowing that down at all because of the fact that the water sale has dragged out or is just nothing materialized there?

We're continuing discussions with a number of independents. First of all I think it's important to know what we have. We have the 11 in Canada. The nine we acquired from APC. In addition to that we are integrating four combination sites and we've recently acquired ADESA Co east which added 24,000 cars or a 24 percent increase in the cars that we've sold. So we think we're on plan. I think it's important to also keep in mind that when you at least from our experience, when you grow a business like this through acquisitions and tuck in green fields which we've done before with ADESA it took us five years to grow that business from a 20 percent market share. The two larger chain competitors that are in the industry that currently have approximately 20 percent of the market share made their first investment in 1991 and 1992. So if you do it prudently and you don't overpay and you buy the facilities in the right locations that fit you strategically, you're not going to go out and buy a 20 percent or a 10 percent market share in a quarter. But we certainly are pursuing it.

And there's no - you haven't run into any major obstacles like there are not a lot of good companies out there that are available or pricing is too expensive or anything like that?

No. It's a matter of just negotiating transactions that make sense for us and are strategic to us.

Okay. Couple other quick things. AFC had a, if I recall, this quarter had much stronger growth in the portfolio relative to the prior quarter. And I was just wondering if there was any explanation for that?

No, nothing unusual that I can think of, other than just perhaps a better - yeah, seasonal growth, from quarter to quarter it's different. Just like any other business.

If I recall, you guys were building a big auto auction somewhere in California. I forget exactly where.

Southwest of San Francisco. We are building and will have I believe it's going live or construction will be completed in the first part of August. And it's going to be a significant increase in the capacity from where we're currently located in that market. It's going to be - it will be the largest auction that we own. It will be a state of the art obviously facility in the auction industry. So I invite - I encourage folks on this call to contact Mr. Thorp. And at your convenience as well we would certainly love to show you this facility.

Okay. Just the last question. I guess given the stock price and one of the issues that's been maybe talked about in the past has been the fit of the two core businesses that you guys have, the energy versus the auto business. Given that auto continues to perform very well and with the exception of the September 11th events has really been a very consistent strong grower for you guys and now sort of the disappointment with the numbers from businesses other than auto. Does that sort of accelerate in your mind the thought process relative to splitting these two businesses?

To us the two businesses continue to make sense for the time being, because of the cash flow currency that they each have for each other. And the balance sheet strength that the two have together. We like our credit rating for our lead in total. It serves the entire company quite well. And I think that's very important. As we go forward to the extent that the companies can stand alone and have access to the capital markets on a stand alone basis is very critical to us. We will see where rationalized and all of this restructuring that we're going through this year and we realize we have a lot of moving parts is behind us and we get into 2003 where you can clearly see the two businesses that we're in and we continue to manage the cash flow of each of the two businesses and in a much easier way for you folks, especially, to be able to see the year over year value of the two businesses, we will then have to take another look at whether or not the market will ever be able to understand the value of those two businesses being combined and we'll have to make the decision at that time.

Great. Thanks a lot, Dave

We'll go next to Charles Matthew (Cole), LCD.

Good morning. Actually, the last two question askers addressed a little bit or a great deal about what I wanted to talk about. But the lady that touched on the stock buy back and then your last few comments, Mr. Gartzke, about going forward in 2003. About 11 months ago there was a change with Ed going out and you guys are going to drive values to 35 bucks. And I understand it's unfortunate as to what's happened in the marketplace and a lot of companies are sharing in this. If you liquidate the investment portfolio, may I ask first, does that also include all the real estate you're going to get out of the real estate end of the investment portfolio also?

No, it does not.

That's just purely the securities?

Purely the securities portfolio.

So you're driving towards a three legged stool, then.

We're driving towards a two legged stool. Don't be confused the real estate is a relatively small part of the corporate liquidity. We currently have resources, staff resources in place with the current real estate holdings we have in the state of Florida and an orderly sale of those assets over the next five to six years will produce very nice rates of return and cash flow to the business and we don't have much choice with respect to that. So we will hold it and enjoy those returns until they're sold.

You have added to those assets in this calendar year, if I'm mother mistaken.

Not this year, Charlie last year we did.

Are you out of an acquisition mode down there and you're going to liquidate over the next five to seven years?

We are developing a strategy for maximization of value of liquidation of that business over the next five years. If there's small parcels that may be available adjacent to facilities that we have in place that make it more salable in total, we may be pursuing that. But not in an aggressive way.

And then as we move into the end of 2002 and hopefully you either have the water company sold or close to closing and looking at a 2003, we're going to see some guidance going forward about two companies and what they're doing together?

Yes.

And with a little respect in this calendar year about splitting those companies up, to try to drive that $35 or more?

The timing was split up.

The timing was split up. I didn't understand exactly what your question was. It all depends on the perception - first of all, the ability to do so with respect to access to capital. And then secondly the perception of what that value gap is and how permanent we may think it might be.

Right. I mean anybody can understand the core business is doing great.

The core business is our strong business and obviously it's our strategy to simplify as much as we possibly can and that's the transition process that we're going through this year that may be very complicated and I'm sure it is. But hopefully at the end of the year, once it's been flushed out, and we clearly have these two businesses going forward, that we can focus on, then hopefully the market will give us a better shake with respect to value in the marketplace.

And one last thing. You addressed it but I want to make sure I'm clear about it. Your conservativeness as a company keeps you from addressing the possibility. At what point is we stop too cheap or is it purely a management of funds decision? For a buy back.

I know what you're saying. It's certainly a function of price and it's also a function of the capital structure that we think is important to maintain to per serve our credit rating.

Thank you. I appreciate it. Keep banging away. You have a tough job, but you're doing better than most

We'll go next to (Ala Montroni) with (inaudible).

Thanks most of the questions have been asked. What's your current cost of debt?

Is that the question.

Yes.

Probably low sevens pretax, probably around seven cents pretax.

Commercial paper is about five and a half cents pretax. Seven percent is long-term.

So it seems, in a market where rates seem to be going down continuously, it seems like you guys have relatively high cost of paper. Is the strategy going forward as you pay down some of this debt to partly reissue some low cost debt and term it out of it?

The debt we have available to call at the current time is the seven and three-quarters, little less than eight percent debt that Dave had mentioned earlier. Then we have some QIPs that are currently callable. The rest of the debt is not callable at this time.

So you can't take advantage of some of the low prices in the market right here?

The interest rates in general are low but to offset that, our spreads are relatively high. If we were to finance today, seven percent rate isn't for longer term debt that far out of the market.

Oh, no, of course not. It seems like there was an opportunity right here. So I wanted to see if you were going to take advantage of it.

The opportunity is in the short-term side and in the short-term side we do have - we issued a couple years ago a floating rate bond and we do have commercial paper outstanding. So we do take advantage of the short-term side. I think as Dave clarified for me, our overall cost of debt is less than that seven percent number just because we have some short-term commercial paper and floating rate debt that's in the two and a half three percent number.

Can you remind us what your payout ratio strategy is in terms of where you like - what's the sweet spot as to where you like the dividend to be relative to earnings.

We don't have a specific target because it depends on the opportunity to redeploy the capital and also the amount of cash that the company needs and also a function of our expected earnings growth. Last year we increased the dividend for the first time in a number of years as it crossed down into the 50s with respect to the payout ratio. I think that the 50s are a nice range for us to operate in. And to the extent that we are able to continue to grow our earnings in a double digit rate, I'm sure that the board will be reconsidering dividend action from time to time. But we can't and won't specifically identify a payout ratio, nor specifically a dividend increase plan.

Okay. Lastly, can you tell, you mentioned the 00:59:14 salvage operations, can you talk a little bit as it relates to the 00:59:18 salvage operations, the competitive environment that you're seeing 00:59:20 out there? 00:59:22 >> DAVID GARTZKE: Like the whole car auction, we have very good 00:59:26 competitors in the whole car auction business. (Manheim) is 00:59:32 certainly a strong competitor. We have a lot of respect for them 00:59:36 and I'm sure they do for us. 00:59:38 In the salvage business, the two that entered the business back in 00:59:42 the early'90s, (Cole) part and IAAI have 20 and 17 percent of the 00:59:50 market, respectively, leaving 50 percent available for us to 00:59:52 address in our strategy. They're good competitors. They've been 00:59:58 around for some time. We have a lot of respect for them. But there still is ample room for another competitor just like there is in the whole car business. But I would take a look at those two companies if I were you, and we certainly have. And they're very good at what they do, especially coal part.

Thank you very much

We'll go next to Matt Burr with Labor Management.

Good morning. Just a couple quick questions. How of the new wave of zero percent financing affect the automotive business?

The zero percent financing has certainly affected the price of the vehicles. But it has not had an impact that we are aware of directly on the volume of cars that come to the auction, which is what determines our profitability as we get fees from cars that are sold at auctions. So to the extent that reduction in prices affects volumes would impact our business if it did. But so far it hasn't.

What it can in the future affect volumes on the positive side to us obviously if someone buys a new car they could be trading an old car which could be recycled into the auction business. And the other side of the potential negative people could buy a new car versus a used. But -

There isn't a hold back scenario because of the reduction in prices where people aren't getting those cars quicker than the other way.

I don't think it's September 11th. It's certainly a different scenario. It's more of a, I don't want to say continuation of rebates, but they weren't suspended very long really when this was in place. It's just bringing that back and we've been dealing with that now for zero percent financing for I don't know five or six months. Late last year and early this year.

And what kind of free cash flow are you expecting to generate from the automotive and the utility business?

I don't know if we publicly stated what that number is.

I don't think that's changed from - I mean the change in cash comes from the securities portfolio liquidation.

Okay. Thank you

We have a follow-up question from George (Rubus) (inaudible) company.

Was there any real estate or investment technologies contribution in this quarter?

Yes, there was real estate - from a venture capital portfolio. But there was not a large piece like Tarpon point in the first quarter last year. But there were ongoing sales from the real estate portfolio. Like there have been every quarter.

Okay. And is it safe to assume that the automotive DNA lease expense and interest expense were fairly similar to the first quarter of this year? There were no big changes there, were there?

I would guess no change at all.

So the bulk of the margin improvement then came from the efficiencies? Because there was a pretty big margin improvement.

Efficiencies at the auction, absolutely.

I think efficiencies, fee increases, new services were all a piece of that.

Is this ahead of your schedule at this point? Because the reason I ask that is if volumes were down somewhat and below your budget, but yet it sounds like the EBITDA is running ahead of budget, at least the margin portion is, does that mean you're getting much more out of the efficiencies part.

Yes, it is. We're getting more out of the efficiency part than we expected. The unfortunate part is the volumes are less than we expected so we ended up pretty much at net net of the place we planned to be.

I think that's why we see such great potential for this last half of the year. If we keep these efficiencies that we've realized and volumes coming up, the net volume basically flows to the bottom line to a large degree. And putting it where we expected it. We stated at the beginning of the year we thought net income from automotive services would be up 30 percent. Year to date we're up 40 percent.

Going back to one of the earlier questions asked regarding the acquisition strategy for the salvage business, has there been any change I guess to purchase some of these properties given that you haven't finalized the water business yet? The sale of the water business?

I don't think we've ever tied our strategy of salvage to the proceeds of the water business. I think we thought certainly that the proceeds from water would provide capital to do that. But we haven't waited for salvage for the water to be sold. I mean we bought (inaudible) not waiting for water. It's one of the issues of coming to what we want to purchase more so than waiting for the money.

So the revisions in earnings does not reflect any kind of slow down in the new salvage business?

No. And I think that's a good point. Whatever we've given guidance, we've never included acquisitions in that guidance. That always would come on top of what our guidance is.

What was the AFC contribution to the automotive EBITDA or net income.

We don't disclose that. We get that question frequently but we don't break that out.

Was there any difference in the corporate expense from the past, because in the past you used to disclose that. So if we look at sort of the historical numbers, is there anything different this time?

No, not significantly.

Okay. Thank you very much

We'll take our final question from Gary Steiner with A 1 asset management.

Just two quick follow-ups. On the acquired auto businesses, I think you had thrown out some numbers before, but I'm not sure I got them. I was wondering where the margins are today versus where they were when you acquired them. And kind of what your goal is out of those businesses and maybe just real quick kind of what actions you've taken specifically at those operations to get the margins up.

Are you talking about the EBITDA margins and the percent of revenue, Gary?

Correct.

I think we've made it public that the acquisitions were averaging about 18 percent when acquired. And from time to time we've mentioned improvement in those percentages. And as it has affected the overall percentages for the company. Our experience, and we hope that the experience on average of our mature stores will increase as well, has been running around 35 percent. As Jim mentioned earlier, on average right now I think we're up to 31 percent. So you can see there's been a significant improvement for the whole system going from 28 to 31 all in. That suggests that those acquired stores are doing a heck of a lot better than they were last year. But statement the automotive services group has done a terrific job in looking at ways to even improve the 35 percent at the mature stores with even a higher number and that continues to be our exciting challenge and opportunities as we look at different services and different efficiencies and quicker ways to clean the cars as they come through and taking more cars through the auction with fewer people, using information technology. And I should probably stop for a second and talk about that. The company has invested a significant amount of money in information technology and it's a very, very valuable asset to have in this business, when you have so many moving parts. And so much communication between your customers and your employees as to the parts that are moving, et cetera, keeping track of providing good information into good management system. That will have a tremendous amount of value to us bringing tremendous efficiencies to us going forward. But it will also be a very valuable tool and weapon, so to speak, in our competitive position with the information we provide to our customers. And that's a part of the increase in our expense this year that we consciously made. So had we not made that investment this year, and part of it is going through the income statement, part of it on the balance sheet, we would have done much better than we're currently doing. And we will get the fruits of that investment in the years. And that will improve our efficiencies.

But I guess my sense was for the next call 12 to 18 months that the bigger opportunity was really on the acquired operations because the margins were so low there. And -

In the short-term that's true but we would be remiss if we did not continue to look for ways to just improve our overall competitive position for the whole organization. That's really the bottom line here in terms of value creation. And certainly it's great to grow the company through acquisition opportunities. No question about it. But to take it to another level, to be a competitor with a national platform, to have better information systems, tools, more products and services, that's really our focus for growth and value and performance.

That's great. And those guys have done a great job. Just one last thing. You mentioned before that auto was up 40 percent year to date. And that you have given guidance for 30 percent for the year. I'm just wondering, given there were a lot of questions before about sort of the earnings reduction and piecing out the different pieces and of course the securities portfolio is a big portion of it. And I think the tone of one of the questions earlier was basically that the entire earnings reduction can be explained by the securities portfolio and if the assumption now is that power prices are a little weaker than what we might have thought, maybe that's not incorporated in the earnings reduction. I'm just wondering if maybe part of this is that auto just seems to be running a little bit better than expectations and might make up for a little weakness elsewhere?

It could if the volumes come back. That's true. We're right on schedule with respect to the very bottom line contribution to the company. Fortunately the efficiencies offset what we expected from volumes. But as Jim mentioned earlier, the volumes come back and we hold our efficiencies, then you're correct, absolutely, it will make up for some of the losses that we have incurred in the first half of the year. And be somewhat of an offset to the cost of us shutting down the securities portfolio as well.

And the key in your opinion in terms of the volumes coming back is largely just whether the rental cars come back?

Yes, it is. There may be others, but none as large as that principal source.

And you guys probably get reasonably good feedback from those, from the rental car companies and I guess are they telling you that the volumes are going to increase in the second half?

That's our expectation. As far as telling us exactly when they're going to come back, they have not. But they're telling us that they're increasing their levels of utilization, getting closer to what normal levels were, whatever that may be, to a point that was made earlier. That may not be exactly 100 percent as it was two years ago, but certainly north of where they are today.

Great. Thanks a lot

Mr. Gartzke, there appears to be no further questions at this time. I'd like to turn the call back over to you for any additional closing comments.

Thank you. As also always I want to thank you for your time and your questions and certainly your interest in our company this morning. I will admit that there are a lot of moving parts to this company this year. And this is certainly by design and I'm not going to apologize for the confusion that's created for the company. It is by design and we're attempting to explain every detail, every part of what we're doing through the year as we do it. The acquisition of great rigs, the shutting down of the odyssey, exiting water. The accounting changes. This is full disclosure. Hopefully as best we possibly can so you can understand exactly what we're doing. But the objective is at the end of the day, at the end of the year that we will have two businesses that will be easy to understand and that collectively we'll continue to provide growth to this company. I need to close again by reiterating our strategy, just to make it clear in everybody's mind what it is and perhaps the fact that it has not changed. Energy services and the strength it has is its low cost generation in the markets we serve. We recently added LTD, as you know, to that asset base, as well as Kendall County. And that will be leveraged going forward. The current market situation is such that we're not getting the margins perhaps in the short-term that we will get in the not too distant future. We're certain that the growth in the (map) region relative to the supply side in the equation will tighten. That was part of the strategy when we did it. And we made that investment and we're confident that it's going to create future value. The recent auction services acquisitions that we made gave us entrance into major markets. And that's very, very important to understand. And we're going to continue to focus on ways to leverage that national presence to make us an extremely strong competitor in that industry. And last, and probably the one that everyone is most interested in, is the water services transaction. I just want to assure everyone that we are certainly committed to selling these properties and hopefully we'll be able to announce something later this year as to when we'll be able to close on both of those transactions. Again, thank you for your time and your interest and as I've always said, we will continue, Jim, myself, and Tim Thorp, to meet with you individually and to return your calls. Thank you

This does conclude today's conference. We thank you for your participation. You may now disconnect.