Good day, ladies and gentlemen. Welcome to the KAR Auction Services, Incorporated Third Quarter 2012 Earnings Conference Call. Today's call is being recorded. Today's hosts will be Jim Hallett, Chief Executive Officer of KAR Auction Services; and Eric Loughmiller, Chief Financial Officer of KAR Auction Services; and Jonathan Peisner, Vice President and Treasurer of KAR Auction Services. I would now like to turn the conference over to Mr. Peisner. Please go ahead, sir.

Thanks, Jim. Good morning, and thank you for joining us today for the KAR Auction Services Third Quarter Earnings Conference Call. Today, we will discuss the financial performance of KAR Auction Services for the quarter ended September 30, 2012. After concluding our commentary, we will take questions from participants. Before Jim kicks off our discussion, I would like to remind you that this conference call contains forward-looking statements within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties that may affect KAR's business, prospect, and results of operations, and such risks are fully detailed in our SEC filings. In providing forward-looking statements, the company expressly disclaims any obligation to update these statements. Lastly, let me mention that throughout this conference call, we will be referencing both GAAP and non-GAAP financial measures. Reconciliations of the non-GAAP financial measures to the applicable GAAP financial measures can be found in the press release that we issued yesterday, which is also available in the Investor Relations section of our website. Now I'd like to turn this call over to KAR Auction Services' CEO, Jim Hallett. Jim?

Great. Thank you, Jon, and good morning, ladies and gentlemen, and welcome to our call. I'll move right into our third quarter performance. And we did fall short of our expectations in the quarter. Adjusted EBITDA was $117 million. This was only slightly better than the prior year. And at ADESA and Insurance Auto Auctions, volumes continue to be challenged. But with that said, I believe that there is a positive outlook for 2013. We've had very good feedback from our customers on both the whole car side and salvage side of our business, which I'll talk more about in my comments here in a few minutes. But the tough years are behind us. 2011 and 2012 have been the toughest years that we've seen in our industry. And I'm very pleased and very proud of how our employees and how our managers have managed through this period of time. We've been able to stay very focused on our business, still producing very strong gross profit, and as we'll talk more about exceptional free cash flow that this business is able to produce. And as I think of the toughest times being behind us, I believe and I'm excited to say that KAR is ideally positioned for a cyclical recovery. As I think about ADESA in the quarter, we saw volumes increase 14%. All of this volume was attributable to the inclusion of OPENLANE. No question, OPENLANE has had a positive impact on ADESA. The OPENLANE customer mix is heavily weighted to the off-lease vehicles. And we knew that these off-lease vehicles were going to be declining in 2012, and it certainly impacted OPENLANE as we expected it would when we made the acquisition in 2011. We did see a slight decline at ADESA's physical auctions. However, we also see…

Thank you, Jim. I would like to expand a little on our financial performance for the third quarter. KAR net revenue increased 5.7% in Q3, and gross profit was 44.4% of revenue, down from 44.9% in the prior year. Selling, general and administrative expenses increased approximately $22 million in Q3. However, approximately $16 million of this increase is due to non-cash stock-based compensation. In the third quarter of 2011, our stock-based compensation was a credit or reduction during the quarter in expense of $8.5 million as a result of the stock price declining during that period. For Q3 2012, SG&A includes stock-based compensation of $7.6 million -- that's an expense, not a credit -- as we saw our stock price increase during the quarter. In addition, we have added approximately $8 million in SG&A for OPENLANE. That is now included in the ADESA segment. KAR generated $117.3 million of adjusted EBITDA for the third quarter. This was only slightly better than the $115.7 million of adjusted EBITDA for the third quarter of 2011. Our Q3 2012 performance was below our expectations and reflects the mix of vehicles sold at ADESA and Insurance Auto Auctions. At both ADESA and Insurance Auto Auctions, our adjusted EBITDA for the third quarter was below the prior year. This was offset by increased adjusted EBITDA from AFC and lower adjusted holding company costs for Q3. The ADESA segment continued to experience pressure on its performance due to the supply of vehicles in the marketplace. We will wait for the year end and AAA survey to assess our market share position. But I feel confident we have outperformed the industry in the United States and in particular, in the dealer consignment segment. I mentioned earlier that mix was causing our performance to be below our expectations…

[Operator Instructions] We'll take our first question from John Lovallo from Bank of America Merrill Lynch.

This is John Murphy on for John Lovallo. As we look at the conversion rate, I mean, it historically was -- is sort of at a low point in the ranges, down year-over-year. And I understand the mix impact here. I was just wondering if you could talk about what's going on with the conversion rate at the dealer level and the institutional level. And I know you don't disclose the exact numbers there, but I was just curious what you're seeing. Considering that pricing is so strong, I would expect the dealer conversion rate to actually be a little bit higher, as well as the institutional. I was just curious if you could break those 2 out directionally for us.

Yes, John, I think you mentioned that it's mixed and it is historically low, and that is the result of us selling more dealer cars and a higher percentage of dealer cars. Even though our dealer business has grown and continues to be at a higher percentage of our overall business, it still does convert at a lower rate, which, at the end of the day, does drag the conversion rate down. So I think it's just a question of the mix, and I think that you'll see that change and go back on the north side as these commercial volumes come in 2013.

And John, you'll see in our Q, which we expect we'll probably file tonight, 45% of the cars sold at ADESA were dealer consignment cars, and that's the highest level we've ever had as a company.

Okay, that's great. And within that channel, there has been no material swing one way or the other in the conversion rate for the dealers specifically. It's just the mix. Got you. And then as we look at this fleet business coming back and the backlog is definitely out there in the market, there's a lot of concern that some of these institutional sellers will go through their own channels or other channels other than the physical or your online auctions. I'm just curious what trends you're seeing there as far as your contracts with some of these institutional guys. Have they changed anything specifically that would really hamper this recovery? Or are we really looking at something that's just more cyclical and not secular here?

Yes, John. I think that we don't see any change. Obviously, our OPENLANE platform serves 90% of the OEMs. And we've certainly checked in, and we feel that they will continue to sell on the OPENLANE platform. It's -- at the end of the day, it's about the money. And you're going to go within a channel that's going to produce the best results. And I think between the physical auctions and the online platforms that are available, I think those brands have been well established, and that's where dealers go to buy vehicles.

Okay. And then just lastly, as we look at AFC, you mentioned that you're growing your business into the Insurance Auto Auctions dealers. I'm just curious how the go-to market strategy works relative to what you're doing at ADESA because, obviously, it's a little bit different of a buyer base or financing base there. And just really curious how that impacts your revenue per loan transaction and your margins there because there seems like there might be a much richer mix with Insurance Auto Auctions and what you're able to get out of your customers. I'm just trying to understand the difference there between the 2.

Yes, John. I don't know that I know what you mean by richer mix, but I will tell you the average loan balance is significantly lower, so it actually probably can at times be a slight drag on that gross revenue per loan transaction of $161. It's still a very small portion of the portfolio but a fast-growing small portion. So again, as we look at that business, we're not focused on $161 as revenue per loan transaction. We're really focused on the profitability, and so if that number were to come down slightly because our mix, motorcycles or average lower balance of recreational vehicles can be higher. So the mix will impact that. The key is you're really the strength of the performance overall on the EBITDA line and I think that's outstanding at AFC. But it hasn't drug it down yet. It could because the revenue on those salvage vehicles to be a little less.

But ultimately, your profits and returns on that side of the business are just as good as they would be on the whole car side?

Yes, they are. And generally, again, it's a salvage vehicle, turns a little faster.

Got you. So it's just the incremental business.

Yes.

Moving on, we'll take our next question from Gary Prestopino from Barrington Research.

Just real quickly, would you have had to lower your EBITDA guidance if Sandy hadn't occurred given the volume trends you were seeing?

Well, I don't think we need to dissect our guidance, Gary, but we've made a comment that one of the impacts was our performance in Q3. So I'll let you conclude what that means. It is not entirely related to Sandy. No, it is not.

Okay, that's fine. And then, Jim, is -- are you still seeing that you're going to do about -- the market's going to do about 7.7 million units this year and then going up to 8.4 million next year and 9 million by 2015? Are those still good numbers to work with here?

Yes, Gary, they are, and we feel confident in those numbers.

Okay. And then is the majority of what's driving this, is this going to be just lease returns? Or is it just a mixture of lease, rental and factory?

I think it's a combination. I think a huge part of it's going to be lease returns. Then, add in the repos, and then we're going to see an increase in rental car returns as well. And then if you can, you're going to maintain this dealer business that we spoke about, especially as we see the SAR increase. I think I read in Wall Street last week, they confirmed sales were up 2 million. New car sales were up 2 million in 2012, and that's expected to rise again in 2013. So when you combine all those factors, that gets you to the 8.4 million and the 9 million that we talked about in 2015.

Okay. And then just to be clear because I've been getting this question a lot. With the car that's damaged by saltwater due the hurricane, is that salvageable for parts? Or does that generally have to be a crushed car because of the saltwater getting on the car itself?

Gary, let's let the insurance regulators and the insurance companies decide that. I think we all recognize saltwater damage is different than fresh water damage. But I don't want to speculate what anybody is going to require or do. It's too early. And I'll -- I'm going to have to pass on giving specifics on that because I think it may vary by carrier. It may vary by jurisdiction. Hey, Gary, before you go, you said 7.7 million. I wanted to clarify in case others misunderstand that. That excludes the online sales of OPENLANE, which in 2011 were about 300,000 units and this year, are expected to be just under that number somewhere. I just want to be clear it's not growth in the industry from 7.7 million to 8.4 million because the 8.4 million does include OPENLANE as well.

Moving next, we'll take our question from Chris Ceraso from Credit Suisse. Christopher J. Ceraso - Crédit Suisse AG, Research Division: So okay, it looked like revenue per unit in IAA was a little bit light. How much of that would you attribute to mix or commodity prices or something else?

Chris, as I dissect that, I highlighted the one item. When we calculate revenue per unit, we consider the net margin on purchased vehicles to be comparable to a provider fee or a sell fee, and that's where we saw the biggest deterioration. It was actually in that component as opposed -- I would tell you, relative to year-over-year performance, while the proceeds were softer, they aren't drastically different. There's a seasonality to the year. And I would tell you it's more probably on provider fees. If anything, it was a very slight impact on buy fees, and I would argue probably not much at all, down just maybe $1 or $2 at most. Christopher J. Ceraso - Crédit Suisse AG, Research Division: Okay. And then I guess that weighed on margin to some degree, too, because it looked like you had a deeper-than-normal seasonal decline from Q2 to Q3 in the margin in that business.

That's exactly right, Chris, because of that tighter margin, which is again the pricing difference between when you buy the car and when you sell it, which is only a few weeks, but we saw that cause that 36.7%. But on a net basis, you're still over 40%. I think that's a very strong performance for IAA. Christopher J. Ceraso - Crédit Suisse AG, Research Division: Okay. And then just coming back to the hurricane, you were pretty clear that it's going to have a negative effect in Q4, but judging from prior episodes, similar episodes, do you have any early expectations of what kind of increase in business it might produce for you as we get into 2013?

Chris, good question, and it's just, unfortunately, too early because the assignments are just beginning. People are just getting back to their homes and finding their cars damaged. And it'll take a little bit longer. We've -- and I don't want to speculate based on media publications how this compares to Katrina or Irene, which is what they're doing. I think we'll just have to wait to answer that. It is a highly populated area, though, so there should be a lot of damaged vehicles.

Moving on, we'll take our next question from Craig Kennison from Baird. Craig R. Kennison - Robert W. Baird & Co. Incorporated, Research Division: Jim, you mentioned a better stickiness with some of your dealer consignments. Could you talk about what is driving your stickiness there?

As we go back, probably 3 years now, and we've seen this decline coming in off-leased volumes and we're going to have to manage through this period of time, quite frankly, our dealer business was as low as 25% of our overall business. And we knew that, that was the opportunity for us to offset these declines. And we put a national team together. And the national team is probably close to 300 people now, working on this national dealer consignment team that went out in daily, called on dealers, trained dealers on how to use our services, how to use our technology, how to log on to our site, how to use the different services. I can go on and on, but it was just getting dealers more and more comfortable with all the services that the auctions have been able to offer. And I think at the end of the day, dealers have learned the true value of an auction, and they've needed to learn the true value of an auction just based on the tight supply that we've been experiencing here over the last couple of years. And as -- so as we go forward, I believe that the good habits that we've created both online and in the lanes, I believe that those dealers will stay with it because it's been a good experience and a good result for them. Craig R. Kennison - Robert W. Baird & Co. Incorporated, Research Division: That's helpful. And then with respect to the salvage business, and I apologize if I miss this, but we know that scrap metal prices declined materially during the quarter. Since you took on more risk on some of those deals, did you actually take a loss? And is that part of the margin issue you saw in the salvage business?

No. We still generated a net margin on the sales of the vehicles. We did not take a loss. Craig R. Kennison - Robert W. Baird & Co. Incorporated, Research Division: I'm sorry, did you actually -- did the decline in salvage metal prices, did that actually influence at all your profitability so to speak?

Again, Craig, it's a good question. There's so many variables that affect the proceeds. I would again tell you that -- I would say the percentage decline in commodities prices might have been even greater that what we saw on proceeds. So I mean, used car prices is another influencer, especially at the high end and on the low end, less or so. I probably couldn't dissect it to that level, and I don't think it created a loss during the quarter of any sort.

Moving on, we'll take our next question from Bob Labick from CJS Securities.

On the salvage side, I know you don't like to speak about specific gains, but you've mentioned on the last call and then again today, broadly speaking some RFP wins. Can you tell us if those volumes are fully reflected in the current volumes at IAA? Or roughly how much we should expect in terms of future gains in volumes from these wins?

Bob, that's a level of granularity we don't get into. We have been feeling very good about our business on an ongoing basis. The recent national RFP that Jim mentioned though, none of that activity has been reflected in the marketplace yet. It was just recently announced.

Okay, great. And then sticking with IAA, IAA, I believe, has a tough comp in Q4, meaning 52 weeks versus 53 a year ago. Is that the same for ADESA and AFC? Or is that just for IAA?

That's just IAA. They're the only segment on that calendar. Everyone else is on a calendar month, calendar year.

Okay, great. And just switching to the balance sheet. You're likely to reach your goal of 3x levered early next year. Could you just tell us the available options with you're free cash flow once you've reached that and how you prioritize them?

Well, Bob, no. I don't think other than the fact that we're focused on generating free cash flow and evaluating the options that we see in front of us, at this point in time, I don't think there's anything specific to discuss. And we have not projected when we'll hit that 3x, but we are very comfortable that we're generating strong cash flow.

Moving on, we'll take our next question from Bill Armstrong, CL King & Associates. William R. Armstrong - CL King & Associates, Inc., Research Division: Most of mine has been answered, but I just have a couple of quick ones. The AFC penetration in the salvage side, is it your plan to start opening some offices on-site in or near your IAA auction, similar to what you have at ADESA?

Again, we don't want to talk about specific numbers, but we do have on-site representation at some of those auctions, whether it be on sale day or even all during the week if there's enough activity. They'll respond to the market. So if there's enough activity, I'm sure they'll be on site. William R. Armstrong - CL King & Associates, Inc., Research Division: So you have individuals there kind of talking it up or making their services available?

That is correct. William R. Armstrong - CL King & Associates, Inc., Research Division: Okay. Interest expense, what should we be modeling for Q4 approximately?

Well, I mean, our cost of funds is at about 5% other than the floaters, which is a little lower. The variable that, that is a little tougher is the securitization interest. And I don't know what your assumptions are there, but it tends to have a little bit lower cost of funds than the 5%. So I think that's about the level of guidance I'm comfortable with. Our cash interest paid excludes the interest on the securitization because we consider that for EBITDA purposes to be an offset to revenue and not corporate interest expense. William R. Armstrong - CL King & Associates, Inc., Research Division: Right. So on the P&L, you've had a run rate of about $30 million per quarter in that neighborhood for the last year. Should we kind of expect it to continue to be in that neighborhood on a GAAP reporting basis?

I don't want to speculate. I don't know that, that's bad assumption though. I don't think any of us are expecting interest rates to go up based on policy, and it's just a function of what's the balances at AFC, which I'm not going to project right now.

Moving on, we'll take our next question from John Healy from Northcoast Research.

I wanted to ask about a comment you made about the storm, potentially, helping used car values go higher. I was wondering if -- I don't know if Tom's on the call -- but maybe you could give some perspective in terms of how long he thinks maybe another step-up in the used car market values could last for? And maybe just kind of revisit any updates you guys have and what you think the used car market could do in 2013.

Yes, I think the comment was that we don't know the actual numbers, haven't been able to quantify the actual numbers. But we know, as Eric spoke, that this was an extremely heavy populated area that we're dealing with. We expect that there's going to be a high number of vehicles that are going to need to be replaced. And when you have that kind of demand -- although it could be short term, when you have that kind of demand, it is going to drive used car prices in those markets and will probably affect used car prices in other markets as well because they're going to have to reach further to get vehicles to fill the void that's being created. I'm looking at an article as we speak here, and it's says here that the National Automobile Dealers Association is predicting that as the result of the storm, December prices of used vehicles up to 8 years old will end up being anywhere from 0.5% to 1.5% higher than earlier projections. So that's quoting the NADA.

Okay, that's helpful. And I was wondering if you guys could remind us -- and I don't want draw a direct comparison to Katrina and Irene to sort of what it can do for the IAA business. But how much of a lift in volume did you guys get at IAA from Katrina? Do you remember?

That was '06, so it's a long time ago. So when we were selling the cars -- I don't have that number in front of me, John. And the Irene was totally different last year, and at no point did we disclose that at that level of detail. We just said it was a contributor to our increases last year, which for the year, in 2011, we were over the prior year by 9%, and that was one of the contributors.

Okay. And just last question, I know you stepped up the purchases on the IAA side yourself a little bit. Is that something that we should expect you guys to continue to do in the fourth quarter and into 2013 to maybe be a little bit more aggressive out there in terms of buying cars and then selling them through yourself?

I think it comes down to we don't have any specific goals or targets that we're trying to achieve in that area, and I think it comes down to the demand. And with the tightness in supply, there was the opportunity by these vehicles. And the folks at IAA did a good job in buying the vehicles, and we'll continue to buy the vehicles as the market continues to demand them.

And the other thing to keep in mind is with our effort to support the insurance carriers in the Northeast, it's highly unlikely we'll buy vehicles in the Northeast because we'll be working through a large supply of vehicles, and that'll take some time. So it -- But yet, on the West Coast, you may meet demand there in a different way. It varies region to region.

Moving on, we'll take our next question from Bret Jordan from BB&T Capital Markets. Bret David Jordan - BB&T Capital Markets, Research Division: A quick question, talking about the RFP business, the national insurance accounts, what's the profitability trend been there? I guess, if you look at this insurance company you mentioned, is the go-forward productivity's sort of on a per car basis comparable to the trailing productivity? Or is pricing playing a role on the RFP side?

Well, we're not going to comment about any details other than what we gave you. But we see the IAA business continuing to perform at a very strong level. And I've mentioned before, as proceeds start to moderate, there could be some declines in margin, but that's because we've been at unusually high levels, not because the business is going to perform at a lower level. And on a net basis being at about 40% for the third quarter, I think speaks to that point. I don't see anything really hurting that business materially. Bret David Jordan - BB&T Capital Markets, Research Division: Okay. So the competitive level of the RFPs hasn't changed materially.

All RFPs are competitive, but I don't think it has an impact on our outlook for the business.

[Operator Instructions] Moving on, we'll take our next question from David Melka from New York Life.

I just wanted to ask you, you've been growing the AFC business very strongly, and at the same time, you've spoken about the fact that you're getting into different things in that business, whether it's the IAA portion of it, whether it's motorcycles and RVs. And you've also talked about the fact that you've managed that on a very decentralized basis because you think that's what helps grow the business the best. But can you talk a little bit about the oversight you exercised over what happens in those fairly autonomous groups as it relates to what they're doing, audits, credit quality, things like that, what metrics you look at?

And David, let me clarify. The 104 loan origination offices are how we interact with the customer. They have a very centralized underwriting process, managed entirely at the corporate level and even collections, while, again, the feet on the ground are out in the street, we monitor and manage that business. It's really more of a hybrid than it is a decentralized portion. Now relative to the credit profile, yes, they're very in tuned to the differences in the type of product that they're floor planning, how it moves, what's the right length. But again, it has so much similarity, has a title. You can track the ownership. Those are the things they look at, and I think they've done a great job. And so these new markets are really just an extension without changing their business processes substantially that they can just, again, leverage it into a different marketplace.

Well, is all the credit analysis and monitoring and some stuff like that, is that all centralized? What decisions are actually being made in the -- in those discrete regions besides marketing?

Yes. No, all the credit decisions are managed here at central office. So if you think of the outlying locations, they're trying to get the customer to apply, and then AFC has a centralized underwriting process that determines if we'll extend credit.

And the monitoring, is that also done and audited from the home office? Or is that something that you rely on the local people to do in a bigger way?

Well, again, we have a subsidiary of ADESA that does over 60,000 lot checks per year. They touch every customer. That's managed centrally. I just don't -- it's a hybrid though because we also expect the managers in the field to be in regular contact with our customers and know what's happening in their business. But I would tell you the formal processes are all managed through the AFC corporate management team and the feet on the street are really contacts at the auction and for the customer. And they have absolutely no influence over the processes.

Moving on, we'll take our next question from Colin Daddino from Gabelli & Company.

If I'm thinking about longer-term margins, what's the trade-off or dynamic on the gross EBITDA margins between maybe the ADESA commercial volume leveraging some of these -- the fixed costs versus some of these volume initiatives, like the higher dealer consignment or closed sales in ADESA, which might be dilutive to margins?

We want to sell every car that comes to us, and the real impact is the lower volumes, there is a fixed cost infrastructure. I think they've done a great job of keeping it at the lowest possible level with lower fixed cost. At the same time, what we're looking forward to is the total volumes increase, without seeing that SG&A growth, is going to be the leverage on the EBITDA margin. And in terms of differentiating, yes, if you had a commercial mix with a lot of ancillary services, the gross profit margin may decline, but the dollars will go up. So we've always looked at that. And it's within a fairly narrow band. And again, I think that's the strength of the ADESA business model right now and how we attack the marketplace.

Okay, great. And then just in terms of the winner of last night's election, it's caused some concern that maybe carried interest for hedge funds or private equity funds might be attacked. So in light of that, with some of your largest shareholders, what are they thinking and where are you in the sales process?

You know what I think? It's best that they answer what they think happened in the election last night. And I'm going to pass on that one. Jim, are you?

I think I'll keep my political views to myself.

And at this time, there are no further questions. I would like to turn it back to your speakers for any additional or closing remarks.

Okay, great. Thank you, Jim, and I'll just wind up by saying thank you for your interest in our company, and thank you for being on the call today. I am genuinely excited and enthused about this business. I feel very good. We know that all the tailwinds or all the headwinds are becoming tailwinds. We know the SAR is going to increase. You know about the lease returns coming back to the market. You know what we've done with dealer consignment, and I think consumer confidence continues to improve, hopefully, the economy. We get past this election -- although, I won't speak to politics. We get past this election and hopefully, things get settled down. And I think it's all good as they say. And I can tell you the management team is focused and excited, and we all look forward to the coming year, closing out this year and to the year ahead of us. And with that, I'll wind it up and say thank you and goodbye.

Thank you. That will conclude today's conference. We thank you for your participation.