DealerTrack Holdings, Inc. Q2 2008 Earnings Call Transcript

DealerTrack Holdings, Inc. (TRAK)

Q2 2008 Earnings Call

August 11, 2008 5:00 pm ET

Executives

Katherine Piscopo Stein - Investor Relations Manager

Mark O'Neil - Chairman, Chief Executive Officer

Robert Cox - Senior Vice President, Chief Financial Officer

Eric Jacobs – General Counsel

Analysts

Analyst for Tom Roderick - Thomas Weisel Partners

Andrew Jeffrey - Suntrust Robinson Humphrey

Christopher Mammone - DeutscheBank

Mitchell Bartlett – Craig-Hallum

Peter Goldmacher - Cowen & Co.

David Scharf - JMP Securities

Gary Prestopino - Barrington Research

Scott Carver - Philadelphia Financial

Presentation

Operator

Welcome to DealerTrack's second quarter conference call. (Operator Instructions) At this time, I will turn the conference over to Katherine Piscopo Stein at Investor Relations at DealerTrack.

Katherine Piscopo Stein

Joining me today are Mark O'Neil, Chairman and Chief Executive Officer, of DealerTrack. Robert Cox, Sr. Vice President and Chief Financial Office, and Eric Jacob, Sr. Vice Present and General Counsel.

Mark will begin today’s call with an overview of our financial results and other key metrics for the second quarter of 2008. He will then provide a quick summary of the quarter from a business and strategy perspective and discuss some of our latest accomplishments as well as the macro economic environment we have seen in the first half of the year. Eric will then provide an update on our pending patent litigation and lastly Bob will provide further details on our financial performance for the quarter and will discuss our outlook for the remainder of 2008. We will then be available to answer your questions.

Before we begin, I would like to remind everyone that remarks made during this conference call may 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 10K for the fiscal year ended December 31, 2007.

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 statements may be based or that may affect the likelihood that actual results will differ from those set forth in the forward-looking statements.

We also use non-GAAP financial measures to represent business performance. A reconciliation of GAAP to non-GAAP financial measures is included in today's press release, which is available on the Investor Relations section of the company website at DealerTrack.com.

I would like to now introduce Mark O'Neil.

Mark O'Neil

I’m pleased to say even though DealerTrack is facing the most challenging time that we’ve seen in both the credit markets and the auto industry, we continue to deliver top line growth and improve our positioning as a technology supplier to the retail auto industry.

The historically strong second quarter for car sales did not materialize and we have seen a similar weak trend in nearing the third quarter. While we were disappointed with our transaction revenue performance in the second quarter, we are pleased with subscription revenue. We are facing many headway and however we remain very confident in the long-term prospects of our business model and the potential of our products.

Now let me provide a high level review of the financials before I get back into strategy and the environment. Revenue for the quarter was $63.2 million. Net income from the quarter was $3.1 million. EBITDA was $13.8 million, and cash flow from operations continue to be strong at $15.6 million. Diluted cash net income per share was $0.22 for the quarter.

As we look back at the first six months of 2008, we have been challenged by the macro economic environment and we're pleased with our performance given that context. We continue to increase the number of lender participants in our network and recently revised the way we count lenders on the network to more accurately reflect the number of financing sources directly available to our Dealer customers.

As of June 30^th, we had 659 financing sources available on the network. In the second quarter, Ambridge joined the DealerTrack network and the numerous credit unions under their umbrella are now available financing sources for our Dealer customers.

We expect the number of available financing sources to continue to increase as we sign up regional banks and credit unions. As you are probably aware, on July 21^st we announced our 700^th connected lender. We believe that we can continue to grow the number of lender participants on our network for the next several years.

We processed 21 million transactions during the quarter versus 23.5 million in the second quarter of 2007. The decline in relationship between dealers and lenders and overall decrease in auto sales have impacted our transaction volume compared to historic levels. This has had a direct impact on net income as each transaction has high incremental profitability and falls almost directly to the bottom line.

As I discussed last quarter, the tightening credit markets have caused lenders to cut off dealers, decreasing our lender to dealer relationship. We count each lender to dealer relationship by pair. For example, one lender’s relationship with 50 dealerships is counted as 50 relationships. The next lender’s relationship with the same 50 dealerships would bring our relationship count to 100. When we started 2008, we had over 226,000 active dealer to lender relationships. By the end of the second quarter, the number of relationships had dropped to approximately 196,000. This reduction includes the eight lenders who exited the indirect auto lending space in the first half of the year. These factors combined of fewer consumers walking into dealership and applying for financing caused transaction volumes to decline. We have seen some continuation of this trend in July with the exit of Chrysler financial, the exit of HSBC from indirect auto lending, and a pullback of other indirect financing sources on leasing. We have not seen a material impact on transaction volume replacing from competition.

The total number of active dealers in the network at June 30, 2008 was 21,735, which decreased from 22,457 at the end of the first quarter. We continue to see dealer consolidation and believe that this consolidation will lead to healthier and more profitable dealerships in the long-term. Approximately 90% of franchise dealerships continue to use our network for their day-to-day financing activities in the U.S.

Last quarter I spoke to you about our aftermark in network. I’m pleased to announce that we continue to sign providers including Allstate in the second quarter. Allstate is the number one provide of GAAP policies in the automotive market and is entering the vehicle service contract and payment extend repair markets. Combined with the addition of EasyCare in the second quarter, we continue to be excited about the long-term prospects of this new transaction product.

I’d like to update you on the progress of two other areas of growth at DealerTrack. Our DMS and Deal Watch. This quarter the DealerTrack, DMS reached several milestones. In May we announced the 1,000 dealership installed with our DMS. In the first year of ownership, we have increased our install base by almost 50% and our installation capacity by 40%. In June, we announced a multi-year contract with GM to offer integrated dealer management systems or IMBS to over 6,000 franchise dealers, making our DMS one of only four providers endorsed by GM under its IDMS program. The DMS results are encouraging in the near term and we continue to believe that the long-term prospects for DealerTrack are excellent. We are working on our implementation model to increase install capacity while maintaining the high quality of customer service that DealerTrack’s customer have come to expect.

Deal Watch is a timely subscription product, because as of November 1, 2008, auto dealerships will be subject to red flag regulations that went into effect at the beginning of this year. Our Deal Watch solution gives dealers the tools to comply with these new federal identify theft prevention regulations. Over 3,300 dealers participated in our free trial of red flags with transaction base component of Deal Watch. We are aggressively pursuing the sale of Deal Watch and red flags to these trial dealerships.

Throughout the second quarter, we had success selling subscriptions in the dealerships. Total subscriptions of the network increased to 31,400, an increase of approximately 1,400 subscriptions in the quarter. Because of our expanding product offerings, our expectation is in the future we will move to selling solutions instead of individual products. In the past, we have reported the average number of subscriptions per dealership in the average subscription price. 2.3 subscriptions and $246 dollars respectively in the second quarter. As our product offerings begin moving toward solutions instead of individual products, we’ll be reporting the average revenue generated by each subscribing dealer. The average revenue generated per subscribing dealer was $547 per month in both the first and second quarters. The average revenue generated per subscribing dealer was $574 per month in the second quarter of 2007.

While growth in subscriptions has been impacted by the economic pressures that our Dealer customer are facing, I’m pleased that over 62% of our Dealer customers currently subscribe to one or more of the products we offer.

We believe our performance in this quarter demonstrates our ability to produce revenue growth despite the industry's increasing challenges. We will continue to innovate and develop products that will help our Dealer customers be more efficient and be more profitable.

Many of you are probably aware of our recent press release regarding the status of our pending lawsuit. I would like to now introduce Eric, our General Counsel, to give an update.

Eric Jacobs

With regard to the litigation against Route One and Finance Express, a hearing was held in the United States district court for the central district of California on July 21, 2008. Judge Andrew Gilford subsequent issued rulings favorable for DealerTrack on five key motions and litigation including several motions for summary judgment. In its rulings, the court resolved disputed issues of inventorship, validity, conduct and Route One’s exposure to a willful infringement claim, all in DealerTrack’s favor.

These favorable rulings for DealerTrack eliminate certain defenses by Route One and Finance Express during trial, allowed DealerTrack’s damages to be leveled and seek attorney fees if Route One’s infringement is found to be willful at trial. The judge deferred rulings on two additional motions pending his upcoming marketing ruling, in which the judge will decide the meaning of certain terms in the patent claims.

The judge also denied DealerTrack’s motion for dismissal on summary judgment of Route One’s defense that DealerTrack did not properly pie arch to patent office. This motion was denied because the judge ruled the defense a matter of fact not a matter of law and therefore is not appropriate for summary judgment.

This decision only allows the defendant to present this as a defense of trial, while many of the other defenses are ruled against by the judge at the hearing.

While none of these decisions decided the case, some of them limited offenses that Route One and Financial Express will present a trial. We remain pleased with the judgments and the progress of our litigation protecting our intellectual rights.

Robert Cox

Our revenue of $63.2 million for the second quarter breaks down as follows: Transactions revenue of $36.3 million, down 6% from the second quarter of 2007. Subscription revenue of $22.9 million, which was a 31% increase from the second quarter of 2007, and other revenue of $4 million compared with $2.5 million from a year ago.

For the six months ended June 30^th, total revenue was $127.5 million, up 16% from a year ago. That breaks down as follows: Transaction revenue for the six months was $74.5 million dollars, subscription revenue was $45.3 million, and other revenue was $7.7 million.

For the first half of the year, 43% of our revenue growth was organic and the balance was due to the acquisition.

Our litigation expenses totaled $2.6 million in the second quarter, while the patent infringement trial against Route One and Finance Express has been delayed until the end of October, we have not changed our projection for litigation expenses for the year, which is $7 million dollars for this year. These projections are based on a fee arrangement that has been negotiated with outside legal counsel.

EBITDA for the quarter was $13.9 million, down from $18.9 million for the same period a year ago. The litigation expenses accounted for a $2.6 million reduction in EBITDA compared to $0.8 million a year ago.

EBITDA for the six months ended June 30 was $27.2 million compared to $33.5 million in the first six months of 2007. The litigation expense is an extraordinary professional fees from an acquisition that we chose not to complete in the first quarter of this year accounted for $6.3 million dollar reduction in EBITDA compared to $1.4 million for the period that ended June 30, 2007.

Diluted GAAP net income per share for the quarter was $0.07. Diluted cash net income per share was $0.22 for the quarter. Both were impacted negatively by $0.04 per share due to the previously mentioned litigation expenses.

Diluted GAAP net income per share for the first six months of 2008 was $0.13 compared to $0.27 per share for the first six months of 2007. Diluted cash net income per share was $0.43 per share compared to $0.53 for the first six months of 2007.

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 second quarter was $15.6 million dollars compared to cash flow from operations of $13.4 million for the second quarter of 2007. Cash flow from operations for the six months ended June was $24.3 million compared to $20.5 million a year ago.

Capital expenditures for the quarter were $5 million and were $7.9 million for the year-to-date.

In March, we announced that our Board of Directors had approved a stock repurchase plan. During the second quarter, we bought approximately one million shares. Since the end of the second quarter, we have purchased an additional approximate one million shares and in total we have spent approximately $34 million dollars to date on our repurchase program. As Mark stated, we continue to invest in our products and services and we believe this continued investment and the company’s product initiatives is critical.

Now let me give you our revised guidance for 2008 annual performance. As mentioned in this review of our second quarter and year-to-date results, the ongoing challenges in the credit markets and indirect auto lending combined with a decline in new car sales volume has put pressure on DealerTrack’s transaction volumes. Assuming a continuation of the current credit situation and with new car sales at a 15-year low, we expect our transaction volumes to decrease compared to historical levels. Because each dollar of transaction revenue is highly leveraged to earnings, we have amended our guidance for the full-year 2008 as follows. Revenue for the year is expected to be between $246 million and $253 million compared to previous estimates of $268 million and $272 million.

GAAP net income for the year is expected to be between $9.4 million and $12.8 million compared to the previous estimates of between $21 million to $22.6 million.

Diluted GAAP net income per share for the year is expected to be between $0.22 and $0.30 per share compared to the previous estimates of $0.48 to $0.52 per share.

EBITDA for the year is expected to be between $48.3 and $54.3 million dollars compared to our previous estimates of $67.3 to $70 million.

Cash net income for the year is expected to be between $33.9 million and $37.3 million as compared to the previous estimate given of $45.6 million to $47.2 million.

Diluted cash net income per share for the year is expected to be between $0.80 and $0.88 as compared to the previous estimates given of $1.05 to $1.09 per share.

This guidance considers June’s seasonally adjusted annual rate of $113.1 million unites and July’s seasonally adjusted annual rate of $12.8 million units and assumes new car sales between 13 and 14 million units for the full year of 2008 and does not assume of recovery of the automotive lending environment this year.

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

Questions-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Analyst for Tom Roderick - Thomas Weisel Partners.

Analyst for Tom Roderick - Thomas Weisel Partners

Just to clarify on your projections for 13 to 14 million units for the year. For every million units, if they were to deteriorate or get better, that that’s roughly the difference between what you previously got it to….because if I was not mistaken, you were around $15 million last quarter?

Mark O'Neil

We were much closer to $15 million and within a couple hundred thousand units. It doesn’t matter. You have to take two variables and we gave you a couple data points. You need to take the change in lender dealer relationships to roughly 226,000 to 196,000 that reduction combined with the reduction in auto sales really has a compounding effect and that’s what drove the numbers down.

Analyst for Tom Roderick - Thomas Weisel Partners

So actually you are much more sensitive to that 196,000 dealer lender relationships. That’s a number that ultimately will drive how bad things get on the transaction side?

Mark O'Neil

It’s the first variable, but a million units does not really matter on the new car side as does the volume of used cars. Data is only reliably available particularly in a timely manner for new car sales. So we’re using that as a proxy, but we’re assuming the ratio of new to used stays roughly the same.

Analyst for Tom Roderick - Thomas Weisel Partners

As far as the mix, like transactions. I think last quarter you mentioned something about prime lending, prime transaction volumes making up for some of the decline in sub prime. Are you seeing any more of that phenomenon or is it starting to spill into prime where that’s not making up for sub prime anymore or is that starting to pick up as far as overall percentage of transaction volume?

Mark O'Neil

I would broadly say that the lending environment has declined on all fronts. I think there’s more sensitivity in the sub prime lending front, but certainly it’s declined on all fronts.

Operator

Your next question comes from Andrew Jeffrey – SunTrust Robinson Humphrey

Andrew Jeffrey - Suntrust Robinson Humphrey

Can you give a sense when you start to look at trends in the quarter and you talk about decline in transaction volume, can you give a sense as to whether or not we should be anticipating sequential declines in the second half in transactions from where we were in the second quarter?

Bob Cox

Our guidance is annual. We haven’t been given quarterly guidance for the third or fourth quarter. What we did see in the second quarter and we mentioned is that we did not see what we usually see, which is a typically strong second quarter. The beginnings of the third quarter has been similarly uncharacteristically weak as compared to fourth quarter which is traditionally weak to begin with. So as far as transaction volumes for the year compared to prior year same quarter, we do expect a decline, if that helps answer your question.

Andrew Jeffrey - Suntrust Robinson Humphrey

Not really, directionally, does the slide we saw 1 to 2Q persist into the second half of the year or at some point, are you anticipating that. Basically given your overall industry assumptions level out, because you are adding finance companies even though as you noted the number of connections between finance companies and dealers is declining. So I just I’m trying to get a sense of projectory on that key driver.

Mark O'Neil

Looking at the forecast, we were very sensitive to the fact that we didn’t get it right, that the second quarter didn’t rebound as it normally does and of course we have that inside knowledge already now on July and the beginning of the third quarter. I think if you look at first half revenue at $127 million and you look at our full year guidance, you can come to the conclusion that we expect it to moderate. We don’t think it’ll decline at the same rate that it has been. If you decline at that rate, the industry is going to be below our 13 to 14 million unit rate.

That said, it’s taken a leg down. We don’t expect it to increase. How much it’ll decline more our numbers suggest a little bit, but we’re not ready to call the bottom, but I would not want to forecast 2009 from here. We’re not comfortable doing that yet until we see more data on dealer lender relationships. We do expect we can add 70 or so lenders to the mix in the back half and that should give us a little bit of cushion here.

Again, we saw it in the first quarter that most lenders have pulled back. We did see a few prime lenders pull back their origination volumes trying to be more conservative. In fact, I know it was announced publicly, Automotive News picked it up, that Chase had indicated they would write no Chrysler releases, when Chrysler pulled out, did not have any adverse selection. The question is, on a macro level, we think there’s going to be some more ripple effect. Do we think the big stuff is gone? We do. Could we see moderate decline? We could. I think the same degree of severity, very unlikely.

Andrew Jeffrey - Suntrust Robinson Humphrey

With respect the litigation, I forgot what you said. The acquisition of abandonment and cost was in the first quarter.

Bob Cox

About a half a million.

Andrew Jeffrey - Suntrust Robinson Humphrey

So it looks like you spent somewhere on the order of nearly six million on litigation on year-to-date. Did you say $7 for the full year? So you effectively front end loaded your litigation expense?

Mark O'Neil

We had an arrangement with our outside counsel that controls our cost litigation. So we feel comfortable with the $7 million projection.

Andrew Jeffrey - Suntrust Robinson Humphrey

It sounds like with regard to the earnings guidance obviously you’re trying to adapt to pretty precipitously declining or deteriorating macro environment. Understood, and I understand the incremental margin impact, but it also sounds like in the second half you’re going to have sharply lower litigation expenses too. Correct?

Mark O'Neil

That’s absolutely right. Another way to phrase that, we’ve taken into considerance in our guidance that it looks like car sales will remain at a substantially lower level. The first quarter was a$15 million run rate. We saw substantial decline in the second quarter and we think third and fourth, certainly the third, will mirror more like the second.

Andrew Jeffrey - Suntrust Robinson Humphrey

It sounds like you set the overall profitability bar at a level at which things would have to get materially worse for you to trip trying to get over it.

Mark O'Neil

Well that’s your description. I think we’re accounting for unknowns for trends that we see in the first half. Some of which admittedly surprised us and we don’t like to be surprised.

Andrew Jeffrey - Suntrust Robinson Humphrey

Given the uncertainty with respect to the macro environment, is there anything structurally you want to do on the cost side to take out expenses. Let’s assume that we’re not going back to $16.5 million units next year, even in a recovery, or do you feel like you’re at a level of fixed cost that is okay for the environment?

Mark O'Neil

Our inclination is to try to hold fixed costs that might grow modestly. We have a number of new initiatives we’re investing in. The accessory business, which you’re well aware of, the independent dealer initiative, ramping our inventory pro product. In fact, you’ll see in the release today of adding substantially new functionality for retail price comparisons in the market. If you look at these new initiatives, they’re our growth ticket that breaks the dependency to some degree on unit sales right now and we want to break that as quickly as we can. So I don’t think we need to put a lot more dollars there, but we’re certainly not going to cut the expense, because that’s going to limit our ability to growth through a flat industry next year.

Operator

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

Christopher Mammone - Deutsche Bank Securities

Obviously you don’t need to get past the front page every day to know about how bad things are in the auto and credit worlds, but just looking at their stock prices over the past couple weeks, they certainly have balanced pretty nicely off of their lows. Could you give us a sense for is there anything consistent what they’ve been saying about their outlook for the environment and what you are saying and what’s incorporated in your guidance?

Mark O’Neil

One thing to take note of with the large publics, Chris, with one of exception and Lithia. Most of them are actually not SKU’d to the domestics where we’re seeing that most significant declines. We are more SKU’d or more or more aligned with the broad industry averages. Many of the publics have more imports and more high line and they have not seen quite the declines the domestics has. So be a little bit sensitive to making parallels there.

That said, we’re optimistic. You look at the DMS business in a really atrocious environment last year, we’ve grown the subscription count 50% there. That’s very impressive growth. You look at the 1,400 subscription count in the second quarter versus roughly 1,100 in the first quarter, you see 20% plus growth.

So we’re very focused on finding the areas of growth that break the dependency on pure car sales and that’s why I emphasize the need to continue investing, because we see the opportunity to break out of the car sale dependency at least in part and we’re going to do that and I think just like the auto retailers are focused on used cars now. They’re focused on parts and service on the controllables. Our controllables are things other than the credit app and the lending environment and that’s where we’re putting our energy.

Christopher Mammone - Deutsche Bank Securities

Is there any other large dealership group out there that might be shopping around for DMS provider that could potentially act as a catalyst for that business going forward?

Mark O’Neil

We have a very healthy pipeline of potential customers in the DMS business. I’m pleased with our pipeline. We’re adding sales capacity there. So you can read into that what you like and we expect that business to continue to grow to healthy double digits.

Christopher Mammone - Deutsche Bank Securities

Could you give us a sense of the EPS and the CapEx guidance for this year be if you were to hypothetically stop on your investing initiatives?

Mark O’Neil

Well, we wouldn’t, so that would boost earnings for the third or fourth quarter and limit our ability to grow in 09 and 10. So I don’t have the answer at my fingertips, but it is absolutely hypothetical, one reason I don’t have it, because we’re not considering it.

Operator

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

Peter Goldmacher - Cowen & Co.

The stock is getting crushed after hours. I think part of it is because you didn’t clean out. Can you talk us through your thought process on why you didn’t clean out?

Mark O’Neil

You don’t see any practice of that. We feel like the level of communication we give, which is quarterly and annual guidance, is appropriate and I think look, if you do a look-back right now and you look at the variables that are uncontrollable out there, they’re substantial. To continue to give more guidance on interim periods, which is suggested to me that we have to give more updates that frankly would make this process very difficult to manage in terms of out reach and communication with running the business. We try to find the right balance. I think we have it. I would not expect that going forward will change our communication habit in any way from what we’re doing now. I think it’s the right balance.

Peter Goldmacher - Cowen & Co.

On the red flag regulation products, 3,300 trials. Can you talk a little bit about what programs you have in place to convert those retrials to paid users and pricing of that product?

Mark O’Neil

In a retrial, obviously, was a registered trial. We have handed the lead to our inside sales team and our field sales team. All the users, we prioritized them by based on number of internal dimensions who we think is the highest probability close and that’s based on volume and use of other products. We’ve segmented them into a one to four probability.

Told the team to start with the fours and work their way down to the ones and we’re very pleased. I think somewhere north of 25% close rate is probably pretty reasonable on the trial and for anyone who has any experience in this, that’s a pretty hefty conversion rate and I think 15 frankly can beat that. So we feel very good about that trial. The product really has terrific momentum and we’ll give you an update maybe not an exact number of how many we have installed, but we’ll certainly give you more color on our next call.

Peter Goldmacher - Cowen & Co.

And how is that product priced?

Mark O’Neill

That product has a couple flavors, but its average price is about $250. It really depends how large a store you’re running, how many red flag poles you’re going to do. We bundle price that, so we price base on unit volume of sales in the store and also that product can be upgraded to something called XD, which stands for external documents, where you scan and store those for compliance purposes. That product approaches $600 on that end, excluding the cost of the scanner.

Operator

Your next question comes from David Scharf – JMP Securities.

David Scharf - JMP Securities

Looking ahead, when the cycle ultimately ends, do you see anything structurally changed in the industry?

Mark O’Neill

I think we will see an absolute reduction in number of dealerships. We assume 500 to 700. We modeled losing as many as 900 in a given year. I think there’s some offsets to that though. Topdown motors has announced specifically that they’re coming into the U.S. They’ve talked about adding 300 franchises. A number of Chinese manufacturers are looking at opportunities in the U.S.

So there’ll be some net adds over the next couple of years driven by Indian and Chinese manufacturers, but the domestics are clearly going to pare down on their number of stores. I think it would happen faster if we weren’t in the real estate crunch we’re in. A dealer’s primary asset in many cases is the real estate, their ability to liquidate that. If it was a very liquid market, I think we’d see a further consolidation faster.

Given that, I think a lot are going to try to hold on to get prior perceived right prices. Means it’ll be slow, but it’ll be steady. If we lose net, 500 dealers a year for the next four years, there’s a 10% structural decline on number of rooftops. I don’t think that impacts our business. On the transaction side, I think you’ll have same number of transactions, few dealers, it doesn’t really matter to us. It does take away a few subscription sale opportunities.

So structurally, you’ll see fewer dealers. I think you’re going to see likely different lending products. I don’t think you’ll see more sub prime entrants and I think you’re going to see at least for the next two to three years a continued tightening of credit standards, but I think the lender dealer relationships will grow, ultimately as car sales pick up, which could be 2009, could be 2010. I think lenders will want to increase the pile, whether they increase them by doing more lending to new car dealers or they expand in the independent space. I think that’s going to happen and I think we’ll see a rebound in the lender dealer relationship.

The last thing, I think structurally you’re going to see more discipline on the dealer’s part. There’s a concept called absorption in the industry, which is the notion of covering all your fixed costs for your parts and service operation and a good dealer runs 100% absorption. I think more than ever they realize that and you’ll see more products and services targeted at helping a dealer achieve that level

In fact, as we look at investment opportunities, we continue to look for opportunities in the back end, because it is a critical part of the profit structure of the dealer and by focusing there it may sound more immune to the vagaries of the new car market. So that’s a couple things we’re looking at and I think you’re going to see more tech spend frankly in dealers. I think they’re going to say headcount is the biggest cost, biggest variable cost certainly.

Technology can really help you get more productivity per headcount and I think we’re well positioned the dealer is focused there more than ever and I think our low cost positioning of our subscription products puts us in the right spot at the right time.

David Scharf - JMP Securities

What percentage of applications are derived from leasing?

Mark O’Neill

The total volume of leasing has been running close to 20% and it varies considerably by manufacturer. The real question is how much of leasing will move into traditional retail financing? What the OEMs are saying is they’re going to take the same dollars they dedicate to leasing and put that to incentive on cars and incentives on retail financing. So a consumer can get almost the same payment with a own the car versus rent the car. If they can achieve that, that’s very compelling and I think we won’t see much sales impact. If they can achieve that, I think that’s partly why we think the car sales number could be $13 to $14 million this year as opposed to $14 to $15.

David Scharf - JMP Securities

Switching to the subscription side, there was nice rebound in units from the first quarter. Can you expand a little bit on that?

Mark O’Neill

We would not anticipate Q1 levels, let me start there. We were disappointed with Q1. We weren’t at full staffing on the sales side. We had some things we did in product consolidation that drove cancellations up and I don’t see those reoccurring here at the end of the year. I think Q2 numbers, more comfortable with those sales levels. DMS is going to continue to be very strong in the second half for us. It’s not a lot of units to our measuring dollars that we will have some visibility into that and we have pretty good visibility into the Q3 pipeline and I feel like Q2 is more like the run rate number.

Operator

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

Mitchell Bartlett – Craig-Hallum

I know you’ve already talked about the investment and the other initiatives and wanting to diversify your revenue sources, but I want to push a little bit harder. Clearly the market environment has influenced the rollout of those businesses as well. Just want to get a feel to the level that you continue to invest. Is it full speed ahead or have you backed off where you thought you would be six months ago. Maybe talk about after market and accessories a little bit more than you have if you would.

Mark O’Neill

So here’s the good news on the new initiatives and it really ties into a comment I made to one of the earlier questions. I don’t think we need to ramp the investment. I don’t think we need to put a lot more dollars in those initiatives, but we need to keep the investment constant in those initiatives.

We can’t pull back, because again, I think that slits our throat on delivering long-term growth in this business and we’re very committed to that and we’re very committed to a broader solution. It’s clear that the broader our solution is, the more that the dealer turns to us as the first technology provider of choice.

After market is up to about 35 signed players and Allstate and APCO are very material players. APCO was EasyCare product a bit ahead of Allstate. They’ve really thrown their energy behind us. They have terrific positioning with vehicle service contract market and the consumer vernacular, it’s called warranties, and with the combination of them and Allstate gives us some very good hats in that market and Allstate is not connected yet and APCO is really just beginning a full rollout. So we’ll see the impact of that as we go into the fourth quarter and I think as many networks, when a few big players decide to join, it makes everyone else look extra hard and we’re starting to see that behavior.

I’m also very encouraged at the rate at which we’re signing up accessory providers. And again, I don’t think that product will impact this year, but I think it has potential impact next year. So continuous investment in those products. They’re large markets. The APCO market is well over $100 million addressable market. When you think of it as a transaction product and just like credit apps have a lot of revenue, so do APCO market transactions.

So getting as much as we can quickly is one of our targets and the accessory market has many of the characteristics of lending, highly fragmented, many many players and diverse geography as much like the credit unions and small regional banks and I think we’re good at it. The connections are much more complex. They’re a bit more costly, because each one is unique, but I think we’re building very good competitive position in that transaction market as well. It’s going to be very hard to duplicate.

We say keep the pedal to the metal there and they’ll be growth engines of the business. One note, the leverage we lost as unit sales declined is the same leverage we’ll get on the upside when car sales come back and it’s a cyclical market. We don’t expect it to stay at 1990’s levels here. When will it come back? I don’t know, but when it comes back, if we have the new products and the leverage on the app side from new car sales, it’s a nice multiplier.

Mitchell Bartlett – Craig-Hallum

The dealer community continues to be fairly interested even though they’re as depressed as they might be.

Mark O’Neill

Yes, and that’ll speak to DMS as well as, look, I’ll even give you a couple examples of inventory. So our DMS product is roughly 60% less than the average DMS installed today. That is a huge price savings when you look at a fixed cost to run your business. It is very clear that dealers are engaged with us and very excited. The pricing on DMS is very attractive and in a down market, it’s even more attractive. We like that business a lot right now and dealers are reaching out to us as much if not more than we’re reaching out to them for that product.

Our inventory product, roughly a $400 to $450 product. We actually just raised prices with the new functionality we announced today. Our competitors are typically $1,000-$1,500 for a very similar product. You have talked about outreach at a time when things are tough. These are the solutions we think dealers look toward and we feel like we’re very well positioned in the subscription business. You wouldn’t have seen the growth first quarter to second quarter if dealers weren’t taking a harder look at DealerTrack because of the environment as opposed to ignoring us because of the environment.

Mitchell Bartlett – Craig-Hallum

You’ve added so many lenders. You’re adding small local and regional lenders. When does that relationship come back into balance made up by the local and the regional people?

Mark O’Neill

Let me give you a sense of impact and range. If you look at the combination of triad and household. So not giving any one proprietary data potentially. About 10,000 dealer lender relationships were lost for those two very large lenders exiting. If you look at a new lender coming on, average lender today probably has somewhere between 50 to 100 dealer relationships.

So one credit union might add 50 say on the low end to 100 maybe on the high end. The high end could probably be as high as 300 or 400, but we had 70, that’s 3,500 on the upside as an average number for the backend of the year. You can’t afford to lose too many households or triads or other large players. We talked on the fourth quarter, Ameri Credit pulling back fairly substantially on their dealer account. These are folks that are very well penetrated in the market.

We can outgrow it ultimately if you take all 700 and you say they’ve got 50 each. That’s 3,500 new relationships. Now how quickly can we get all of them? It’s going to take us a few years. That’s a lot of offset and I don’t think we’re going to see the same rate of decline. We could see a bit more decline. I don’t think it’s the same rate. It makes me feel that if we’re not at the bottom, we’re getting toward the bottom and I think we ultimately outgrow it. What happens in the very near term? Impossible to predict.

Operator

Your next question comes from Gary Prestopino – Barrington Research.

Gary Prestopino - Barrington Research

Getting back to this Deal Watch, the red flag product, is there any other competing product out there, Mark?

Mark O’Neill

Not as comprehensive, there are other red flag products. Red flag is a subset of a broad compliance solution and we see no competitor that has the same breadth of solution. Plenty of players have a red flag product and identify theft product, but not in an integrated holistic fashion. It’s a subset, what’s driving the sale of the product. We’re very well positioned competitively. I’d say clearly in a market leadership position and we don’t see anyone catching us in the near term.

Gary Prestopino - Barrington Research

Getting back to this leasing issue. Domestic OEMs pulling out of leasing, does that on a longer term basis help you in any way?

Mark O’Neill

No. In fact, the only thing I think it does, it potentially takes risk out of the industry and makes the healthier lenders argue that’s a good thing. But on the flip side, one of the things that leasing was good for and this is for the dealer and for us. When your lease came up, you went back into the market and looked for another one and generally looked for another car concurrent with a new lease. And so, it created a very defined trade-in cycle and dealers really like that. They like the every three years, you force the customer back to the store.

Now what was happening was leases were starting to extend in term and so that was being mitigated, but I think that slightly hurts the industry, because we don’t have the forcing the consumer back. I will tell you historically the average retail loan paid off at about 34 to 36 months. So you don’t have a huge gap, by definition of loan being paid off was generally result of the trade cycle, but we might lose six months in the pipeline of the customer not coming back and maybe at the worst case it’s a year. That hurts everyone a bit, but the industry adjusts to that. It’s a one time. Once you adjust, then you have a standard trade cycle post adjustment, but that’s the only negative I think that we could come up with in the near to medium term.

Gary Prestopino - Barrington Research

There’s been so much demand created by the OEMs with leasing special deals or whatever. Do you think that maybe realistically the number isn’t $16 to $16.5 million of new car sales? Maybe it’s getting down to a $14.5 to $15 million every year going forward?

Mark O’Neill

There are couple variables that work here and I think there’s a demographic factor that is unlikely to keep us at a sustained $14 million level. It was the beginning of the decade, believe it or not, folks were forecasting that that in 2010 to 2015 range we’d hit a 20 million unit year just driven by the demographics in the U.S. Aging population, most of the car purchases are made after the age of 50, but an individual purchases more care in that roughly 20 to 30-year period than they do in the first 20 to 30 and you look at our demographic trend.

What I think will also happen in the next three years is you’ll see a much better balancing of the vehicles the consumers want, what the manufacturers are making. One reason we’re seeing the disconnect this year at these low levels is the average consumer doesn’t want a truck. They want a highly fuel-efficient car and the larger the car the better and they just can’t make enough of them. Talk to a Honda dealer how well they’re selling hybrid Accord and Civics. That’s where the demand is and I think that assuming oil prices stay high and the plants are rebalanced to produce more hybrid fuel-efficient cars, I think you’re likely to see a spike in demand.

Whether it starts next year or toward the tail end or it’s in 2010 or 2011, but at some point I think you’ll see a lot of pressure there and I think you’ll see all the new cars coming. Look, GM will have its first almost complete electric car, the Volt, is scheduled to be introduced in 2010. Nissan has an all electric car coming in. If these vehicles really take hold, that will drive demand back into the market and you’ll see the trade cycle increasing and that’s all good for us. So there are a lot of variables at work. I am not a proponent that will stay below the $14 million level. If it is, it’s a short stay. It’s a year. It’s a year and a half. It’s not multiple years beyond that.

Gary Prestopino - Barrington Research

Could you address if you can with your transaction product, the tool kit. How is it SKU’d between domestics and foreigns as a percentage and then how it is SKU’d between used and new vehicles? Do you have those numbers or do you make them public?

Bob Cox

Gary, on the new and used side, we SKU approximately 60% of the used. On the foreign versus the domestics, I would frankly say we would match the dealerships out there. So we’re as equally penetrated in the imports as we are in the domestics.

Gary Prestopino - Barrington Research

Did you give a percentage of revenues that were organic in Q1?

Bob Cox

So I think what I gave here is six months. I’ll get the individual quarter for us, Gary, as we wait and I’ll mention it to everyone on the call.

Operator

Your last question comes from Scott Carver- Philadelphia Financial.

Scott Carver - Philadelphia Financial

Given that the gap pulled back so much from the leasing side, do you have a sense of what Route One’s market share is versus your market share and how that’s changing in the last couple weeks, last couple months?

Mark O’Neill

The impact, we know Route One is highly SKU’d to the domestics. There are three anchor customers are the big three domestics and they only have one other manufacturer I believe directly. Their other ownership anchor is Toyota. The domestics have been hit very hard. It’s impossible to look at the vehicle sales count and not conclude that Route One must be under increasing financial pressure due to reduced volumes. Do we have any data to give you specifically? No, but I think it’s a reasonable inference.

Bob Cox

Gary, the answer to the organic question in Q2 was Q2’s organic growth was 9%. Keep in mind that encompasses the reduction in transaction volume.

Operator

There are no more calls at this time.

Mark O’Neill

Team, thanks very much for the continued support. Thanks for all the questions today. We’ll be available as we always are to answer questions one-on-one, etc. and we’ll be on the road over the next six weeks trying to make sure we reach out and folks continue to understand and know the story. So thanks for the continued support. Take care, everyone.

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