Openlane Inc (KAR) 2008 Q2 法說會逐字稿

Welcome to the KAR Holdings Incorporated 2008 second quarter earning conference call. Today's conference is being recorded. Today's hosts will be Brian Clingen, Chairman and Chief Executive Officer of KAR Holdings, and Eric Loughmiller, Executive Vice President and Chief Financial Officer of KAR Holdings. At this time, I'd like to turn the conference over to Eric Loughmiller.

Good afternoon, and thank you for joining us for today's KAR Holdings second quarter earning call. Today we will discuss the second quarter performance of KAR Holdings and its predecessor companies, ADESA and Insurance Auto Auctions. As you all know, KAR Holdings completed its acquisition of ADESA Inc. and simultaneous merger of Insurance Auto Auctions in April 2007. Accordingly, we will provide commentary on the performance of KAR Holdings and to the extent necessary its predecessor companies. At the conclusion of our commentary, we will take questions from participants on the call. We will try to accommodate all questions at the end of our call. Before we begin today's discussion, I would like to remind you that the conference call may contain forward-looking statements. Such statements 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. During our comments we will comment on EBITDA and adjusted EBITDA and other non-GAAP measurements of financial performance. Please refer to our quarterly report on form 10-Q for an explanation of these terms and reconciliations of non-GAAP measures to our GAAP financial statements. Now I will turn it over to Brian for some overall comments on our performance and other items of interest.

Thank you. I just have a few brief comments before we review our performance in greater detail for you. On the positive side, we continue to be extremely pleased with the strong performance we are seeing out of both of our auction groups, and that performance has been in the face of what, as you all know, is a very difficult continuing environment out there. We also at the ADESA whole car auction business, are acutely aware of the difficulties that many of our customers are currently facing, and I can tell you that [Tom Cantos] in the analytics department, [Jim Hallett] and his corporate group as well as the auction managers are working very hard doing everything they can to try and help these customers who are going through some of these unprecedented difficulties in the marketplace both with residual lease values as well as what has been going on in the overall used car marketplace. But in spite of this, again we continue to be very pleased with the performance that we see out of the whole car auctions, both on a volume of cars as well as the conversion rates. The auctions are performing again at a very strong level, and we have been very pleased. And the same holds the IAAI salvage auctions, where the first six months we had exceptional performance, and we were very, very pleased with the results that we are seeing here, continuing as we've said in the past, to feel that our hybrid auction methodology there has really been bearing out in the marketplace since what we believe is what offers our customers the strongest returns for their vehicles. And it really is bearing out just in the performance of this business and its continued strength.

That being said at the salvage auction business, we do think that miles driven will impact this and we do see that starting to happen. There is a strong correlation between overall miles driven and then the number of total vehicles. So clearly we think the second half of the year will be impacted somewhat negatively by this, but the IAAI salvage auctions, as I said, had an outstanding first six months and in spite of the headwinds of the miles driven being off, we think that this business will continue to perform at an extremely high level. On the negative side, our AFC finance business continues to struggle in what is you all know a very difficult environment. We've seen significant reduction in our portfolio size, which frankly we are not concern with. We would expect to see it and we have seen it pretty analogous and correlating pretty closely to the overall shrinkage in the sales market out there. But what has continued to trouble us is that overall write-offs and our delinquencies have continued to disappoint, and this is what we have been very focused on over the past 9 to 12 months and continue to be extremely focused on, but I can say that we are disappointed that we are not seeing stronger improvements in some of our credit statistics to date. So it is our number one focus at the moment.

We do think that the difficult environment that these independent dealers that we are financing are experiencing will continue for a while. These dealers are being squeezed from a number of different sides. They've had to deal with the devaluation of the inventory as we've seen the prices of SUVs and trucks specifically come down, so they've taken a hit there. They've taken the overall hit from just general sales decline and then finally the lack of and continued diminished alternatives for consumer finance of their customers is a third very difficult situation that these independent dealers are currently having to deal with. That being said, we are still very committed to the business, and we think it will continue to be a very successful business for us. We are unfortunately realizing the benefits of our diversified business model in that our AutoVIN lock check business, which is part of the AutoVIN group doing inspections has been called upon extensively during this difficult period as well as our par remarketing and repossession business, which unfortunately we have been using at AFC probably more than we would like to, and then finally our ability to move the vehicles that we need to take back through the auctions in the most efficient and profitable manner for us. So definitely a benefit having access to all of these pieces as we continue to struggle through the difficult finance environment.

As I said we continue to be very committed here. We do think this business will come out on the other side of a difficult environment probably with fewer competitors in this space, but we think we are well positioned to succeed in this business as we move forward, and we continue to believe it's a critical offering in our overall auctions in providing the strongest buying environment. A final note I had was concerning an acquisition we did during the quarter. We had an announcement out several weeks back that we acquired LGB, which was the internet software company that originally wrote and continued to service our live block internet function at the ADESA auctions. LGB was a very successful operation that provided not only this software and service to us but to a number of other auto auction businesses both in the U.S. and internationally. So we were excited to be able to buy this business. We are very committed, as you know, to the growth and continued development of our overall internet sales and we do think this will be a very strategic acquisition for us as we continue to build that portion of our business. So those were all the comments that I have and I'll turn it back to Eric to go through some details of the financial performance.

Thank you, Brian. Yesterday we reported our financial results for the second quarter of 2008. We have filed our form 10-Q, which is available on our website at www.karholdings.com. We are pleased with our performance in the second quarter, given the economic conditions that existed in both the United States and Canada. KAR Holdings consolidated revenues for the second quarter of 2008 up $468.5 million increased 17.2% over revenues of $399.7 million for the prior year. This increase reflects the addition of new salvage and whole car auction sites from acquisitions as well as growth from our base business. In fact excluding revenues from acquired businesses, we saw second quarter revenue increased 10.3%. Adjusted EBITDA as defined in our credit agreement for the second quarter of $122.6 million increased 15.7% from $106.0 million in the prior year. Our current leverage excluding the capital lease obligation for Atlanta is $2.579.700 billion. We have net available cash of $17.7 million at June 30, 2008. Based on our pro forma adjusted EBITDA for the 12 months ended June 30, 2008 of $431.5 million, our net total leverage is at 5.98 times EBITDA.

Now we would like to briefly discuss the performance of each of our business segments. ADESA Auctions reported revenue of $291.2 million for the second quarter of 2008 compared to $242.8 million in 2007, an increase of 19.9%. ADESA experienced a 12% increase in the number of units sold. The number of units sold on a same store basis increased 4%. This is particularly strong growth given the reduction in units sold throughout the auction industry of 2.8% for the second quarter of 2008. In addition to growth in the number of units sold we also benefited from a 7% increase in the average revenue per vehicle sold. The ADESA sales team has been successful in getting our customers to understand the value of our ancillary services. In current market conditions, where certain vehicles are experiencing declines in value, the value added services offered by ADESA assist our sellers in maximizing their returns on the vehicles sold. Our conversion rate for the second quarter of 2008 was 59.9%. This compares to a conversion rate of 60.7% in the prior year.

Gross profit for the three months ended June 30, 2008 of $126.8 million represents a 15.1% increase from $110.2 million the prior year. Gross profit as a percentage of ADESA Auctions revenue was 43.5% for the second quarter of 2008, compared to 45.4% for the same period of the prior year. This decline in gross profit as a percent of revenue reflects the increased cost of transportation including fuel costs, the increased labor and other costs associated with the increase of ancillary services and the labor associated with running a higher percentage of institutional vehicles, the total vehicles in the second quarter of 2008 as compared to the prior year. This shift in mix to a higher concentration of institutional vehicles requires an increase in cost as we marshal institutional cars for a longer period of time and generally have increased labor as the cars tend to be touched more often between the time of check in and the time of sale. SG&A costs for ADESA Auctions for the second quarter totaled $59.5 million, an increase of 20.9% from $49.2 million in the prior year. Of the increase in SG&A, $3.3 million represents nonrecurring costs associated with process improvement activities, associated with Project Pride. Excluding these non-recurring charges, SG&A costs increased 14.2% in the second quarter as compared to the prior year. This is in line with our increased revenue. The largest component of the remaining increase in SG&A cost is costs incurred at sites acquired subsequent to the second quarter of 2007.

Revenue for the first six months of 2008 for ADESA Auctions of $576.3 million increased 20.4% from $478.7 million in 2007. Operating profit generated by ADESA Auctions of $82.9 million for the six months ended June 30, 2008, increased 8.2% from $76.6 million in the prior year. However if we exclude non-recurring charges from operating profit for each period, operating profit increased 17.1% for the six months ended June 30, 2008 as compared to the same period in the prior year. Insurance Auto Auctions revenue for the second quarter of 2008 of $148.5 million increased 23.4% from $120.3 million in the prior year. IAAI increased its units sold in the second quarter by 17% as compared to the prior year. While acquired sites account for the largest portion of this increase, IAAI generated a strong 5% growth in units on the same store basis. Our same store comparison includes all branches owned prior to January 1, 2007. IAAI's gross profit of $58.4 million in the second quarter of 2008 increased 39% as compared to $42.0 million for the same period in the prior year. IAAI also had improvement in its gross profit as a percent of revenue as gross profit increased to 37.8% of revenue from 34.9% in the prior year. This improved gross profit is the direct result of the integration of acquired businesses including ADESA Impact into the IAAI operating model. The ability of our sites to use our auction operating technology known as ASAP and our customer reporting capabilities within CSA today enhances our services to our customers, primarily insurance companies. This also allows the streamlining of our operations in a manner that reduces costs and maximizes returns for our customers and the revenues for IAAI.

I believe our ability to efficiently integrate acquired sites onto the IAAI system is a significant differentiator for the Company. IAAI has already completed the integration of a portion of the sites acquired from VERASTAR in February and will complete the integration of the remaining sites later this month. SG&A costs for IAAI increased only 0.6% to $16.6 million in the second quarter of 2008 from $16.5 million in the prior year. IAAI's revenue of $290.6 million for the first six months of 2008 increased 19.5% from revenues of $243.1 million for the first six months of 2007. IAAI's strong revenue performance was in large part carried through to an increase in operating profit to $41.5 million in the first six months of '08 as compared to $19.4 million for the prior year. We continue to believe our operating systems customer reporting technology improved coverage of North America with 149 IAAI sites in the U.S. and Canada and our hybrid auction methodology, which allows live and Internet buyers to participate in auctions simultaneously is contributing to our success in serving our customers and improved operating efficiency that contributes to improved profitability.

Unlike ADESA Auctions and IAAI, AFC's performance reflects the current realities of the financial services industry. For the second quarter of 2008, AFC revenue declined 21.3% to $28.8 million from $36.6 million in the prior year. While the number of loan transactions processed declined only slightly, we experienced a decline revenue per loan transaction to $95 in the second quarter of '08 compared to $120 in the prior year. As you probably know, loan losses incurred at AFC generally are reflected as a reduction of revenue in the period recognized. As a result, a significant portion of the reduction in revenue per loan transaction is the result of the current economic climate and the related increases in credit losses. In addition, interest rate spreads tightened in the second quarter of 2008 as compared to the same period in the prior year. The reduction in revenue for the second quarter is also reflected in reduced operating profit of $9.8 million as compared to $17.9 million in the prior year. We are expecting these trends to continue into the third and possibly the fourth quarter of 2008. The number of independent used car dealers is declining, the number of bankruptcies has increased and retail use car sales have declined and are expected to remain soft for the remainder of this year.

AFC revenue for the first six months of 2008 of $63.7 million declined 14.4% from $74.4 million in the prior year. Operating income of $23.9 million for the first half of 2008 has declined 35.4%, reflecting the tightening of interest rate spreads and the increase in loan losses realized in the first half of this year. The management team at AFC is focused on adjusting its operations and maintaining costs in line with performance levels. We believe AFC can be an important component of our long term success of KAR Holdings and are positioning AFC to have sufficient capital resources when conditions improve and this once again is a contributor to our growth. In the difficult economic times impacting the financial services businesses and retail used car sales, AFC has focused on tightening its credit availability and improving the overall quality of our managed receivables. This is evidenced by the decline in total receivables managed by AFC to $809.8 million at June 30, 2008 as compared to $847.9 million at June 30, 2007. In no way does this impact the availability within our securitization facility. We continue to have $600 million in committed funds available in our $750 million securitization facility that expires in April 2012.

KAR Holdings generated $91.5 million in cash from operations in the first half of 2008. As we expected, we were able to repay revolver borrowings utilized to fund our acquisitions in February 2008 prior to June 30, 2008. We have invested $45.7 million in the first half of the year in property, equipment and computer software. In addition to scheduled debt repayment of $7.8 million in the first half of the year, we recently repaid $11.2 million in principal on the senior term loan as a result of realizing proceeds from the securitization of our rental portfolio at AFC. We continue to investigate opportunities to monetize assets on our balance sheet. Although we do not have a transaction to announce at this time, we continue to work with various sources to sell certain properties and enter into long term leases. We are currently contemplating a sale leaseback transaction for selected properties that could yield up to $100 million in proceeds, of which 50% will be used to repay the senior term loan, with the remainder available for investment in the business. Our current cash resources, including cash from operations combined with available funds under our revolving credit facility, are sufficient to meet our needs for the foreseeable future. Thank you for attending the call today and I will now turn it back to Dwayne, our operator, to facilitate questions.

Thank you. (OPERATOR INSTRUCTIONS) Our first question will come from Phillip Volpicelli with Goldman Sachs.

Can you hear me?

Yes we can. Please go ahead.

With regard to the slowing environment for used car transactions and consumer credit being more difficult, what would typically happen in that environment? I'm assuming that cars will sit on your lot for longer periods of time before they convert and it may take a couple of auctions for them to convert assuming that prices are adjusting over time. Do you charge your sellers a fee to keep the vehicles on your lot for a week or a month or two months?

So I can understand your question, are you talking about used dealers who have cars on their lots for longer period of times?

It would be -- so let's say a car comes off lease or comes from a dealership, it goes to an ADESA lot, there's some work done on it and then it goes through auction in a normal cycle. What I'm thinking is that cycle used to be a week is now going to be a month maybe two months. Do you charge a fee to basically warehouse that vehicle for -- ?

It really is not the case. We've had a few isolated incidents where the vehicles are actually at the auction for a slightly longer periods of time, but it really is reflected in our conversion rates and what you'll see is a that our conversion rates have remained pretty consistent over this entire period of time and while the conversion rates have been consistent, which means the cars are selling, the prices definitely have been lower and obviously that's where the customers have been getting hurt. So really it's not the case that we see cars staying at the auction lots for greatly extended period of times of time.

So if I understand it, if I'm a lessor of a vehicles and I get 100 vehicles back, I'll bring those to your auction, they spend a short period of time at your auction and then they convert or they don't. If they don't convert, do they go back to the lessor or do they stay on your lot?

No. They stay on the lot and they get ran again. But that's -- it really -- that example that you just gave is a difficult situation where a consigner has made a decision to no sell a car and then run it again in a week or two weeks. So it's been a difficult environment where that seller typically is not seeing a better price that second time he runs it. Clearly for us, it is a more expensive process. We have to touch it, we have to handle the car and we don't get paid additionally for those second runs if you will.

Is that something that you would consider putting a fee on that if a vehicle doesn't convert twice, maybe you charge $50 or $100?

As you can imagine, it's not a particularly good situation for that seller. So it would be a difficult conversation. What we have spent a lot of time doing, and I mentioned Tom Cantos and the analytics folks, they have worked and spent a lot of time with customers, working with them, trying to establish where their expectations of price should be so that these vehicles get converted at the highest rate possible. And so it's been a -- obviously as you know from all the news accounts, a very difficult environment where those prices have come down dramatically, but nonetheless the market is clearing.

And Phillip, this time the industry has accepted that sellers fees contemplate the cars being stored, ran through auction and also the industry realizes they don't sell the first time all the time. So I think that's embedded in the pricing, which really doesn't contemplate any type of marshalling fee in that circumstance or entry fee for the institutional vehicle.

Got you. Great. I'll ask one more before I get back in queue. Can you give us an update on the cost savings? I believe there is $60 million to $70 million in cost savings that you've laid out in the past. Where are we on those, how much have you realized and are you still on track for the 60 to 70?

Yes. Good question. Let's break it into its component. First Insurance Auto Auctions, their cost savings were really two components. One was the redundant corporate SG&A and through the second quarter we had the ability to add any difference between the $10.5 million that was included in our estimate and the actual savings as a pro forma adjustment. And if you look at the pro forma adjusted EBITDA table, you will notice we are not adding anything back in the fourth quarter of that period of time, June 30. So we have realized the full amount of the $10.5 million. In addition to that, we have operating costs at IAAI and we are on target. The total with SG&A and auction operations was $25 million to $30 million of net savings, and we are on track to realize that. We've realized a significant amount of that. Really the only remaining component is for us to complete our work in the eliminating redundant facilities where ADESA Impact and IAAI may have operated in the same market. I will caution you we may not eliminate all the facilities we intended, but that is a function of the growth in our business where we have found ourselves needing space in those markets and we have the land. So net, while we may not save all of the resources we bought or the cash, it will be because we have grown the business beyond our expectations in that particular market.

At ADESA Auctions, the savings were estimated to be $35 million to $40 million and we are right on track action, perhaps even very slightly ahead of where we thought we would be on a site-by-site basis. That's a long process. We are rolling out the Pride Project to all 60 of our auctions. Through the quarter we have completed the implementation at 18 of the 60 sites but we started -- after the first set, we started with the largest auctions. So we are receiving significant savings. Again at the sites we have gone to, we are at or slightly above the net savings projected and we think by the end of this year, we will have been able to achieve on an annual run rate basis the $35 million to $40 million in savings at ADESA Auctions that we anticipated. We will not have completed the implementation of Pride at all sites, but we will have completed that at all of our largest sites and most of our medium-size sites. So what will be left will be the smaller sites.

Thanks. I'll get back into queue.

Thank you Phil.

Our next question is from Kathryn O'Connor with Deutsche Bank.

Good afternoon.

Hi.

I guess in light of what is going on, maybe if you can give us some thoughts on the whole car market in general. I guess with leasing, discussion new car sales, used car sales, repossessions. I know it's hard to measure with so many moving parts, but what is your view on the whole car market and sort of what the minimum and maximum number of units you think can be sold at auction this year are.

I think what we've been a little surprised at and frankly kind of pleased is that, while the market has seen some tremendous upheaval and disruptions for instance in what is going on with the manufacturer vehicles, some of the dealer consignment vehicles, we have seen decreases in the amount of those cars coming to the auction. At the same time, we have seen tremendous increases in vehicles coming from some of the financed institutions on repossessed vehicles. Our lease returns continue to be strong, and a number of the institutional accounts have really offset the dramatic declines that we had in other areas. So I guess that is a lot of sound and fury to tell that you that the overall volumes have remained remarkably consistent, while the components of them have changed very dramatically. As far as going forward, we really are getting comfortable with the fact that the marketplace as it moves away from one financing source and goes to another, we do see the cars come back to auction. They just may come back as a different piece. In other words, to the extent that lease returns several years out may show some dramatic declines based on the withdrawal of several of the larger institutions offering leases. We think that repossessed vehicles from those vehicles that are financed and ultimately come back at approximately the same percentage that they have in the past, but with a much larger volume of outright financed vehicles, we should see the volume offset from those. What we are looking for and hoping for is with some return of strength in the overall market to see more of the dealer consignment business come back to the auctions. It is probably the most profitable component of our business, and so that being off, certainly affects margins and the return of that business, we think will even add further strength to the performance of the ADESA Auctions.

And on specific numbers, ADESA analytical services has published some information that in 2007 total units sold at auction was 9.6 million, and through six months volumes year-over-year had declined 2.8% and there's been some publication in the industry indicating they are expecting that low single digit decline year-over-year. So the numbers I've seen are estimates that would be clearly above 9 million but slightly down from '07 levels.

There's no fear in the near term that if people start to extend the cycle in terms of purchasing that that's going to affect your overall volume?

Again I think that's probably more likely being seen in the total number of used car transactions, which is focused -- of that what was known as 43 million is down about 5% according to the analytical services group, but that's really being seen on the retail side and the auction volumes don't seem to be seeing that, and I think that is because of the wholesale marketplace. It's really different than the retail marketplace. There are changes in mix. Again as we've talked on the road show and in other presentations I've done, the mix changes but it seems like the capacity of these auctions is in that 9 to 10 million and there's a sufficient supply of vehicles looking for a channel to move the vehicle, that may be driving why that number is staying so consistent.

So you don't really see us hitting those minimums that we saw maybe in like the late '90s?

Well, the late '90s was actually a growth period from previous years. It's grown up to the current amount. I didn't you are going back to the mid '90s and that actually just the origin of the numbers from the analytical services group that they can present. It's because they don't have any data prior to that and you are looking at at that 7.5 and then 8.5 million in the mid '90s. That was a growth period. I don't think that was a period of decline, although again we've talked to Tom Cantos and his group, there's no formal evidence as to what the number was prior to that but it was to be a period of growth as leasing became more popular post the 1993 recessionary period.

And then maybe just in terms of what the whole industry did, the whole industry's down 2.8%, you guys on a same store base up 4%. Can you just let us know what you are doing to outperform the market and what that implies about your market share now?

Well, I mean I think it probably is what you would imagine, that we are getting some market share improvement, and we've said from the outset that Jim Hallett and the sales team that he has put together and the individuals that he's brought in or brought back to the organization really have had an impact, and we've continued to see that. We think that they have been able to win share, and we've got a lot of people working really hard at it because you can lose that almost as fast as you win it, not quite that easy, but I think point in fact we have seen those market share wins and they've been a tribute to Jim and the team that he's got over at ADESA.

Okay. So that is not a function of you cutting prices or anything like that. You just think it's a function of having a better sales team and working more aggressively towards increasing share?

I really do think that there still is a fair amount of relationship aspect to the business, and it's very important.

And in fact I can tell you our auction revenue per unit sold has actually increased. So we have not cut prices. We don't do that in ADESA auctions. It's not across the board but regionally, as they see the opportunity, they are able to increase prices and that has continued despite the current market conditions.

And then maybe just one other thing about the whole car segment before we move on to AFC. I saw in the commentary that there are some notes about lower margin acquisitions, so maybe some acquisitions you made where margins aren't as high as the rest of the group. Is there any upside in terms of getting those properties in line with the rest of the whole car division?

Absolutely. And in fact, our recent acquisition in Pennsylvania had a totally different staffing model than we use in our auctions, and we have put them much earlier in the process for Project Pride, because we know we can generate some savings but more importantly we can get the operation more efficient and more consistent with other ADESA auctions by instituting these processes and procedures. We clearly believe when we are acquiring an independent operator, our knowledge over a large number of sites allows us to see best practices. We take those to those sites and it doesn't mean their business wasn't run well, but we just run it at a different scale and I think we can take some of those experiences and some advantages to those sites. We have a technology that we implement. That is a big component in helping an auction more efficiently, is utilizing technology as opposed to manpower to track vehicles and to run your auction. So yes, I do think there's opportunity there.

Okay. And just in terms of the AFC business, is it possible for you to give us a little bit more color in terms of each of the line items in AFC? So maybe talk a little bit about securitization income and the difference year-over-year and what is really driving that portion of the AFC business and then run through interest fee income and what is driving that portion and then provision for credit losses and just give us a little color about each?

I can give you a little color about each. Securitization income is really the total revenue stream for those receivables that end up securitized. So it includes fees. It includes interest income. It includes perhaps credit losses associated when we retain the loss and we realize the loss, and so that is the biggest component. Then you have fees and interest income. Those relate to receivables that are not within the securitization. Therefore you aren't recognizing their income in that single line item and the provision for loan losses, you can see that is a very small component. That is a very insignificant amount of the activity that is related to it. Most of it is caught up in the net revenue that is recognized in the securitization income line in our reported financial statements.

Because the provision for credit losses year-over-year changed, isn't that large in that one line item, but what you are saying is that the credit losses that you take in within the securitization, that is coming through in the securitization income. So that is part of the reason why the number decreased so much year-over-year?

Right. And the best way to look at that is in the revenue per loan transaction going from 120 to 95, that's reflected in the securitization income line. The decline is directly related to loan losses and reduction in interest rate spread and the largest component of that reduction is the credit losses.

Okay. And then there was a line in the 10-K about some of -- some things that were financed in the securitization facility coming back onto your balance sheet and you wrote in there what the face value was and then at what level you brought those back onto your balance sheet. Can you just talk a little bit about how that runs through the numbers? And whether or not the loss from the face value to where you are take it back onto the balance sheet is already reflected now in the numbers?

Yes. I'll do my best. Yes. What happens is when it becomes ineligible within the securitization, we are required to repurchase that and they become ineligible when they reach a past due status of a certain age. As we buy them back, the accounting provisions -- because when you have a securitization you're required to recognize the transaction as a sale of the asset. So when you get it back, you have to buy that asset back, record it at fair value and there is a difference oftentimes between the face value and the fair value and that is in fact reflected in our results in our revenue.

So that would be in the securitization income line.

Correct.

I guess taking all of this together you think that the second half of this year is going to be -- going to be similar results to this period. Do you think it will be of the same magnitude or do you just think that the results year-over-year will still be -- the comps will be negative but with some improvement sequentially?

I think the best guidance I can give you is talk to your economist instead of me. I can't predict it. We just don't see any signs of the recovery yet. So I'm not going to probably give you an indication of what I think the economy is doing. It just too hard for me to do it. It's not my training. But what we are seeing are volumes, activity at the auctions, activities at AFC and what we are telling all of those of you attending this call is really we have yet to see any indication that there will be significant improvement. We think it will happen, and what I don't want to do is predict when it will happen.

Okay. And then just one last kind of overall strategy question. Do you generate more free cash flow now that you've done some significant acquisitions? Are you going to be thinking more of debt repayment or are you still looking for some maybe deals that are to be had out in the market? In terms of acquisitions?

I think we have continued to try to be opportunistic if we see significant opportunities. That being said, I don't think that our focus has changed any from the outset, which was we think that our leverage should see -- our leverage statistics should see continued improvement and we would expect to see that from a combination of paying down some more debt. We still have some things to be done with the balance sheet. Eric made brief reference to a scaled down sale leaseback transaction, as well as a couple of other smaller items that we have available. So we do think and our focus continues to be on improving our overall leverage, and when we have an opportunity for acquisitions, we are taking a look at them. That being said our focus really has not changed from the outset.

And as you know, our debt agreements basically tell us you either use it to grow the business say through acquisition or capital improvements or if you create the cash, the excess cash flow would require us to pay down debt. If we have excess cash, we are motivated to pay down debt unless there's another use that we think can contribute even more to the Company and its growth and delever us through increased EBITDA.

Great. Thank you.

Thank you, Katherine.

Our next question is from Jeff Skoglund with UBS.

Hi. Can I ask you a quick follow-up on that last comment on sale leasebacks. Is that -- has there been any updates or developments on that front? Still on hold, right?

Well, not on hold -- what I was indicating is we have some new sources we are talking to, and I think in the near future, Jeff, there is a chance for us to do something scaled down from the previous levels we talked about and I gave in the commentary right now it looks like up to about $100 million, and that's what we are looking at. And it's at attractive cap rates if we are able to complete the transaction.

Okay. You mentioned earlier that you have a lot of empathy for what your customers are going through, and you said you are trying to help them. If you are not reducing your pricing, what are you doing? Are you just offering more services and technical support --?

I think that's part of it. I would say that probably the largest area of input that we can provide is through Tom Cantos and the analytics people. We do a tremendous amount of data analysis, and we have access to virtually all the transactions occurring pretty much across the country. So we are taking a look at best venues for these customers. We are taking a look at where inventory appears to be either building to levels that are going to cause pricing problems or alternatively perhaps where inventory could be moved to maybe get a better price. So there is a lot of work and there is a lot of time that Tom and his group is spending with customers, trying to help them with the pressures that they have there.

Can you review just the basics of how the fee structure works again?

Sure.

I'm trying to figure out what the impact of the sudden fall in pricing in certain segments might have.

Basically at the auction we are going to charge a seller fee and a buyer fee. The seller fees are negotiated with the suppliers of the vehicles, and institutional customers that have high volumes are likely going to have more bargaining power and have a lower fee than say a dealer that brings in one car at a time or five cars at a time. So that's part of the fee structure at auction. Then you have the buyer fee -- and that seller fee is fixed by contract, Jeff, for that customer and they'll vary depending on a number of different variables such as what service level the customer expects, how many vehicles they have available that we think we can run through auction, all kinds of factors like that. Then the buyer fee, though, is a fixed fee. At this point any buyer will pay the same fee as any other buyer at that price of the car. It's a tier pricing structure that increases as the value of a car sold increases in $1,000 increments. As it gets to the higher value cars, it may be more than $1,000 increment. But essentially, the fees at these $1,000 increments do not move up. It is not a commission type calculation. It's more of a nominal increase in each $1,000 increase. Ancillary services are priced in order to incent the customer to use the services and that is why ancillary services have lower margin than the rest of our business because we are not trying to compete with the mechanics and the body shops. We are trying to really generate sufficient margins that we can also allow our customer who spends $600 to maybe increase the value of that car by $800 or more dollars. So that tends to be what we call low double digit to mid teen margins on those types of services and those are -- I call them a la cart pricing but we price it based on the individual service.

I spoke to Tom Cantos and I was wondering if you get his latest view of when -- if the SUV prices are stabilizing or if not, when he anticipates them doing so especially with gas prices easing off?

Tom is not with us right now, but I'm sure he would be happy to share his input and his views on that sort of information. So I guess I would encourage you to get a hold of him. I think you'll find it if you've spoken with him before, worked with him before, he really is very helpful and he's been very open to not only working with the customers but he has spent some time working with the press giving his thoughts and his feelings on those sorts of things.

But generically, have you started to see stabilization?

I think Tom would say that he's in the early stages of starting to feel better about what is happening with those prices.

And Jeff, I can refer to an Auto Remarketing article that was online this morning that I read and it indicated SUVs are becoming attractive again because the small cars, compact, subcompact hybrids are all at such premiums. People are saying it's not worth the premium for the gas mileage. I'm going to go buy this SUV. And that's -- it said in there that it has caused a stabilization of SUVs. And that was in Auto Remarketing, the online version.

There's been a lot of articles -- similar articles in the press going through the economics of that. I wondered if it -- I'm sure it affects people making decisions whether or not to trade in their vehicle, their SUV, I just didn't know if it was causing people to actually buy an SUV.

I will just say anecdotally, over the past few weeks, we have seen increase in conversion rate on SUVs. We don't publish that number, but we are seeing that there appears to be a lot more demand for the SUVs at the current pricing.

Last question just on dealer help, whether or not you've seen any problems in terms of the buy side of your business.

I commented -- I guess the biggest impact -- on the Insurance Auto Auction side, it's a strong buyer population. There's a lot going on there, so I want you to know that is really a strong base, as you know, with used cars staying in service longer, a big component of their business is going to dismantling for parts. So that's very strong. When we go to the used car business, we are seeing and -- again Tom Cantos hasn't published a number but he has indicated in his recent articles, there is definitely a decline in the number of independent used car dealers and those are a big component of our buyers. They, the independents as well as the franchise dealers and then you have also read about some of the -- the Big Three in particular are trying to rationalize the number of dealers they have in their franchises. So it appears that some of them may have changes in their business. So I would say, generally speaking, at ADESA auctions we are seeing some declines. With that said, there are still at our sites, there's close to 50,000 registered buyers that are still active.

But so far the attrition has been quarterly in that you haven't seen a lot of -- I guess your numbers would support this -- you haven't seen a lot of delinquencies or bad credit behavior?

At the ADESA auctions level?

At the whole car --

At the whole car level, no. We have had some periods in this year in our Qs that we've announced a little bit of an increase in bad debts but it's really insignificant numbers in relation to the Company as a whole. You're right, it's very small.

Unfortunately when those dealers decide to stiff someone, it's the finance company.

Our next -- Did you have a follow-up?

I was just going to say, that's -- which is -- you mean AFC, right?

Yes.

Okay. Thank you.

Our next question is from Justin Boisseau with Gates Capital Management.

Hi. Thanks. You cited $11.5 million of nonrecurring charges in the quarter. Can you tell me first where they were sprinkled between SG&A and cost of goods sold and, second, if you can tell me where they show up in the EBIT reported for the segments?

Justin, I don't have that with me, and I think you asked this of me every quarter. We don't do it by segment. Perhaps a follow-up with -- I don't know how to do that. We really don't disclose it at that level. I don't want to be nonresponsive to that, because you are trying to understand the business.

Okay. I can follow up. Thanks.

Okay.

Our next question then is from [Adam Moss] with Columbia Management.

Thanks. A few questions. On the ADESA side, it looks now that revenue per vehicle sold, I estimate kind of the in the mid 500 area. And that is up very nicely over the last couple of years. I think you were in the high 400 area a few years ago. And I'm just trying to get a better understanding. What are the primary drivers of that growth between price, mix, ancillary services? Thanks.

I think the largest part of those increases are being driven by the ancillary services and, as Eric mentioned, that is our lower margin revenue, but that is where you are seeing the big increases in the revenue per vehicle. And that is a function really of I think we have had success and continue to have success in convincing customers that it's wise for them to use those services. And then secondly, I think that we've had some inflation if you will in the cost of those services. So the combination of those two are really the bulk of what is the driving the increase in the revenue per vehicle.

And we generally -- on the auction side, we've been able to get that mid single digit range increases in revenues per buyer fees.

Great. And then on the AFC again, you disclosed I believe in the quarter there was approximately $7.5 million of credit losses within the securitization and I'm wondering is that the number that is netted against the securitization income on the income statement?

Yes it is.

What was that number in the prior year second quarter of '07? Do you have that handy?

No. But I can get it if it's in here. Do you have another question while I look?

Yes, just a final question on the salvage side, how much has foreign buying been helping that business? That is all I have. Thanks.

It's hard to quantify, but foreign buying is a growing component. When I say hard to quantify, there is a number of cars sold domestically that are probably being shipped to ports and these are being brokered overseas and they are just using a domestic buyer.

So we estimate right now it's anywhere from 25% to perhaps a larger number than that, but it is a very strong and what we think is a growing component of the business in salvage and they've done a great job of developing those foreign buyers and really working with them. And [Tom O'Brien] and his group have really had that as a focus and they've done very well with it. Tom and a number of his team has been spending a lot of time with the ADESA folks on helping develop those same sort of international buyers and we really are focused on developing the international buyer base at the ADESA auctions as well. So it has been a growth area. We think it's going to continue and it has been a great strength at IAAI. We are hoping to see it be an improving strength at ADESA as well.

When you said 25%, that is 25% of what?

Of our sold vehicles.

And what would you say that percentage was, say, a year ago?

More than likely it's growing. I would probably say it's in the high teens. And again, Adam, a big part of this is the relationship of the dollar to foreign currencies as well.

Sure, understood. And then do you just have the credit loss number for the second quarter? We can follow up offline, I guess, if you want.

I give the December 31 number, not the year end number, but I can tell you -- we'll have to follow up. The number was substantially lower. I do know that.

Thank you very much.

And I can get it or you can go look at the Q from last year and you'd find it --

Thank you very much.

-- in the footnotes.

We do have a follow-up from Phillip Volpicelli with Goldman Sachs.

Thanks. With regard to the revenue per loan transaction being down at 95, have we seen that stabilize since the end of the second quarter and when you look at your expectations for the rest of the year, do you project that it continues to fall or starts to stabilize?

I would again -- what I would tell you is that that number has continued to decline and it really is being driven by our write-offs and while I think they've stabilized, they've stabilized at a number that clearly is not acceptable to us. So while we expect to see improvement in it, I think that, at the moment, we haven't seen the overall environment improving where I would be comfortable telling you it's going to start back up here in the next quarter or two quarters. It will eventually. I think that the team at AFC who have had a rough first six months are bracing for some continued rough times in the back half of the year.

And that number has declined through the second quarter. I've looked -- stabilization again you are asking me to predict, because you have to look at that -- you can't look at that in a point of time. You have to look over the case of at least a quarter because of how we process credit losses and write-offs.

Okay.

But I would tell you, it would appear to me that it's not going to go much lower. I just hate to say that --

I understand.

-- until we see the activity.

And then you mentioned in the Q that there was an immaterial issue with regard to the covenants that was resolved before the end of the quarter. Can you just describe that for us?

It's just that payment that's been processed of $11.2 million. For those of you that are in the bonds, you go look, there's a letter out there that indicates that that payment relates to including the rental portfolio in the securitization. That occurred earlier. It was just detected when we made the payment, which we should have made earlier. That is the only thing that was resolved and we've paid the penalty interest associated with it.

So it's all done and it won't happen again.

It's all done and it was an isolated event, that there was only one if them that related to the rental portfolio. It only applies to the initial sale.

Got you. And then you mentioned salvage volumes may decline with lower vehicles driven, I think the lower vehicles driven is about 4%. You guys had about a 17% increase, 5% organic, 12% acquisition. But the acquisitions probably stay with you for most of the year. Are you assuming that the organic goes down to flat or turns negative? How are you thinking about that?

I think that there's a high correlation between miles driven and the 4% down versus where we would see our volumes go to. That being said, we really, and again credit to Tom O'Brien and the IAAI team, have seen some strong out performance in the first six months of the year. And while they continue to worn that the miles driven will catch up, we think that they are showing some real wins, both on the customer side and operating efficiency side of the business. So I am, again, somewhat optimistic that we won't see the full effect of the decline in miles driven impacting that business, but we'll see -- what I would say is that the outperformance in the first six months of the year out of IAAI was truly exceptional.

And Phil to your point about acquisitions let's be clear. One of the ways we've been winning business is there's two national players in this market right now, and maybe a third, and then a lot of independents. We acquired the independents, the ability to continue to grow on a same store basis will be more difficult because that is one of the sources for us getting new business. So it would not surprise me as we've acquire VERASTAR and we've acquired Las Vegas, that yes, even though we are performing at a very high level, same store growth may not be even positive because we've already acquired those businesses.

Got you. And in terms of other participants, obviously the two big ones in your two markets are okay. Smaller auctions that are out there either on salvage or whole car, are you aware of anyone going bankrupt? Is anyone under severe pressure that can provide a very cheap opportunity for you to add scale?

I'm not aware of anything but that's, to be honest, not what I'm looking at especially if it's in a local market. I'd be the wrong person. And we are opportunistic, as Brian mentioned earlier. There are good chance people are calling if they are looking for a buyer because we're the only buyer that's really been active at the level of multiple auctions.

Last question, fuel cost, it's a little bit less of an issue now with oil coming down, but I think the Q mentioned that tow costs were up $5.3 million and you were going implement some surcharges there. Has that been receptive? How much do you think I'll be able to offset going forward?

I can't quantify it, but I will tell you it will be a fraction of the increase. Surcharges in our business, whether it would be the salvage business or the whole car business are very difficult to pass on. Our contracting processes are complex with very large corporations, who probably fight for reductions in periods of increased cost, as you probably know by who we deal with. But we are hoping to get some surcharges when it's fuel related. I think they'll be a minor impact, but nonetheless it will help us.

Thanks guys.

I think we have time only for one more question, Dwayne.

Very good. And that will be a follow-up from Kathryn O'Connor with Deutsche Bank.

Hi. Thanks for taking my questions again. I just wanted to see if -- I may have missed it before. Did you give a little bit of color about what was happening in terms of July I think after the Carmax used retail data came out last week, we had a lot of questions bout real and market demand for used cars. Can you let us know how the month is going?

I think that I would say it's more of the same, and at the outset, we had said that given the difficult environment we've been generally pleased with the auction activity and I think that continues to be the case.

And I would tell you this is a seasonality issue. July tends historically at both the salvage businesses and the ADESA auctions, whole car auctions to be a slower period of time. So I'm not sure it's a bellwether to determine what will happen over the next several months. July and August tend to be soft months at both.

You don't feel there was a huge drop off or a swing one way or the other that would concern you?

We did not see it in our business as we see it year-over-year comparisons and where the performance was to our plans, we didn't see any dramatic drop off.

And just again, you are asking detailed question without commenting too much, over the course of the last couple of weeks we have seen improvement in conversion rates, which seems to -- at least for the cars on the block, the sellers are recognizing what the values are and that the buyers are offering a fair value. And we are seeing -- but again, don't read too much into that. It's July and early August.

Okay. And then just back to the salvage question and the correlation to miles driven, I know that you had a 5% year-over-year or positive year-over-year comp on the same store basis and I'm just wondering can you give us an idea what the industry was doing? We have that number for the whole car side, but we don't really have it for the salvage side.

It continues. The estimate at the beginning of the year was low, up around the 2% level, and I've heard nothing to tell me that that number isn't about right. I don't think -- and I think you are having fewer automobiles on the road. I know there's been a reduction in the insurance industry and total claims process, that's been published, but the number of claims resulting in total loss has increased as a percent of the claims pool. So it would appear to me that that might be again looking at very low single digit growth in the industry, it seems to be the number, but I don't have any update beyond that.

Okay. And then last one here on AFC, I think in the past you may have told me that of all the cars that are sold at your auction, 10 to 15% have financing and then generally speaking that AFC had about 40% of the independent financing market. Can you tell me with the reduction -- or your attempts to reduce the portfolio, what if any of those numbers have changed?

I don't know that we've said 40%, because we don't really know how to define the market. They could be financing at banks and all that. Let's say that at about 30% of the cars financed by AFC roughly or cars acquired at our auctions and you are right. That probably translates in very close to 15% are financed at AFC. There are probably a lot of other cars sold and financed by other sources at our auctions and our competitors auctions. So I don't want to try to assert which numbers are which.

I think Katherine, if your question was are we seeing any market share gain or loss at the AFC level, my guess would be no. I think that we have two significant competitors in the floor planning to the independent dealers. We've seen some smaller independent dealer floor planners go out of business very rapidly, but the market share that we have had I think has remained pretty consistent.

So it really is 10 to 15% of whole car units are financed at your auctions in general and then -- or is that just 10 to 15% you AFC financing of your own?

10 to 15% of cars sold at our auctions are financed by AFC.

Okay.

We aren't speaking to how many are financed by the total industry.

And the 30% number is?

How many units floor planned at AFC were acquired at ADESA auctions as opposed to independent auctions, the large competitor that is out there, or wholesale transactions.

Perfect. Thank you.

Dwayne, I think that is all the time we have today.

Very good. That will then conclude today question-and-answer session. We would like to thank everyone for your participation, and wish everyone a good day.