Openlane Inc (KAR) 2006 Q3 法說會逐字稿

Good day, and welcome to the Adesa Inc.'s third quarter 2006 earnings conference call. Today's call is being recorded. For opening remarks and introductions, I would like to turn the conference over to Mr. Jonathan Peisner, Vice President of Investor Relations of Adesa. Please go ahead, sir.

Good morning, everyone, and thanks for joining us today on Adesa's third quarter 2006 earnings conference call. Joining me on today's call are Dave Gartzke, our Chairman and CEO; A.R. Sales, President and COO; and Tim Clayton, our CFO. Also with us today are Chuck [Taft], [DVP] of Sales and Marketing and Ron Beaver, our CIO.

Before we begin today's call, I'd like to remind you that this conference call contains forward-looking statements. Such statements, including statements regarding the Company's and industry's 2006 outlook, future volume increases and trends in used vehicle sales and conversion rates are subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those projected, expressed or implied by such forward-looking statements.

The earnings press release from last night and slides that are now available on our website have the full text of the safe harbor statement, and you should refer to it in the context of the statement made on this conference call.

To further assist you on this call, we have compiled a set of slides that can be viewed under the Investor Relations section of our website along with 2006 and historical quarterly segment income statements and statistics. We posted our slides earlier this morning to our website, AdesaInc.com, and hopefully you've had a chance to review them. Following today's call, the webcast replay and slides, along with the telephone replay, will also be available on our website.

Many of the numbers we'll be discussing today can be found in yesterday's press release or on the slides and other information on our website and in this webcast. Some of the financial metrics we'll be discussing, such as EBITDA, are non-GAAP measures, and as such, they're reconciled to GAAP in the slides.

I'd now like to turn this conference call over to our Chairman and CEO, Dave Gartzke.

Thanks, Jon, and good morning, everyone. Yesterday, Adesa reported third-quarter revenue of $273 million, bringing our year-to-date revenue to $834 million. Similar to our first and second quarters, the record revenue level is a result of more vehicles coming to auction, which is a positive trend and consistent with our internal expectations.

The third quarter also saw a continuation of lower year-over-year conversion rates. The decline narrowed significantly compared to what we saw the first and second quarters; therefore, we're encouraged that this trend continues to be -- or appears to be improving.

DSG continued its strong performance, seeing growth in both loan transaction volume and revenue per transaction.

For the quarter, we reported EPS of $0.38 versus $0.35 cents in the prior year. Given that retail used vehicle sales for the quarter posted the steepest percentage decline in the last decade, we're very pleased with our third quarter results.

Last quarter, we told you that the retail used vehicle market should be improving towards the end of the year, and in September, it began to turn around. Some of the signs of improvement include the falling gasoline prices, which in part led to the first price increase for the full-size SUVs since April of '04. Retail vehicle prices are back into the 50% to 60% price band of new vehicle prices, which is significant for used vehicle sales at our auctions. And last, retail used vehicle sales appear to be rebounding, as the 5.1 August to September sales increase is a very positive move.

These are all positive developments which provide optimism about auction sales and conversion rates for the fourth quarter and into '07.

On that note, I'll turn it over to Tim for more details on our financial results. Tim?

Thanks, Dave, and good morning. I'd like to provide a little more commentary on the quarterly results before Dave and A.R. take you through the quarter's strategic and operational highlights.

On a consolidated basis, Adesa reported revenues of $273 million for the quarter ended September 30, 2006, which represents a 13%, or $32 million, increase over the third quarter of 2005. Similar to last quarter, the growth in revenue was due to increases in a number of areas, including auction ancillary services revenue, principally for reconditioning and transportation services, increased as 15,000 more institutional vehicles were entered during the quarter.

Fee income also increased in the quarter as a result of selective price increases and higher vehicle values versus last year. Increases in the number of loan transactions and revenue per loan transaction resulted in 12% revenue growth at our Dealer Services Group. And finally, acquisitions and changes in foreign currency exchange rates also contributed to our revenue improvement.

While Adesa experienced strong revenue growth during the quarter, our operating margins decreased to 21.4% from 23.2% in the third quarter last year, as much of the incremental revenue was related to lower-margin ancillary services from the additional institutional cars coming to auction. Another factor impacting the operating margins for the quarter was that our conversion rate was 58.2% as compared with 58.8% last year, or a decrease of approximately 60 basis points. This was the lowest third quarter conversion rate since 2002. As a result, we incurred costs to handle more vehicles coming to auction and incurred costs associated with vehicles that didn't sell.

These factors, coupled with compensation adjustments, increased transportation and fuel costs and the effect of foreign currency changes resulted in our operating costs growing slightly faster than our revenue.

On a consolidated basis, SG&A increased 13% or $7.2 million, due principally to normal increases in compensation, FAS 123(R) costs of $0.8 million, newly acquired auctions and the effect of foreign currency changes.

Consolidated operating profit decreased by $2.4 million or 4% as improvements at our Dealer Services Group more than offset higher holding Company and slightly -- and a slight operating profit decline in our Auction Services Group.

Interest expense dropped to $7.1 million, a decline of $0.3 million. This was driven by lower debt levels from normal debt repayments during the quarter, partially offset by higher rates.

Income taxes increased as compared to last year by $2.1 million, as the effective tax rate increased about 80 basis points, and Q3 2006 pre-tax income was up $4.9 million. The year-ago quarter was favorably affected by a provision to return adjustment. The decline in the effective rate versus the second-quarter tax rate is primarily due to the final settlement of pre-spin-off tax matters with our former parent company. We expect our tax rate in the fourth quarter to be similar to that which we had in the first half of the year.

Net income for the quarter was $31.4 million, or $0.38 per diluted share, versus $31.5 million, or $0.35 per diluted share in the third quarter last year. The third quarter last year included non-recurring costs associated with debt refinancing activities. After adjusting for the impact of these costs, third quarter 2005 net income would have been $33.1 million or $0.37 per diluted share.

Turning to our individual business units, revenue at our Auction Services Group increased $28 million or 14%. The primary drivers were higher fee income, in part related to the increase in the value of vehicles being sold, volume-driven ancillary revenue from shop and transportation services and benefits from recent acquisitions. Vehicles sold in the quarter rose 16,000 units to 492,000 units, while revenue per vehicle rose 10% to $480 dollars per vehicle.

Cost of services increased by $21 million, primarily as a result of costs associated with providing additional shop and transportation services, including $400,000 more for fuel, and higher costs associated with handling 15,000 more used vehicles than [in] prior year. Currency changes also adversely affected our costs. SG&A costs increased $6.4 million due to normal compensation adjustments, newly acquired auctions and foreign currency. Some of this increase is also related to the increase in vehicles entered as we incur incremental costs to target and process vehicles into the auction. ASG's incremental stock-based compensation for the quarter was $0.5 million.

Operating profits at the Auction Services Group decreased $0.7 million as compared with the prior year as incremental handling costs associated with increases in vehicles entered coupled with the lower conversion rate caused our operating costs to increase without the associated auction-block revenue.

At our Dealer Services Group, we saw continued strong growth in loan transactions and revenue per loan transaction, causing revenue to increase 12% in the quarter. Like last quarter, this revenue growth was primarily due to increases in vehicle values, interest rates and a slightly longer average loan life.

Operating costs were relatively flat in the quarter, which enabled us to leverage our infrastructure for processing the incremental loan transaction volume. Combined, this resulted in a $4.1 million increase in DSG operating profits, which climbed from $20.3 million a year ago to $24.4 million in the current quarter.

Loan transaction volume for the quarter rose 5% to 290,000 units. Driven by this growth and benefits from higher interest rates and vehicle values, revenue per loan transaction rose 7% to $127. At quarter-end, the portfolio stood at $787 million versus $665 million in last year's third quarter. Similar to prior quarters, the portfolio was 95% current.

EBITDA for the quarter was $72.2 million versus $66.3 million last year. After adjusting the prior year's quarter for the effects of the debt refinancing costs, EBITDA was up $3.5 million or about 5%. The current year amounts obviously include the $800,000 expense related to the adoption of FAS 123(R).

Debt for the quarter -- at the quarter-end was $360 million, down $57 million from June 30, 2006. We increased the efficiency of our capital structure by paying down $50 million of revolving debt at the end of the quarter. As a result, our debt-to-capital ratio at quarter-end was $23.1 million -- 23.1% versus 26.3% last quarter. In addition, we're pleased that in September, Moody's upgraded our senior credit facility to Ba1.

Cash at the end of the quarter was $218 million, of which $45 million was available for strategic use. Available cash was down only $13 million from the second quarter despite paying down our revolver and completing the Texas salvage acquisitions. As of September 30, we had $247 million of availability on our revolver.

As we look to the end of 2006, our earnings guidance for EPS is to be at the lower end of the previously issued guidance range of $1.47 to $1.55 per diluted share. This guidance includes both the impact of FAS 123(R) and previously incurred charge related to Kitchener.

Lastly, CapEx for the first nine months totaled $24 million. As a result, we now expect fiscal 2006 CapEx to be $10 to $15 million below our prior guidance of $48 million.

And with that, I'll turn it back over to Dave.

Thanks, Tim. I want to take this opportunity now to provide you with a brief update on our strategic initiatives, and then A.R. will talk about operational developments as well.

Acquisitions -- during the quarter, we announced the completion of the acquisition of three salvage sites in Texas, which gives us a significant presence in the second largest salvage market in the United States. We're very pleased with this transaction. I think it'll serve our salvage strategy and our Company very well. I also feel very good about our acquisition pipeline, which unfortunately is all I can say.

Organic growth -- we're actively working to expand our auction facilities to support additional growth. We've recently announced the addition of our Syracuse, New York facility, which our 42nd salvage site. We also announced the groundbreaking of Kansas City in our last call, and we expect to have this facility completed by late next year. We continue to be aggressively looking for land to expand the Phoenix and the Dallas facilities as well.

In addition to our auctions, we're also looking at a number of markets for expansion of AFC, including major markets where we don't currently have a presence as well as some markets that require additional loan production offices.

I'd now like A.R. to walk you through some of the other operational developments for the third quarter. A.R.?

Thanks, Dave. We had a good quarter from an operating standpoint. We continue to win accolades from our customers with the Company receiving Toyota's Premier Award at the recently concluded NAAA conference.

In addition to that, we further strengthened our e-business team with the hiring of [Bob Shane] as Vice President of E-Business. This allows us to move forward with a consolidated approach under Bob to all of our e-business efforts. Most recently, we executed the consolidation of two existing Internet auction platforms into one so that the Dealer Block and Bid Now and the Buy Now are on the Adessa.com platform.

Most importantly, we continue to make progress and move forward with the one operating mindset that Dave has talked about for some time. We're finding that the realignment of the business groups back in June is leading to significantly better coordination of dialogue with customers, yielding additional opportunities for AutoVin, for PAR and for the salvage operation.

And just as importantly, we've talked to you in the past about our desire to transition the Company to a lien-service environment. I'm pleased to report that the operational excellence, which as you might recall has two components -- one is process standardization; the other one is centralization -- has now moved to the execution phase. We have the internal resources in place. The rollout is underway as we speak, with site reviews of our key value-added processes. We have targeted three auctions, two in the U.S. and one in Canada, that we believe will provide the baseline for the best practice on the processes that are being reviewed. This will be completed during quarter four, and we expect the implementation to begin in earnest the first quarter of 2007.

Just as importantly, our move to centralized purchasing is now gathering steam with a Purchasing Director now in place. So we continue to be excited about our ability to execute in all of the operational objectives that we've set forth.

That concludes my comments. Operator, we'd now like to turn this call over to Q&A. Following the Q&A, Dave with have a few brief closing remarks.

[OPERATOR INSTRUCTIONS] And we'll take our first question from Brett Hoselton from KeyBanc Capital Markets. Please go ahead, sir.

Hi, guys. This is [Brandon Farrow] for Brett. Can you guys walk through the what looks to be -- I think it's about an $18 million organic revenue increase in the Auction Services Group and maybe kind of highlight the breakdown there, whether it's higher ancillary service fees or price increases or higher used vehicle prices? Can you bucket the $18 million increase?

We can go through that. We typically don't break out that level of detail, but as we mentioned in the call, the primary drivers were higher auction ancillary services. That's probably the most significant driver of that, which includes the shop and transportation. The second most significant, if you will, would be the price increases that we saw across auction and salvage, which is -- we don't really break out between fee increases and the value of the vehicles going up, which is a significant factor in that.

Those are -- and -- those are the primary drivers of that, and then the currency effects for the Canadian exchange rate was probably another significant factor.

When you -- I think part to the organizational realignment, too, was to better structure yourselves to increase dealer awareness of some of the benefits on ancillary service fees relative to some of the institutional consigners. Are you seeing that? I mean, are you seeing increased dealer penetration on some of those ancillary services yet? Has that yielded any benefits? Or --?

Yes, I think we really haven't focused that particular piece. I think the realignment is really more focused on the dealer consignment side, on getting to that space with better information, and if Chuck wants to comment after I finish, but we now have the SalesForce.com platform rolled out. We're in the process of rolling out the e-mail companion to that. And so the bulk of the efforts during the third quarter in the dealer space has been to roll out the platforms and get to the dealers with a more information-based approach, which we believe is beginning to pay dividends in terms of bodies in the lane.

Chuck, do you want to add anything?

Well, what -- our primary focus now is getting them to use our core services to buy and to sell, and then we'll try to penetrate that market later. We're trying to get them to use auctions more rather than use other ways of wholesaling their vehicles.

Okay. And then if we were to basically assume the same used vehicle demand environment as we move into '07 that currently exists, can we think about the increase in the institutional supply of vehicles next year as off -- lease returns a little bit, how would you see that affecting conversion rates relative to where we are today, which is sub-60%?

Well, it gets back to the mix of the vehicles that we'll have net of those two changes. As you know, the typical conversion rate for the dealers is in the mid-40s, and a typical conversion rate, certainly, for the institution is higher than what we're experiencing today but certainly significantly higher than that. So I think that we're mostly concerned about the relative conversion rates of those two, not so much about the blend or the mix of the two and what the blended outcome is for the whole organization.

So our expectation for next year is that hopefully we're going to continue through the initiatives on the dealer focus to improve our conversion rates for the dealers and also see an increase in our conversion rates for the institutions as well, certainly, relative to this year.

The blended rate, I think, is something that we really can't speak to today.

And then, lastly, why the reduction in CapEx guidance? Any areas where there were specific shortfalls year-to-date and for the fourth quarter?

Well, I think the most, I guess, specific one would probably be in the area of IT, as Ron has come in during the year and done a, really, a thorough assessment of where we are. And as a result, we had kind of slowed down our spending and plans during the year as Ron kind of got his hands around things, and that's probably the main reason from a timing standpoint. That might -- would just slide into '07.

Okay. Thank you, guys.

Thanks, Brandon.

And we'll take our next question from Matt Nemer from Thomas Weisel Partners. Please go ahead, sir.

Good morning, everyone.

Hello, Matt.

Morning, Matt.

First question is -- can you break out the same-store growth in units for the whole car business and the salvage business? Is that something that you've done?

No, we really, Ron -- Matt, this is Jon. We have not broken it out by each separate area. Overall, it was just slightly up, but we don't break it out into further detail than that, Matt.

Okay. And then, any additional color on the changes in fees or price increases? Is that just the standard annual increase? Or is there something specific there?

Well, we -- as you know, the prices [or] the values of the cars coming through the auction are increasing as well. And because of our fee schedules, that gives us an increase in the revenues per car sold as well. So that certainly has been a benefit to us, a significant benefit to us, both on the Auction Services side as well as the Dealer Services side. And I'm sure that there's been some modesty increases as well.

Okay. And then, turning to compensation expense, I was just curious if that's a metric in the auction business that's tied to revenue increases. It seems like with your operating profit down slightly, I was curious to see that compensation expense was up, and there was incremental option expense. Can you sort of walk us through what metrics that's tied to? I realize it's only one quarter, so --

Yes, I think that's probably the main factor to look at in terms of the one quarter. The incremental option expense is something that the accounting rules require that we do differently this year than last year for options that may have been granted well in the past. And so that incremental cost is just some expense that we've reported this year. Other --

Not due to the granting of the additional options.

No, it's just a change in the accounting rules, frankly. There's really no other specific, significant compensation factor there that would have driven into the current quarter. I think it's normal compensation adjustments. There are obviously some performance measures that we have for individuals at both the auction level -- at the auction level that are affected by the performance of the individual auctions, which helps us drive bottom-line performance at those locations, which gets factored into that. But all kind of normal, annual kind of plans that are established at the beginning of the year.

Okay, fair enough. And then, could you give us an update on the First Look initiative and any other major IT initiatives.

[technical difficulty]

I'm not sure if you can -- when you say IT initiatives, what -- is there some specific question you have? Or, I mean, we're continuing to evaluate a number of technology-related initiatives within the organization. There are numerous different things that are in process.

Yeah, the one that I'm most curious about is your arrangement with First Look.

Yes, it -- this is Chuck Taft. First Look is a marketing arrangement whereby their -- all of our information is downloaded into their system, so all of their subscribers are able to -- if they need a vehicle -- the first choice that they would have is to try to find it in our inventory somewhere. So it's a marketing arrangement where we're working together to meet the needs of their subscription dealers at this point.

Any usage metrics? Or is it just too early to know?

It's too early to know. I mean, their subscription base is in the -- they're in four digits now, so they're growing quite well, but it's too early for us to discern any noticeable pattern shifts.

Got it. Okay. Thanks so much.

Thanks.

And we'll take our next question from Craig Kennison from Robert W. Baird. Please go ahead, sir.

Good morning.

Good morning, Craig.

Good morning, Craig.

First question for Dave here -- the Texas salvage acquisition appears interesting to us in that you appear to have achieved some scale in the market with three acquisitions in one local market. Are there other opportunities like that on the acquisition front, where you can get more than one facility in a location?

Well, that was a salvage facility, or acquisition, as you know, and in order to provide coverage to a region, you need multiple points of distribution, which the sellers had. So that made that a bit different than perhaps an acquisition of a whole-car facility. As we look forward into further acquisitions of salvage, you may see that from time to time where you buy the multiple outlets that a seller may have, as that independent seller has to have that, either that or a network with other suppliers in that region.

So the short answer is yes, hopefully we will see more of those. Whether they'll be that size or not is another question, but we expect to see more of that.

Thank you. And then with -- a question for A.R. You've been there for approximately six months or so, and you've talked about a number of initiatives, including focusing on unifying the Company. Can you give us some metrics, either from a revenue, organic-growth perspective or a profit perspective, that would help us measure your progress on these initiatives?

It's really tough to do. I think that most of the things that we have, certainly on the revenue side, tend to be anecdotal in terms of a coordinated effort on the part of, let's say, AutoVIN and an auction that would have taken place independently in the past, resulting in landing some additional volume. We are in the process of putting a fairly detailed plan for next year that will include the opportunities that we see, and -- but we're sort of right in the middle of the budget. So I think the -- I would talk about the tone and the evidence that we're seeing is very positive; although, it's hard to put a number to it.

Okay, and then, finally, on the IT front, it sounds like you've delayed, maybe, some investment in IT. Is that accurate? Are you delaying projects that we should expect incremental spending next year? Or are we finding areas where we can save money on the cost side?

We're assessing our needs, our strategic needs, including a lot of business-unit, obviously, involvement to drive that. And as we assess our priorities into '07, I would expect that we'll see the return to expenditures in the IT area that we've had in the past, if not more. It's a strategic investment for this Company, and we are taking the time that we need to take to make darn sure that we're investing these things in areas that are gonna have the biggest impact on the organization.

So the short answer is yes. You should expect to see some recovery or pickup in the investment in our technology going into the fourth quarter and into '07.

Okay, thank you.

And we'll take our next question from John Murphy from Merrill Lynch. Please go ahead, sir.

Good morning, guys.

Good morning.

Good morning.

Hey, John.

Yeah, I just had a quick follow-up question on the conversion rate here. I mean, given that you had more institutional -- or a higher mix of institutional vehicles in the quarter, I mean, why is the conversion rate down? Is there something going on with institutional conversion rates?

Well, as we mentioned earlier, the conversion rate for the institutionals has been down relative to what we would expect and certainly relative to historical levels. It's improving as we get to the last month of the quarter, but because of the retail used vehicle being soft, that has impacted significantly the conversion of those institutional cars. So therefore, we're processing the vehicle, but we're not putting it across the block, a certain percentage of them, and therefore, we're having cost but no revenue.

And that situation has continued into the third quarter, but the good news is we are beginning to see the retail market strengthen, the conversions on the institutional cars are also strengthening. So we're expecting that in the fourth quarter and into '07, that we'll return to, if you want to call it, normal levels.

So the [inaudible] are suddenly getting a little bit more picky about the prices that they're taking -- because, typically, aren't they taking market-clearing prices?

Buyers are.

I'm sorry?

Buyers are.

Okay, got you. Then, on the $787 million managed loan portfolio that you have in AFC or DSG now, how much room do you have left on that facility?

Well, we have -- the $787 million, only, I think $500-, roughly $500 million is due to the securitization in our facilities. I think it's $550 million.

Okay. And is that having any -- I mean, it sounds like there's a bigger gap between your gross cash and your balance sheet of $218 million and your available cash of $45 million than there typically is. I mean, is that -- are those two items interlinked in anyway?

No.

No, I don't think so. I think it's pretty similar, actually, to last quarter.

Yes, the amount of flowed and the restricted cash -- I mean, it's pretty consistent, John.

Okay. And then one question on the heavy inventories in the new vehicle lots. I mean, is that going to have any [knock-on] effects in the fourth quarter? I mean, what's your take on that as far as an impact on your business?

Well, you would expect if their inventories are building that sooner or later they have to downsize those inventories. So the speculation would lead me to conclude that we would start to see more vehicles come in to our auctions. That's typically the way that we view inventory build up or size downs. If they're running tight, then that would tell us that they don't have -- they'd have to stock up.

So in reality, it could be good for volumes here in the next couple quarters as they blow those vehicles out.

Yes, it could.

And then, just lastly, on your relationship with Toyota -- could you just expand on what your current relationship is with Toyota and what you're doing for them?

Well, we -- as you know, we have a pretty high market share position with Toyota, and what we're doing is starting to implement their [inaudible] techniques into our operating units. So we're -- they're -- we're able to utilize some of their resources to help refine our processes at our auctions, which is something that they're involved with worldwide with all of their partners and suppliers.

But as far as the services you're providing -- you're providing not just vehicle auctions, but aren't you servicing them as far as online?

Yes, we are. We do all of their upstream activity. We do all of their lease-end activity for them through our systems. We do all of their inspections, their lease-end inspections through our AutoVIN subsidiaries. So we feel like for the long term, they're a great partner to be in with right now.

So essentially, you're operating their Smart Auction for them -- I mean, GM's Smart Auction - you're operating a system that's almost, essentially, analogous to that for them.

Yes, that's exactly correct.

Great, thank you very much, guys.

Thanks.

Thanks.

And we'll take our next question from Tom Bacon from Lehman Brothers. Please go ahead, sir.

Good morning. Thank you.

Hi, Tom.

Hi.

[Inaudible]

I was just curious -- I mean, given that you -- I hate to keep sort of beating a dead horse on the conversion rate, but in terms of the mix between the institutional and the dealer vehicles -- I mean, you would expect if you had a higher mix of institutional that your conversion rates would have been better. And I guess the way I was kind of looking at it was -- is there -- because of the whole inventory buildup of new vehicles on the dealer lots -- I mean, is the impact that these guys are not doing anything with their used vehicle inventory?

So in other words, you're getting less dealer vehicles coming to the auction because they have fewer trade-ins, and also, they don't want to build their used vehicle inventories because they have such big new vehicle inventories? I mean, is that kind of why that conversion rate is going down versus --?

No. This is Chuck Taft again. No, basically, what -- the conversion rate is affected by -- that the buyers are being a lot pickier this year than most years because retail used is so soft. We've actually -- we've actually entered more dealer cars this year. We've helped try to clear those, but our conversion rates are down because the demand isn't there. So it's just a factor of all of the things in the macro-economy that have been going on that have slowed that retail used volume temporarily, we think.

And is that -- I mean, in terms of -- I know you guys always talk about a clearing price that these things are going to trade at. And I mean, even though prices are down this year, they're still probably -- at least, looking at your data and some of the other data out there that prices are still higher than they were last year at this time. I mean, is it still just a matter of -- and inventories are building -- I mean, are prices still too high?

Well, they're certainly moving in the right direction, as I alluded to earlier, being at 57% -- I think that's where they're currently at on average -- versus 63% last month. So it's certainly moving in the right direction.

Okay. And in terms of the -- I was also wondering if you could tell us -- obviously you had a higher mix of salvage vehicles in the quarter as well, and I was wondering if you could give us an idea of what a shift between used car vehicles and salvage does to the margin.

There's not a significant impact of that given the relative order of magnitude in terms of the vehicles sold and such.

Pricing's about the same, and certainly, we don't have reconditioning services on the salvage side, so [inaudible] relative to the institutional cars, the margins would be better. But relative to the dealers, perhaps not. But --

100% conversion.

Yes, 100% conversion. So it doesn't degradate our margins, if that's your question.

Okay. So, I mean, the mix change there doesn't change margins one way or the other?

Not that much.

No, not significantly.

Okay. And then just one other question on Dealer Services. I mean, it seems like -- you would think that given the growth there and sort of the development in the retail used vehicle market that you're gaining share. And I'm just wondering -- and obviously you've been pretty competitive and aggressive with what you've been doing there. Is there still opportunity for you to grow share in that business? Or --?

Certainly. Our share on the Dealer Services on the dealer consignment is -- relative to our institutional -- is --

No, no, no, no -- DSG.

Oh, DSG, okay. Oh, yes, certainly. And relative -- I'm sorry, I was on the wrong page. And on the Dealer Services Group, we've looked at the market that our coverage -- with our coverage where the branch locations is at. There are certain markets where we don't have a branch at all. There's other markets that are growth markets where we may have one branch. So we're looking at strategic locations for markets that are currently being covered by DSG that perhaps don't have adequate coverage and other markets where there's no coverage at all.

So the short answer is -- yes, there are a number of markets where we can expand the new branches into.

Okay. And maybe just one quick thing to sort of get back to salvage. I mean, can you talk a little bit about once you take over an indepdent auction, how long does it take you to -- I'm assuming that the profitability of those may not be as good as your overall profitability in that business. And how long does it kind of take you to bring the volume in and get the cost structure to where you need it to be?

Well, sometimes these auctions are operating at a pretty high efficiency. But on average, they're not, and it takes several years to get the EBITDA percentages relative to revenue to the levels that we have in our locations. It doesn't happen overnight, but it's certainly, is the source of the improvement in the profitability for the first year or two. In that same period of time is when we're looking at new volume, new accounts, which typically takes a year or two before we start getting some top-line improvement as well.

So in the short term, the improvement comes from cost efficiencies. In the longer term, the improvement comes from new business in those locations. And there are some costs in the first six months or so because of the way that integration costs and maybe some benefit costs to the employees that the independents don't have.

Okay, that's it for me. Thank you.

Thanks.

And we'll take our next question from David Magee from SunTrust Robinson Humphrey. Please go ahead.

Yes, hi. Good morning.

Good morning, Dave.

Just a couple of questions. One is -- the -- what's the visibility in terms of the vehicle yield? It's had impressive growth here the last couple years. Can we be pretty confident that that will continue to grow and -- or are we kind of at a peak level now?

So your yield numbers are revenue per vehicle sold. Is that correct?

That's right.

A lot of the growth has been tied to incremental ancillary services because of the increase in institutional cars that are entered into the auction. As we -- as that continues to grow -- as those institutional vehicles continue to grow, we would expect to see that number continue. But I'm not sure it will be at the same kind of rate.

Everything else being equal, if the price of the vehicles continue to go north or trend north with cost of living increases and so on, [we'd] expect to see continued increases in terms of revenues per car as well. So as long as those trends continue in terms of the price of the car, and from time to time, some modesty increases by ourselves as it relates to the fee relative to the margins of both sides that sell and buy into our auctions, we should expect to see the same level of increases that we've seen in the past.

Okay. And then, with regard to the -- back to the conversion rate -- is -- was last year's performance -- can that be seen as an appropriate, I guess, high-level -- high watermark in terms of where that number can go? Or can you go north of 63%? And is -- I'm just trying to get a sense for what the opportunity would be on the conversion rate over time.

Again, your question relates to the entire Company, and an objective for the Company would be, again, looking at a target for the dealer sales, which we're expecting to increase, and also for the institutionals, that they return back to normal. Then we look at the blend of the two.

Not knowing what the dealer relative to the institutional sales are projected to be into '07 relative to this year, it's really difficult to answer that question.

Are you looking at a quarterly basis or an annual basis for that conversion rate?

An annual basis. The -- okay, the -- last question I have. Can you comment on -- [as far as the] new car dynamics right now and what we're seeing, I guess, with new cars today that might be influencing your business plus or minus at this point?

This is Chuck Taft. I think it depends on what they -- how they stay the course, and do they pull on the levers that gets inventory to go away. So that will have the greatest impact on us. If they stay the course, it'll be -- retail used will, we feel like, will rebound. But if they pull the lease lever or the rebate lever, obviously we'll enjoy some benefit from that as well because there'll be increased trade activity with the dealerships.

So you want them to become more aggressive in terms of trying to promote [trade-ins]?

I don't know if we want them to become. We just feel like, historically, when inventories build, there's a lever pulled, and we feel like that may happen again.

I think in our position there are certain benefits and certain detriments that come from both sides as those things occur. And given our position to take dealer cars or more institution cars, or as prices moderate, those cars will move off the -- off of our lots. And we -- as we said, there's certain benefits that come either way.

Okay, great. Thank you.

And we'll take out next question from Gary Prestopino from Barrington Research. Please go ahead, sir.

Hi, good morning, everyone.

Good morning, Gary.

Gary.

Hi, Gary.

A couple of quick questions. Dave, that salvage site in Syracuse you said you were opening, is that a new site or an acquisition?

It's a new site. It's on eight acres or so, and we opened a new location in that market just to have better coverage.

Okay. And then you mentioned about AFC expanding its footprint. You have 85 sites now -- or offices right now. What would be your best guess as to where you'd want to take that by the end of '07 and some major markets where you're looking to move into?

I'm going to let A.R. answer that question.

Yes, I think right now we probably could look at three to four more sites by the end of '07. And you can look at a map, see where we're not, and those are some of the larger metropolitan areas where we don't have a presence.

Keep in mind, Gary, this is a very good business, obviously, but it's also a business where you have to control it. So you have to be very careful how you manage the controlled growth in this business. So three to four branches relative to 85 branches, I think, is a very manageable level of growth for that business.

That's fine. And then, on loan -- vehicles financed, it looks like they were up about 4.7%. Do you count renewals on floor plan financing as a number for your loans extended on a quarterly basis?

Yes.

Yes. [Inaudible]

So was there a lot of renewals this quarter -- given the fact that there's a lot of inventory at these dealers?

I don't -- I don't get the sense that there was anything unusual or significant there. It was a fairly standard quarter from that standpoint - perhaps a little bit more because the duration of our portfolio went out a little bit, but nothing meaningful.

Okay. And then, lastly, given that retail sales are at a low point on a ten-year basis, based on your experiences historically, what happened -- what happened the last time this occurred, say 12 months out versus where we are now -- in terms of your business and the retail business?

I'd have to maybe direct you -- it's a little difficult, a lot of different factors there; although, we kind of discuss how, I think in '02, this is kind of the last time we've seen this low of conversion rates in the third quarter. And in the years following that, we saw a pretty decent conversion rate. So it's hard to draw -- as they say, what is it, 'past performance is not necessarily an indicator,' but it --

I think it -- well, this is Chuck Taft. Internally, we've been looking at it. Our struggle, quite frankly, is ten years ago, we were kind of a regional auction chain, and right now, we're a national auction chain. So we're trying to look at the impact of that as -- vis-à-vis where we were ten years ago. So it's kind of been a struggle to put our hands around it. But we maintain a lot of optimism around the healthiness of the used car market.

Okay. Let me phrase the question another way, then. What do you see as the key issues out there to get the used car market back on track which is going to positively impact your business? Is it completion of inventories of new cars, used cars at the dealers? What are some of the key issues there?

Well, [inaudible], I think -- obviously the whole macro-economic environment's a big issue. I think pricing -- prices of the vehicle -- we saw that start to come down, as Dave mentioned, into that 50% to 60% band. As that continues to moderate, I think that would help. That's helpful.

The things -- this is a macro-driven situation, obviously, with the fuel prices and everything adversely affecting the perception of value of these vehicles, and managing people's expectations is our challenge in our industry to provide the optimum liquidity for everyone. When the conversion rates drop, it isn't -- it doesn't help the customers that are selling the vehicles, and we've heard this from the institutional side. And it certainly doesn't help us.

So in terms of managing expectations, that's our job, and I think that that's the one thing that we can focus on and need to focus on to help our institutionals and our dealers on the sale side as well as the buy side so that we have optimum liquidity in the lanes. That's always been our challenge with these situations where we have these events -- we call them random shock events that tend to create this uncertainty in terms of the short-term and longer-term value of these vehicles.

Okay, and last question. Did you say you purchased land in Phoenix and Dallas for expansion or you're looking to purchase?

We are looking. We -- hopefully we're getting close to making an acquisition in one of those two areas.

Great, thank you.

And we'll take our final question from [Jeff Curry] from [Skystone] Capital. Please go ahead.

Good morning. Two quick questions. First, on AFC, the gross margins there were higher than they've been in the last -- basically since you started reporting the segment, and the cost of services per loan went down sequentially. What drove that? And were there any changes to the reserves?

Well, the main drivers in the growth margin -- revenue goes up -- revenue per vehicle and the number of loan transactions processed by, frankly, roughly the same number of people. So holding those costs constant. I don't think there's anything significant. Reserve movements, cost of business, doing a number of different areas of our cost of business, including bad debt and other activities, all were pretty much a wash in the quarter.

Although, sequentially, on roughly the same loan volumes, cost of services went down about $1.5 million in absolutely dollars.

Hey, Jeff, this is Jon Peisner. Can I get back with you after the call on that?

Certainly. No problem. Secondly, and quickly, recognizing there's both revenues and costs in Canadian dollars, what's the EBIT impact of the FX gains?

We don't disclose it down to that level at the EBIT kind of number, Jeff.

Okay, thank you.

I believe that concludes the question. Just maybe a final comment on the last question. The operating leverage of both of these businesses is very good. And when you can sell one more -- or finance one more car at these locations, you're not significantly increasing your costs, but you're getting the benefit of that one more car, which has a profound impact. The same thing is true with respect to the values being financed. You're not doing any more work. You're not incurring more costs, but you certainly get more revenue, more profitability when you get that benefit. So again, that kind of demonstrates the operating leverage of both of the businesses when more vehicles come through, or more transactions come through our facilities.

In summary, I feel very good about the quarter, and I certainly look forward to the final quarter of this year and into next year. We've got excellent focus in this Company on the strategic initiatives that we believe are going to have a profound impact on our performance [at] this organization in the future.

I know that you're patiently asking questions about some of our investments in technology and our operational excellence and some of these other areas, as you rightfully should. We're extremely focused on them. It may take a little bit of time. In some areas it may take three months. In other areas, it may take a year before we see the significant improvement in our profitability and our bottom-line performance from these initiatives.

But I want you to know that we're really excited about the direction of this Company. We expect the volumes to improve from what we've experienced the first three quarters of this year. As always, I always appreciate your support, and I want to thank you again for joining us today.

This concludes today's question and answer, and at this time I'd like to turn it back over to Dave Gartzke for any closing -- any additional remarks?

You just heard them, gentlemen.

[Technical difficulty]