DealerTrack Holdings, Inc. 1Q08 (Qtr End 3/31/08) Earnings Call Transcript

DealerTrack Holdings, Inc. (NASDAQ:TRAK)

Q1 2008 Earnings Call

May 6, 2008  5:00 pm ET


Katherine Piscopo Stein - Investor Relations Manager

Mark O'Neil - Chairman, Chief Executive Officer

Robert Cox - Senior Vice President, Chief Financial Officer


Gary Prestopino - Barrington Research

Edward Yruma - J.P. Morgan

Franco Turrinelli - William Blair & Company

Christopher Mammone - Deutsche Bank Securities

[Unidentified Analyst] - Thomas Weisel Partners

Peter Goldmacher - Cowen & Co.

David Scharf - JMP Securities

Andrew Jeffrey - Suntrust Robinson Humphrey


Good afternoon, everyone, and welcome to DealerTrack's first quarter 2008 conference call. As a reminder, today's call is being recorded.

At this time, I will turn the call over to Ms. Katherine Piscopo Stein at Investor Relations at DealerTrack. Please go ahead, ma'am.

Katherine Piscopo Stein

Thank you, [Andrea]. Good afternoon and welcome. Joining me today are Mark O'Neil, Chairman and Chief Executive Officer, and Robert Cox, Senior Vice President and Chief Financial Officer of DealerTrack.

Before we begin I would like to remind everyone that remarks made during this conference call will contain forward-looking statements made pursuant to the safe harbor provisions 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 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 the actual results will differ from those set forth in the forward-looking statement.

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 website at

I would like to now introduce Mark O'Neil.

Mark O'Neil

Thank you, Katherine, and welcome to the Investor Relations role. Hello, everyone. Thanks for being with us this afternoon. I'll begin today's call with an overview of our financial results and other key metrics for the first quarter of 2008. I'll then provide a quick summary of the quarter from a business and strategy perspective and perspective and discuss some of our latest accomplishments as well as recent industry developments. Bob will provide further details on our financial performance for the quarter and will discuss our outlook for the remainder of 2008.

Let me start by saying I'm pleased with the 24% increase in revenue growth in the first quarter of 2007. This growth was driven by strong increases in both transaction and subscription revenue. We have made progress this quarter even in the face of an economic environment that has been challenging for many businesses, including DealerTrack. Our transaction growth was significantly impacted as many national subprime lenders first quarter volumes were down by as much as 30% from the prior year.

Let me provide a high level review of the financials before I get back into strategy.

Revenue for the quarter was $64.3 million, up 24% from first quarter 2007.

Net income from the quarter was $2.3 million, and EBITDA was $13.3 million.

Diluted cash net income per share was $0.22 for the quarter.

As we look back at the first three months of 2008, we're pleased with the ongoing execution of our growth strategy. We have further expanded network participation across each of our customer and partner categories. We had 503 financing sources connected as of the end of the first quarter, a gain of about 46% from March 2007. Many of you will remember that on February 9 we announced our 200 millionth credit application processed through the network, an incredible milestone.

The number of active dealers in the network at March 31, 2008 was 22,457, which increased 2% from the end 2007. Approximately 90% of franchise dealerships continue to use our network for their day-to-day financing activities in the U.S.

Our independent dealer initiative was piloted this quarter and is part of our long-term growth plan to increase the number of active dealers in the network. We are also seeing expansion of our aftermarket network, with 20 providers live on the network and others in process. We continue to be excited about prospects for this service. We're excited to announce that this month ASGO, a leading provider of automotive aftermarket products, will go live on the network. Dealers using the DealerTrack aftermarket network will have free access to real-time information on EasyCare's products and services.

We have accelerated the signing of diverse suppliers to DealerTrack's accessory solution. As of yesterday we had 8 accessory providers signed to the network, including some of the largest warehouse distributors in the U.S. who have coverage and sales in all 50 states and Canada. We see the customization of vehicles as a growing business with our technology being the bridge between suppliers of specialty accessories and dealerships that are looking for increased profit opportunities.

We continue to have success with cross selling our products and services. Total subscriptions in the network increased to 30,098, which represents 29% growth from a year ago. While growth in subscriptions has been affected by the economic pressures that our dealer customers are facing, I'm pleased to note that over 59% of our dealer customers currently subscribe to one or more of the products we offer. The average number of subscriptions per dealer has risen to 2.23, driven by both an increase in sales to existing dealers and sales to first-time dealer customers.

Transaction volume also increased for the quarter. We processed 23.9 million transactions in the network during the quarter versus 22.7 million in the first quarter of 2007. As we have previously stated, the decline in subprime lending and overall decrease in auto sales have impacted our transaction growth compared to historic levels.

As we look at the transaction volume and revenue for the past quarter, we see a negative impact from many subprime lenders continuing to tighten credit standards and steadily cutting off dealers. While a majority of dealer reduction occurred in 2007, a handful of subprime lenders continued the behavior in the first quarter of 2008. The effects of the changing lending environment were compounded by lower sales in the first four months of the year, which Bob will discuss further in our guidance. We've not seen a material impact, negative impact, on transaction volume or pricing from competition.

We believe our performance in this quarter demonstrates our ability to grow despite the industry's increasing challenges. In short, we will maintain our focus on helping dealers achieve greater profitability and creating greater efficiencies for the lenders, aftermarket providers and others that serve our dealer customers.

Lastly, we expect revenue and profitability to improve in the traditionally strong second and third quarters.

Bob will now provide further detail about our first quarter 2008 financials and discuss our guidance for the remainder of the year.

Robert Cox

Thank you, Mark.

Our revenue of $64.3 million for the first quarter breaks down as follows: Transaction revenue of $38.2 million, which is up 11% from the first quarter of 2007, subscription revenue of $22.4 million, which is a 42% increase from the same period last year, and other revenue of $3.7 million compared with $1.7 million from a year ago.

Our transaction growth was impacted as nine of our top subprime lenders saw their transaction volumes fall approximately 1.8 million units from the first quarter of last year. Although we grew transaction revenue for the quarter, this decline in the volume by these lenders negatively impacted our transaction revenue by 7%.

Total revenue grew 24% compared to last year, and of this growth, 55% was organic and the balance was due to acquisitions.

We experienced an increase in expenses this quarter. We incurred normally high marketing expenditures due to our NADA trade show, but also saw increased expenditures, including $3.2 million in legal fees due to outstanding litigation and $0.5 million in professional fees relating to an acquisition that we chose not to complete. The anticipated total litigation expenses for 2008 are expected to be approximately $7 million, and the vast majority of those expenses will be incurred by August of this year.

Additionally, due to a decrease in interest rates and a shift away from investments such as auction rate securities, we have experienced and expect to continue to experience a decline in interest income compared to previous expectations. This quarter we reported $1.6 million in interest income, approximately $0.6 million [inaudible] than originally expected.

Our effective tax rate for the quarter was 45.5% due to the impact of certain permanent items related to Canadian intangible amortization. Our expectation for the full year of 2008 is an effective tax rate of approximately 40%.

Taking into account the increased litigation expenses, the professional fees and the lower than expected interest income, net income for the quarter was $2.3 million compared to $4.8 million a year ago. Cash net income was $9.3 million for the quarter, down from $9.5 million for the first quarter of 2007.

The litigation expenses and the professional fees I mentioned had an impact of $2.3 million on both GAAP net income and cash net income compared to $0.3 million in the first quarter of 2007. Both of those numbers are after tax.

EBITDA for the quarter was $13.3 million, down from $14.6 million for the same period a year ago. Litigation expenses and professional fees accounted for a $3.7 million reduction in EBITDA compared to $0.6 million a year ago.

Diluted GAAP net income per share for the first quarter was $0.05 per share. Diluted cash net income per share was $0.22 for the quarter. Both were impacted negatively by $0.05 per share due to the previously mentioned litigation expenses and professional fees.

Detailed reconciliations of GAAP net income to our non-GAAP financial measures of EBITDA and cash net income are included as attachments to today's press release posted to our company's website.

Cash flow from operations for the first quarter was $9 million, an increase of 65% compared to cash flow from operations of $5.5 million for the first quarter of 2007.

Capital expenditures for the quarter were $2.9 million.

Now let me give you our revised guidance for the full year 2008. Based on the decrease in transaction volume by many subprime lenders and auto sales results year-to-date, including April's seasonally adjusted annual rate of 14.4 million units, which is a 10-year low, we've revised our guidance for the full year 2008 as follows:

Revenue for the year is expected to be between $268 million and $272 million compared to previous estimates between $270 million and $276 million.

GAAP net income for the year is expected to be between $21 million and $22.6 million compared to the previous estimate of $24.8 million to $26.2 million.

Diluted GAAP net income per share for the year is expected to be between $0.48 and $0.52 per share compared to the previous estimate of $0.56 to $0.60 per share.

EBITDA for the year is expected to be between $67.3 and $70 million compared to our previous estimate of $71.2 to $73.5 million.

Cash net income for the year is expected to be between $45.8 million and $47.4 million as compared to the previous estimate given of $50.4 million to $51.8 million.

Diluted cash net income per share for the year is expected to be between $1.06 and $1.10 per share as compared to the previous estimate given of $1.14 to $1.18 per share.

The revised guidance includes our lowered expectation for interest income, previously estimated at $9.8 million now estimated at $5.4 million for the year. This reduction has a negative impact of $2.7 million net of taxes or $0.06 per share on both GAAP and cash net income.

The cumulative impact of the reduced estimate of interest income, the professional fees for the acquisition we did not complete, and the increase in the effective tax rate have a negative impact of approximately $0.08 on our per share earnings guidance for the full year 2008.

Our guidance assumes 43.3 million shares outstanding and does not include any shares repurchased under the stock repurchase plan.

Although a number of manufacturers still maintain a seasonally adjusted annual rate of 15.5 million units, which we used in our original forecast for 2008, our revised guidance considers the lending and sales environment we have experienced in the first four months of the year, including April's 14.4 million unit seasonally adjusted annual rate. We anticipate a normal seasonal increase in revenues and photography through the traditionally stronger second and third quarters of 2008, and we look forward to the end of expenditures relating to our outstanding litigation.

That concludes our formal remarks for this call. We'll now turn it over to the operator to take any of your questions.

Questions-and-Answer Session


(Operator Instructions) Your first question comes from Gary Prestopino - Barrington Research.

Gary Prestopino - Barrington Research

Mark, it looks like even though the environment on the lending side looks weak, it looks like the dealers are still spending money, you know, your subscriptions are up, it looks like your average subscription price is up. Can you comment a little bit on some of the other activities that your company is doing right now in their environment relative to the transaction or the ToolKit product?

Mark O'Neil

Yes, Gary. I wouldn't say there's any material change in what we're doing. Our primary focus on that side of the business is continuing to add new participants and making sure those participants who are on the network and have been on the network continue to use it.

We haven't discussed this, I don't believe, on a previous call, but one of the functions that we do staff internally, we have a group that monitors dealer usage of the network, and that group is always looking for anomalies. A dealer has been a high user and has stopped using it, a dealer who has been a heavy user and becomes a moderate user, and we make hundreds of calls each month. And sometimes it's as simple as it's a new person on the team and they don't have a password, and sometimes it's more complex, they've had a shift in the lenders they're using, they've had a shift in the type of business they're writing or not writing.

So that's an activity, although it's been in place for awhile. We're much more active in getting users who don't have passwords; there's been a lot of turnover in the industry now. As sales have declined, dealers are quick to pare back staff or to trim staff, and therefore we need to stay on top of this to make sure there's always available users and we're doing that.

And we're continuing to add lenders. In fact, we added a fairly interesting new lender just this week that is a very highly automated lender. They're not only an application user but also a DDS user, and we simultaneously launched both transaction products for them, which is a first for us. So, look, it's an example of innovation, a very unique screen. It's an automated dealer sign up screen. The dealers can get to this lender faster. There are no constraints on field sales people. They are launching two products simultaneously with very innovative function on call backs.

And so, look, you know, like all of our products, we continue to push innovation, we continue to tweak processes to drive volume and, you know, we'll continue to look for those kinds of opportunities. So, you know, I think it's more of that focus.

Gary Prestopino - Barrington Research

Can you comment just on, you know, some of the uptake in some of the newer products you have, aftermarket, network leads, network accessories and Arkona.

Mark O'Neil

Well, you've got most of the gamut there. Let me start at the end because my memory's better there.

On DMS, terrific performance. That team continues to do a great job of closing business. The challenging economic environment as well as the support of the Asbury team have really been two drivers that have helped that business. Not only is the install going very well at Asbury, but they continue to be a terrific reference account for us, which is helping close more transactions. I think the tight auto environment makes dealers scrutinize expenses such as technology more than ever, and that's been a benefit. And so we're very happy with the performance of the DMS business.

You asked on a number of the other products, accessories, leads, etc. Let me start with accessories and saying that is still very much a year end 2008 product. When we bought the initial technology, it needed a lot of work. It needed to develop the electronics parts catalog that would really fully support that business. That's a very manual effort, although it'll be very propriety and high value once it's complete, but it's got a ways to go. We did roll out a new generation of software in March. We still consider that product in a beta mode, and I would not expect to be able to maturely talk about that product until the fourth quarter of this year.

We did have one interesting event on the beta side. It's one data point so I wouldn't read too much into it, but again, we've created a self-enrollment capability on our software, and we had a dealer, a bit to all of our surprise, self enroll to become an accessory customer. Again, you know, it's one data point. It's a sign. But a lot of development work going on now, and why don't we agree that, when we do the second quarter update and third quarter, we'll give you a lot more detail there. But at this rate, we're happy with the development work. There's really nothing to speak of from a substantive volume perspective and there won't be until the end of the year.

Leads, really nothing to tell you there. This is a test that I would say has gone well. We're not knocking the cover off the ball. Our primary issue there is we need more suppliers of leads on the network. Dealers continue to give us feedback that there aren't enough good quality leads to bid on, and until there are, until we get signed some large players, I don't think we can expect large income from there. The good news is it was a very nominal development cost, and today we've probably already gotten the return on that development cost. I'm just not sure I can hold it out that it'll be a high volume product.

And the independent dealer initiative, much like the accessory initiative, we said that was going to be a second half of the year effort. I would still characterize it as that where we can give you measurable results.

It was delayed. Two national lenders who had committed to coming on and we counted on to launch the program backed out because of the fear of going into that segment, that it would be perceived internally in their organizations, other government structures, as a bad move given all the credit turmoil. Despite the fact that we believe our product would mitigate those risks, they didn't want the headline risk and they pulled out. That set us back. We think we'll be at the five critical mass number for a number of states by the end of the second quarter, and we'll start to get a read.

The very few data points we have, again, are very strong on that, but the clear message is you need more lenders and we don't have more lenders connected yet, but we're working on it.


Your next question comes from Edward Yruma - J.P. Morgan.

Edward Yruma - J.P. Morgan

Can you talk a little bit about transaction pricing? I know sometimes you see a little bit of sequential weakness, but I was a little bit surprised by the amount of the drop off sequentially.

Mark O'Neil

Don't be, Ed. It's purely a mix issue, a shift to lower price product in the quarter, mainly driven by a significant uptake in credit bureau transactions. That's it. Nothing more to explain to you there. No shift in the business.

Edward Yruma - J.P. Morgan

And if you could talk a little bit about the acquisition that you decided not to pursue, was it that you didn't like the technology after you'd done some more diligence or are you taking a more conservative outlook given the environment on acquisitions?

Mark O'Neil

I would say no to the latter. We're not taking a more conservative approach. However, one of our primary concerns as we dug deep with this company was its ability to be a three to five-year grower. And we just - the deeper we dug, the more we were concerned that it couldn't provide the long-term growth that we were looking for as a company. And, look, that was a big trigger.

There were other issues regarding the economics, the financials, that further weighed our decision to not go further after a very in-depth due diligence process. You can see from the money we spent, this was not our typical small private company transaction. It was a larger one potentially, and we spent a lot of resources to make sure it was a good fit. And I applaud the team that had the discipline to make the decision that it wasn't a good fit. It wouldn't provide the things we wanted long term.

Now that said, we have not pulled back at all from our interest in completing acquisitions. We've made a number of offers out there to smaller private companies. Whereas the market has reset from a valuation perspective, I don't think most small private companies have reset their price expectations. And so until we have alignment there, again, the discipline factor comes in. We have a multiple range, a discounted cash flow model, etc., we're going to stick to, and as long as we can do deals that are high value to the business we'll go forward. If we can't, then we wait. We'll be very patient.


Your next question comes from Franco Turrinelli - William Blair & Company.

Franco Turrinelli - William Blair & Company

I have several questions. Let me throw a couple out and then I'll get back into queue and follow up later.

I guess my first question is I understand the litigation expense, but you'd sort of told us about that in the previous quarter so we certainly had it in our numbers and I think most of the other analysts did, but nevertheless, expenses in both the cost of goods line and the SG&A line were quite a bit higher than we had anticipated. And apart from, you know, dumb analysts, you know, I mean, was there anything that really kind of happened in the quarter that we should be aware of from an expense point of view?

Robert Cox

Well, Franco, I'm not sure anything stands out per se. I think if you look at Q1 versus Q1, you've seen our cost of goods line go up a bit purely on mix in relation to Arkona being in this Q1 versus the prior Q1. Now that wouldn't change from Q4, obviously.

An increase perhaps in some of the non-cash expenditures, we saw about $3.5 million pre-tax in relation to stock comp as compared to about $2.1 million a year ago, so that was obviously a pretty good-sized number. And our amortization number was also up by about $2 million to $7.6 million versus about $5.5 or $5.6 a year ago. So without kind of going line by line in the models, I can't tell you each item, but those are certainly a number of them.

Nothing else stands out per se as a heavier cost of sale. Now as we mentioned, the acquisition is in there. And really, the only other thing is, as we've seen some reduction on the application side of the business from the subprimes that we mentioned, those are indeed pretty profitable transactions. So, you know, like we've always discussed with you folks, those drop pretty quickly to the bottom line. So losing those transactions means, you know, we face quite a bit of pressure on the profit side.

Franco Turrinelli - William Blair & Company

I mean, maybe a different way of asking the question - and I know that you don't provide quarterly guidance; I'm not looking for that - were there any significant surprises in the expense structure relative to what you had in mind when you originally taught guidance back in February?

Robert Cox

Nothing significant, no.

Franco Turrinelli - William Blair & Company

And then on the other front here, I mean, if I'm understanding the guidance revision correctly, essentially the operating  let's call it the operating business guidance is unchanged, but we have some significant nonoperating adjustments, notably interest income. And I guess one thing that I'd sort of like to understand is what's really happened, you know, since February to today to cause what is a pretty substantial revision in interest income. And I realize there's been a federal funds rate cut, that's okay, but it's obviously much more than just that.

Robert Cox

Well, I think there's been several rate cuts since then, so the yields that are available in the, let's say the - or call it the norisk. Of course, we all thought certain other things were very low risk a quarter or two quarters ago. I can say that our yields have been cut in half since the early part of the first quarter. Now one thing we had not experienced or had not had experience with is failed auctions. Now that's pretty commonplace and part of our vernacular.

We have about $18 million, between $18 and $19 million, in remaining auction rate securities. These are all double A and triple A rated securities, but there isn't a market for those right now. So, look, we've taken the position that we're going to take no risk and that capital preservation is obviously our number one goal here, so we're getting 2% yield or thereabouts on invested income at this point. I can tell you at the beginning of the year that - or at the end of last year that number was, you know, at the 4% or better range.

Mark O'Neil

I think it's fair to say, too, even, Franco, look, late January or early February is a pre-Bear Stearns world. Look, I think there was still confidence in select parts of the auction rate market. Certainly our bankers were giving us that advice, that they were highly liquid, particularly if we stayed in double and triple A.

And we had a good-sized position in those, and we assumed that would stay and it changed. Now we got out of chunk of them, and we believe, you know, we'll ultimately get out of these, the remainder. But it was in the original number, and it's not there today. And, you know, the market changed. And it, you know, as you saw, it was a few million dollars. It wasn't a little number. But I think there wasn't sufficient data to make that call when we gave our original guidance or certainly not that it'd trickle down to us.


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

Christopher Mammone - Deutsche Bank Securities

I guess following up on Franco's line of questioning, is it safe to assume that the bottom line guidance would not have changed if not for those nonoperating items?

Robert Cox

Well, you can see when you do the add back they basically account, right? You put $0.08 back and you're at the same guidance range. Look, you know, inevitably in any forecast you have some elements where you have uncertainty and so you plan a midpoint number or you put a little cushion in.

Our revenue is coming down a bit, so let's be clear about that. I mean, not to skirt it, it's a modest bring down, and we're bringing it down mainly driven by, you know, anticipated credit app volume based on lending behavior.

But substantively the, you know, the earnings impact is not only impacted by that almost one for one, but these other items that we've talked about, whether it's - we did have a large acquisition we walked away from. We did have a big interest income expectation. We did have a higher Canadian tax rate than we anticipated. Good news, though, the Canada business doing terrific.

So look, those I would put in a bucket as much as you're characterizing as nonoperating, but I think it's fair to put some operating in. But the substantive numbers, when you add them up, are non, which says the business is still pretty darn healthy despite the headwinds.

Christopher Mammone - Deutsche Bank Securities

And then I guess moving to the top line side of guidance then, yes, it looks like April auto sales are pretty abysmal and you cited a 10-year low if you analyze that number. I guess just trying to get a sense for, you know, what kind of wiggle room do you have on the top line now? I mean, does that - does the range that you're now guiding to represent in your minds a worst case scenario or could we see it actually revised from here if the normal seasonal pickup in the summer doesn't actually take hold?

Mark O'Neil

Yes, Chris, we don't have a lot of wiggle room is the straight answer. Look, we were very reluctant because we didn't see anyone in the industry who'd pulled their numbers down to 15. You see one or two, you know, verbal commentary that suggests that it could be a 15 million year. But I saw a quote just last night saying that if we lose a million units this year - so last year was a 16.2 year and this year there's some, obviously, talk already about a 15.2 year  we haven't seen that rate of decline year-to-year since 1991. So a 17-year, you know, kind of anomaly. That's a bit concerning to us, that we are in uncharted waters for, you know, almost two decades here of behavior.

We didn't assume the year would go into the 14 millions, although April's run rate says, you know, it came up at that. We said we're, you know, high 14s, low 15. A couple hundred thousand units, we've always said, don't make a difference but, you know, 500,000 units at times start to make a difference. And if 15 goes to 14.5 or 15 goes to 14, I don't think we have that much cushion in our numbers.

Christopher Mammone - Deutsche Bank Securities

And then, just on the volume that's gone away in the subprime part of the world, I mean, is this lost volume something that you expect is only temporary and will it come back to the platform at some point when the cycle improves down the road, or just given what could be changes to lending standards and tightening in the market, is there a chance that this volume could be permanently lost?

Mark O'Neil

Boy, Chris, it's a very good question. I wish I had a very definitive answer for you. We don't know is the straight up short answer. I think the answer is somewhat tied to the assessment of when will the lending markets generally loosen back up? So, you know, as in any credit-related crisis, you have the period of crisis and tightening, and then a good performance, a loosening. It will loosen up some, and we will get some of this volume back. If we don't get all of it, we'll get a good chunk of it. But to put a time on it is very difficult at this stage. I think we're too early on in still the tightening phase to be able to assess that.

Now, what we can say - and it gives us some encouragement - I can say a couple things. One is we do continue to add new network participants, and we continue to have really good dialogue with players who aren't on our network. We continue to see the prime customers really using this crisis to gain share and build their position, and that's very encouraging, that the folks who have good balance sheets putting them to work.

You know, we continue to see some interesting new products to help drive transaction demand. I mean, we were encouraged by the independent dealer initiative. We're a little more encouraged by some of what's happening in accessories. So it's not all negative news. I mean, the reality is we have some positives. Again, we think there's a timing gap, and we think they can offset it. If the market comes back sooner, that's only a positive. If it goes for an extended period of time, as long as our new initiatives take hold, I don't think it really matters to us.

But I will say, and it relates back to the acquisition question, as we look at the positioning of our business long-term, we look to reduce our reliance on any one single either external element, like our sales, i.e., transactions, or any customer segment being a driver to the business. I think one of the healthy things about, you know, what's happened recently is you learn from it and you learn, you know, where some of the external exposures are that you may not have understood. And I think we're weathering it pretty healthy, and we're taking the learning and making sure we position the business so we're not subject as much as we can in the near term to these forces.

So, you know, we're still very optimistic going forward, but we're cautiously so as opposed to unbridled optimism that may have characterized a year ago timeframe.


Your next question comes from [Unidentified Analyst] - Thomas Weisel Partners.

Unidentified Analyst - Thomas Weisel Partners

[break in audio] for Tom. Hoping you might be able to give me an update on the litigation. It seems like you're pretty confident you'll incur most of the expenses by August. What gives you that sort of confidence and, you know, why won't it necessarily drag out beyond that timeframe?

Mark O'Neil

Well, there's a hearing scheduled. You know, the case is scheduled to go to trial in late July, and the anticipated trial time, based on similar cases, is a few weeks. And so, you know, with a trial complete, let's say by midAugust, we would expect the bulk of the expenses to be complete.

So, look, what could happen differently? I suppose the trial could be pushed out. Neither ourselves or the other parties seem interested or are pursuing a strategy to extend the time. I think we're all anxious to get this behind us, for different reasons. And I still feel like the range of timeframe and expense we've given you is reasonable.

Now, you know, the unknown, I don't think we need to worry about it. I think at this stage it's not likely to be a significant 2008 expense item but, you know, depending what happens at trial there could be appeals. I mean, let's assume we got - we asked for an injunction against the defendants here. Look, they might decide to appeal it. That might drag it out. That would be a huge positive signal, though, to have won the first round.

And we might decide, you know, well there are different courses we could take, let's just say, at that stage of the game that could change things. But I think substantively you and us and the external world will know a lot and will be able to define the risk and the expenditures very well through August. And something beyond that is likely not a material 2008 item.

Unidentified Analyst - Thomas Weisel Partners

And, you know, it's [inaudible] the issue but, you know, you spent a lot of money on this and obviously your competitors as well are spending a lot of money on the litigation as well, but they're much smaller than you. Can you talk about how they're actually surviving, especially given the macroeconomic conditions and these litigation costs? It seems like at least one of these guys would disappear, you know, given the amount of money you guys are spending on this litigation.

Mark O'Neil

Tom, I think you answered your own question. We'll let you have another one since you didn't really take one there, if you have something else.

Unidentified Analyst - Thomas Weisel Partners

That was mainly it, actually.


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

Peter Goldmacher - Cowen & Co.

So what have you gotten for your $3.2 million in the quarter? I know they had the Markman hearing about six months ago. We haven't heard anything from you guys on the Markman hearing. Have you gotten anything from that?

Mark O'Neil

We had one summary judgment motion in our favor. The defendants requested the judge rule on our third patent. They wanted to have it thrown out. The judge basically denied their motion. That was a huge positive for us.

But what have we gotten for our $3.2 million? We've got a very well-prepared case for trial. We have had to spend more money than we would like to have spent because we have not had the Markman results and therefore you have to prepare for multiple scenarios which you might not have had to have done had we had more clear direction from the Markman.

But it is very possible now that we will not have a Markman result right up to trial, and we're going to have to argue this during it. That's a bit unusual, to say the least. But there have been a lot of unusual things in this case to date, including how long it's taken.

Look, we're at the tail end. That's what we should all be excited about. We're containing the expenses. You should be equally excited about that. And we have no less enthusiasm for the expected outcome today than we had four years ago when we first filed the suit.

Peter Goldmacher - Cowen & Co.

Mark, can you help me understand why you haven't had any ruling on the Markman? Is it seven months now?

Mark O'Neil

Longer - eight, whatever - because the judge has chosen not to issue a ruling, and that's his prerogative in this case.

Peter Goldmacher - Cowen & Co.

I'd ask for a refund.

Mark O'Neil

Well, we're not paying the money to the judge. They're going to our law firm.

Peter Goldmacher - Cowen & Co.

Maybe that's the problem.

Mark O'Neil

As the plaintiff, we're not - that's a whole different line of discussion which probably is inappropriate. It's definitively inappropriate - let me be clear on the record for this conversation - but thank you for the suggestion.

Okay, let's get back to the real world. Okay. Is that it, Peter?

Peter Goldmacher - Cowen & Co.

Yeah, that's it.


Your next question comes from David Scharf - JMP Securities.

David Scharf - JMP Securities

A couple questions, Mark. One, I probably know the answer to this but I know you don't want to get too far down the path of kind of opening the door to more disclosure than you want, but any likelihood going forward as Arkona becomes more prominent in the mix - I mean, it's certainly prominent in your business strategy - that we might get quarterly updates on rooftops, installments?

Mark O'Neil

It's possible, David. I think at this stage of the game it's a pretty fierce competitive battle. I don't think it's in our interest from that perspective to give you those as much as they might help you. And look, I don't rule out a day that we're going to have to do it anyway and probably give you more financials behind it, not just rooftop numbers.

We're just not quite there. I would tell you, you know, from a comfort perspective, we continue to use all the capacity we've put in place. We continue to believe that business will be very accretive on an EBITDA basis, just as we've said on the last call or two. We're just not very vocal on our conquests here because I don't think it does anything for our business as much as it makes it challenging for you.

Let us think about how we can give you more color on that business without hurting ourselves competitively because certainly it is a long-term strategic growth segment for us, and we'd like you to have some insight, we just don't know how to do it in a way that doesn't hurt us. So we owe you one there, to figure that out. I'm not sure we'll figure it out in a quarter, though we may figure it out in a few quarters or more.

David Scharf - JMP Securities

And maybe following up on that product a little, I thought in a prior question regarding gross margins in the quarter, the slight drop, you know, the issue of product mix was mentioned, which obviously can move around a lot quarter to quarter. And I think Bob mentioned, you know, perhaps more Arkona in there versus a year ago or Q4 [as a result].

As we think about the company going forward, potentially at some point in time or perhaps, you know, the mix of transaction versus subscription if flip flopped and maybe at some point we're looking at 60% of the revenue from software and a lot of that from the DMS product, should we be thinking about the margin profile of the company any differently than it is now, or ultimately would we think about the same gross and operating margin outlook for all of these recurring revenue [items].

Robert Cox

Yes, what I would do, David, is look at the last three full quarters where we've had Arkona fully in the mix, and you see a pretty consistent gross profit, you know, mid to high 50s level.

Arkona's core subscription product is no less profitable at the gross profit level than most of our DealerTrack products. However, as we've discussed before, both the onetime charges, which involve a pretty good installation effort and related cost of sales as well as equipment sales, which we do to facilitate the installations where we make very little money, we do that as kind of an accommodation and, frankly again, to facilitate the install. So there's a few of those that I think if you look at the last three quarters, they're pretty consistent and that's the way I would model unless we tell you something different or we, you know, engage in a business that's a little different and we'll make it clear for you.

But that's the right way to think about it.

Mark O'Neil

But at this stage of the game, to your longer-term question is the margin profile going to change with the increasing percent of software revenue in the mix, and the answer is, I think, no. I think we're pretty comfortable with the ability to increase margins over time, and I think we're comfortable whether the business is 50/50 software as a service and the balance being transaction or 60% transaction and the balance, 40%, being software. We're fairly disciplined with either product of trying to hit our targets longer term.

And I think there's lots of incremental subscription opportunities that are really highly accretive and, frankly, a lot stickier than the transactions, which give me some comfort on that side. On the flip side, we continue to see transactions being able to grow at a very rapid rate, much faster than any subscription can grow. One of the reasons we haven't given you guidance on the mix because, you know, if accessories really kicked in in the fourth quarter, which is a bit premature, I wouldn't expect any of that kind of behavior until probably next year, or independent dealer did, it could shift our mix fairly quickly in the quarter and could shift our ability longer term to get closer to a balanced model.

So stay tuned. They're both good. We continue to invest in both of them because we see them as both very high margin products. They just have different growth characteristics in the early days and certainly different predictability characteristics.

David Scharf - JMP Securities

And maybe just a couple quick ones on the transaction side. Obviously, we've exhaustively discussed headwinds on the subprime side which, you know, like everything will eventually reverse. I'm just curious, you know, the transaction growth was actually a little more resilient than I would have expected given the origination environment we're in. On the prime and near-prime side, is there any evidence that those, for those customers, that dealers are sending out more apps than they were perhaps a year ago or is that pretty steady, do you think?

Mark O'Neil

No, there's some data out there, and I believe it's CNW data, saying that dealers are sending more apps to prime sources. But it's [inaudible] we're talking about an app more, not multiples of three, four and five. So if they historically sent 1.8, maybe they're at 2.7, 2.8, 2.5. So it has clearly picked up a bit, and that's why we said it has been an offset. And we do see some of the prime players really using this opportunity to gain share, and that's helped us mitigate some of the subprime.

But remember the historical ratios, you know, two credit applications to write one prime loan, and I think from six to 12, you can use 8 or 9 to write an application - to write one subprime. You know, it takes a lot of aggressive prime activity to make up for that lost subprime customer on the app side. And that's been the headwind that's so difficult to overcome in the near term.

We're happy with the transaction volume, too, and, you know, frankly, we get some of these other products to market sooner here, you know, again, I think we've got the offset we're looking for if the market doesn't turn as quickly as we all hope it does.

David Scharf - JMP Securities

And lastly, just a quick one on e-contracting. I'm going to just ask you to comment on some of the feedback I've got. You know, a few lenders have remarked to me that, you know, obviously the adoption is still very slow and it's really up to the dealers to embrace it and, you know, there's one captive out there that's kind of mandated all their franchises to be on e-contracting. But, you know, a few non-captive lenders had mentioned, you know, as soon as you get a GMAC on one of the Big Four, you know, at some point just mandating that all their dealers start doing this that the floodgates open and obviously everybody's a beneficiary.

I guess number one, do you agree with that, and number two, any sense that that's anywhere on the horizon because obviously you're well positioned for a huge adoption rate to take off once the big guys mandate that.

Mark O'Neil

I absolutely agree with the statement that if one of the big auto manufacturers or captives gets behind it, that's a significant catalyst for growth.

One of the positives is we haven't really seen our competitor's technology. In fact, you know, we know one captive has chosen to develop their own version of e-contracting separate from the Route One platform. And, you know, to the extent everyone fragments and goes different ways, I would temper my answer. And it may be because the technology is more complex than everyone realized, that's why we haven't seen it.

But there is a positive out there that early pilots we've seen are using at least the same hardware we're using, and that could again help speed adoption where, you know, you've got part of - you've got a common platform you can share from a hardware perspective, and then it's just a question of having two different pieces of software.

So I would say if you saw us announce a major captive on e-contracting, that would be a significant catalyst to both transaction and subscription growth, and it would be a driver for e-contracting. And one or two going in that direction is likely to move virtually the whole group. I think, you know, again, we're at a tipping point. We have enough independent lenders, we have one strong captive, we need another or two more and I think we're on the downhill side of that mountain to climb.


Your next question comes from Andrew Jeffrey - Suntrust Robinson Humphrey.

Andrew Jeffrey - Suntrust Robinson Humphrey

Bob, going back to the average subscription price, which was, yes, down sequentially about 6% year-on-year, can you give us a little more detail as to how much of that mix of product, transaction product, and how much of that is mix of financing sources?

Robert Cox

Oh, when you're talking average subscription price, it's not going to be driven at all by finance. It's really just mix of product. So, you know, in the first quarter it's fair to say less [desking] was sold and more [focal] was sold, or activity reports or Website Plus. You know, $99 products, just had a little bit higher take rate than the $400plus products, and that would shift the average price. It's really - there's nothing to give you more substantively than that, Andrew.

Andrew Jeffrey - Suntrust Robinson Humphrey

And so, going back to the earlier question regarding the aftermarket network, for example, you're not seeing any lift from sort of the newer products here? It continues to be mix among some of the electronic application functionality that's driving pricing? We shouldn't be thinking about any new products moving the needle at this point?

Robert Cox

Yes. Sorry, I thought you were on average subscription price versus average transaction pricing. They're both mix related, and the only transactions that would materially move transaction prices, there are really three - the aftermarket network, the independent dealer initiative and the accessory network. None of those three are at a stage in their development cycle that could move the needle enough there. And let me say, I left one off - econtracting would be the fourth, and we just talked about we need a catalyst there.

So none of the three, I think, can move it substantially this year, and I'll add econtracting to that, even as a fourth. So this is going to be a mix issue for the balance of this year. By the end of this year I think we'll have some good clarity on independent accessory and aftermarket and be able to comment to you what we'd expect to happen next year. But for this year we're going to be somewhat bold in the mix.

Mark O'Neil

The other thing, Andrew, is e-docs could have a pretty good effect on that. You know, again, that's the sister product to e-contracting, but we did experience a pretty strong transaction quarter from some of the lower-priced products, like credit bureaus. So again, all additive but it did pull down average price by, I believe, about $0.10 from last quarter.

Andrew Jeffrey - Suntrust Robinson Humphrey

And then as far as the little bit of an uptick you saw in active dealers and that the trend has been down, is that  anything to report on the independent front or is that just kind of noise in the numbers?

Robert Cox

A handful of those, you know, 20% of the incremental were independent. But not true of - that product is still very much in pilot. There is, you know, I guess there are two now, two active lenders, I believe, on that network. It's just not enough to move it. There's not really a product to sell. \

And we are tweaking a couple of subscription products. It won't be ready until June for the independent dealer initiative or the independent dealer market that are going to go along with that transaction product. Really, the ebb and flow you saw from December until now, it was third quarter to fourth quarter dealers dropped and then fourth quarter to first quarter, it picked up. It's a few hundred dealers and frankly, if you'll notice, if you go back to '06'07, you'll have seen similar behavior. It really - it's dealers being active on the network or not in the latter half of the year when volumes go down. I wouldn't read anything into the 400.

Andrew Jeffrey - Suntrust Robinson Humphrey

And then finally intra-quarter and, you know, when you look at April, any trends, I mean, where volume's demonstrably worse as the quarter progressed? You know, should we be looking for - I see he's given the revenue guidance, but should we be looking for any sharply curtailed volumes in the second and third quarters or is it the seasonal trends sort of start to offset some of what's happening at a macro level?

Mark O'Neil

Well, we think the seasonal - the second and third quarters are the two strongest quarters for, you know, I think forever. The question is how strong are they going to be in the context of the total year? You know, we just spent a little bit of time talking about, you know, that we now think this is the 15 million year, not 15.5. If that happens this year, you are going to see a stronger second and third quarter.

You know, I was talking to an F&I manager just the other night from a store and he said look, you know, he's got a number of customers who've been in the store, are talking about they're going to come back with their rebate checks, you know? It isn't suggested it's a major trend, but clearly there's some expectation that some of those checks will be spent in dealerships.

And we have seen that in the non-prime, near-prime world in the first of the year when you - as soon as you can file an electronic tax return and get your rebate, we do see behavior - purchase and attempt to purchase behavior - increase. So you would expect some of that. You'd expect some seasonal, you know, upticks in the summer months, as we have every year, but the question is are they going to be in the context of a very weak year or are they going to be in the context of a year where a lot of manufacturers are still saying the second half of the year will be much stronger than the first?

We don't know and so instead of opining on which way it's going to go, because we don't feel like we know any better than anyone else we've just said look, we're assuming it's not 15.5. We're putting in, you know, it's 15. And there's a half a million units out and we assume that some subprime folks will continue to tighten up. We're not assuming anyone's going out of business, but some of the same behavior continues. And that gives us a little cushion. If there's upside, great. If it gets a lot worse, as we said to someone else, we haven't forecasted that in.


Your last question comes from Franco Turrinelli - William Blair & Company.

Franco Turrinelli - William Blair & Company

Thanks, my follow ups have been asked.

Mark O'Neil

Thank you. Does that do it? Everyone got their questions addressed, I'll assume. Operator, there's no one else in queue?


There are no further questions in queue.

Mark O'Neil

Okay. To everyone on the call, thanks for your continued support. Thanks for your time today. We look forward to continuing to deliver as we've said we're going to deliver for the rest of the year. Thanks, everyone. Take care.


And this concludes today's DealerTrack conference call. We thank you for your participation.

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