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KAR Auction Services, Inc. (NYSE:KAR)

Q2 2011 Earnings Conference Call

August 10, 2011 11:00 ET

Executives

Jonathan Peisner – Vice President and Treasurer

Jim Hallett – Chief Executive Officer

Eric Loughmiller – Executive Vice President and Chief Financial Officer

Analysts

Gary Prestopino – Barrington Research

Tony Cristello – BB&T Capital Markets

John Murphy – Bank of America/Merrill Lynch

Rick Nelson – Stephens

Bill Armstrong – C.L. King & Associates

Scot Ciccarelli – RBC Capital Markets

Craig Kennison – Robert W. Baird

Matt Fassler – Goldman Sachs

Tom Shandell – Goldentree Asset Managemnet

Operator

Good day, ladies and gentlemen, and welcome to the KAR Auction Services Incorporated Second Quarter Earnings Conference Call. Today's call is being recorded.

Today's host will be Jim Hallett, Chief Executive Officer of KAR Auction Services Incorporated; Eric Loughmiller, Executive Vice President and Chief Financial Officer of KAR Auction Services Incorporated; and Jonathan Peisner, Vice President and Treasurer of KAR Auction Services Incorporated.

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

Jonathan Peisner – Vice President and Treasurer

Thanks, Michelle and thank you for joining us this morning for KAR Auction Services second quarter earnings call. Today, we will discuss the financial performance of KAR Auction Services for the quarter ended June 30, 2011. After concluding our commentary, we will take questions from participants. We will make every effort to accommodate all the questions within the hour we have scheduled today.

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 are subject to certain risks, trends, and uncertainties that could cause actual results to differ materially from those projected, expressed, or implied by such forward-looking statements and such risks are fully detailed in our SEC filings.

I would now like to turn this call over to KAR Auction Services' Chief Executive Officer, Jim Hallett. Jim?

Jim Hallett – Chief Executive Officer

Great. Thank you, Jon, and good morning, ladies and gentlemen and welcome. I will start with the performance of the consolidated entity, and despite flat car revenue, I would say that I am very pleased with the performance for the quarter. Adjusted EBITDA margin topped 28%; adjusted EPS was up 19% and this is consistent with the 15% to 20% long-term target that we have stated and again these businesses continue to be very strong generators of free cash flow.

Again, we have talked to you much in the past about the complimentary nature of our businesses, and I think as you look at our performance for the quarter and year-to-date even for that matter, it shows how these businesses are really able to offset the ebbs and flows of the different business units.

A couple of financing highlights, we completed in the quarter that Eric is going to talk about in more detail. We did complete the refinancing of almost all of our debt, which allowed us to push our maturities out to 2017 and remain covenant light and we were successful in amending our U.S. and Canadian securitization taking the facility up to $750 million and extending those maturities out to 2014 and we were able to attract, very attractive pricing on this securitization and I think this is reflection of AFC’s strong track record of performance over the past couple of years.

In terms of the business units, Insurance Auto Auctions continues to perform. Revenues were up 10%, adjusted EBITDA was up 11% and they experienced a 5% increase in volume as well we were able to achieve higher revenue per units. This revenue increase was primarily driven by buyer’s fee, which is primarily driven by the higher cost of used vehicles. IAA has continued to focus on their synergetics project as you know this is the efficiency cost takeout standardization of processes and things of that nature.

Continue to have success with the vehicle remarketing division or as we refer to it as the VRD. VRD focuses on selling those low end cars. They don’t typically make it to a whole car auction. I often refer these as the push, pull, drag sleds that are sitting in the back row of dealer’s lot. We have now rolled this VRD program to approximately 50% of our sites at IAA and we will continue to roll out more sites as we go forward, but we are having good success with that program.

Another area that we have experienced some recent success with in the IAA is the rental car companies and I think IAA has been enabled to leverage ADESA’s relationship with many of these whole car providers and sell these rental cars. As you know, these rental car companies are for the most part self insured and there is a number of vehicles that are damaged as we would say less than perfect and these vehicles in the past have been sold out a whole car auction and we have now piloted a program with the rental car companies to sell these rental cars at Insurance Auto Auctions and the result have been we have had very good success.

I believe get them in front of a better buyer base that would buy these damaged vehicles. We have been able to increase the proceeds for the rental car companies and as a result we are getting more and more of these rental cars coming to Insurance Auto Auctions and then particular there is one large rental company that were working with that is really setting the pace for this business at Insurance Auto Auctions.

At AFC, they have just continued to exceed expectations. Revenue was up over 20%, adjusted EBITDA was up nearly 30% and this growth is primarily have been driven by the number of loans transactions and the revenue prevalent transaction. We have also seen a growth in our customer base and number of units floored and we feel like that we are definitely increasing our market share in the space.

Like Insurance Auto Auctions the tight supply at ADESA is really a positive for AFC as well. AFC continues to have very disciplined growth. The portfolio remains over 99% current and with the new securitization in place, and the additional capacity it does provide us with more opportunity and AFC is now expanded in to motorcycles, RVs, boats and things of that nature.

At ADESA, at the risk of sounding like a broken record is more of the same. Volumes may become even more challenging as we go forward. The tight supply is going to continue to be a challenge. It's been a challenge through 2011 and as I have stated before and we will restate again today, it's going to continue to be a challenge in 2012.

The National Auto Auction Association came out with their second quarter industry volume numbers and, in a word, they were disappointing. They were down 11%. At ADESA, revenue was down 8% and we had a 14% decline in volume, but if there was a bright light, it would be the gross profit. We were able to maintain gross profit of 44.2% of revenue, and I believe that this is a reflection of a couple of things. Number one, our continued focus on dealer consignment that we are really started 18 to 24 months ago.

Year-to-date, our dealer consignment is up over 15% and we are confident that this fares better than the industry. We don't feel we are done on the dealer consignment initiative. We still feel there is room to continue to grow that segment of our business and we continue to focus on that.

And then the other factor that I would say contributed is the ongoing PRIDE focus, and again the PRIDE focus is the efficiency process standardization that you familiar with at ADESA. We have been able to consolidate some auctions, where we have been able to co-locate Insurance Auto Auctions and ADESA on the same property. We are currently in the process of co-locating both those entities in Montreal right now as we speak.

In some cases, we have been able to expand the general manager scope of responsibility. We have one general manager now overseeing both the Insurance Auto Auctions business and the ADESA business at the same site. We piloted that in Edmonton last year and that’s something that we think we can continue to leverage over the North American footprint in some cases as we go forward.

And as we look at our year-to-date, we feel that our volume decline is generally tracking with the industry. In terms of the outlook, I believe that long-term the trends remain positive. New vehicle leasing remains very strong. As you know, that’s a huge driver for our business and there has been a number of entities report on the penetration levels of leasing and I think you’ve probably read those as much as we have.

Toyota appears their production is nearly back to the pre-earthquake levels that took place earlier this year. Used car sales are reported to be the highest they have been since 2007. And as I have said previously and I’ll say again the world doesn’t end in 2011 and it doesn’t end in 2012, but there is no question that our primary challenge will be navigating the next 18 months as we go forward.

On our last call, I shared with you my vision and my commitment to technology. I just want to touch on technology here a little bit and tell you that, that hasn’t changed. We continue to focus on enhancing our technology at all of our business units. We have a number of different enhancements in the works and just to touch on a couple of that we have rolled out, ADESA has continued to deploy the auction track technology, which is the GPS system that allows you to identify a car. This has been a benefit to ADESA. It’s allowed us to reduce out lot labor as well as been very well received by our customers. It’s a huge benefit to our customers in terms of their people finding and locating cars in a timely manner.

The Insurance Auto Auctions has rolled out their mobile version of the website and they have also enhanced their vehicle search capabilities through their iPhone applications. AFC is in the process of upgrading their technology platform as we speak. I would say we have a lot going on in technology and we have a number of enhancements that we plan on bringing to market and we will keep you posted as those things become live.

In terms of our guidance, we are not changing our expectation for adjusted EBITDA of approximately $500 million for 2011. However, with that said, I will remind you that we are focused on very tight supply that is causing tremendous pressure at ADESA and that will continue to be our number one challenge. And to-date, the strong performances at Insurance Auto Auctions and AFC as well as a number of actions that we have taken within the business units have really caused us to offset the weakness that we’ve seen at the whole car level.

So, I am going to wrap up for the moment and allow Eric to do his financial review. And then after Eric completes his comments and just before we go to Q&A, I’d like to come back with some commentary on our guidance and outlook for the remainder of the year. Eric?

Eric Loughmiller – Executive Vice President and Chief Financial Officer

Thank you, Jim. I just have a couple of things to cover today. First, I would like to provide some more detail on the effects of our refinancing of debt. As Jim mentioned, we completed the refinancing of our debt in May and redeemed our 8.75% senior notes and 10% subordinated notes in June.

Our goal in this transaction was to increase our flexibility to repay debt and extend the maturity of our senior debt. I am pleased to report that this was accomplished. Furthermore, we will have a modest reduction in our aggregate interest expense this year. We issued $1.7 billion of senior term loan B and have available $250 million of undrawn revolver. This debt has interest at LIBOR plus 375 basis points with a 1.25% LIBOR floor.

The term loan B is covenant light, and the revolver carries the senior leverage covenant that applies at any quarter end there is an amount outstanding on the revolver. As a result of the refinancing transaction, we have recognized $53.5 million in costs related to the extinguishment of our existing debt. This cost related to redemption premiums paid on the repayment of the notes and the write-off of unamortized debt issuance costs. In addition, we terminated the existing interest rate swap arrangement and expensed a cash payment of $14.5 million that is recorded as interest expense in the quarter.

The interest rate swap had a remaining term of 13 months at time of termination. The after-tax impact of these debt issuance costs aggregated $42.2 million or $0.31 per share. I will remind you that we still have $150 million of floating rate notes outstanding that are due in 2014. The floating rate notes bear interest at LIBOR plus 400 basis points with no LIBOR floor.

I would also like to give some more detail on guidance for 2011. As Jim mentioned, we expect adjusted EBITDA of approximately $500 million. This will result in earnings per share of $0.45 to $0.50 per share. Previously, we had provided guidance on earnings per share of $0.75 to $0.80 per share. The difference relates to the loss on extinguishment of debt and the termination of the interest rate swap arrangement. We also provide guidance on adjusted earnings per share basis. We anticipate adjusted earnings per share of $1.20 to $1.25. This did not change from our previous guidance.

Adjusted earnings per share, excludes non-cash stock compensation, stepped up depreciation and amortization from the 2007 LBO transaction, and two new items. We have adjusted for non-recurring loss on the extinguishment of debt and another income item, which was recognized as a result of previously recorded contingent consideration from an acquisition. These adjustments are detailed in our earnings announcement and our filing on Form 10-Q.

A couple of items for which I have provided previous guidance have changed as well. Our effective income tax rate is now expected to be approximately 25% instead of 30% as previously discussed. This reflects the impact of the tax deductible costs associated with the extinguishment of debt. I would also like to give clear guidance on our expected cash taxes. We expect our cash taxes for 2011 to aggregate $40 million to $50 million.

Previously, I have indicated capital expenditures will be $80 million in 2011. We are now expecting 2011 CapEx to be $85 million. This increase reflects increased investment and technology at AFC as mentioned by Jim and an increase in capital expenditures at Insurance Auto Auctions as a result of additional growth experienced in this business unit.

At June 30, 2011, our net leverage ratio is 3.5 times. We are pleased with our progress in reducing our leverage. As you know, we issued our 10-Q last night in addition to the release of our earnings announcement. This gives a comprehensive explanation of our financial performance. So, I won’t go through any other detail today.

I will now turn it back to Jim for a few final remarks. Jim?

Jim Hallett – Chief Executive Officer

Good and thank you Eric. And ladies and gentleman, just before we go to Q&A, I want to come back and speak to the guidance that both Eric and I have been talking about here over the last few minutes. And I want to start out by assuring you that we have a plan in place to achieve our goals for 2011.

I want to speak to the visibility that we have within these businesses looking out to the next six months. At IAA and AFC, we believe our visibility is pretty good and we have pretty good understanding of where these businesses are going to be and how they are going to perform. At ADESA, I would term it as being extremely cloudy more so as cloudy as what I have ever seen.

As you know in the first half of 2011, we mentioned that the shortfall at ADESA was covered by Insurance Auto Auctions and AFC. I am hopeful that that’s also going to be the case for the second half of 2011. And I would remind you that the tight supply challenges that we see at ADESA are truly a benefit to IAA and AFC’s performances. I think it’s become clear that the industry will be under 8 million units this year. Tight supplies are going to continue for the reminder of this year on the whole car side of the business. And I think it would be prudent of me to caution you that there is no assurance that the strong performance at Insurance Auto Auctions and at AFC, we’ll continue at the same levels for the remainder of the year and offset the impact of these lower volumes at ADESA.

So, are we faced with some challenging conditions? Absolutely, yes. But I believe that our consolidated performance of our businesses remains our strength. We have natural hedges that we spoke about between our businesses. We’ve spoken about the strong cash flow generation. The repayment of our debt will reduce our interest expense. And as a result, I believe that this company will have the ability to perform in these challenging conditions.

So with that, I will turn it over to Rochelle and we will go to Q&A.

Question-and-Answer Session

Operator

Thank you. The question-and-answer session will be conducted electronically. (Operator Instructions) And our first question we’ll hear from Gary Prestopino with Barrington Research.

Gary Prestopino – Barrington Research

Good morning, everyone.

Jim Hallett

Good morning guys.

Gary Prestopino – Barrington Research

Jim, the Las Vegas site that you opened up, did that come on stream in early in the quarter or later in the quarter? Was that in the mix this quarter?

Jim Hallett

Gary, that came out in June. We’d hope to get it open a little bit earlier, but as a result of some issues that we had there, it actually didn’t get opened up until June.

Gary Prestopino – Barrington Research

But you did have the units from the Premier Auction Group in the mix this quarter, then?

Jim Hallett

Yes, that’s correct Gary.

Gary Prestopino – Barrington Research

Okay. And then could you give us an idea what percentage were dealer cars this quarter versus last year at this time?

Jim Hallett

Yeah, dealer cars, I would say, without pointing an exact number are in excess of 40% of our total business.

Gary Prestopino – Barrington Research

Okay. And then, Eric, could you give us an idea of what amount of capacity is left at AFC?

Eric Loughmiller

Yes, Gary. With the expansion on the securitizations, we feel we have a lot of capacity. We’re borrowed out now in the neighborhood of $550 million with a couple of $100 million of capacity. And again the advanced rates didn’t change. So, there is plenty of room to grow that portfolio through the term of the arrangement.

Gary Prestopino – Barrington Research

Okay. And then lastly and I’ll jump off. You said the interest expense was going to be coming down because of the refi, could you give us an idea of what we can expect now or how much it would come down vis-à-vis the first half of the year?

Eric Loughmiller

Well, giving guidance isn’t my specialty, Gary, but I think you can look at it, it’s going to come down about 65 to 70 bps as the effective change in the rate because of the LIBOR floor at one and a quarter that puts that term loan B at 5%, and that will put us, I think, again about 65 to 70 bps of savings

Gary Prestopino – Barrington Research

Okay, thank you.

Jim Hallett

Good. Thank you, Gary.

Operator

And next we move to Tony Cristello with BB&T Capital Markets.

Tony Cristello – BB&T Capital Markets

Thank you. Good morning.

Jim Hallett

Good morning.

Tony Cristello – BB&T Capital Markets

First question I have is maybe a bit more clarity on sort of the guidance and the outlook. I guess I sense a bit of optimism, but in the same breadth there is a bit of a cautionary tone. You talk about ADESA, and maybe the volumes, obviously, it sounds like sub 8 million from our industry standpoint, maybe a little worse than you might have expected them to be at the beginning of the year. And you’ve had also the benefit of IAA and AFC. The worst that ADESA gets is it a direct then opposite in terms of IAA and AFC should get that much better or I guess in your text you actually said you are not sure that those trends can continue. So, I am trying to understand the confidence that you have in the various segments to help each other offset or is the guidance you are giving just based on where we are today, and if things worsen, you may not have that same comfort level? I am sorry, that’s a longwinded question.

Jim Hallett

Yeah. And hopefully I’ve got most of that. And let me start just by saying that most importantly, we look at this business on a consolidated basis and we have a plan in place to reach our goals for 2011 which I stated. And I think that’s most significant. The cloudiness that I spoke about at ADESA, there is no question there is a lot of things going on that’s causing unusual behavior as I would term it. I think dealers are – change their profile of the used cars that they sell. The dealer who typically hasn’t sold a five to seven-year-old car with a 120,000 miles on it is now holding on to that car and selling it. Dealers are going to greater lengths to acquire cars, whether they be from wholesalers or swapping between dealers or going to auctions completely across the country. I think there is just a lot of un-surety. And then you have factor into that what’s going to happen to the SAR. If that increases what impact that will have on tradings and vehicle prices and the number of vehicles that will eventually make it to the physical auction. I think with all the things that are going on, there is just uncertainty with respect to the ADESA level where as I mentioned we have much better visibility and a much better grip on how we think the other business units are going to perform, which again gets us to a comfort level of approximately $500 million on a consolidated basis and that’s really what we are focused on.

Tony Cristello – BB&T Capital Markets

Maybe one other question if I can. When you talked about the changes you are seeing in the dealer side of the business and holding on to these longer cars, cars longer that are 120,000 miles or such, if you look at your dealer consignment mix at 42%, with the initiatives you have in place, is there a number that you wanted to get to? Do you want to be at 50%? And how does that ultimately help your business if the trends in the industry seem to be shifting a little bit and maybe they are not a permanent shift, but certainly near-term shift nonetheless?

Jim Hallett

Yeah. I think to answer your question I think that our goal would to be at the market in terms of mix. If I’ve got my numbers right, I think the mix was 55% dealer business and 45% commercial business. And if that’s where the market is, that’s where we’d like to lineup.

Tony Cristello – BB&T Capital Markets

And I assume all the initiatives and infrastructure you have in place to get there is working, it’s there, and now it’s just a matter of time to finish sort of achieving to that path to get to the 50?

Jim Hallett

I think you said it well. We are very pleased, number one, with how we rolled out this initiative, very pleased with the focus that we have had and the success we have had. And the nice thing about it is we feel there is more run way. There is more opportunity on the dealer side of the business and we feel that with the team that we have in place, at ADESA, we feel that, that will continue to get better as we go forward.

Tony Cristello – BB&T Capital Markets

Okay, thank you for the time.

Jim Hallett

You are very welcome.

Operator

And next I will move on to John Murphy with Bank of America/Merrill Lynch.

John Murphy – Bank of America/Merrill Lynch

Good morning guys.

Jim Hallett

Good morning John.

John Murphy – Bank of America/Merrill Lynch

I have a couple of questions here. Good morning. First question is just on the conversion rate at 60.8% at ADESA, I mean, obviously that was a pretty significant drop from where it’s been running for the past really five, five quarters. And I know you highlighted an increase in the dealer business that converts at a lower rate as part of the reason. I am just trying to understand with everything that’s going on in the used car market and dealers pushing that business even harder and used car prices up, I mean, is there anything else going on there, is it really just mix, because it seems like the conversion rate should be higher given the market dynamics right now?

Jim Hallett

John I think you answered it with your first statement, it’s really dealer consignment cars convert at lower rate. So, we have to get a lot more of these vehicles and we convert them at a lower rate and when you measure in the drop of the commercial vehicles, that’s the way the numbers work themselves out and there is nothing else that I could point to that is causing that change in conversion other than the impact of dealer cars converting lower.

John Murphy – Bank of America/Merrill Lynch

And if that conversion rate is somehow the mix shifted back and you were converting in a 400 to 500 basis points higher, so 64%, 65% range. I mean, your margins in ADESA would just be significantly higher. Is that a fair assumption or were there be any cost creep if that conversion shifted?

Jim Hallett

No, I think it’s a direct drip to the bottom line. The – obviously I’ll let Eric do the math, but in terms of conversion rate, that’s a huge driver of our margins and a huge driver of our profitability. So, as that conversion rate jumps another 1%, 2%, 3%, 4%, that’s going to have a significant difference on our margins and our profitability.

Eric Loughmiller

Yeah, John, and the only caution I would add to that is when you start putting those commercial cars back in, there is a higher use of ancillary services, which can blend it down slightly. But again, the levels we're at now, we sustain those levels when we had high commercial sales and we're holding them in there with the dealer consignment. So, I don't know if there would be a big move, but that would be my only caution as if you saw them using more transportation or something that could have minor impact on it.

John Murphy – Bank of America/Merrill Lynch

Okay. And then just a second question on volumes. And, Jim, you mentioned that used car sales as they're being reported by the industry are the highest that they have been since 2007, yet auction volume from the NAAA are actually own 11% in the second quarter.

And I am just trying to understand if there is some shift going on away from auctions in the near term, or is this a trend we're seeing and the dealers are bypassing the auctions and retailing more vehicles? I am trying to understand what happened in the quarter, if I am just misunderstanding that, or something is changing here.

Eric Loughmiller

John, I believe as a temporary response to supply is just so difficult for dealers to get enough inventory to fulfill their inventory requirements that they are just hanging on to more cars and they're going more places to get cars, and perhaps in some cases they're getting to these cars before they make their way to the physical auction.

John Murphy – Bank of America/Merrill Lynch

Okay. And then just lastly, if we look at Insurance Auto Auctions, it has been outperforming, as you mentioned, offsetting somewhat the pressure on ADESA, and you mentioned VRD and your focus on doing more business with rental car companies. Is there any cannibalization that's going on here, where some of the business is moving from the ADESA line item to the Insurance Auto Auctions segment?

I know you mentioned there were a couple of site where is you're starting to combine the General Manager role. And I am trying to think if we should be looking at these business maybe as a whole of Insurance Auto Auctions and ADESA together as opposed to separately, because it seems like there is some fungibility in volumes beginning to develop.

Jim Hallett

I think that's a good point. There is no question that there has been business, there has been and I wouldn't use the word cannibalization, but I would say there has been business that has shifted as a result of the relationships with ADESA.

ADESA has been able to introduce Insurance Auto Auctions to a myriad of customers, who previously did not do business with salvage auctions and this comes back to what we talk about in terms of channel optimization or best venues and now we're really able to provide our customers with the opportunity to look at both venues and recently as you've already said, but the risk of repeating we now have these rental car companies trying pilot projects with us and quite frankly some of these pilot projects are working out.

In some cases, we didn't necessarily get all of those cars out of ADESA, but it did take some cars away from ADESA there is no question. So overall I would say there is a smidge of cannibalization here, but on the other hand I think there is a growth in this segment for car overall.

John Murphy – Bank of America/Merrill Lynch

Okay, great. Thank you very much guys.

Jim Hallett

You are very welcome.

Operator

And next we will move on to Rick Nelson with Stephens

Rick Nelson – Stephens

Good morning.

Jim Hallett

Good morning Rick.

Eric Loughmiller

Hi Rick.

Rick Nelson – Stephens

Thank you. You mentioned ADESA volumes were down 14%, the industry down a 11%, can you talk to what’s you think is happening to market share both in the dealer consignment side as well as the institutional business.

Jim Hallett

Yes, Rick, if you take a look at our business, first of all, we've told you in the past that our business is historically 70-30, 70% commercial and 30% dealer, and so obviously the bigger segment of business is down is the commercial business. So, that's going to have more of an impact on the ADESA commercial numbers, but on the other side, the flip side of that coin is the dealer consignment business. We've been able to grow that business above the market. So, I think that speaks to the volume declines. We've lost it on the commercial side, but we've actually done quite well on the dealer side.

Rick Nelson – Stephens

When do the off lease vehicles begin to grow up again? That's later around a 2012 that would positively impact the institutional business?

Jim Hallett

Yes, I'm sorry Rick. I just didn't get the first part of your question. I'm sorry, would you mind repeating that?

Rick Nelson – Stephens

When do off lease vehicles begin to turn up again, that would have a positive impact on the institutional?

Jim Hallett

Right. Yes. I'd say for sure we're going to see those leased vehicles in 2013, but towards the end of 2012 we could see some of the early terminations coming back. So, we expect, especially as some of these leases were written in 2010, we could see some of those cars start to return late 2012 but I think the real impact will come in 2013.

Rick Nelson – Stephens

Comparisons get more difficult as we move through the remainder of this year and into next year from an institutional side of the business?

Jim Hallett

Rick, we've been under pressure in this business. It really began in the latter part of last year and I would say, was heavily focused beginning in the fall and definitely in the fourth quarter, but to characterize the comparisons getting easier in today's environment is really difficult for us because it's things have changed in terms of the supply vehicles. But yes, volumes were down in the last part of last year more so than they were earlier in the year. So, I do think again the comps are a little easier if you want to call it that.

Rick Nelson – Stephens

New vehicle inventories begin to improve. There is some talk that we're going to see some pickup in incentives from the JA3 and the other OEMs. How do you see that affecting used car values, and IAA's business as well as a pickup perhaps affecting the ADESA volume side?

Jim Hallett

Well, there is no question as the new car sales increase, that should increase trades and that should increase volumes at the auctions and transactions, and you might see a decline on the proceed side at Insurance Auto Auctions. But I think given the choice, we would be pleased to see the SAAR rise and number of trade-ins increase, which would have a much greater impact than what we would see being eroded on proceeds at IAA.

Eric Loughmiller

Rick, I'll add to that. There just doesn't appear to be any relief on aftermarket parts pricing right now. I mean that's a driver of this. If people are repairing the cars, it probably is not as direct a relationship to a point in time measurement of new and used car pricing. I mean there is high demand at the salvage auctions and it's really to drive the aftermarket parts business, which is collision repair oriented.

Rick Nelson – Stephens

Also Eric, I'd like to ask you about the SG&A expense ratio this quarter. With all the adjustments, it's a little difficult for us to look at that, but it appears as if it lightened on this quarter?

Eric Loughmiller

Yes, in fact if you take out the stock-based comp, which is the direct reflection of movements in our stock price. If you take that element out of that, we were actually down as a percent of revenue about 70 basis points.

Rick Nelson – Stephens

Okay. Thank you and good luck.

Jim Hallett

Thank you.

Operator

The next we will move on to Bill Armstrong with C.L. King & Associates.

Bill Armstrong – C.L. King & Associates

Good morning Jim and Eric.

Jim Hallett

Good morning, Bill.

Bill Armstrong – C.L. King & Associates

Follow-up on one of those previous questions so it looks like ADESA in the second quarter lost the market share in the institutional side, are you seeing man higher or any other players getting more aggressive in that area?

Jim Hallett

I think to speak to your first point, yes. We've lost a little bit of share on the institutional side, just because of our high levels of institutional car. In terms of what's going on with the competition, I think I will stay away from commenting on that.

Eric Loughmiller

Bill, I'll add to that. I mean we don't like to make excuses about these metrics, but the interim data that NAAA puts out is based upon some estimation. Quarter-to-quarter there is some odd movements I would just highlight for you, that's why we really don't measure market share until we hit the annual numbers which is based on a survey of all of the auctions and is actual data. So when we compare our numbers of units sold, it's actual number of units sold and this is same data we submit, but not all of the data that they are using is as precise as that and we know that, so that's why we say generally in line. Next quarter, you may have somebody that reported this quarter that didn’t report in the first quarter and that affected it. And so we look at it more over a period of a year.

Bill Armstrong – C.L. King & Associates

I see. On the SG&A line, for ADESA, you had more auctions in operation than a year ago, but your SG&A was actually down slightly in dollars, where did those declines come from?

Eric Loughmiller

Well, again, Project PRIDE is the biggest mover of that. We look at it. We’ve talked about dealer consignment where we have invested in the marketing spend there, but in other areas of our business we have had reductions. And we continually look at our headcount what support staff are needed to support the current levels of activities and I have to tell you I am proud of the ADESA team. They have been proactive in trying to keep as much of their costs in line with the current activity levels. So, that’s the primary driver in my view of what keeps it down. And it is built back to 2007 I would argue that a greater percentage of our cost structure even on the SG&A front was more of a fixed nature and that we’ve kind of made it a little more variable than we had previously. So, I think that’s helped us.

Bill Armstrong – C.L. King & Associates

I see, okay. And then finally on interest expense, I know you don’t want to give forward-looking guidance on that, but the – was it $49.7 million in the second quarter. If you stripped out any one-time items, what would that number have been, if there were any one-time items?

Eric Loughmiller

Well, on interest expense?

Bill Armstrong – C.L. King & Associates

Yes.

Eric Loughmiller

You can take out just a second I’ll give you the number. $14.5 million pre-tax was the cash paid on the interest rate swap termination, take that out.

Bill Armstrong – C.L. King & Associates

Okay.

Eric Loughmiller

Everything else was interest expense.

Bill Armstrong – C.L. King & Associates

Got it, okay. Thank you very much.

Eric Loughmiller

And that includes non-cash amortization of debt issuance costs, so – but you can go to our cash flow statement and then figure out most of it.

Bill Armstrong – C.L. King & Associates

Right, right. Okay thanks.

Eric Loughmiller

You’re welcome.

Operator

Next we move to Scot Ciccarelli with RBC Capital Markets.

Scot Ciccarelli – RBC Capital Markets

Quick housekeeping one item first, the IAA figures, is that all same-store sales?

Eric Loughmiller

Yes. We have not added any auctions at IAA last year.

Scot Ciccarelli – RBC Capital Markets

Okay, that’s helpful. And then I guess again not to I am sure the horse is glue at this point, but about ADESA volumes you mentioned that 2012 is also going to be challenging, but obviously the comparisons gets much easier following what’s going on in 2011. So, I guess what I am trying to figure out is 2012 is still just going to be under pressure, so it won’t show much of a rebound from 2011 or do you think year-over-year 2012 will actually be worse than 2011?

Eric Loughmiller

Given what we are experiencing Scot. I think we’ll wait till the economists come out and we look at all the activity, but Jim’s commentary was very specific. I mean, we don’t see any indicators that would say there will be a great change to the market conditions other than what he spoke to some of the behaviors and the dealers, if the SAR were to increase that might help bring some activity, but again pressure on supplies is the key. That’s what we are expecting.

Scot Ciccarelli – RBC Capital Markets

But that doesn’t really makes sense mathematically. I mean, your 2008 was kind of where late ‘08 early ‘09 was kind of the peak of the decline I suppose in the new car sales run rate. If you use that typical three-year timeframe for leases etcetera, it means end of 2011 or kind of mid part or end of 2011 should really be the peak of the supply? Is there something else that is occurring that I am just not appreciating properly?

Jim Hallett

If I understand your question right, we refer back to 2008 and 2009 even though that was kind of at the peak of the recession or the meltdown and what was going on in the marketplace. We still had a lot of volume to run off these portfolios. So, we were still running off volume in ‘08 and ‘09 and into ‘10. And during that time, leasing came to a standstill and the credit market started to tighten up and repos kind of dropped off a little bit. And we used – so we really start to refill the pipe in 2010. And so…

Eric Loughmiller

And I will add to that Jim, the SAR was declining throughout 2009. So you are right, I mean there is a number of factors, Scot, you are on that, but lease originations return on a much lower number of new car sales. And we didn’t see the rebound and the SAR really come in until ’10.

Scot Ciccarelli – RBC Capital Markets

Okay. I will follow-up the answer. Thank you.

Jim Hallett

All right, Scot.

Operator

Next we move to Craig Kennison with Robert W. Baird.

Craig Kennison – Robert W. Baird

Good morning. Thanks for taking my question as well.

Jim Hallett

Good morning Craig.

Craig Kennison – Robert W. Baird

Good morning. Eric, the 25% tax rate is that on a GAAP basis or adjusted pre-tax profit just want to confirm?

Eric Loughmiller

That’s our effective tax rate on a GAAP basis.

Craig Kennison – Robert W. Baird

And is there any nuance I am not appreciating about the impact on pre-tax profit on an adjusted basis of that tax rate?

Eric Loughmiller

Well, the nuance Craig is the fact that most of those adjustments result in tax deductions. I mean, that so what I am doing is giving you the nuance of the rate goes down, because a lot of those adjustments are tax deductible, but I am not taking them out on my pre-tax GAAP income.

Craig Kennison – Robert W. Baird

Okay, that’s helpful. Thank you. And then…..

Eric Loughmiller

And that’s why Craig just to be clear that’s why I gave you the guidance of $40 million to $50 million on cash taxes, because there I don’t think you can get to the number, that is where the nuance occurs that you are referring to. As your pre-tax on an adjusted basis is up, so I am giving you the cash tax number we expect rather than a percent.

Craig Kennison – Robert W. Baird

Understood. That’s helpful. Thanks Eric. And Jim, I think one of your online competitors recently announced they would be offering a buyback guarantee, is that a disruptive new service and is that something you would consider?

Jim Hallett

Yeah. And something that we have actually that the industry is down and it’s been a practice of the industry over the years from time-to-time. I think it’s maybe something new for that particular entity. But there are insurance programs in place where insurers, you can buy insurance that will protect you to buy the vehicle back over the course of 60 or 90 days and refund 95% of your vehicle purchase or something of that nature, but it’s a program quite frankly that we used over the years as well for specific customers and specific promotions.

Craig Kennison – Robert W. Baird

And just to confirm is that a service you currently offer either directly or through an insurance partner?

Jim Hallett

Yes, it’s a service that we could provide through an insurance affiliate. And different markets offer it based upon market conditions there, but again we aren’t retaining that risk generally. I mean, I am not aware of any right now, where we are retaining a risk we insure it all though a third-party. And they – and actually the customer pace for the insurance not us.

Craig Kennison – Robert W. Baird

Got it. Thank you.

Jim Hallett

You’re welcome.

Operator

And Matthew Fassler with Goldman Sachs will have our next question.

Matt Fassler – Goldman Sachs

Thanks a lot. Good morning. It’s Matt Fasler sitting in for Brinkman today.

Jim Hallett

Good morning.

Matt Fassler – Goldman Sachs

So two questions, first of all, thanks for you candor unless going on into ADESA. And you spoke to some of the cyclical drags and the turning points we might see. Is there anything of a structural nature that you have see having gained or lost momentum in terms of impediments to the whole car auction business model this quarter, whether it’s what the rental car companies are doing or online on the auctions in the whole car space anything like that?

Jim Hallett

No, Matt. I would say things are nothing out of the ordinary things that are pretty consistent than it’s much of what we stated already.

Matt Fassler – Goldman Sachs

Fair enough. And then I am sorry go ahead Eric.

Eric Loughmiller

And Matt I was going to add Jim did comment maybe the only thing you are seeing grounding dealers or buying more off-lease vehicles because of the residual value that were set three years compared to the used car values of today. It’s very attractive for them to do that. I mean, that’s not structural. I think that’s temporary, but that is an impact we are monitoring.

Matt Fassler – Goldman Sachs

Got it. And then you spoke about IAA and AFC sort of holding their ground and essentially acting as hedges. Not to take the decision in this action, but if there were an item to watch for in IAA and the salvage business in particular, that will be potentially concerning what would it be what should the watch fronts on the horizon be here?

Jim Hallett

I am sorry Matt. Would you mind just repeating that for me?

Matt Fassler – Goldman Sachs

Yeah, sure, of course. Just real briefly, it sounds like IAA and AFC are doing well, you sort of said, I guess almost the pro forma statement, there are no guarantees that, that continues. Is there anything that could possibly, what would we look for that might not move in the right direction in the salvage business that would be offset by an offset in the whole care business?

Jim Hallett

I think that the thing I would point to I guess would be there is a job and proceeds the salvage business is obviously there is a number of factors that affect product prices including used car values, including currency, including miles driven scrap prices. If there was a significant change in those areas, it could possibly bring down the proceed prices at IAAI, which would not allow them to perform it at the same level.

Matt Fassler – Goldman Sachs

Got it, fair enough. Thank you so much.

Jim Hallett

Okay. You are welcome.

Operator

The next question we will hear from Tom Shandell with Goldentree Asset Management.

Tom Shandell – Goldentree Asset Managemnet

Hi thank you. Good morning.

Jim Hallett

Good morning Tom.

Tom Shandell – Goldentree Asset Managemnet

Some of my questions were already answered. Question -- sort of a housekeeping question on the supplement. If I look at page three, which has the quarterly breakdown of all of your EBITDA calculations, you show nonrecurring charges in this quarter of 16.2, and non-cash charges of 46.2.

And I was hoping you could help me understand which of those -- your EBITDA calculation is from net income going up, and I usually look at the other direction, so I am just trying to understand what I should and shouldn't include in my add-backs. So I was wondering if you can help me understand which of these items are below the operating income line and which are above. I mean, I presume the non-cash charges has a lot of the loss on debt retirement in there because of the size.

Eric Loughmiller

Yes, but it does not include the 14.5% from termination of the swap because that was an interest expense which is up above.

Tom Shandell – Goldentree Asset Managemnet

Sure.

Eric Loughmiller

But everything else is above if you look at it the differentiation is above the operating income line. It’s an add back. It was below that line or then the exception will be depreciation and amortization, there is operating cost we show separately.

Tom Shandell – Goldentree Asset Managemnet

Okay, but the adjustment to contingent acquisition cost that didn’t include other income?

Eric Loughmiller

That rest of the SG&A.

Tom Shandell – Goldentree Asset Managemnet

That rest of the SG&A?

Eric Loughmiller

Yes.

Tom Shandell – Goldentree Asset Managemnet

Interesting okay. I appreciate that.

Eric Loughmiller

Yes, its an operating cost it’s the new actually Tom it’s the new accounting for business acquisitions its not how we used to do it.

Tom Shandell – Goldentree Asset Managemnet

Okay. That’s helpful. Switching to IAAI could you help understand what percentage of the business this quarter was sort of your traditional business and what percentage it was rental and charity and things of that sort?

Eric Loughmiller

We still continue to be about 85% insurance. It did fall just slight below at this quarter, but for the year it was still running right around 85%. There is not a big change there. And I don’t think that surprising because when the summer months whether its fewer insurance claims so I think it’s probably more seasonal than anything that it probably dropped a little bit.

Tom Shandell – Goldentree Asset Managemnet

How many natural disaster can we seem to be experiencing weather related, do they have meaningful change in the volume of business?

Jim Hallett

It is one of the more meaningful things that occurs throughout the year as weather related claims and it has been a very interesting cycle as you probably know with the numbers of tornados, floods and the heat all the things have go with heat have really created some situation whether it would be the tornados or the floods or the severe storms.

Eric Loughmiller

Thus hardly goes snow and ice.

Jim Hallett

Snow and ice earlier, but I’m talking that’s probably been something that’s been a trend in our favor that is have normal for the summer months.

Tom Shandell – Goldentree Asset Managemnet

But in the quarter what were the tornado activity etcetera was that a meaningful benefit to your volume?

Jim Hallett

No, its not meaningful so far because there is a lot of that is occurred in taking average term of 75 days form the time that the cars are assigned to us that the time we sell it. But again meaningful over the course of the year weather related as an impact and again that’s what’s keeping the insurance volumes probably at the normal levels, but remember there are natural disasters every year there is just each year there is some place else its weather it’s a hurricane or tornado its kind of a recurring thing that these weather events occur.

Tom Shandell – Goldentree Asset Managemnet

Okay. So, the quarter had some pretty good cash flow and I know money is fungible, but the way I line up the numbers, it would appear that your good cash flow was invested in these receivables held for investment, which apparently have good return. Can we think about when we model the company that, that will be a reasonable use of free cash flow going forward?

Jim Hallett

There will be an impact of us growing. As we grow the AFC portfolio, you will see us utilize some of our cash, because we retain $0.225 on the dollar and securitize the remainder. In periods where we were running that portfolio off, it was a significant generator of cash. So Tom yes, that’s part of our model. Although I don’t think you will see the moves as drastic as they occurred in ‘08/09 and the growth is more steady now.

Tom Shandell – Goldentree Asset Managemnet

All right. But we could probably think about this quarter being more normal?

Jim Hallett

Yes. This quarter is fairly normal, yes. I mean, again there is a bit of seasonality in that business. You build up and then it kind of lags into this – their portfolio will lag a little bit into the fall where it will start to see some more activity generally as they get near your end and people start buying inventory and flooring it as they prepare for the next season.

Tom Shandell – Goldentree Asset Managemnet

I see. Finally, the whole car business, as you mentioned is supply constrained, but yet in AFC you're picking up share. So I guess the question is are you making whole car floor plan loans, or are you expanding the type of loans to include just general floor plan loans to used car dealers who may not be buying cars at auctions?

Jim Hallett

Tom, right now, it’s being driven by used cars that are being floored. With our recent improvement, we have been able to expand, but that’s still there are limitations on the ability going to these other baskets. There is a limit to the securitization, but right now the number of units floored which is actually vehicles, cars has increased substantially.

So, we’ve got a number of things going in our favor, but it’s primarily cars. We are moving in a little bit more into the specialty area that Jim mentioned. We have that capacity, but again it can’t grow substantially because there are limits as to how much of the securitization can be used in those areas.

Tom Shandell – Goldentree Asset Managemnet

Right. But I mean, are you flooring cars that are from auction or are you replacing incumbent lenders and just capturing more customers?

Jim Hallett

We are flooring cars purchased at auction. There is a little bit with the activity of the retailers buying cars from consumers. We will floor those vehicles up to black book prices and things like that, but we still are predominantly flooring cars acquired at auction. That’s our focus and that’s where they are getting their growth.

Tom Shandell – Goldentree Asset Managemnet

Okay, thanks Jim and Eric.

Jim Hallett

Thank you. Rochelle, we put time for one more question, what was next.

Operator

Okay, we’ll move on to Gary Prestopino with Barrington Research.

Jim Hallett

Hey Gary.

Gary Prestopino – Barrington Research

Yes, I am fine. Thanks.

Jim Hallett

All right. I think we may have one more person we could their question.

Operator

Okay. Mr. Prestopino, your line is open.

Gary Prestopino – Barrington Research

I am done.

Jim Hallett

He is done.

Operator

Okay, there are no further questions.

Jim Hallett – Chief Executive Officer

All right, Rochelle. Maybe just before we close out here, I would just close in saying thank you for being on, and thank you for your interest. We're definitely going through some challenging times here. And this certainly isn’t the first challenge that we have dealt with as you think of what we have been through over the cars, actually what we have been through in the first half of this year and then as we take a look at what we have been through over the last three or four years is the management team.

And I would just remind you that this is very, very talented management team, very passionate about this business. And we are a scrappy bunch and we find a way to get things done. And I can tell you that we will fight to the better into deliver on our goals and our expectations and with that, hopefully we will continue to see things move in a positive direction here. So, I will wind up with that and thank you very much for your time and interest today.

Operator

And that will conclude today’s call. We thank you for your participation.

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