Good day, ladies and gentlemen and welcome to the KAR Auction Services Inc Q3 2018 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer-session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference Mike Eliason, Treasurer and Vice President of Investor Relations. You may begin.

Thanks, Gigi. Good morning and thank you for joining us today for the KAR Auction Services third quarter 2018 earnings conference call. Today, we’ll discuss the financial performance of KAR Auction Services for the quarter ended September 30, 2018. 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, prospects 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 measure 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?

Thank you, Michael, and good morning ladies and gentlemen and welcome to our call. Today, I plan to review our performance for the third quarter, discuss TradeRev performance in our push to win the dealer-to-dealer space, talk about how we prepare for catastrophic weather events in the salvage business and update you on the impacts of the recent storms we’ve had in our business, update you on our outlook for used car volume and values and then I will update you on the progress of our proposed spin-off of Insurance Auto Auctions and conclude with some comments on our 2018 guidance and the status of our potential acquisitions. Looking at KAR’s performance for the third quarter, we saw 11% growth in consolidated revenues, which drove 24% growth in net income per share. Our performance was negatively impacted by a $15 million pretax loss from TradeRev in the third quarter. Adjusted EBITDA for the third quarter was up 3% over the prior year excluding acquisitions adjusted EBITDA was up 10%. I think this demonstrates the strength of all of our core businesses. I will provide more commentary on TradeRev in a few moments. ADESA’s performance in the third quarter was what I would call a mixed bag. Revenues increased 10% and this was 8% excluding TradeRev in 2018. However, gross margin was weighed down by the mix of ancillary services, expansion and the expansion of the ADESA Assurance program that reduced gross margins by 50 basis points alone and the transportation incentives that were offered by TradeRev. In terms of the number of vehicles sold, we saw the trends that we’ve been discussing for the year continue. Total volume at ADESA increased to 11% with same-store volumes up 7%. The same-store volumes were driven by a 14% increase in commercial vehicles,…

Thanks, Jim. I have just a couple of items to cover in more detail today. First, I would like to spend a couple of minutes discussing the margins at ADESA. The third quarter adjusted EBITDA margins and related incremental adjusted EBITDA margins were unusually low. In analyzing the performance at ADESA for the quarter, I saw unusual variations in the performance as compared to the third quarter last year. Last year we had only 1% growth in same store revenue, while adjusted EBITDA grew over 7%. This year was somewhat the opposite. After excluding acquisitions, revenue was up 8% and adjusted EBITDA was only up 5%. Our revenue mix is what drives this result. Lower margin revenue from transportation and increases in purchase vehicles sold contributed to higher revenue without a corresponding increase in adjusted EBITDA. The declining gross profit margin and same-store adjusted EBITDA margin relate to our mix of revenue in the third quarter and not to any identifiable deterioration of margins for specific services. In fact, excluding acquisitions, gross profit dollars per car sold decreased only $1 in the third quarter and is up $3 for the first nine months of the year. At Insurance Auto Auctions, our gross margins and adjusted EBITDA margins benefited from less hurricanes and tropical storm activity in 2018 as compared to 2017, while we incurred just over $1 million in losses in the third quarter of 2018 this was a significant decline from the prior year. We have had significantly fewer total loss vehicles from catastrophic storms in 2018 as compared to last year and this has a positive impact on our operating results for the year. AFC was up against a tough comparison in provision for credit losses in the third quarter. While the provision for credit losses was only…

[Operator Instructions] And our first question is from John Murphy from Bank of America. Your line is now open.

Good morning guys. This is Aileen Smith on for John. Focusing in on the TradeRev losses for a second, is the 3Q loss of $15 million a good run rate to think about for TradeRev going forward on a quarterly basis, which would be consistent with your comment that TradeRev losses will persist for the next few years? Or should we think about losses stepping up in any material way in the future?

Aileen, at this point in time, there’s a little bit of seasonality to it. So I’m not going to give you a number. But the third quarter at $15 million was the highest quarter we’ve had this year. I’m not expecting it to be higher in the fourth quarter. And in February, we’ll give you more guidance into next year.

Okay. That’s helpful. And can you give a little bit more color on the incentives that you highlighted in your press release being used to promote TradeRev? Are those kind of one and done incentives to get your customers on to the application in using the service? Or are they transaction- based in any way? And what has generally been the response in customer demand for TradeRev as a result of the incentives?

Yes, so this is Jim. First of all, the station incentive is obviously to incent new customers to come on to the platform and use the platform, and we continue to provide the transportation as an incentive. It’s been extremely well received. In fact, we are shipping cars across the entire country to – and we’re reaching dealers that we probably have not reached in the past. And I would suggest that this isn’t a one and done. It’s something that we’ll continue to monitor and something that we will continue to use as an incentive. But at some point in time, I would expect that, that will possibly reduce itself as we get more and more dealers in volume transactions on the platform.

Okay. Great. Thanks for the detail. And last strategic question for Jim. You guys have made a number of acquisitions and investments over the past few years with a particular focus on data capabilities and fleet management, including DRIVIN and STRATIM. As you think about KAR Auction Services five, 10, 20 years down the line, what market position do you think you guys will be occupying? Or what point in the value chain do you ultimately want to sit? And would you be willing to get into broader fleet management services?

Yes. I think that we’re focused on the wholesale market, the B2B space. As I think about the future, I think about a global company that is providing all of these services and deploying all these assets that we have around the world, not only here in North America. I think the assets that we’ve acquired, we’ve established in early leadership position. I believe when you look at TradeRev and my expectations for TradeRev and how that will transform the way car dealers around the world do business, data and analytics, the early success that we’re seeing and the leadership position there. I think it’s about serving that whole sale space and same focus on that whole sale space at this point in time. And then if you think about another asset we’ve acquired in STRATIM, we have a seat at that table, and we’re focused on mobility. And mobility is in the early stages of evolving here in North America. I just think we’re really well positioned to serve our customers and stay focused and say stay disciplined on our space and not just chase every shiny object that might appear.

Great. That color is really helpful. Thanks for taking my questions.

You’re very welcome.

Thank you. Our next question is from Bret Jordan from Jefferies. Your line is now open.

Hey good morning guys.

Good morning, Bret.

Hi, Bret.

Hey. Is it possible for me to get a bit more data as far as the TradeRev’s penetration goes? How many dealerships you might be exposed to or – you commented that your volume was up greater than 2x year-over-year in the quarter, but just some way that we can start benchmarking its penetration?

Well, if you think about TradeRev and you think about the network it serves, I mean, it serves, I can say, virtually serves every dealer in North America right now. It’s rolled out completely across Canada. We’re in every province in Canada. We’re in every major cities in those provinces. We are coast-to-coast here in United States, and we have a very strong buyer base in the United States. Now with that said, we’re in most major markets. We do have some wholes that we are filling in as we go forward with our 2019 plans. And we have a very detailed strategy as to how we will roll that out. And then you think about who participates on them, the sellers are really franchise dealers, so it’s open to all franchise dealers, which number is somewhere in the neighborhood of 18,000 franchise dealers. And then from the buyer standpoint, it’s open to all franchise and all independents, so yet, had another approximately 35,000 independence that can buy, so you’re dealing with a network of about 55,000 dealers just here in North America that can buy and sell transact on the platform, if that answers your question.

Yes, I guess – well, maybe from a market share standpoint, I guess ACV is out there trying to do something somewhat similar. Do you have a feeling for how much of the volume is occurring in that dealer-to-dealer network is going on TradeRev versus an alternative?

Yes, Bret, we know that there are other companies out there, not only ACV, but there’s some others companies trying to enter these space as well. And we don’t have numbers that could tell us what our share is. I just know that we are focused on trying to establish ourselves as the leader in gaining that leadership. And in doing so, we think that we have some very good assets that we can share with TradeRev. But with TradeRev, such as financing with AFC, transportation with CarsArrive, the use of data and analytics, all these other assets we really feel gives us an advantage to try and win that space. And that’s really what we are going for here. I mean, this is a huge investment. This is a huge commitment. I can tell you that as you know, I’m a former dealer. I’ve never backed up on my vision. I’ve never backed up on my commitment and I’m even more excited with what the results have been here that we shared with you today. I’m even more excited today than I was at the date that we purchased the company. And I think, as I said in my comments, days is transformational not only for North America. This is going to change the way dealers do business around the world.

Okay. Great. Thank you.

You’re welcome.

Our next question is from Craig Kennison from Baird. Your line is now open.

Good morning, thank you for taking my questions as well. I wanted to follow-up on the TradeRev incentive question asked earlier. I know you’re, obviously trying to pursue a first-mover advantage and that makes all the sense in the world. But are you confident you can pull back on some of the incentives or freebies that you are currently offering once you’ve achieved your scale?

You know, Craig, this is Eric. We have markets where we offer those incentives to kick start that market and then we have pulled back. So yes, we have evidence that we can pull back on those incentives. The key is though the right balance. How much incentive, how much growth, what are we pursuing, how competitive is the marketplace. Do we want to bring outside the market buyers into it more aggressively? All that fits into the equation. But yes, we have tested the model where we pull back on the incentives and have been able to sustain the volumes in those markets once we’ve developed the market itself.

And I would just add, Craig, that this is a willy-nilly approach. We have a very detailed plan as of the strategy and as to how we are going to execute on strategy. And as you mentioned, the focus is on volume right now. And we need to win the volume, and we need to win that leadership position and I think as we do that, then we can determine how we go about advancing the product from there.

Thank you. And my second question has to do with more macro considerations. You’ve got a very strong business and it’s defensive in many ways. But I’m curious if we were to encounter a downturn, maybe a garden-variety recession where we saw automotive side SAAR drop maybe 10%, something like that. How would your business react to that type of environment? And what kind of decisions would you make in advance to prepare for that type of slow down?

The first thing I’m going to say is that we’re looking at our business as being very resilient research and resilient. I mean, we’ve seen a major downturn from 2008 to 2013. And I think everybody knows how we managed through that and saw the outcome of that. And the one thing with our business, a lot of our labor is variable and our cost structure is variable, and we can adjust as the market adjusts. But there is a number of different levers that we could pull, and I think we’ve demonstrated that for the course of time. And Eric, I’d invite you to add to that.

Yes, and Craig, in a period of economic pressure, we pull back on CapEx, which we can do. We focused on generating more cash and, obviously, that allows us to focus on how we can maximize returns to shareholders sometimes in a period where there might be lower growth rates. The other thing with the visibility we have, as you know, you mentioned 10% pull back in SAAR, that would hit our market two to three years later, because the trades and lease returns and all of that. And we can adjust our labor forces. Jim mentioned there’s a lot of things we can do that kind of protect their business model and the performance even in recessionary periods.

Yes, I would just add that, as we went through the great recession from 2008 through 2013, a couple numbers I gave you is ADESA lost almost approximately 500,000 transactions during that time. AFC got cut in half during that time. And over the course of those years, we never went backwards ones. I think the worst we did, we stayed flat one year and every other year we actually grew our business and that’s probably what I’m most proud of during those recessionary times.

Okay. That’s great context. Thank you.

You’re welcome.

Our next question comes from Gary Prestopino of Barrington Research. Your line is now open.

Hi, good morning. I’ll be jumping around conference calls, but you’re increasing your investment in TradeRev to roll it out. But yet, Jim, you said on the call, it’s rolled out coast-to-coast. So could you maybe explain, you say it’s rolled out coast-to-coast, but you are spending money to roll it out. So I am trying a little fuzzy there was going on. So could you maybe explain that?

Yes, I can, Gary, is number one, we’ve got markets that stretch around the East Coast and we’ve got markets on the West Coast and we are kind of fell in the middle. And I think that what I would go back is maybe I didn’t articulate properly but we’ve got the buyer base that’s coast-to-coast, and now we are going to most major markets in we’re kind of coming from the East Coast to the West Coast and were kind of fell in the middle.

Okay. So basically, the statement you made is it’s not really rolled out across the country, and that’s what you are spending this money to increase...

Okay. Let me help clarify. We focused on the largest cities first and now we’ve got to go deeper than that.

Okay.

This is a dealer-to-dealer market, so you’re going to gradually go into smaller metropolitan areas and get market share as you stretch the geography – geographic coverage.

Can you give us some idea of will this continue throughout 2019?

Yes.

Okay. All right. Thank you.

You’re welcome.

Our next question is from Chris Bottiglieri from Wolfe Research. Your line is now open.

Very quickly if I recall one to start with. You said the international acquisitions would be accretive from day one versus the bolt-ons and then the gross profit per unit was down only $1 year-over-year. Did I hear that correctly ?

Yes, you did.

Okay, perfect.

And by the way, we don’t want to predict accretive quite yet. They are profitable. Adjusted – I want to be careful accretive, we haven’t done purchase accounting and not everything is final, but we would expect them to be contributing to profits. I expect them to be accretive to value and accretive to earnings, if not immediately, very shortly thereafter.

Got it. Okay. That’s a good clarification. And then I want to take a dig on IAA. So from the macro perspective, it seems like axillary to kind of to slow it a little bit. The total loss rates were down year-over-year. Yet you grew volume and inventory ex CAT was reasonably strong. How do I reconcile this data? Are you taking share or you retained other vehicle segments?

I think that number one, I think we are winning some share in the marketplace. And I also think that we are rolling out some new products and new services. And we continue to believe in the hybrid methodology where we’re continuing to offer every car in a physical environment and physical auction as well as offering that vehicle online. And that business is in a position now where as you look at the major drivers of the salvage business, those drivers are all tailwinds and have been for some time, and we look forward to continuing as we go forward. And not to name them all, but as you think about the major drivers, we always talk about the miles driven, we think about commodity prices, we think about international buyer base, international currencies, the cost of repairs, the age of vehicles on the road. I mean, the list goes on and on. Those are really all tailwinds and are supporting the salvage business. And when you’ve got those kinds of tailwinds and you’re winning more business organically and adding a few new customers, it’s proving yourself out here.

That makes a lot of sense. And I guess just on the total loss rates given a positive confluence of factors in that backdrop, why are total loss rates decelerating? Can you tie that to used car pricing being stronger? Can it be like movements in currency with the dollar getting stronger or maybe the scrap metal weakening, some affects the salvage estimates?

I actually think it has to do with storms and weather-related activity as much as anything. It’s been a pretty mild year in percent of total losses in comparison to total claims. These storms tend to have 100% total loss are very close to it as they go into the statistics. And hail damage has been – I mean, it’s more than hurricanes, Chris. It’s hail damage. We’ve had got a couple of events, but I’d say it’s been a light year and that might to be factoring into it as much as anything. But talk to the insurance carriers, they’ll probably give you more color than we have.

Got it. That make sense. Thank you. I appreciate it.

Our next question is from Stephanie Benjamin from SunTrust. Your line is now open.

Hi, good morning.

Good morning, Stephanie.

Just wanted to get a bit more color, if possible, on just the margin profile at ADESA. I think expectations over the past quarter – we will see that pressure from these acquisitions. But this was kind of the first quarter of the year where ex acquisitions, margins did deteriorate. So just wondering if there is anything specific to just 3Q or just kind of quarter specific that caused the slight deterioration from even the first half ex acquisitions? I know you called out a couple of factors, but just trying to see what has changed I guess throughout the year.

Yes, Stephanie. Good question. I think it’s purely a result of the mix as we’re seeing the mix of vehicles from online and physical. The one thing I would point out to you is that we had record ARPU at physical auction of $850. And that means that a lot of these cars that get to physical auctions, they – sellers are doing a lot of work to these cars to prepare them for sale. And the margin profile, on many of those services is less than just the traditional auction fees, and that does draw your margins down somewhat. But as I’d like to say, we’re just sooner to report a higher percentage or will just sooner report more dollars than – unfocused on the dollars.

And Stephanie, let me add a little bit of color. Going back to the third quarter of 2016, the gross margin at ADESA in that quarter was 41.1% and actually 39.1% in the fourth quarter of that year and then rebounded. It really is just the mix of service and how – what revenue we’re generating. And there can be a bit of seasonality. We did have a lot of transportation in the third quarter, and that’s a lower-margin – that is probably the lowest-margin ancillary service we have and that weighs it down.

Got it. That’s great. And then also just kind of my other question is little bit more high level. You commented on seeing some pressure on wholesale value, which is really the first time this year. Just trying to wonder if you have a particular take on what might be driving that as well, considering demand has remained pretty strong. Just wondering what you might see going on there?

Yes, Stephanie, first, let me start by saying that as I said, 2018, I mean, prices exceeded all of our expectations. We went into 2018 thinking that the market capacity, take it down 3% to 5%. And as you know, this is the first time we’re talking about any decrease at all. I think it’s just a matter of supply in the marketplace. You have a very, very strong supply of off-lease vehicles and – which I mentioned repossessions continue to be strong. And the supplies in the market and I think, we’re coming into that time of the year where we’re thinking about Santa Claus, and we’re thinking about the seasonality where there may be a tendency for prices to drop off. But I don’t think it’s anything that’s going to be material.

Got it. That’s really helpful. All right, thank you so much.

You’re welcome.

Our next question is from Bob Labick from CJS Securities. Your line is now open.

Good morning. Thanks for taking the question.

Good morning, Bob.

Yes, starting on TradeRev. I don’t know if you can say this yet or not, but can you talk about maybe how long it takes to reach scale in any given market or profitability? And the expected ROI on the investment

You know, Bob, I think it really varies from market to market. Often times, be dependent on the receptivity of the market. Often times, it’s going in and getting that big anchored customer in that specific market, which can really have quite an immediate effect versus going in and maybe the size and the mix of the dealers that you attract initially. So the bottom line is I can’t tell you anything that directly would determine that. I think it varies from market to market. Eric, would you add anything?

Yes. The only thing I’m going to add, Bob, is the individual markets then have to reach a scale that you talked about. Not locally, but as you can see from our income statement, it’s going into SG&A. And we hit – we’ll hit an inflection point across all markets that we can absorb that SG&A and become profitable across the enterprise. It’s not market by market. As much as getting the entirety of the market adding up to a scale, we cover the fixed cost and then I think it’s takes off. And we have experience with that, as you know, in technology businesses that we have been operating much longer on the commercial side.

Got it. Great. And then just in general, maybe, how the volumes trended at the sellers that have used TradeRev for more than a year?

I don’t have that – that is a metric that the business is highly competitive. I probably won’t want to be giving that out publicly. But they do focus on retention, repeat sellers and all of that. That is a big focus of theirs. And in the roll out, first time seller getting them to repeat is a key objective of the team, and I know they’re having success doing it. I don’t have a metric that’s available to me today. I’ll tell you that, Bob. If I had it, I’d be probably hesitant to give it out.

Fair enough. Jumping to IAA. Maybe just clarify a little bit. I think you said in the upcoming Form 10 you’ll have 3.5 times leverage for SpinCo. Is that the targeted leverage going forward? Or will – is that still – is it supposed to both still be about below three times? Or how have you thought about that leverage? And if that is the target, does that imply that you expect more M&A on the RemainCo side and that’s where would probably drive debt up on that side later?

So Bob, your rhetoric. We were expecting at the spin date that SpinCo will be levered at 3.5 times. That’s subject to a final decision by the Board of Directors at the time of the spin, but we’re giving you that indication is that is what we expect at that point in time. Relative to that decision, there’s many factors that go into it. One of which is we’ve talked to you about these international acquisitions and other things we’re working on. So those would influence the leverage at some future date for RemainCo and again, as we get closer to the spin, it will all make more sense when we have more facts. But as of today, we’re giving you that indication.

Okay, perfect. Thank you.

At this time, I am showing no further questions. I would like to turn the call back over to Jim Hallett, CEO of KAR Auction Services Inc.

Okay, great. Thank you, everyone, for being on today. We continue to be grateful for your interest in our company and our stock. And I think it’s really exciting time. I think, it’s exciting as we finish up 2018, and we go into 2019. I think we have a good visibility into what the markets going to bring to us. We’re excited about the spin that’s come up. I think we’re going to create two great stand-alone companies here for you with two very strong management teams. And then I’m excited about many of the assets that we’ve talked about today when you think about the transformation that’s going on with TradeRev here. And then we talked about data and analytics and the early leadership position we have there and our involvement in mobility. I’m really pleased that I think we made really good bets, solid bets that really focused on our business and really serves our customers, and we are going to stay focused, and we are going to stay disciplined, and I think we’ve got a lot to look forward to. So thank you for being on today, and we look forward to talking to you in February. Thank you.

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now disconnect.