DealerTrack Holdings, Inc. Q4 2008 Earnings Call Transcript

DealerTrack Holdings, Inc. (TRAK)

Q4 2008 Earnings Call

February 19, 2009 5:00 pm ET

Executives

Katherine Piscopo Stein – Investor Relations

Mark O'Neil – Chairman and Chief Executive Officer

Eric D. Jacobs – Chief Administrative Officer

Robert J. Cox III – Chief Financial Officer

Analysts

David Scharf – [JPM Securities]

Tom Roderick - Thomas Weisel Partners

Christopher Mammone - Deutsche Bank Securities

Peter Goldmacher - Cowen & Co.

Gary Prestopino - Barrington Research

Mitchell Bartlett - Craig-Hallum Capital

Presentation

Operator

Good afternoon everyone and welcome to today’s conference call. Today’s call is being recorded. At this time I will turn the call over to Katherine Piscopo Stein of Investor Relations at DealerTrack. Please go ahead ma’am.

Katherine Piscopo Stein

Thank you John. Good afternoon and welcome to DealerTrack’s fourth quarter conference call. Joining me today are Mark O'Neil, Chairman and Chief Executive Officer; Eric Jacobs, Chief Administrative Officer; and Robert Cox, Chief Financial Officer. Mark will begin today’s call with an overview of our financial results for 2008 and other key metrics. He will then provide a summary of the quarter from a business and strategy perspective. He will also discuss some of our latest accomplishments; the auto lending and sales environment; as well as our growth strategy for 2009.

Bob will then provide further details on our financial performance for the quarter and full year 2008. At the end of the call, Eric will provide our guidance and assumptions and we will then be available to take your questions.

Before we begin, I would like to remind everyone that remarks made in this conference call will contain forward-looking statements made pursuant to the safe harbor provision of the Private Securities Litigation Reform Act of 1995. These statements are neither promises nor guarantees, but involve risks and uncertainties that could cause actual results to differ materially from those set forth in the forward-looking statements, including without limitation those risks detailed in DealerTrack’s filings with the SEC such as our 2007 annual report on Form 10-K.

We disclaim any obligation to publicly update or revise any such statements; to reflect any change in our expectations; or in events, conditions or circumstances on which any such statements may be based or that may affect the likelihood that actual results will differ from those set forth in the forward-looking statements. We also use non-GAAP financial measures to represent business performance. A reconciliation of GAAP to non-GAAP financial measures is included in today’s press release which is available on the Investor Relations section of the company’s website at dealertrack.com.

I would now like to turn the call over to Mark O’Neil.

Mark O'Neil

Thank you Katherine. Hello and thanks to everyone for joining us. I don’t have to tell anyone on this call that 2008 brought economic challenges to auto lending, retail auto sales and automotive dealerships that we have not seen in decades. The second half of 2008 changed the environment in which DealerTrack operates.

As a result, on January 5 we realigned our workforce to sharpen our focus on growth opportunities. We believe this realignment will enable us to emerge from 2009 a stronger company and a definitive leader in providing on-demand software and data solutions to the retail auto industry.

Before I discuss our strategy I’d like to provide some financial highlights from 2008. Revenue for 2008 was $242.7 million and GAAP net income was $1.7 million. Cash net income for the year was $34.3 million and adjusted EBITDA was $47.3 million, which includes the impairment charges of $6 million relating to the write-down of certain auction rate securities in 2008.

There are several important business metrics that impact our performance. The total number of lender to dealer relationships at the end of the year was approximately 156 thousand. This number decreased an additional 13% from the third quarter of 2008 as certain lenders merged; others decreased the number of lenders that they’re willing to receive applications from; and some lenders exited the indirect auto finance market.

The number of lender to dealer relationships has directly impacted our transaction volume in 2008. Transaction volumes were further impacted by a decline in auto sales. Our total transactions processed in the fourth quarter were 14.3 million compared to 20.8 million transactions in the fourth quarter of 2007. For the year we processed 79.7 million transactions versus 90.9 million in 2007.

We had approximately 730 financing sources connected as of the end of the fourth quarter, a gain of 37% from December, 2007. We believe that adding lender participants to the network is a competitive advantage for us and gives our dealers an increased opportunity to fund deals. We expect to add over 100 net new financing sources in 2009.

Total number of active dealers in the DealerTrack network at the end of 2008 was approximately 19,700. This decrease from over 22,000 active dealers at the end of 2007 is largely attributed to approximately 900 franchised and 3 thousand independent dealers closing during 2008. We expect this trend to continue through 2009 as the National Automobile Dealers Association forecasts another 1,100 franchise dealers will go out of business this year.

We continued to experience success cross selling our subscription solutions to dealerships. Total subscriptions in the network increased to over 34 thousand, which represents 18% growth from a year ago. That said, dealership closings had an impact on our subscription business and we saw increased cancellations in the back half of 2008. Despite this trend, we added 1,120 net new subscriptions in the fourth quarter and 5,277 in 2008.

We are pleased that approximately 14,350 of the active dealers on our network now subscribe to one of more of the subscription products we offer. In January of 2009 our sales team began focusing on offering integrated solutions to our dealer customers instead of individual products. These four solutions are DMS; Inventory Management; Sales and Compliance. We believe this will increase customer usage and retention rates and will allow DealerTrack to capture a larger share of dealer spend.

To reflect this change to solutions going forward we will provide the average monthly spend per subscribing dealership, which rose to $595 compared to $543 in the fourth quarter of 2007.

Now let me discuss our progress on a few key initiatives. A silver lining of these challenging economic times is that dealers are looking for ways to use technology to reduce costs and drive greater efficiencies. We believe that DealerTrack’s DMS solution is ideally positioned to meet these needs. We continue to enhance our DMS and experience greater adoption of this solution by dealers. To meet the increasing demand we have increased our DMS installation capacity. During 2009 we expect to increase the headcount supporting our DMS business by approximately 100 people, which will roughly offset the size of the realignment of our workforce in January of 2009.

We expect this investment will see a significant return in the latter part of 2009 and accelerate in 2010. As we previously announced, at the request of Asbury Automotive Group we have accelerated the rollout and installation of our DMS in their 93 dealerships. To date, we have completed installations in approximately 30 stores. Asbury has publicly noted the cost savings and efficiencies they experience with DealerTrack’s DMS. They have also been a great partner for us. We hope to continue building on this relationship in helping Asbury and other dealers find new sources of profit and efficiencies.

Additionally, we further expanded the number of OEM integrations with our DMS. Currently we have 18 manufacturers integrated. This represents over 93% of dealership franchised in the United States. These integrations allow seamless communications for vehicle and parts ordering and support other aspects of dealerships’ interactions with their OEMs.

Our recent contracts with GM announcing DealerTrack as an IDMS provider and Audi of America support of our DMS have been important milestones for DealerTrack. We believe these endorsements serve as encouragement for franchise dealers to look at the cost savings available by subscribing to DealerTrack’s DMS.

In addition, in November we announced that Ford of Canada had selected DealerTrack’s DMS as its private label iCONNECT product. We believe this is a strong point of entry for our DMS into the Canadian market. Although we do not expect the Ford of Canada partnership to be a material source of revenue in 2009, we believe that we can leverage our existing network to distribute our DMS and other solutions in Canada as we have in the United States.

Similar to our DMS solution, dealers are increasingly turning to our Inventory Management solution as a technology product that increases inventory turns and profitability. We believe the market for Inventory Management is well over $100 million. Dealers continue to recognize the need for efficient inventory management to increase profitability. We believe this will be one of the fastest growing and most important solutions that dealerships will adopt in the coming years.

In 2008, we made several improvements to Inventory Pro, making it a more powerful tool that provides dealers with all the technology they need to manage their inventory. To increase our penetration in the expanding Inventory Management market and broaden our solutions offering we acquired AAX, Price Driver and other assets from JM Dealer Services in January, 2009. We expect this acquisition will generate approximately $17 to $19 million in revenue in 2009 and help increase our average monthly spend per subscribing dealership.

This acquisition enables us to offer a full range of Inventory Management solutions; AAX, Inventory Pro and Price Driver. These three offerings enable us to meet different dealer needs and to go to market with a good, better and best strategy. AAX is the industry’s leading solution and is used by the nation’s top six dealer groups. It delivers powerful used vehicle profit management for dealerships by coupling insightful analysis of transaction data with successful in-store consulting services.

Inventory Pro is a plug-and-play solution for low-touch and self-service dealers that include analytic capabilities provided by ALG and the ability to update Internet pricing. Lastly, Price Driver helps dealers see current market pricing for vehicles in a clear and detailed format. As a part of our Inventory Management solution, each option helps dealers stock the right cars at the right price to improve efficiency and profitability. To summarize, we believe our three product strategy positions us as the market leader in the rapidly growing Inventory Management space.

As we look ahead to 2009, our growth strategy for the business remains constant. First, we expect to expand our customer base. We will continue adding financing sources to our network for the focus on credit unions and regional banks. As I mentioned earlier, increasing the number of financing sources available to our dealers helps us maintain our competitive advantage and helps our dealers find financing to sell cars.

Two, we expect to cross sell DealerTrack products. As I’ve discussed during this call we are moving away from selling our products as single-point offerings. By simplifying our offerings into four solutions we believe our dealer-facing sales force will have increased success in cross-selling to existing customers. We have increased installation capacity for our DMS solution to meet demand and believe that satisfaction with our DMS solution will encourage dealers to add other DealerTrack solutions in the future.

Third, we’ll expand our offerings. We continue to add features and functionality to our four solutions to help our customers reduce costs and increase profit. Fourth and lastly we expect to pursue acquisitions and strategic alliances. We will continue to focus on identifying businesses to increase our market share or that have products, technology or services that complement our current offerings.

Last month we exhibited at the annual National Automobile Dealers Association where we introduced several product enhancements. In particular, the launch of OpenTrack was met with great enthusiasm by dealers and technology vendors alike. OpenTrack provides third party vendors a seamless, secure integration with our DMS to help offer our DMS customers access to technology products without compromising security or efficiency.

Our goal at DealerTrack has always been to provide the best available technology solutions to dealerships. However, where another product meets the dealer’s needs we want to provide a seamless integration to increase the dealership’s efficiency. Since NADA we have signed up ten technology partners and are reviewing contracts with over 50 more.

Our strategy with OpenTrack is similar to Apple’s strategy with the iPhone. We are encouraging technology providers in the industry to build applications which will seamlessly at a low cost integrate with our DMS, making it a true best-in-class, broad-based solution. An additional benefit of this strategy is that we expect these integrated technology partners will actively promote our DMS, further building on our sales momentum.

Additionally we announced enhancements to our compliance solution which include industry leading Adverse Action functionality. Federal law requires dealers to send Adverse Action notices to consumers who seek funding and are denied. Our technology uses automation of this process to help dealers manage these requirements efficiently.

We also introduced an enhancement to our DMS that includes a customer relationship management or CRM system with Internet leads management capability. This functionality is expected to be further integrated to our other solutions.

Last week, DealerTrack spun off certain assets related to its non-core SCS business to a company controlled by David Trinder, a former Senior Vice President. The SCS business which accounted for approximately $1.9 million of revenue in 2008 is an administration system used by after-market providers as their back-end origination solution. SCS is a separate system that the DealerTrack after-market network although it does integrate with the after-market network.

We expect this disposition to allow us to focus on growth opportunities without impacting the integration of SCS with our after-market network. As a result of this transaction, DealerTrack expects to recognize between $100 and $300 thousand gain on sale of assets during the first quarter of 2009.

Lastly a brief update on our pending patent litigation against RouteOne and Finance Express. The judge in the case recently moved the trial commencement date from February 24 to April 21 due to a conflict in the court’s schedule.

Bob will now provide detail about our fourth quarter and 2008 financials. Bob.

Robert J. Cox III

Thank you Mark. Our revenue of $54.7 million for the fourth quarter breaks down in the following; transaction revenue of $25 million, a decrease from $35.3 million for the same period last year; subscription revenue of $25.6 million which is a 19% increase from the fourth quarter of 2007 and of which 100% of that growth was organic; other revenue of $4.1 million compared to $3.9 million a year ago.

For the year 2008 total revenue of $242.7 million represents transaction revenue of $132.4 million, down 10% from 2007; subscription revenues of $94.7 million which grew 26% from 2007; and other revenue of $15.6 million.

GAAP net loss for the quarter was $1.1 million compared to GAAP net income of $4.1 million a year ago. GAAP net income for 2008 was $1.7 million. Adjusted EBITDA for the quarter was $7.7 million and $47.3 million for the full year. Adjusted EBITDA excludes a $6 million write-down related to certain of our auction rate securities in the third and fourth quarters. Cash net income was $6.2 million for the quarter compared to $10.9 million for the fourth quarter of 2007. And cash net income for the year was $34.3 million.

GAAP net income in the fourth quarter and the full year were negatively impacted by a $1.2 million write-off net of taxes of an impaired intangible asset related to DHL exiting the domestic overnight shipping business. DHL notified us of their departure from the U.S. market in the fourth quarter of 2008. Since then we’ve been in the process of relocating this facility to near the FedEx hub in Memphis, Tennessee. We expect to run duplicate operations in Ohio and Tennessee until we have ramped up the Memphis facility, which we expect to be fully operational in the second quarter of 2009.

At that point, the Ohio location will serve as our disaster recovery site. We are extremely pleased with our new relationship with FedEx and with the efficiencies we have experienced to date.

Detailed reconciliations of GAAP net income to our non-GAAP financial measures of adjusted EBITDA and cash net income are included as attachments to today’s press release, posted to our company website. GAAP net loss per share for the fourth quarter was $0.03 and diluted GAAP net income per share was $0.04 for the year. Diluted cash net income per share was $0.16 for the quarter and $0.82 for the year.

Cash flow from operations for the fourth quarter was $15.3 million compared to cash flow from operations of $23.3 million for the fourth quarter of 2007. For the full year 2008 cash flow from operations was $61.5 million compared to $56.9 million for the full year 2007. We ended 2008 with $199 million in cash, cash equivalents and short-term investments on the balance sheet.

Capital expenditures for the quarter were $3.2 million and were $16.8 million for the year. In the fourth quarter, DealerTrack repurchased approximately 200 thousand shares of our stock for approximately $5.1 million. During 2008 we repurchased a total of 3 million shares for approximately $49.8 million.

Now let me hand it over to Eric to give you our 2009 full year guidance. Eric.

Eric D. Jacobs

Thank you Bob. With regards to expected GAAP results, total revenues for full year 2009 are expected to be between $242 million and $250 million. We expect our revenue mix to continue to shift towards subscriptions.

GAAP net loss for the year is expected to be between $11.1 million and $9.6 million. Included in our expected GAAP net loss for the year are the following; an estimated $4.2 million of amortization of intangible assets and approximately $300 thousand in professional service fees related to the acquisition of certain assets, including the AAX suite of Inventory Management solutions and services from JM Dealer’s Services; and approximately $4.7 million in restructuring charges related to the realignment of our workforce and the relocation of our digital services business which are each net of taxes.

GAAP net loss per share is expected to be between $0.28 and $0.24 for the year. With regard to expected non-GAAP results, due to changes in accounting rules we can no longer capitalize acquisition-related costs. Going forward we will provide adjusted EBITDA. We expect adjusted EBITDA for 2009 to be between $31 million and $33 million to exclude the following approximately $7.1 million of restructuring charges, of which $4 million is expected to be a non-cash expenditure; fees of $400 thousand associated with the acquisition; and a $200 thousand charge for the relocation of our digital services facility.

Cash net income for the year is expected to be between $16.7 million and $18.2 million. Diluted cash net income per share is expected to be between $0.40 and $0.44. The per share expected cash net income is based on an estimate of 41.5 million diluted weighted average shares outstanding and the per share expected GAAP loss is based on 39.5 million basic weighted average shares outstanding.

Three key assumptions that impact our guidance are an approximate decline of 10 to 15% in lender to dealer relationships in 2009; new car sales for 2009 of approximately 10.5 to 11.5 million units compared to an approximately 10.5 million run rate in the fourth quarter of 2008; and used car sales from franchised dealers of approximately 12 million to 13 million units for 2009 compared to 2008 total sales of approximately 13.2 million units.

That said, we see a potential catalyst for improvements in automotive sales through the stimulus legislation signed into law this week. The bill includes $1.7 billion in funding to provide temporary tax breaks for consumers purchasing a car or light truck in 2009. Additionally, the Federal Reserve has [inaudible] $200 billion for accounts intended in part to stimulate auto financing. These two pieces of stimulus combined could positively impact the return of automotive financing in our transaction business.

Also included in our guidance is the acquisition of assets, including AAX from the JM family which we announced on January 22. The purchase price was approximately $32.6 million in cash plus professional service fees and expenses. We expect [inaudible] to be diluted to adjusted EBITDA margins in 2009 and to become accretive in 2010.

As we look at adjusted EBITDA margins for 2009, we expect them to be compressed, particularly in the first half of the year. This will be a result of a reduction in transaction volumes, integration of the recent acquisition, and increased investments in our DMS business. We believe that we will have improved leverage in our subscription business in the back half of 2009, driven in part by increases in DMS and Inventory Management sales.

We expect the fourth quarter adjusted EBITDA margin to be in the 17 to 18% range. The first half of 2009 will be difficult to compare to the first half of 2008. We did not see the rapid deterioration of the automotive lending environment and retail sales until the second half of 2008. We expect that this trend will continue, at least through the first half of 2009 because for the first time since 1982, January’s seasonally adjusted annualized rate of sales, otherwise known as SAR, fell below 10 million units.

Capital expenditures for 2009 are expected to be between $18.4 million and $19.7 million. Capital expenditures expect to be higher than our typical rate due in part to the continued build-out of our new Canadian platform, integration of the acquisition and the relocation of the digital services facility. In 2010 we expect capital expenditures to return to more historic like levels.

Our guidance assumes an effective tax rate of approximately 32.5%. That concludes our formal remarks for this year. We’ll now turn it over to the operator to take any questions.

Mark O'Neil

Operator, before we do, this is Mark O'Neil. One correction and one statement, everyone, a moment ago Bob indicated that we had repurchased approximately 200 thousand shares in the fourth quarter. That number is actually 400 thousand shares for approximately $5.1 million. So again a correction from the 200 to 400.

The only other comment I’d like to make, many of you on this call know Bob personally. You’re aware that he is leaving the company at the end of the month. I think I speak on behalf of all of you that he did a great job over the last number of years not only helping build the company but reach out and explain our complicated business model in a clear and coherent way to you guys and built a lot of trust along the way, and a huge thank you to Bob for the job he did and the beginning of a transition to Eric carrying on where Bob left off. So Bob a huge thanks to you. Operator, we can open the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from David Scharf – [JPM Securities].

David Scharf – JPM Securities

First question is more macro in nature. As you look at the next few years not just 2009, Mark is your guess that the 10 to 15% contraction in dealerships that you’re forecasting for this year is going to be more of a multi-year phenomenon? I mean just as try to gauge ultimately what the end market looks like here, what’s your best guess for the number of rooftops going out three years?

Mark O'Neil

Well, let me call it three to five years. I think we’re somewhere between 15 and 17 thousand dealers. And if you go out in the three to five year timeframe, you’re going to probably see a few net adds to offset what will be substantially the domestic contraction. So look GM has announced that they expect over a five year period to shut about 1,700 dealers.

And I think if you look at the efforts underway by Ford and Chrysler their numbers aren’t quite as large, but let’s assume for a moment they’re proportional to their market share to GM. That might be a total there of almost 4,000 dealers, slightly less than that. Starting with a base of 20 that puts you at 16.

We do know that a number of Chinese companies have expressed interest in the U.S. market over the long term. That will probably add to the count. We know a couple of the Korean manufacturers continue to expand their dealer count. And we do think a number of Indian manufacturers and particularly Mahindra and Mahindra has already announced that they expect to expand a dealership base here. So if you get down to 16, maybe you add 500 more or maybe they’re 500 less. That puts you somewhere in that range of 15 to 17 and I think the market probably stabilizes long-term there.

From our perspective, that’s not a bad thing. I think it’s a much healthier dealership base. I think the same number of transactions are spread through a smaller base. And that really helps driver dealership profitability from our perspective than you might say, “Well, jeez, if it doesn’t impact transactions, what about subscriptions?” The good news is we’re starting from a very small base and so whether we’re selling into 20 thousand dealers or we’re selling into 16 thousand dealers, I don’t think our opportunity substantially changes in the next three to five years.

In fact, I’d argue that new solutions such as our Inventory Management solution that are really just beginning to be adopted over the last two years by dealer have plenty of runway for growth, regardless of how many dealerships we have. And I’d say substantially the same comment for our DMS products. So we like the contraction. We think it’s necessary. We think it’s healthy and we think we can benefit from it.

David Scharf – JPM Securities

Switching to the DMS side, adding 100 personnel this year on the installation front, can you put that into context for us? I mean, how many people are working on the installation team right now? Just trying to get a sense for what magnitude of demand you’re ramping up for.

Mark O'Neil

Look, for competitive reasons I don’t want to give you the exact installation capacity, but percentage-wise I believe during last year we gave you an indication we added about 100 folks. They were substantially in the DMS and install arena. So you can say we are matching again the level of increase that we put in place in 2008 and look we wouldn’t be putting that in place if we didn’t see the demand from the dealership community.

You know, go back and reflect on NADA. You know, in our traffic NADA was substantially down this year because dealers pulling in their horns and not traveling. So those who came to the show were very focused on achieving an objective of finding a new solution or two. We were at almost max capacity at handling the number of people interested in demos on our DMS. And I think look that is a reflection of the times. As we’ve said in the call, it’s tough times.

Our solution is substantially less than the competitive solutions on the market. We continue to add a lot of functionality to it without raising the price. And that is driving interest in the dealership base. And we will slow down the investment at the end of 2009. Part of the reason margins will continue to expand is because we think we’ll be at close to the saturation level of what we could install a year based on available contracts coming up for renewal and our expected [conquest] rate but this year is a year we thought it didn’t make any sense to slow down that investment because we were there.

And of course you’re aware that that’s a very nice recurring revenue business, so once you get the install base in it, it does substantially help our ability to cross-sell as well.

David Scharf – JPM Securities

And then the last question, since you’re starting to bump up against more of a regular renewal cycle, can you give us a sense of what percentage of subscription contract value might be up for renewal throughout 2009? Obviously with dealership contraction the cancellation rate becomes more important in our calculations.

Mark O'Neil

If you said look, you know, let’s take the number we just gave you. NADA dealership closures are expected to be about 1,000 – 1,100 is the exact number over a base of 20 thousand so it says approximately 5% of the dealer community will go out of business. We have about two-thirds of the community on our site. Five percent of two-thirds would be 3%. You know, it’s impactful. We’ve factored into our numbers. I don’t think – it’s not going to be the primary driver of our subscription performance, David, as we look at 2009.

Do we expect to have some impact? Yes. If there’s a prepackaged bankruptcy and we’re way off on the 1,100 look, it could impact modestly our numbers. But it’s not a variable I’d focus on as being a key driver of the business for 2009.

Operator

Your next question comes from Tom Roderick - Thomas Weisel Partners.

Tom Roderick - Thomas Weisel Partners

Mark I wanted to ask just another question about the 100 heads that you’re adding on the installation capacity side and get a sense for what’s driving that? Is there a backlog of existing demands, deals that you’ve already won that perhaps are falling behind on the installation? Do you need more heads for the Asbury installation? Or is this in fact just due to excess demand out there in the marketplace? Folks actually looking for a lower cost solution and you want to be able to ramp up the sales rate. I’ll stop there and then I’ll ask a follow-up on it.

Mark O'Neil

So, Tom, I’ll give one small point of clarification. Of the 100 people, 100% of the 100 are not installation. They’re substantially there. We are adding some salespeople. Again the team will grow there almost 50% on the sales side again because we don’t think we can adequately handle the incoming demand as well as we’d like to, to give demos and adequately service the customers who are interested.

But substantially the team will go into the installation side and as we’ve told you through 2008 there’s a significant ramp up time for those folks. You know, we’ll put 100 folks on and whether you’re in the selling capacity or you’re in the install capacity, it takes three months, six months, maybe as long as nine depending on how much experience you come with to really get up to speed. So it’s important for us to do that to grab the momentum.

So you can gather from that statement that we expect demand to continue to increase. I don’t think we’re missing anything today from an install perspective, but I think we are miss – in terms of not getting backlog installed to your question, but I do think we are not adequately addressing all the dealers who have an interest in having a full-blown DMS proposal because we don’t have enough people to support the presentation of those.

Tom Roderick - Thomas Weisel Partners

And just a follow-up on that, if you don’t mind. So in the last several months you’ve added a handful of additional manufacturing partners on the DMS side and now you’ve sold AAX into the mix, so higher end Inventory Management solution – does this mean that you’re better prepared to service larger, nationwide dealer groups from a DMS standpoint? And if so, can we expect to see DealerTrack add another Asbury type of customer to the mix in the next couple of years?

Mark O'Neil

Asbury I believe, depending on how you count, I think is number four, number five, number six player in the industry. They are a national footprint substantially. I don’t know that there’s any dealer groups in all 50 states. But Asbury spans certainly the smile states and a substantial part of the U.S. with 93 dealerships. But look our focus is providing dealerships to any dealer that’s interested. There are only ten top ten, right? And we have one of the top ten right now. I think our success with Asbury has caused lots of folks to take notice. I can’t tell you any more specifically kind of who’s interested or who we expect to conquest.

I can say, though, that having more manufacturers is definitely making it easier to conquest the multi-store groups. We’re running into less objections. I won’t tell you that we don’t still out some, where a dealer group who has say six or eight or ten franchises, which is really a sweet spot install for us, and if one of those stores we didn’t have a factory integration for held up the sales cycle a bit. It is holding us up less right now, but it still holds us up occasionally. And I think as we move forward in 2009, 2010 that will be less of an issue.

And I’ll give you a sense of one. Let me give you a little more detail. Audi of America sent out a letter to its dealers and that letter basically said that dealers by switching to our DMS could expect a net profit increase of 50 to 75 basis points. You know, it’s that kind of endorsement and that kind of active support by manufacturers that I think is really going to accelerate the interest in the DMS.

And look there isn’t a manufacturer out there that doesn’t want to help their dealers out and if there’s a good low-cost solution that can help their dealers be more profitable, they’re getting behind it. And I think you might see more activity in that area to help us than you would see in the – you know, us focusing on a top ten dealer group conquest.

Operator

Your next question comes from Christopher Mammone - Deutsche Bank Securities.

Christopher Mammone - Deutsche Bank Securities

What if the government efforts don’t do what they’re set out to accomplish? I mean, how much worse do you think as an observer of the industry it could get from here?

Mark O'Neil

Well, Chris, we rely on industry forecasts and we took I think there were 11, 12, 13 different forecasts, Deutsche Bank was one of them that we collected. So we looked at what the OEMs were saying. You know, they have full time economists on staff. We were looking at what investment banks were saying. We were looking at what kind of industry specialists were saying. And we took the aggregate numbers for that group. And then we were a bit more conservative. And again that’s how we came up with our range of 10.5 to 11.5.

You know, do I think it could get much worse? You know, the January was 9.8 million. The difference between 9.8 million and 10.5, you know 700 thousand units. Mathematically it’s not that significant to us. We could probably get through that kind of difference. It’s more what would the compounding effect be and what happens to used cars? What happens to lender to dealer relationships?

And that’s harder to assess than – look, I think we have adequate conservatism in our numbers. And I think the reason I feel that is I listen to the manufacturers talk about replacement demand and the efforts they’re putting out, whether it’s on the new product side they’re basically matched demand with supply.

Look, I think the industry can sustain a 10 million rate even in this kind of terrible economy. How bad does it get? I haven’t seen any forecasts that’s a low 9 and that’s where I’d start to get worried. If a million or two million units fall out, we’ll want to re-look at our numbers. If we’re off by half a million, we’re not going to spend a lot of energy there.

Christopher Mammone - Deutsche Bank Securities

Do you have the used car – what were the total used car sales in 2007? I know you gave the 2008 number in the press release.

Mark O'Neil

Two-thousand-seven was 14.2, 2008 was 13.2 and we’re telling you between 12 and 13. One of the activities we’re clearly seeing and this is of course helping our Inventory Management solution, there is an enormous focus by dealerships on used cars. And I think part of the sales that aren’t happening on the new car side are transferring to used; i.e., customers are trading down. And I think new car franchised dealerships are successfully pulling some of the sales out of the independent dealer market.

And I think both of those variables help us feel comfortable that although it’ll come down a bit next year, it won’t be substantive. Now used cars matter more to us. We are a little bit more aligned to used cars than new, so I’ll make the statement and I’ll transfer my statement from new to used, if we lost a half a million used units, I would begin to be concerned. And I would be very concerned if there was a million less units, whereas we weren’t quite as concerned on the new car side, because again we’re a little more aligned to used car transactions.

And oh by the way, used car transactions drive a lot more profitability for a dealership, so that falling back will hurt the dealership community more than if they pull a number of new car and would hurt us more.

Christopher Mammone - Deutsche Bank Securities

Could you give us the dilution in pennies of the AAX deal in your 2009 guidance?

Mark O'Neil

Let me give you a sense of basis points to margin. Figure about 2% hit to margins in 2009.

Operator

Your next question comes from Peter Goldmacher - Cowen & Co.

Peter Goldmacher - Cowen & Co.

Hey Mark can you just mention your new and used car forecasts? Are they in line with the NADA forecasts or?

Mark O'Neil

Yes, Peter, you know what? I’m going to read you kind of high-low range. You know our new car forecast is 10.5 to 11.5 million units. We took a lot of publicly available data and I’m going to just pull that out for you right here. I’ll kind of give you the range. Deutsche Bank, Wachovia, BNET Auto, Goldman Sachs, Edmunds, GM, Ford, Chrysler, [Crowe Horwa], J.D. Power, NADA, those were our sources. All names you probably recognize there, at least nine out of ten.

And if you look at their average, they’re at about 11.5 and I told you our range is 10.5 to 11.5. Does that help you any?

No one by the way – no one, there’s very little forecasting in the used car business. So that forecast is substantially ours just based on a few data points we could get together. There isn’t the same degree of forecasting on that variable.

Peter Goldmacher - Cowen & Co.

So the investments in the Arkona business indicate that you guys are seeing traction and all things are going well there. What sort of reaction are you seeing from ADP and the Reynolds and Reynolds guy? We saw this quarter that they launched their own transaction portal. Are they doing anything on their pricing for their DMS business? Are they acting as though their business is under pressure as well?

Mark O'Neil

Well, ADP’s public so we’ve seen some of their guidance numbers and I think we’ve seen some contraction in their expectations for the U.S. auto business. I’ll let you look up those specifically. Is that due to the industry? Is that due to us? Clearly the decline in number of dealers is going to hurt those who have the most number of installs. So that’s one of the variables I’m sure that’s putting some pressure on it.

We know we’re putting pricing pressure on the industry. We have seen a couple of instances where our competitors have attempted to bring the pricing down. That’s a real tough position for someone. You know, you get into the customer saying, “Jeez, so I’ve been paying X for five years, ten years, maybe even 15 or 20 years and all of a sudden DealerTrack comes along and you’re telling me you could drop your price 50%.” Look, it doesn’t engender a lot of good feelings. And once we start that conversation, we win most of those but we don’t win them all.

And so I think competitors are trying to use price. But I think – you know, look, it’s one of multiple tools that they have. They have a long term relationship and those are good. And they try to leverage that. And in some cases they might have different integration or functionality. And they try to leverage that. But obviously from the numbers we’re sharing with you in terms of adding the people, we wouldn’t be adding people if we didn’t see demand for the product. I think we’re really in a terrific sweet spot right now.

Operator

Your next question comes from Gary Prestopino - Barrington Research.

Gary Prestopino - Barrington Research

One quick question. You’re more aligned with used vehicles versus new, but is there a differential on the amount of credit apps for financing for used versus new?

Mark O'Neil

Yes, slightly more credit apps per used car than per new car. And that’s in part driven we believe because of the credit profile. It’s usually slightly lower on used than it is on new and the lower the credit profile, the more apps it takes to get a funded contract.

Gary Prestopino - Barrington Research

When these DMS solutions come up for renewal or re-bid or whatever, I think I talked with you, you said there’s about 20% of them come up every year, right?

Mark O'Neil

Yes, most dealers are on a five year contract.

Gary Prestopino - Barrington Research

So in the time that you’ve owned Arkona and you’ve been out in the market doing this and really relative to what you may have seen over the last couple of months here, the amount that come up for renewal, how many are actually renewed with the incumbent versus go out for an RFT? What percentage? And is that percentage growing as these dealers become more under financial duress?

Mark O'Neil

You know, we don’t have perfect data here to say the very least, so I’m going to give you directional, qualitative with some numbers thrown here. Kind of what we’ve seen and what we kind of project, so historically and I’ll go back to kind of 2007 when we first acquired our DMS solution, we estimated about 4 thousand came up for renewal that maybe of that 4 thousand 1,500 looked and maybe we saw about 750, 600, 700, 800 – somewhere around there. Dealer customers come to us being Arkona at the time and asked for a bid.

Now we know a certain percent of those really didn’t want to switch and they used us a stalking horse. If you fast forward to the end of 2008, I think that 1,500 number is probably closer to 2,500, maybe even 3,000 who are actually looking, considering. How many seriously are considering and how many are using us still as a stalking horse? It’s a reasonable percent because it is a lot of work to switch. But it is less than it was and we’re converting a lot more of them. And we’re getting a lot more opportunities.

We’re also seeing folks start to process much earlier than they started. We were doing demos at NADA and I can even think of one that I’m thinking of that I was personally involved with right now where the customers a year-and-a-half out and already starting to think about it; and wanting to understand alternatives and wanting to kind of plan around maybe some of the changes I may want to make to their processes if they switch to us.

The data is somewhat mixed now with I’ll call it a very elongated sales cycle, but we are seeing a lot more forward looking. A lot more dealers thinking ahead because they realize it does take some planning and if they start early, they can make the process a whole lot faster both for us and them.

Gary Prestopino - Barrington Research

Could you kind of just outline very simply the key functionality differentiators between these three inventory products, AAX, Inventory Pro and Price Driver?

Mark O'Neil

Sure. So let’s start at the top and I’ll again just talk generally here. AAX is what I’ll call the full boat, the top end solution, the Lexus that may be of our product offering. And it can do multiple things. It could basically – will tell you what you need, what you don’t need, where to dispose of it, and oh by the way we offer the opportunity to have what we call Deal Results Managers, DRMs, participate as part of the sales process. And those DRMs basically act as consultants, to take the data and help a dealer really interpret it down to a single vehicle or very nuanced level.

And we’re finding that that’s just a huge differentiator. We have a lot of skill based folks there who come out of the industry with really in-depth knowledge of cars and valuations. And so not only are we giving you kind of all the data to run your business, we’re giving you someone to help you interpret that data.

If you go down to Inventory Pro, basically strip out the consulting support and you have a product that tells you what you need more of, what you need less of, and a product that can tell you where to find it. A little less robust than some of the – you know, how many data points we pull from although that gap will narrow. Historically AAX had a little larger database of transactions, a larger database of install customers and data really differentiates you in this business to try to optimally tell you what a car is worth, how to price a car.

And the third product, Price Driver, is really nothing more than a product that will tell you what the going retail price of a car is based on data that we collect from Internet sites. So it’s basically taking all the data we can get from websites out there and tell a dealer, “Look, you think you know how to appraise a car and you know whether you should buy more of the LX’s than the DX’s.” What you then might use Price Driver for is to help you price a car, to basically say what in a given zip code, a given mileage range from the dealership, what are other dealers listing inventory for where you wouldn’t have easy access to that data. So call it a pricing tool substantially and stand-alone it pretty much functions just as that product.

Gary Prestopino - Barrington Research

Did I hear someone say that this acquisition was going to be a 200 basis point hit to the EBITDA margin versus ’08?

Mark O'Neil

Yes, you heard me say that. And again that’s a year one. As we go into 2010, the latter part of this year we see margins coming back to our norm.

Gary Prestopino - Barrington Research

But we’re talking about the adjusted EBITDA margin, right?

Mark O'Neil

Yes.

Gary Prestopino - Barrington Research

So that would make the assumption that this was – I’m trying to understand this because you’re back D&A back into your adjusted EBITDA margin. This was not a very profitable company, Mark, or is there some tweaking that you have to do here?

Mark O'Neil

No, again much like what we were doing in DMS they were doing in inventory. They were making significant investments and I’m just not prepared to talk about some of those. There’s some exciting things we’ll hopefully launch end of this year or 2010 that look, you know, you’re building huge databases and you want to perfect the information you’re basically providing to a dealer in terms of getting pricing down from maybe the nearest $100 to the nearest $10. That takes a lot of data. It takes a lot of partnerships with companies to find that data and to integrate it and to run regressions and run testing. There’s a lot of development resources going into building new functionality, again that we’re not really prepared to talk about today.

But they were making very big investments in the development of the technology, and so they weren’t nearly as profitable as we are. And that causes a dilution. That said, like us and we put the multiple products together we start to get scale. And by the end of the year that scale helps us get margin.

So I’m going to speak more broadly now to margin. Figure the acquisition cost us – again, these are all round numbers. I’m not going to be very precise for you. Say the acquisition cost us 200 basis points of margin and of adjusted EBITDA margin. The investment in DMS probably the same again. So there’s 400 points. And look at the decline in transactions this year relative to the last year and that’ll give you the balance. Take note of the guidance we gave you that by the fourth quarter and we’re not assuming transactions come back, margins really start to improve.

And that sets us up for a terrific 2010.

Operator

Your next question comes from Mitchell Bartlett - Craig-Hallum Capital.

Mitchell Bartlett - Craig-Hallum Capital

Mark, are you getting a little bit more pessimistic on the number of lenders that are going to be left standing at the end of the day than maybe you were six months ago, three months ago? That’s question number one. Let me just ask my three questions then I’ll just hop off here. The ADP-Reynolds and Reynolds credit app network, this is somewhat related, do you see the potential that there might be some pricing leverage that lenders might have between the two networks? I know that theirs is a very, very immature network at this point, transaction network.

And then the final question’s on the bundling. I’m a little confused and maybe you could just talk to that a little bit more.

Mark O'Neil

So let’s talk about lender-dealer relationships. We do expect it to continue to decline and we gave you that number in our guidance that we expect it to decline 10 to 15%, so look it is going to come down some. Why did we choose that number versus another number? You know, this is a combination of quantitative and qualitative data. We have spoken to a lot of our largest lenders. Most of our largest lenders have said they expect volumes to be flat for the year, relative to their back half of 2008 originations.

And so we look at most of the big guys, obviously we’re going to be more [inaudible] on volume saying that they’re going to stay fairly flat, meaning they’re going to kind of keep their existing dealer relationships, keep their lender originations. And then we’re going to add 100 net new. But we know that some other small players will get out or some sub-prime folks will get into some trouble. But I think we have about the right number. And again we’re looking out – you know, there’s a lot of effort going to help lenders out. And the OEMs are coming back a little bit more.

GMAC fell off from the fourth quarter but now they’re at I believe a chartered bank and they’re going to start lending again. And Chrysler was in a little bit of a bind and now they’re going to start lending again. And these things help the market generally. And so do I think more will fall out? Yes. Do I think we’ll see the same degree of fall out in ’09 as we saw in ’08? No. Because I think then we’d see a significantly larger contraction in car sales and we’re not expecting that.

Mitchell Bartlett - Craig-Hallum Capital

Just to be clear if I could interject, this is about originations contracting more than it is a big lender leaving –

Mark O'Neil

Well, it’s – when you look at lender-dealer relationships, it all relates to originations but it really is a gauge for how many lenders are available for a dealer to send credit apps to? I mean, credit apps are a substantial part of our transaction volume. So a contraction of lender-dealer relationships means fewer transactions per car sold. And I think again we’ve taken the best data we have out there, we’ve assumed it will contract and look could it happen more? I suppose it could. We could be off on any of our numbers. But again we’ve taken last year as a proxy and taken recent run rates and we think we’ve given you a pretty good number.

Eric D. Jacobs

This is Eric. There are three things that impact lender-dealer relationships. If lenders merge like we saw in the fourth – I think the fourth quarter with Wachovia and Wells Fargo. That’s two going down to not necessarily one, one plus. You have others decrease their originations and you also have some leave the business. So those on the lenders side those three things can impact lender-dealer relationships.

Mark O'Neil

I think most of the big mergers have happened. There are not a lot of other big banks to merge right now and there aren’t – on the exit side, I don’t think we’re at risk at any of the largest guys exiting auto. Again I’m sure there will be a lot more small lenders. There were 50 some odd who fell out last year. Will be have 30, 40, 50 exit this year who are small? Look, we could accommodate that. That’s very possible. I just don’t think you’ll accelerate versus 2008.

So let me speak to your other two questions. ODE, open dealer exchange, that’s the competitive platform that was announced. I think what I’d say first and foremost is it’s taken us nine years to put 730 lenders into a really comprehensive, fully functioning network. It will take years under any scenario to duplicate even a portion of that. And I think therein lies our advantage. And if I was forward-looking a bit, I would say in the next two years or so we’re not too far away from 1,000 lenders. How long would it take someone to replicate that network? A very long time.

And I think we are continuing to explore new functionality that we can bring to that network, to differentiate ourselves. And I think sometimes competition is a good thing. We’re more focused than ever on identifying some of those differentiations.

On the pricing side, at the end of the day the dealer goes where they’re going to get a deal sold. So let’s assume a lender’s free on the new site, but there are 20 lenders you can choose from on the other site. You’re not going to go through all the work to send it to the one because it’s free to the lender when it’s free to you the dealer either way. So I think pricing is variable but I don’t think it’s a driver of behavior, not on the dealer side and not in the near term.

And let me speak to the last comment, which is bundling. So over the years we’ve developed a lot of solutions, right? NADA Bookout, Kelly Blue Book, e-contracting, Sales Maker, Deal Watch, Inventory Pro, Bookout Pro, e-menu, etc., and as we were coming to the conclusion of 2008 we had 13 products; with the acquisition of AAX that was going to bring us 14 products, and if you look at Price Driver as the unique product, it’s 15 products. We started to say, “Look, this just doesn’t work. A salesperson cannot present 15 products and oh by the way, 15 products sold individually sets you up for lots more challenge on install; lots more challenge on utilization. Why don’t we find the natural packaging of those products and sell them as broader solutions?”

So now the sales solution includes some of our toolkits, our credit app products; includes Toolkit; includes the ability pull bureaus; includes the ability to desk the deal, to compare finance sources against each other; includes the e-menu functionality which is the software that helps you present after-market products which you’re going to do in the F&I office. And you can upgrade in that case to add some compliance functionality. That is a much more natural sales package than selling each of those products individually.

And so we have now a sales solution. We have a compliance solution. We have a DMS solution and an inventory solution. And you can say, “Well, in inventory what would be the solution?” Well, instead of selling Bookout separately we might just buy an NADA Bookout or a Kelly Blue Book you can buy a bundle of books to wit the whole inventory solution so that the appraisal module is more complete and more fully functioning.

And again it makes a lot more sense in terms of how you sell to the dealer and for us in terms of supporting it and renewal rates, we think there’s just a lot more – it’s a lot more economic for us to sell it and support it in that format.

Mitchell Bartlett - Craig-Hallum Capital

And the average ASP’s go up.

Mark O'Neil

Naturally average ASP’s go up. We think individual product cancellations go down because where you may use a single product or piece of function less, you won’t get rid of the whole solution if you’re using other parts of it so that helps renewal rates. It helps ASP. And frankly it positions us more as a solutions provider and not a product company. And the more we talk to dealers, the more they’re looking for solutions providers. And I think look, we won’t get there overnight but we’re very much starting the transition. We started it in the fourth quarter and we’ll work on it through this year.

Operator

Your last question comes from David Scharf – JMP Securities

David Scharf – JMP Securities

Actually my follow-up’s been answered. Thank you.

Mark O'Neil

Okay. Great. Well, if there are no other questions let me just reiterate once again my appreciation for your continued interest, continued support and we’ll look forward to talking to you guys I’m sure over the next days and weeks to help you understand more about the business than we’ve given you today that can help you get a better understanding of our strategy for this year. So really appreciate it, guys. And thank you very much for your time. Take care everyone.

Operator

This concludes DealerTrack’s conference call. Thank you.

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