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Executives

Jonathan Peisner - Vice President of Investor Relations & Planning and Treasurer

James P. Hallett - Chief Executive Officer and Director

Eric M. Loughmiller - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Gary F. Prestopino - Barrington Research Associates, Inc., Research Division

Robert Labick - CJS Securities, Inc.

John Lovallo - BofA Merrill Lynch, Research Division

Bret David Jordan - BB&T Capital Markets, Research Division

John R. Lawrence - Stephens Inc., Research Division

William R. Armstrong - CL King & Associates, Inc., Research Division

Colin Daddino - Gabelli & Company, Inc.

KAR Auction Services (KAR) Q4 2012 Earnings Call February 21, 2013 11:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the KAR Auction Services, Inc. Q4 2012 Quarter Earnings Conference Call. Today's call is being recorded. Today's hosts will be Jim Hallett, Chief Executive Officer of KAR Auction Services, Inc.; Eric Loughmiller, Executive Vice President and Chief Financial Officer of KAR Auction Services, Inc.; and Jonathan Peisner, Vice President and Treasurer of KAR Auction Services, Inc.

I would like to now turn the conference to Mr. Peisner. Please go ahead, sir.

Jonathan Peisner

Thanks, Augusta. Good morning, and thank you for joining us today for the KAR Auction Services Fourth Quarter Earnings Conference Call. Today, we will discuss the financial performance of KAR Auction Services for the quarter and year ended December 31, 2012. After concluding our commentary, we will take questions from participants.

Before Jim kicks off our discussion, I would like to remind you that this conference call contains forward-looking statements within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties that may affect KAR's business, prospects and results of operations, and such risks are fully detailed in our SEC filings. In providing forward-looking statements, the company expressly disclaims any obligation to update these statements.

Lastly, let me mention that throughout this conference call, we will be referencing both GAAP and non-GAAP financial measures. Reconciliations of the non-GAAP financial measures to the applicable GAAP financial measures can be found in the press release that was issued yesterday, which is also available in the Investor Relations section of our website.

Now I'd like to turn this call over to KAR Auction Services' CEO, Jim Hallett. Jim?

James P. Hallett

Great. Thank you, Jon, and good morning, ladies and gentlemen, and welcome to our call. My comments will be a little extended this morning as we do this call; number one, it's our year-end call, and there's been a couple of significant events that have taken place in the quarter that I believe that I should provide you with more color on.

So turning now to the summary of our financial statements or results. We finished 2012 with revenue of almost $2 billion on the sale of approximately 3.3 million vehicles. This represented a 4% growth over the prior year. Our adjusted EBITDA came in at just over $500 million, and that gave us an EBITDA margin of 25.5%, and this was the low end of our guidance range, which I'll talk more about here in just a few moments.

A couple key items that impacted the 2012 results for ADESA and ultimately for KAR. Number one is we did have an unforeseen weather event take place in the very last week of the year. We had a winter storm that started out in Texas and worked its way all the way through New England during the last week. And typically, during the last week of the year, we put in a conservative budget, but even our conservative budget was missed as dealers just weren't able to get the auctions -- weren't able to get cars to auctions or get cars sold. So that did bring our volumes in lower than we expected for that last week. And then we also had the double whammy effect of the additional expense of having to remove the snow, and this reduced ADESA's EBITDA, and overall, I believe this took us to the bottom of the range.

So as we look at the whole car volumes at ADESA, they remain low in the fourth quarter. We're expecting that the NAAA results will be out within the next couple weeks, and we expect that those volumes will be reported at approximately 7.9 million vehicles sold in 2012 for the industry. This will include the 260,000 vehicles sold from our OPENLANE platform. ADESA's volumes overall are up 8%. This includes OPENLANE. If we just look at our physical auctions, our physical auctions were down 4%. So we believe that the whole car volumes have absolutely hit the bottom in 2012. And I'll come back and talk a little bit more about what we see going forward in the future.

But with that, let me now turn to Superstorm Sandy and provide you with some color. There has been much read and much documented on Superstorm Sandy, but from our viewpoint, let me tell you that Superstorm Sandy was the most catastrophic event in the history of Insurance Auto Auctions. I'd say it was the perfect storm in the worst of ways. We were dealing with the most dense, heavily populated areas of the country, the most difficult infrastructure in most parts of the country when you think about the bridges and the parkways and the roadways and the access to move vehicles.

And then we're dealing with some of the most expensive real estate in the country. And we had to acquire an additional 400 acres to store and manage to sell these vehicles from. Many of you may have seen the pictures that made the way around the world of 2 runways that we had at the Calverton Airport in Long Island, New York, where we had 20,000 flooded vehicles parked.

And then we were dealing with the regulators. It wasn't easy dealing with the regulators as they made it very difficult for outside transporters to come into the state of New York in the haul vehicles. In many cases, we would expect to haul 6 to 7 vehicles a day, and we were lucky if we could get 2 vehicles hauled a day.

But all in all, we put a team of hundreds of people together throughout the entire KAR organization. And this was not just people from Insurance Auto Auctions, but there were people from ADESA, people from AFC, people from all parts of our organization that were working to help out and serve our customers throughout this entire process.

Obviously, we have a lot of additional costs in terms of travel and lodging for the people that we are able to fly in to handle the storm. We had towers from all over the country. We recruited towers through our CarsArrive network, towers from as far away as southern states of Florida, Alabama, Mississippi, Louisiana and Texas. We had to purchase an additional 40 loaders just to manage moving these vehicles around at the various sites. At one point, I think we had 14 sites making up this 400 additional acres. And then we had to import technology not only to check in the vehicles and process the vehicles, but then to be able to sell the vehicles over the Internet from these remote sites.

So at the end of the day, I think our commitment was to the speed at which we could serve our customers. And I do expect that the way that we handled Superstorm Sandy will pay great dividends as we go forward. In fact, I can tell you it's already paid dividends, and I'll speak more to that in a few moments. But this was the first catastrophic event that Insurance Auto Auctions has ever lost money on. And as we reported, we had a pretax loss of $9.1 million in the fourth quarter of 2012. We sold approximately 10,000 of these vehicles in the fourth quarter. In 2013, we expect that there will be an additional loss of approximately $10 million and that most of these vehicles will all be sold as we get to the midpoint of the year. So that's kind of the color in the story on Superstorm Sandy.

And now I'd like to turn to our outlook for 2013. We're expecting to see growth in the whole car auction volumes. We expect the growth to be in the order of 5%. This will track to 8.4 million vehicles in 2013 for the industry. We would expect that that number will get closer to 9 million vehicles by 2015, and we expect that we can even do beyond 9 million vehicles as we move past 2015.

There's no question that more commercial vehicles will come into the mix. But one thing that I would point out is I would expect that we will hold our position with dealer consignments. I'm really proud of the work that this organization has done in terms of developing dealer consignment over the last 3 or 4 years to fill the blade of the commercial cars. And I expect that that business will be able to stick as we go forward.

The off-lease vehicles have hit bottom in 2012. We know that those vehicles will begin to grow in 2013 and continue to grow into the foreseeable future. And I've reported on previous conference calls that there are some that believe that leasing will represent 50% of all new car sales by 2017.

Another important segment for us is repossessed vehicles, and I believe they hit bottom in 2012 as well. Retail activity is very strong. The North American car -- North American SAR, excuse me, continues to grow. Used car sales and used car prices continue to be very strong. In fact, there's been a number of articles out and one in the Wall Street Journal that you may have read this morning just speaking to the strength of these car prices and the retail sales activity that's going on. The credit markets are back to normal. And with all these things in place, I think it lines up for more repossessions to come our way. So that's a good thing for our industry.

So as we think about this mix shift that's going to take place of going from more -- or going to more commercial vehicles coming into the marketplace, this is also going to prove very well for the use of our ancillary services. If you think about who are the heavy users of these reconditioning and mechanical services, it's the off-lease cars, the rental cars, the repossession cars. And we expect that we will provide more of those ancillary services. We'll be able to grow our revenue per vehicle sold with the use of the services, and this will improve our margins, as well as it will allow us to benefit from the scale of our operations.

And then I want to speak a little bit about the integration of OPENLANE and ADESA. This integration has gone extremely well. I think we had a very detailed integration plan, and the team has executed on all of their timelines. And now we are operating all of our U.S. auctions on one combined platform. adesa.com is the only site. We have one single site now that dealers can enter and purchase vehicles on.

And as you know, OPENLANE dominates the private label sites. We provide private label sites for an excess of 90% of all the manufacturers in North America. And as I like to say, that means we get the car first. We get the car at the very top of the funnel. We get the opportunity to sell that car first in a closed sale. And if it doesn't sell in a closed sale online, then we get to sell that car in an open sale online. And if it doesn't sell in the open sale online, then we get to sell that car at a physical auction. But it's really channel optimization, and I think with us getting the car first with 90% of these manufacturers, it really gives us the opportunity to control the sale of these cars as it works its way through the funnel.

So with that, we're feeling good about the whole car business, and we're feeling good about the volumes that are about to come our way.

Now turning to AFC. AFC just continues to be a very solid performer, and I believe that the growth in whole car volumes at auctions will continue to serve AFC very well. Credit remains very strong. The whole cost of funds is very much in our favor. And AFC continues to look to expand into other markets. We've talked to you in the past about the opportunity to finance motorcycles, RVs, heavy-duty equipment and power sports. We did get into some of that business in 2012, and I would expect that we'll further penetrate that business in 2013. So all in all, I would say that AFC is in a very strong competitive position and has the opportunity to grow as we go forward in 2013 and beyond.

And then turning to Insurance Auto Auctions. Obviously, 2012 was somewhat of a break in the strong growth record for our salvage business. But I would expect that Insurance Auto Auctions will grow again in 2013. We're seeing stable proceeds. We expect growth in net revenue, and we expect growth in our insurance volumes. As well, we have our VRD, which is the vehicle remarketing department, that's the selling of low-end whole cars, continues to grow for Insurance Auto Auctions, as well as our charity segment continues to grow. And we'll continue to purchase vehicles at Insurance Auto Auctions, although I would say that our purchased vehicles will pretty much remain flat with what we've seen in 2012.

So what have we seen so far this year? Obviously, off-lease volumes will continue to improve. And I would like to call your attention to the fact that the off-lease volumes really started to improve in the second quarter 3 years ago. So there won't be a consistent improvement in off-lease vehicles. I believe you'll see those volumes start to ramp up in the second quarter, and the bulk of those vehicles will come in the second half of 2013. Again, AFC, we expect that portfolio will grow, and the credit stats will remain strong. And Insurance Auto Auctions is going to continue to operate pretty much as we're expecting.

One of the things that I'd like to call your attention to is the last time that we spoke, I mentioned that we were involved in an RFP process with 1 of 2 major RFP that were outstanding with major insurance companies. And now we've got the results of that second RFP. In both cases, we entered these RFPs with a majority of the market share. And when the RFPs were finally settled, we actually increased our market share with both of these providers. In fact, we have reached multiyear agreements. And a couple things I had mentioned: the key reason cited for us winning this additional business was the strength of our returns; and it was also mentioned that the way that we handled the whole Superstorm Sandy event was very much recognized and was appreciated in the way that we handled that whole debacle that took place up in the New York and New Jersey regions.

And the reason that I want to mention this, because I've said in the past, I don't normally talk about wins and losses, and I don't plan on talking about them each time we get on a call. But I think over the last year, 1.5 years, there's been a number of you all that have asked, "Is there a trend to go to national exclusive contracts?" And I would say this is your answer. We don't believe there's a trend to do that. In fact, we believe there's a trend for these national insurance companies to use multiple vendors. And I think it's witnessed with the awarding of this business. So we're feeling very, very good about this business and feeling very good about winning these RFPs and winning this additional business as we go forward.

As I turn to our guidance for 2013, we expect adjusted EBITDA to be $535 million to $540 million. This excludes the $10 million loss from Sandy. Our board has announced that our first quarter dividends will be paid, $0.19 per share to the shareholders of record on March 25, and the actual dividend will be paid on the 4th of April. And again, I will draw attention to our free cash flow and our priorities. We will continue to focus on repaying debt. Our goal is to be 3x or less in 2013. We'll pay our dividends, and then we'll continue to evaluate other strategic opportunities for continued growth within our businesses.

So with that, I'd like to now turn it over to Eric for additional commentary on our financial performance. And then I'll come back, and we'll do some Q&A. So I thank you, and Eric?

Eric M. Loughmiller

Thank you, Jim. First, let me highlight our free cash flow generation for 2012. As Jim mentioned, KAR generated $500.2 million of adjusted EBITDA. We utilized $95.8 million to pay cash interest on our corporate debt, $102 million for capital expenditures and $65.3 million for cash taxes. The net result is free cash flow of $237.1 million. From this free cash flow, we utilized $26 million to pay dividends to shareholders and $85.9 million to repay debt during 2012.

We also had an atypical use of cash for working capital at December 31, 2012. This is primarily driven by 2 factors. First, we have significant costs associated with the towing of Sandy vehicles. In addition, we saw strong growth in our AFC loan portfolio. As I have mentioned before, we fund about $0.23 on $1.00 of this growth using company cash.

I would also like to point out that our capital expenditures were greater than what we had expected. Approximately $7 million of our capital expenditures relate directly to capital deployed in November and December in order to handle the Superstorm Sandy vehicles. The good news is a substantial amount of the items deployed in New York and New Jersey will be relocated to other sites once we are done processing the Sandy cars. This will include over 40 loaders purchased and the technology equipment put in place at our temporary locations. The increased capital expenditures were partially offset by reduced cash taxes. Many of the costs incurred as a result of Sandy created tax deductions that reduced our cash taxes in the United States.

Now let me speak to our overall operating performance. KAR, through its operating businesses, sold over 3.3 million vehicles in 2012, a 6% increase over 2011. Approximately 57% of the vehicles sold were whole cars, with the remainder being salvage vehicles. Consolidated revenue of $1,963,000,000 was 4% greater than the prior year. Consolidated gross profit was approximately 45% of revenue and remained relatively consistent with the prior year.

Our selling, general and administrative expenses increased by $30 million in 2012. This increase represents an additional $24 million of OPENLANE SG&A and an increase in stock-based compensation of approximately $6 million. Our effective tax rate for 2012 was 39%, a little bit lower than what we had anticipated for the year.

An important item to note as you analyze our financial results is that IAA incurred a pretax loss of $9.1 million related to the Sandy cars. In accordance with the definitions in our credit agreement, the onetime temporary costs incurred as a result of Sandy have been added back in computing adjusted EBITDA. The $9.1 million loss reflects the short-term nonrecurring expenses incurred in Q4, partially offset by the gross profit realized upon the sale of the Sandy vehicles. We have not allocated any costs related to our normal operations to the Sandy loss. As you can see in our press release and financial supplement issued last night, we are separately disclosing the net Sandy loss.

We have provided the financial supplement, which gives you performance information for each of our business segments and summary information on our overall performance. We expect to file our 10-K, which will give a more detailed analysis of our performance tomorrow.

I would now like to provide some more information on our guidance. Jim has already outlined our expectations for the cyclical recovery of ADESA, so I'm not going any further on that. IAA, as he mentioned, is well positioned in the salvage auction industry entering 2013. We have seen a lot more winter weather activity in late 2012 and early 2013 than 1 year prior. You may have noticed snow coming from Tucson, Arizona through the Great Plains yesterday. This is a more normal winter than what we experienced a year ago. This has led to the stable flow of vehicles into the salvage auctions that we have expected and will expect.

AFC is also expecting to continue increasing the number of loan transactions. We expect to achieve this growth by increasing the number of active dealers, achieving greater utilization of available lines of credit with our existing dealers and expanding our floorplan lending in other areas that Jim already mentioned. We are in the process of expanding the amounts available in our securitization facility and extending the term beyond its current maturity of June 30, 2014. The process is moving along well, and we expect to complete the amendment process in the next couple of months.

Now let me expand on our guidance for 2013. Jim's already mentioned our expectations of adjusted EBITDA of $535 million to $540 million. We also expect cash interest expense of approximately $94 million, capital expenditures of approximately $95 million and cash taxes of approximately $85 million. This will result in free cash flow of $261 million to $266 million. We expect to allocate $104 million of our free cash flow to dividends based on our current quarterly dividend rate of $0.19 per share. Future quarterly dividends are subject to the approval of the Board of Directors.

We expect earnings per share to be $0.82 to $0.87 per share. This assumes an effective tax rate of 41% for 2013. I would also add there are no add-backs or adjustments to our GAAP earnings per share. We also provide our guidance on adjusted earnings per share of $1.13 to $1.18. Our adjustments to GAAP earnings per share on a pretax basis are: the 2013 net loss from Sandy of approximately $10 million; stepped-up depreciation and amortization from our 2007 LBO transaction of approximately $46 million; and noncash, stock-based compensation that we estimate at approximately $10 million.

Now one other item that I would like to briefly discuss as a result of a number of inquiries from our investors is the possibility of KAR utilizing the internal REIT structure. This is a tax structure. We have done a preliminary analysis of the structure and have identified a number of items that impact our ability to pursue this tax-efficient structure. First and foremost, we utilize leases from a majority of our property. While this does not preclude a company from utilizing the REIT structure, it does make it more difficult to meet the test that requires 75% of gross assets to be qualified real estate assets. In addition, our businesses are diverse and include a number of areas that are not qualified real estate activities. And finally, our strong presence in Canada creates a substantial amount of our taxable income outside the United States, where this structure does not provide that same tax benefit. A substantial amount of taxes we expect to pay in 2013 relate to Canada or various U.S. state income taxes. The complexity of the KAR businesses and diversity of its offerings would likely result in significant costs and efforts to pursue this structure. We'll continue to monitor activity around the REIT structure as more information becomes available.

I think that's enough comments. And so now we'll turn it back to Augusta for the Q&A. Thank you, everyone.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from Matthew Fassler of Goldman Sachs.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Two questions, and the first to Eric. You essentially alluded to -- a moment ago when you discussed the weather environment, and it relates to the salvage business. So I guess this year, you saw some pressure on adjusted EBITDA even when you back out Sandy for that business. And to your point -- in terms of your point earlier, it had been on a pretty good growth trajectory prior to this. Do you think that the improvement is likely to be manifested in better volumes? Did the -- what do you think happens to operating leverage and the -- given the kind of weather backdrop that you see now, which presumably will be the backdrop that impacts 2013?

James P. Hallett

Yes, Matt, this is Jim. I would say to you that obviously, with the volume situation, we expect the volumes will increase. Not only will they increase based on some of the climate conditions that Eric spoke to and that we're experiencing with a more normal-type winter taking place and more normal-type weather. But I think also from the gains that we've made with our recent customers on an organic basis, it will -- in terms of increasing our market share, that business will continue to grow and offset.

Eric M. Loughmiller

And Matt, I'd like to clarify a point. The weather impact was really at ADESA. At IAA, I would not attribute much of the performance in 2012 to that last week of the year. And in fact, the bigger impact was they were dedicating so much resource to processing these Sandy cars, that there were -- collision cars or non-Sandy cars were probably slowed down by the insurance companies and processing at a slower pace. But that's all good news because that's just timing, right? I mean...

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

But alluding, I guess, to the broader weather winter issue, and we've seen it for lots of aftermarket players as well, the lack of a winter in 2012, not that there weren't as many accidents, breakdowns, etcetera. Presumably it will flow through to kind of salvage volume over the course of the year. That was really the essence of the question. And I guess the reference -- I want to make sure I'm interpreting this right -- the reference to the snow that we've seen as a good thing for the flow of goods into that business.

Eric M. Loughmiller

That's right. And we've already seen it in assignments.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Got it. Second question, just to make sure I understand the compensation of the salvage P&Ls. So I guess adjusted EBITDA adds back the impact of Sandy; adjusted net income includes it. As we think about the revenue number, I guess you said that the adjusted EBITDA -- or rather the loss associated with Sandy is offset by the gross profit dollars associated with Sandy-related sales. So as we think about adjusted EBITDA margin, do we need to make any adjustment to revenue to try to get a good look at the real underlying business? Because presumably the revenue number is a bit inflated by some of those Sandy numbers. How do we get the cleanest look at profitability is my real question.

Eric M. Loughmiller

Okay, Matt. But I want to clear -- you said something I want to be clear on. Adjusted earnings per share is adjusted for the impact of Sandy. GAAP earnings per share is not. And...

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Okay. So all the adjustment numbers exclude the Sandy impact?

Eric M. Loughmiller

Correct. And you are correct, the impact -- we've talked about -- historically, the average revenue per vehicle in salvage is in the 400s, okay? The Sandy cars tend to be flood cars, and they sell a little bit higher, generate a little bit more revenue, so I'll let you extrapolate your math on about 10,000 cars in the fourth quarter was the revenue impact. And the costs associated were significantly higher in cost of goods sold or cost of services than they normally would be, so the margin there was very, very small. What we will tell you is if you were to exclude the impact of the Sandy cars in all parts of our balance sheet, we continue to have a gross profit that was above 40%, consistent with how we've been performing.

Operator

Your next question comes from Chris Ceraso of Crédit Suisse.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Just a couple of things. First on Sandy, is there any anticipation that there's a favorable tail here that we might see, vehicles that didn't get processed, that maybe at some point throughout 2013, you'll be able to process at more reasonable cost levels? Or is this it, it's over, the vehicles are done as of, whatever, Q1, Q2 with the high costs, and you're excluding all of that, and the only positive byproduct is that you won some more business?

James P. Hallett

Well, we clearly have a positive byproduct of winning more business. And what I was just mentioning in the previous question, a positive byproduct of this is there were -- actually, they slowed down, the insurance companies slowed down title processing to the extent that they were really focusing all their attention on Sandy initially. And that probably pushed some cars out into the pipeline, Chris. Cars that would've been processed perhaps in November and December probably led into the early part of the year. And that's a phenomenon that was actually more than just the Northeast because a lot of these companies were dedicating resources nationwide to get these things processed. In fact, we established 3 centers outside of the New York, New Jersey area just to handle Sandy titles, so we could accelerate the process for our customers. So I do think there's a little bit of a positive move into the year, and we'll just have to wait and see. I'm probably more excited about -- no offense to anybody that's been stuck in the snow and Nemo and all that -- by the winter weather and what that's done to kind of the ongoing volumes of the salvage industry.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Okay. And then second question. So Jim mentioned what we've all been watching is the number of off-lease units should hit a turning point in 2013. That's good for ADESA. Historically, when things start to go better for ADESA, typically, your margins at IAA and AFC tend to be a little bit lower. So is that pattern expected to persist? Are we going to see a better year for ADESA in '13 versus '12, but maybe a weaker year in terms of profit margins at the other 2 businesses?

Eric M. Loughmiller

Chris, that's interesting. And that was kind of the structure of the business. But what's happened is with the acceptance of aftermarket recycled parts in the collision repair industry, there's much stronger support today than there was 5 years ago. That seems to be holding up the salvage values despite, perhaps, softening in used car values. And so what we're seeing right now, and I think you look at some of like an LKQ or companies like that, they're not anticipating that the cost to acquire their inventory will decline because of the strong demand in the collision repair business. So at this point, we are not seeing, perhaps, the weighting shift going from a stronger ADESA leading to a, call it, somewhat weaker performance of IAA. We actually think we're in a market that is well positioned for both to do very well despite both experiencing increasing supply.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

And what about AFC, Eric?

Eric M. Loughmiller

Well, AFC, we love it because, as you guys know, when you can make money with money, it's a pretty attractive business. Their average loan value might drop a little bit, but this strong market has really made the credit statistics. Cost of funds are fantastic. I can't think of being in a better position than AFC is in today with their 104 loan origination officers out there touching the customer. We have AutoVIN doing lots of lot checks so we're -- the cars are there, and that's -- you lose money when the car disappears. So I feel very good about AFC will continue its strong performance. And they're gaining -- they seem to be gaining share despite the fairly weak auction business. So I'm really looking forward to when the supply returns, and there's more cars to floorplan.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

So maybe some pressure because of softer used car values, but the other inputs to that model seem to be all in favor.

Eric M. Loughmiller

They seem to all be in favor. And again, that pressure on used car values will actually probably mitigate any credit risk because the values are staying fairly consistent. We do not see declining used car values. We see very modest change, if anything. They're talking about 1%, 2% declines. That doesn't impact us. I mean, that's not the level at which we see major changes in any of our businesses.

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Okay. And then just lastly, one housekeeping item. Can you bridge for us the adjusted EBITDA to the adjusted EPS? In particular, what is your assumption for book interest expense? I know you gave the cash number. Any kind of other income or expense in the share count?

Eric M. Loughmiller

Again, the share count, other than Treasury method, probably has a little -- a very modest increase. In terms of cash interest, you can look in our financial statements. There's $10 million to $15 million of noncash interest amortization of debt issuance costs, et cetera, and that number is fairly consistent over the term of the debt. And that -- so I don't expect a significant change there. And what was the third? There was a third one, Chris. Did I miss one?

Christopher J. Ceraso - Crédit Suisse AG, Research Division

Well, there's the other line, other income or expense. Anything notable there?

Eric M. Loughmiller

On the adjusted EBITDA, again, our credit agreement picks up things such as severance, integration costs. However, those are not adjusted in the earnings per share at all. Only the items I mentioned were adjusted in our guidance on earnings per share, the 3 things: step-up in the D&A was $46 million pretax; $10 million in stock-based comp, and that's just a budget assumption in our expectations. We aren't in the stock prediction business, but we put a number in there, and that's the number that was in our results. And that's added back in both. And then you have the hurricane -- or the Superstorm Sandy impact, pretax of $10 million.

Operator

Our next question comes from Gary Prestopino of Barrington Research.

Gary F. Prestopino - Barrington Research Associates, Inc., Research Division

A couple of questions here, Eric. On AFC, could you tell us, or if you have it already, what the ending portfolio was and the amount that's current?

Eric M. Loughmiller

Well, I can tell you it's over 99% current, and -- just a second, I -- Gary, I have to pull something out to tell you that. I didn't actually have that right in front of me. It will be in the K.

Gary F. Prestopino - Barrington Research Associates, Inc., Research Division

Okay, if you don't have it, that's fine. I'm just...

Eric M. Loughmiller

But I can get it, Gary [indiscernible]

Gary F. Prestopino - Barrington Research Associates, Inc., Research Division

[indiscernible] is how much more capacity do you have right now? And then you said you were going to try to increase the capacity. So I'm trying to get an idea of how much bigger it could get or what capacity do you have there to grow it.

Eric M. Loughmiller

We were -- the portfolio, it's in the press release, is the finance receivables net of allowances. So the total portfolio was right at $1 billion, just slightly above $1 billion on a gross basis. And we had -- in terms of obligations, financed $713 million outstanding on the securitizations that currently have a capacity of $750 million with just over another year. And we're very comfortable that we -- that's sufficient. There is a seasonality to the AFC business. It hits its peak around the end of the year or this year, a little bit into January. And by February, you're starting to see the inventories on the dealers' lots as they sell into the tax season decline, comes down, and then it begins growing again, typically, late summer, early fall as they start building inventory for that season. So Gary, we're very comfortable with what we have now. But as we look beyond June of 2014, obviously, we think that the ability to grow the AFC portfolio continues, and we want to expand the capacity in a reasonable number that could take care of us for the next 2 to 3 years.

Gary F. Prestopino - Barrington Research Associates, Inc., Research Division

Okay. But you can't make that public, what you want to -- what you're going to expand it to?

Eric M. Loughmiller

Well, I'd rather maintain my position with the banks that we're dealing with it, other than to tell you we're dealing with it. So no, I'm not ready to give you a number yet, but we will shortly when we have a deal.

Gary F. Prestopino - Barrington Research Associates, Inc., Research Division

Okay, that's fine. And then, Jim, you mentioned on channel maximization with OPENLANE, you get a first shot at a closed auction virtual, then an open virtual, and then a physical, right?

James P. Hallett

Right.

Gary F. Prestopino - Barrington Research Associates, Inc., Research Division

But you actually control the car on the closed auction. But do you actually control it on the open virtual auction as well, and then control it as well going into the physical? Or is that something you really have to negotiate with the OEM or work with the OEM if it doesn't sell in a closed auction?

James P. Hallett

Yes, good question, Gary. We control it on the -- obviously, on the closed. We control it on the open. And then the seller has the decision on where it goes physically. We would hope that because we're getting them at the top of the funnel and controlling them to those first 2 stages, we would hope that the -- that when they go to physical, that ADESA could be the first choice there, but that's not always the case.

Gary F. Prestopino - Barrington Research Associates, Inc., Research Division

Can you kind of share with us maybe what percentage of the cars are actually sold under the closed and open virtual that you offer?

James P. Hallett

I think we've reported that all of our online sales is in the order of 32% overall. That includes open and closed and includes our LiveBlock sales as well.

Eric M. Loughmiller

And all segments, not just commercial. Not just..

Gary F. Prestopino - Barrington Research Associates, Inc., Research Division

From that inference, we could get an idea of just what the amount that you control can be sold, and then what the amount is that the sellers would actually have an option on. And lastly...

Eric M. Loughmiller

And Gary, let me clarify. Of that 32%, about half is LiveBlock, which is sold from physical auction, and about half is online only. And we've talked about that before.

James P. Hallett

Yes.

Eric M. Loughmiller

But those are rough numbers. So it's really the half that's online only, so I've got your number down in the mid-teens.

Gary F. Prestopino - Barrington Research Associates, Inc., Research Division

Okay, great. And then lastly, can you share what percentage of vehicles Insurance Auto was now doing that are noninsurance?

James P. Hallett

I think we're pretty much running in that 80-20 range.

Eric M. Loughmiller

Yes, we're a little over 80% insurance. And obviously, with the Sandy cars, it'll probably cause that percent to be a little bit higher because those are all insurance cars.

Gary F. Prestopino - Barrington Research Associates, Inc., Research Division

Right. And you had said in your -- in some of your comments earlier that the revenue or the prices on these cars were better than normal salvage because they're flood. So the whole issue with what happened with Sandy was not really that the cars were not selling at decent prices, it was all expenses?

James P. Hallett

That's right, Gary. And in many cases, as -- when you think about that New York, New Jersey area, we're dealing with some very high-end vehicles here. And the prices for these flood cars has been above what we would normally see for salvage vehicles.

Operator

Our next question comes from Bob Labick at CJS Securities.

Robert Labick - CJS Securities, Inc.

Just want to clarify a few things. Eric, in your earlier comment, you mentioned that IAA margins, x Sandy, were north of 40%. Is that for the full year or for the quarter? Because I was calculating closer to the 36% for the quarter, x Sandy.

Eric M. Loughmiller

It would have been for the full year. And I think when you get to the Q, you'll see -- I would tell you I think your margin for the fourth quarter is a little low if you took Sandy out. It was a little better than that.

Robert Labick - CJS Securities, Inc.

Okay, great. And once we get more details, I'll dig into it there. And then also, obviously, you guys mentioned, and we certainly know, with many of us living in New York, that it's expensive here. But I was wondering if you could give kind of an order of magnitude in terms of the cost differential from this storm versus previous cats, where you guys have said you've never lost money before. And in terms of that, the storage, towing, labor, I mean where did the -- losing $20 million on this, I think most have come as a surprise to you initially. I guess that's the question, was it a surprise to you? And can you just -- without quantifying the numbers but by order of magnitude, what were the biggest costs versus your expectations?

James P. Hallett

Yes, there's no question that the storm was so isolated and so heavily concentrated in that New York and New Jersey areas. The biggest cost, no question, was what we provide in terms of towing and also, in terms of securing land. Those are -- and then the team of people that we had to assemble to handle the cat itself made up the bulk of the cost.

Eric M. Loughmiller

And Bob, I'd like -- you said surprise. It was something we didn't expect, but I would not use the term surprise. As we're incurring these costs, we know it. Yes, it was unexpected but not a surprise because that was the market, and we were in that market. And Jim mentioned it in his remarks, our customers are demanding, and we were responding with speed and commitment to getting those cars into our locations and then getting them processed. The best comparison is Katrina as an example, and it was in different part of the U.S. And you know what? At Katrina, we didn't make a lot of money, but we processed a large number of cars for a small amount of profit, and this was a loss. I mean, that kind of quantify -- that $20 million loss, either one of these things, and that's not what you expect.

James P. Hallett

Let me give you just a couple stats as you compare Sandy and Katrina. At Katrina, we had to secure 110 acres of land; Sandy, over 400. Katrina, we had to bring in 50 additional towers; in Sandy, we had to bring in 600 additional towers. In terms of assignments that we're handling, we were handling 10x as many as Simon's [ph] in the course of the first 3 weeks than we were in Katrina. So everything was just on steroids. It was just a lot more coming at us a lot faster, and people are expecting us to react in a much more expedited manner.

Robert Labick - CJS Securities, Inc.

,

Okay, that's helpful color. And then particularly with IAA, could you just comment on the purchase core mix in the quarter versus a year ago? I think you commented that you expect it to remain flat at current levels for 2013. But could you tell us what it was in the quarter?

Eric M. Loughmiller

Bob, I don't have that right here handy. It was actually less than it was in previous quarters and not surprisingly because of the activity we were dealing with in the Northeast. And we'll have in our K the amount for the year, but I -- again, I could look it up, but I could follow up with you. But it was a little bit less than previous quarters, and it was above 5%, as I recall.

Operator

Our next question will come from John Lovallo of Bank of America Merrill Lynch.

John Lovallo - BofA Merrill Lynch, Research Division

First question would be, just getting back on this Sandy versus Katrina comparison, how would you kind of characterize the quality of the vehicles? I know you said that there's more higher-end vehicles that came through. But in terms of just the reusable parts, would -- is it fair to say that the cars in Sandy probably had more reusable parts because the floodwaters receded more quickly?

James P. Hallett

There's no question to your first point. The Sandy cars were a higher-dollar car. When you think of higher-dollar cars in that region, you think of the luxury cars, and you can figure those brands, the Mercedes, the Audis, the Lexuses and Porsches and things of that nature. And we're also dealing with saltwater here. And saltwater causes tremendous long-term damage to these vehicles. So I don't think I'm in a position to comment on reusable parts other than the fact that when you're dealing with saltwater, you're dealing with vehicles that are going to have long-term damage.

John Lovallo - BofA Merrill Lynch, Research Division

Okay, that's very helpful. And then if I could maybe just ask one kind of high-level question on just the REIT conversation that you were talking about. Just very broadly speaking -- I mean, when I think of your business, I think of kind of the value that you add would be in creating a market, allowing more eyeballs to see each vehicles, assuring title transfer to the buyer, assuring payment to the seller, those are kind of the main things that I think about. But do you -- would you -- how would you kind of characterize the value associated with storing a vehicle? I mean, is there any way to kind of think about that?

Eric M. Loughmiller

You know what? If you look at the way that we engage with our customers, we charge a sell fee, and the sell fee is -- we've talked about this a long time -- much smaller than the buy fee. And the buyer is clearly not going to pay us through how long that car sat there. And the sell fee is -- I mean, if there was a portion of our fee attributable to the storage of the vehicles, I would think it would be a subset because, John, of all the things you mentioned. Look at all that we're doing for that sell fee, and only a small portion might be attributable to the time we store the vehicle.

Operator

We'll go next to Bret Jordan of BB&T Capital Markets.

Bret David Jordan - BB&T Capital Markets, Research Division

A couple of quick questions. Number one, I think you'd said that maybe some higher-than-expected CapEx late in the year related to Sandy. Could you give us some more color on how much incremental CapEx you experienced from Sandy? And I think you also felt that maybe some of those assets could be reallocated in 2013. Sort of what was the spending driven by? And as you reallocate those assets, do we have, I guess, lower utilization because you had to build up for the surge in Sandy?

Eric M. Loughmiller

Yes, it was $7 million of the $102 million was specifically for Sandy, and a substantial amount of it will be reallocated, not 100%. There was some that probably related to work we're doing on the temporary side where it may not be cost-effective to move things. But majority will be -- not reallocated, will be utilized, redeployed as part of our plan. And so that's a piece of it, the $102 million. And then there was another piece that I didn't actually put much color on. We were a little above where we started the year because we really went after the OPENLANE integration that Jim talked about. And we did spend a little bit more by plan to accelerate the pace at which we could get to a single site. And so those are the -- really the 2 things that contributed to us being at $102 million versus where we began the year, expecting around $90 million.

Bret David Jordan - BB&T Capital Markets, Research Division

Okay, great. And then one last question I guess on the whole car side of the business, and the dealers are focusing pretty intensely on increasing their used ratio of cars sold. Are you seeing sort of headwinds to whole car access as they're trying to keep some of these off-lease vehicles or what typically would have been a wholesale out on their lots to resell as used?

James P. Hallett

I would say, Bret, we're maybe seeing the opposite of that. What you've got is you've got more supply, more vehicles coming into the market. And where in 2012, dealers were squeezing every vehicle they could, trying to hang on to these vehicles, now with the additional supply coming, I think that we'll see more of those trade-ins making their way to the physical auctions.

Operator

We'll go next to John Lawrence of Stephens.

John R. Lawrence - Stephens Inc., Research Division

Just a couple questions regarding the wins on the insurance side. Could you broaden that a little bit and give us the profile of those customers? I guess the point is is they continue to use alternative parts as part of their mix, and that continues to grow. Give us a little history there with these 2 guys, and would that be the case in point?

James P. Hallett

I think we would clarify to saying that they were major insurance companies and probably in the top 10 in the nation. And to your point, they would be users of alternative parts.

John R. Lawrence - Stephens Inc., Research Division

And you would sense that that's increasing over time just like the industry has?

James P. Hallett

Yes, there's been the -- I think Eric mentioned earlier in his conversation -- in his comments is the use of alternative parts is now more -- much more widespread accepted throughout the industry. And we expect that that will only increase.

John R. Lawrence - Stephens Inc., Research Division

Right. And secondly, can you give any kind of a sense of -- if you look at the buckets of mix between foreign nameplates sold versus domestic, any sense of what kind of pricing you get differential between those 2 buckets?

James P. Hallett

Are you talking salvage or whole car?

John R. Lawrence - Stephens Inc., Research Division

Either one. Both.

James P. Hallett

Yes, really, we don't look at that, and we don't break that out. I mean, you can have a high-dollar domestic car, and you can have a low-dollar domestic car. I mean, it's all based on the car and the inventory that we receive, and it's all based on the selling price of the vehicle.

John R. Lawrence - Stephens Inc., Research Division

Yes, I just didn't know if you -- when you've put it all together, was there any major differences?

James P. Hallett

I think -- yes. No, I would say that we don't look at it -- we don't split it like that. When we put it all together, we just look at the overall averages.

Eric M. Loughmiller

Yes, and the industry looks at luxury, not source. I mean, there's no difference between a domestic luxury car and a foreign luxury car. It's the luxury car that gets the premium, John. And I would say generally speaking, I mean, you might have some people that favor one brand over another in a local market, but it's not widespread.

James P. Hallett

Yes. With that said, though, I would -- I think the point out that I would add is we do have some specific sales in the country that we call high-end sales or luxury brand sales. These are specialized sales, and they occur at specific sites. And because they are all premium cars, we do achieve premium pricing on those cars. But again, it's not a huge part of our business.

John R. Lawrence - Stephens Inc., Research Division

Yes, and the turnout [ph] would be lower.

Eric M. Loughmiller

And Jim, wouldn't you say there are more foreign luxury cars than domestic luxury car brands right now, right?

James P. Hallett

Yes.

Eric M. Loughmiller

So John, there are more foreign luxury brands.

Operator

Our next question will come from Bill Armstrong of CL King & Associates.

William R. Armstrong - CL King & Associates, Inc., Research Division

On the Sandy vehicles, to what extent can you pass on the towing and storage costs to your sellers?

James P. Hallett

Well, Bill, as we said, we don't speak specifically to individual contracts, but we've never lost money on a catastrophic event. In fact, we've made money on all these events, and we're expected to handle these events in the normal course of business within our contracts.

Eric M. Loughmiller

And there are provisions for catastrophic vehicles to generate some opportunities for revenue. But I think you can tell from our results, it's not sufficient to cover the costs we incur.

William R. Armstrong - CL King & Associates, Inc., Research Division

Normally, not getting into any specifics, but just as a general rule, though, you're always going to have towing costs no matter -- whether it's catastrophic or not, and at least some of those are passed on to -- in your fees, right?

Eric M. Loughmiller

Again, generally, our fee structure encompasses the recovery of our tow costs. They're not passed on on a cost-plus basis, generally. And Bill, let me -- a chance to highlight this. Even in the other catastrophes where we said we did not lose money, they did not generate the same profitability, though, as our normal collision salvage vehicles. They didn't [ph] lose money.

William R. Armstrong - CL King & Associates, Inc., Research Division

Yes. Now I seem to recall that the Sandy -- I'm sorry, the Katrina cars, and I think this was a little bit too early, or had a lot of saltwater damage, and they ended up being very low value. Sandy, they weren't sitting in water that much, but still wouldn't that have really done -- killed a lot of value for mechanical or moving parts, and maybe wouldn't have affected the sheet metal, but I would've thought that still those cars would've had maybe less-than-average value?

James P. Hallett

Well, less-than-average value, I would say, just the nature of the vehicles and the type of vehicles, there was just many more high-dollar cars, which are going to result in high-dollar prices. They're still going to have this extended damage, but I think you're just dealing with a higher-dollar car.

Eric M. Loughmiller

But Jim, you went to the airport and saw the 2 runways. It looked like a new car lot, didn't it?

James P. Hallett

Yes.

Eric M. Loughmiller

And those cars aren't selling for anywhere near their value as a normal car, right?

James P. Hallett

Right.

Eric M. Loughmiller

As a whole car.

James P. Hallett

Yes, they're probably still selling for the same percentage of their original actual cash value.

William R. Armstrong - CL King & Associates, Inc., Research Division

Got it. Okay. And then just one last question on going -- shifting to ADESA. You're looking for repos to start to increase again this year. Is that being driven by -- and this is in volume. Is that being driven by lower credit quality and just the expectation of more new car sales and a higher rate of default, or there's other things?

James P. Hallett

I think it's a couple things. Number one is the new car business is back. The used car business is strong, and credit is back. People are extending consumer credit, and it's just a fact of the numbers. The more credit you extend, the more repos you're going to receive. And it's just the business is back to what we would consider normal levels.

Eric M. Loughmiller

And a part of that would be making loans to lower FICO or Beacon scores, right?

James P. Hallett

Right.

Eric M. Loughmiller

I mean, that's how you sell more cars.

William R. Armstrong - CL King & Associates, Inc., Research Division

Right, got it. And then just in terms of getting some perspective on that, if we're looking at I think it was about 8.4 million units that may get sold this year, about what percentage of that would be repos, roughly?

James P. Hallett

I think we reported that number last year.

Eric M. Loughmiller

Within the industry, it's likely in the mid-teens, somewhere, as a relative number. At the peak, we know the industry reported, the peak was 1.8 and the bottom is 1.2, so it's somewhere between those 2, right, Jim?

James P. Hallett

Yes.

Eric M. Loughmiller

Actually, the peak may have hit 1.9, but it's in that magnitude for the industry.

Operator

And we are at the top of the hour of our -- or do we have time for another question?

James P. Hallett

We can take one more question, I think?

Operator

Okay, great, and that will come from Colin Daddino with Gabelli & Company.

Colin Daddino - Gabelli & Company, Inc.

I guess my first would be kind of maybe another way to ask John and Bill's question about the Sandy vehicles. Do you have a sense for maybe who's buying them? Is it the LKQs or are people just drawing them for kind of scrap or buying them to rebuild them?

James P. Hallett

I would say, probably the best answer is all of the above. You've got your rebuilders, your recyclers. Obviously, you've got your foreign buyers. I mean, it's -- I think it's just the consistent distribution to all these different constituents that buy salvage vehicles. I don't think there's any one group that is more focused on these vehicles than another.

Eric M. Loughmiller

And let me add one more comment. By buying through the salvage auctions, it's a heavily regulated process. The titles are marked. We feel the salvage industry protects the public. Reported numbers of Sandy cars are more than double what the salvage industry will process. I would focus more on those that aren't running through our auctions and where they're going than -- ours are professional registered dealers who have licensing requirements, and they know what they can and cannot do with those vehicles.

Colin Daddino - Gabelli & Company, Inc.

Great. Okay. And then was there -- is there any impact from -- maybe at ADESA from Sandy for dealer inventories that were destroyed? I mean, is that even meaningful? And then would those vehicles then come and show up in the salvage in IAA?

James P. Hallett

If I understand the question, we -- just let me make sure I understand. Are you asking would some of the Sandy vehicles show up at ADESA?

Colin Daddino - Gabelli & Company, Inc.

Vice versa. So did you maybe lose ADESA volume from dealers that had some cars they were thinking about wholesaling and then maybe got destroyed in the quarter, and then would they show up in salvage?

James P. Hallett

No. I think it would be a very insignificant number. So the truthful answer is that I don't have a number or a number that I could point to, but when you think about the lost sales, Sandy, I think, represented somewhere in the neighborhood of a couple hundred thousand vehicles. And so in the overall scheme of things, we're dealing with a pretty small number.

Eric M. Loughmiller

Yes, it was like 250. And the other thing that I would call, and that I would mention, even at our site, we did not have any damage to any vehicles that were on our sites because we knew it was coming. We made sure they in high ground. I would suspect that the reason the number is small is because of the warning that this was coming and that their lifeblood is their inventory. I'm guessing most of the dealers moved the cars.

Colin Daddino - Gabelli & Company, Inc.

Okay. And then last question. You don't have to answer, I guess. After the secondary and the dividend implementation, have you talked to kind of the remaining private equity owners and have a sense for what they're thinking of doing with their remaining holdings?

James P. Hallett

Colin, I would say that what we're -- what I'm focused on is I'm focused on running the business, and I'll let the private equity guys figure out what their thoughts are going forward.

Operator

That does conclude today's conference. Thank you all for your participation.

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