Good day, ladies and gentlemen and welcome to the KAR Auction Services Inc. Corporated Q4 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 be given at that time. [Operator Instructions] As a reminder, this conference call may be recorded. I would now like to introduce your host for today’s conference Mr. Mike Eliason, Treasurer, Vice President, Investor Relations. Sir, you may begin.

Thanks, Krystal. Good morning and thank you for joining us today for the KAR Auction Services fourth quarter 2018 earnings conference call. Today, we’ll discuss the financial performance of KAR Auction Services for the quarter ended December 31, 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. As I get started, I wanted you to know that my comments will be a little more extensive today than most of our calls. I want to take the time to share my views on some of the longer term trends that I believe will help you better understand the direction of our industry. So with that, let me provide a agenda for you of what I plan to cover today and then I’ll get into my comments. I want to provide an overview of KAR’s performance for the fourth quarter and the full year, discuss key trends and performance metrics in each of our business segments, update you on our TradeRev initiative, provide you with a overview of two acquisitions that we’ve completed after year-end, review our guidance for 2019, provide you with an update on the status of the spin-off of Insurance Auto Auctions and as I close, I want to comment on some of the trends that I see impacting our used car businesses as we go forward. So starting with the fourth quarter, on a consolidated results, we saw a revenue for the quarter increase 4%. Our adjusted EBITDA for the quarter was up 6%, and operating adjusted net income per share declined 2%. This decline was primarily due to increased interest expense due to the increased interest rates on our corporate debt. Turning to the full year, KAR generated $3.8 billion an increase of 9% over the prior year. This led to net income per share of $2.42, a decrease of 9% from the prior year and operating adjusted net income per share of $2.96 which was up 18% from the prior year. Looking at the business units, and starting with…

Thank you, Jim. Let me start by adding a few comments on our performance in 2018. In analyzing our fourth quarter and full year consolidated financial performance, I want you remind everyone of the impact of the changes in tax laws in 2017 that distorts our comparisons of net income and net income per share on a GAAP basis. The passing of the Tax Cut and Jobs Act of 2017 reduced the corporate income tax rate in the United States and we recorded a net reduction in income tax expense of $91.6 million in the fourth quarter of 2017. When comparing 2018 results to 2017, this is the cause of net income and net income per share decreasing. Jim highlighted aspects of our performance in each of the business segments; I want to highlight a couple of other items for you today. First, I want to comment on Insurance Auto Auctions inventory levels. At December 31, 2018, the number of vehicles on our property was up 1% over the prior year. We call this inventory but I want to remind everyone, we generally do not take title and the value of these vehicles is not on our balance sheet. Given the elevated inventory levels we experienced throughout 2017 this is a very strong number going into the first quarter. At AFC, we had an increase in the level of loan losses in the fourth quarter as compared to the previous four quarters. We expected this increase to occur and expect loan losses to be below 2% in the early quarters of 2019. In the ADESA segment, we saw a number of positive trends in total volumes sold across all of our platforms, revenue per unit and operating profit and adjusted EBITDA in the businesses that make up the ADESA segment,…

Thank you. [Operator Instructions] And our first question comes from John Murphy from Bank of America Merrill Lynch. Your line is open.

Good morning, guys. I've got a long list here. So I'll try to keep it to two or three here. Just first Jim, you were mentioning the lines [Indiscernible] between retail and auctions. I'm just curious as you think about the transformation of the business over time, it sounds like you might be a little bit more willing to deal with sort of pseudo trade-ins or buying cars from consumers and then maybe redistributing them through the system or through the retail system. Just curious what you mean by that? And if you might move from less of the -- from an extreme market maker, a big market maker, I should say, to potentially maybe taking some principal risk on vehicles more like a traditional wholesaler obviously with massive scale. I'm just kind of just trying to understand that comments.

Yes. John, first of all thank you for your question. Good morning. I think that it's obvious that consumer's biggest pain point oftentimes is the trade-in and getting what they think is fair market value for the trade-in. And we think there's a possibility for TradeRev to work through the dealer network to provide that instant cash offer that a consumer could actually download an -- download an app, they could inspect their car and they could submit it. And they could get a immediate guaranteed price on their vehicle that they could take to one of our dealers that we do business with. And that dealer would do one of two things. They would immediately cut them a check for the car, or secondly, they would take that car on trade-in for the price that it was appraised for. And we believe that the transparency that TradeRev would provide in the transaction creates the confidence in the consumer to more easily do business, and it also helps our dealers sell more vehicles and that's a good thing both ways. Everybody wins.

Okay. And maybe just a follow-up on that. Has there been anything like this tested as you're developing TradeRev with dealers or is this more sort of a potential plan that you're going after in the future, and trying to understand where this stands in process?

Yes. John, without identifying the market we are piloting this as we speak.

Okay. Well, we're looking forward to hearing about that more in the future. I guess the second question is if we look at the ARPUs in physical auctions continuing to grow versus sort of covering the company for a really long time, I mean they're at sky high relative values to what we used to think about it as normal, but it does appear that there is an increasing acceptance and use of your ancillary services. I'm just curious if you could talk about where you're really getting the most bang for your buck in these ancillary services. And that as we move to the future will these ancillary services still be available to you or to the customer because you're not touching the car in a physical auction, and can you kind of jam these into the channel in a different -- or I shouldn't say jam, but push them into the channel in a different way that you may still be able to capture these high levels of ancillary service revenue.

So John, we think that there is continued opportunity with these ancillary services, and that's why quite frankly we created what we call KAR Remarketing Services, as a separate division operating within the ADESA segment. First let me give you couple of examples. We feel there's an opportunity that some of our sellers may decide to do reconditioning of the vehicles before they go online in some cases. We think in another case that consumers will -- or sellers will do reconditioning after they haven't sold online. And rather than sending them mainly to a physical auction, they would put them back online to sell once the vehicle is reconditioned. And then I would also say the area that we're starting to focus on is this whole mobility space. The world -- I would say, North America is very much behind the rest of the world when it comes to mobility. Now there's been a lot of investment in mobility here in North America, and it's only a matter of time before these fleets roll out. As these fleets roll out, these cars are going to need to be serviced, these fleets are going to be -- need to be maintained. And there is the traditional services that we do at the auction, where the car arrives at the auction and we do the services, we believe there is now an opportunity for us to bring the services to the vehicle. And there is a lot of services that we can deliver to the fleet and manage the fleet wherever the car is parked. So as we continue, we want to expand those services. You have seen us going to keys, you've seen us going to dents, inspections, whether it's wheel repair now or a windshield repair or replacement of tires, whatever that service can be, even down to the point where many of these fleets are going to need to be repositioned on a daily basis. The vehicles are going to be -- need to be refueled on a daily basis, and we believe that's the space that we can play in. These are our customers. These are the people that we do business with today, and now we just look to do business with them in another environment.

Okay, that's helpful. Then lastly, there seems to be a little bit more trepidation or as to the timing and the potential for Insurance Auto Auctions. And I'm just curious what you really think is changing there? Does this have to do with the capital markets and recapitalizing both of the companies with maybe new debt? Is there something there, which is sticking point, I'm just trying to really understand what is kind of changing? It just seems like there's a little bit more trepidation.

John, as I mentioned in my commentary, we continue to evaluate spend as well as other options to maximize shareholder value. And at this time, the spend remains on track for completion in 2019. Though, as we stated, we may at any time and for any reason abandon or modify the change -- or modify or change the terms of the spin-off depending on the results of our evaluation. So, I continue to stand by that.

Would it be fair to say there might be a bidder in the wings that might have emerged that may have changed this?

No, John. I mean, we're not making any comment like that at all.

Okay. All right, thank you. Okay, thank you very much guys.

Thank you.

Thank you, John.

Thank you. Our next question comes from Ryan Brinkman from JPMorgan. Your line is open.

Hi, Ryan.

Hi, good afternoon. What is the gross margin -- thanks for the operating loss detail on TradeRev. What does the gross margin profile of TradeRev look like? And you were to halt the discretionary investments that you've been making in SG&A to drive the trade line top line -- the TradeRev top line higher. What would the operating margin look like then or the operating profit look like then? And what is the sort of operating or EBITDA margin target that you have for that business over time?

So Ryan, currently we are expensing transportation incentives against the revenue of that business. So when we talk about we talk about gross profit of over 75% that would be after we get past this heavy investment in transportation incentives. Right now the margins are -- the gross margins are below that. Relative to operating margins and EBITDA margins like we look, we think they have the attributes of our online businesses which are very strong margins. Actually if you look at the OPENLANE business, well over 50%. At the same time, it's a developing business in its early stages I don't want to go out with a number right now, other than to tell you we think it can be a very high operating margin business. Once it reaches maturity has scale within the markets is operating and probably would -- I would add to that has more mature markets than developing markets, and so that we can leverage the SG&A. But I'm not going to put a number on it this early in its development.

But sometime after 2021, it will become accretive to operating margin, while also maintaining growth characteristics. Is that fair to say?

That's the goal that Jim mentioned that he has given them. Let's execute, and yes, I believe we can achieve that goal.

Okay. Thanks. And then just last question on CarsOnTheWeb. Anymore background you can provide there including for example, without the purchase price, but how much revenue and EBITDA are you incorporating into your 2019 guide that results from the acquisition? And how do you expect this business to grow over time? What are its profitability targets? What does it take to trigger the additional earn outs disclosed in the acquisition press release?

So Ryan, we give guidance $10 million to $15 million, most of that is CarsOnTheWeb. It is the sum of Dent-ology to smaller business, but most of that is CarsOnTheWeb. That's the disclosure we're giving today. We'll give more disclosure after we have some purchase accounting information at Q1. Relative to top line revenue, we are not guiding on that as we don't guide on revenue for the corporation, but this is a business that has a great opportunity to grow, and I think that's what we will focus on. Jim may want to add some comments there about customers we might introduce to them that they haven't had access to.

Yes. I think there is a great opportunity to grow this business. I may have mentioned, but we have a buyer base in 50 different countries throughout Europe that are actually bidding on and buying these vehicles. And we believe, not only can we increase that buyer base, but we believe there is an opportunity that we can introduce them to many of our relationships that will help grow that business. As well I think there's resources that we can add to support that team, that's going to be operating in place over there. So we do see good growth opportunities here in Europe.

Okay, that's helpful. Thank you.

Thank you.

Thank you. Our next question comes from Chris Bottiglieri from Wolfe Research. Your line is open.

Hey guys. Thanks for taking the question.

Hi, Chris.

Wanted to follow up on the -- there is a consumer element. Do you foresee this being completely internally driven or would you want to, I don't know partner or acquire a consumer platform like Cars.com or something to that effect to get scale there?

Chris, that's a good question. Our focus is on using our existing product set, especially TradeRev. And Jim mentioned the instant cash offer. That does not mean we always use our capital for the transaction. In many cases, the dealer will take that price for the trade. Right, Jim?

Right.

So don't think of it as, all of this results in a transaction where we put out capital. And if we do using our data and analytics we feel we have the best pricing tools that they can be used in this marketplace and we have the network of options to move that inventory within days. So we don't see that is having big exposure on the valuation.

Got you. I guess I was speaking out loud here, but I mean your reputation is extremely well known within the business circles, but I can't imagine to many consumers know who are. I guess how would you deliver the traffic needed to I guess; compete in that market without maybe partnering or acquiring something?

Well, I think there is a process that takes place, and it's one market at time, and we are in pilot now. And as we continue in advancing it from market to market, it's really bringing awareness to the brand in that market. And again that will develop over the course of time. It's like any new product that's just getting consumers whereabouts, and there will be an awareness brought to it through the dealer network as well.

Got you. Okay. And then just one final question. When I think about the core ADESA profit -- apologies if we discussed this but the TradeRev year-over-year growth was slightly less than last quarter in the gross profit per unit metric, so I prefer to look at, seems to have been a little bit worse. What's the takeaway for the core ADESA business on a gross profit basis ex-TradeRev?

Well again, ex-TradeRev, I think the mix is a big issue always in the fourth quarter, Chris. I've mentioned that in prior years as well and you end up outside of TradeRev having more revenue, some of it slightly lower margin and then it's typically followed again in prior years by a very strong first quarter, because those ancillary services lead to the ultimate sale of which is a very high margin transaction for us, following doing all the work that tends to be done in the fourth quarter. So again, the ADESA, the ADESA business ex-TradeRev, I look at that gross margin that again being such a strong performer above 40% ex-TradeRev. And when you look at that, we can sustain that over the long haul. You did mention the deceleration in growth. Let me just speak to that. There is a seasonality in the retail sector and I think it was felt actually buy the used car dealers as well. The fourth quarter has a bit of, shall we say, risk around what happens near the holidays and they had a little bit of softness and nothing that bothers us in that. We weren't losing share to anybody else. There were just fewer transactions. However, we grew 63% year-over-year. That's still very strong growth.

That's it. Okay. Thanks for help. I appreciate it.

Thank you. Our next question comes from Derek Glynn from Consumer Edge Research. Your line is open.

Yes, good morning. Thanks for taking my question. How should we be thinking about the expense or SG&A trajectory in 2019 on a consolidated basis? And do you think you could drive leverage in SG&A despite continued elevated investment in TradeRev?

Yes, Derek. We have some initiatives in place that we aren't spending much time on today, that we are very focused on SG&A in the core businesses and focusing our spend on the parts of the business that are really driving growth. So again, TradeRev, a big jump in TradeRev going from one quarter in the prior year to four quarters when a significant portion of their cost structure is in SG&A. So, as I look at that, yes, I think we can drive some leverage off of that. We will still invest more SG&A into the TradeRev launch, but we'll get leverage in the rest of our businesses. Jim, do you have anything to add?

Yes. Derek, I'll just add to that. SG&A is a daily focus. It's not a quarterly focus and where we're focused on SG&A every single day. And one of the things that I would draw attention to is I think going forward, as we think about our employee base we're going to have to invest in employees that have much stronger technology digital background. As this business transforms and we move to the digital products that we're talking about and the technology platforms that we're talking about, whether it be in North America or around the world, we're going to need a different skill set there, and again, as we think about the SG&A and the people we need to hire, we're keeping very laser focused on that.

And Jim you've remind me some -- including our shared services back office operations, we need to get more power out of digital processing, robotic process automation and things that we're looking at. So we do have a very focus on trying to process more transactions with fewer people in the future or not more people. I mean we grow the company without expanding that shared services footprint any more than we have to.

Okay. I appreciate the color. And just a quick follow-up. So, prior to the acquisition, I believe, CarsOnTheWeb, company had a target for 100,000 units sold by 2020, 2021. Just wondering how we should think about the trajectory there, some investment, perhaps synergies can we expect you to possibly exceed that target? And secondly is there anything you could share with respect to the ARPU figures for CarsOnTheWeb or how it compares the ADESA online average?

Yes, I mean, I'm going to be very generic here because again we just announced a deal that closed at the end of January, and we'll give more details after our first quarter results where we put some balance sheet, but we do agree, I won't comment on their previous goals and targets other than to say. We believe the combination of our company with their capabilities can accelerate their growth in that marketplace, beyond what they were expecting on their own. And second, their ARPU and things like that were actually very strong and comparable. It's interesting, well it's an online marketplace, it is not a private label marketplace. So it's comparable to what we get in our auction businesses, in the physical auction businesses, and we haven't seen evidence of a lot of pressure on that because it's such a high value transaction. Their value proposition is not just the sale of the vehicle. As Jim mentioned the processing across borders, the VAT, the handling of the transportation. They have a really superb business model that we think we can leverage into strong growth in that marketplace.

Okay. Thank you.

Thank you. Our next question comes from Daniel Imbro from Stephens. Your line is open.

Yes, hey, good morning guys. Thanks for taking my questions.

Good morning.

I wanted to start in the dealer-to-dealer channel. You know Jim; you talked about the competitive landscape shifting in recent quarters. If we think forward beyond 2020, has that increased competition in competitive landscape changed, where you think the long-term profitability opportunity is for TradeRev? Or said another way, with more players in the space has that pie got cut into the more pieces longer term or has the timeline to get to your original goals you think has been delayed as we ramp the business and have seen these losses near term?

Yes. So, Daniel, thank you. First and foremost, I think there's no question, there are more players that are wanting to enter this space. And I think what that truly confirms for me, is it confirms that others see opportunity here. The other area I would say is we are seeing considerable investment in this space that I mentioned in my commentary that confirms that others see a lot of value in this space. And at the end of the day, I believe that there won't be one winner. I believe that there will be at least a couple that have the lion's share of the market here, and I planned on being that leader. With that said, I think our timelines are pretty much in line with our expectations. It may have taken a little bit longer to get rolled out; a lot of it's been just getting the people hired and getting the boots on the ground and getting the people in the market. And then as I mentioned, it's found that we need to really support the dealer at the dealership level more. That dealer is asking us not only to help get the vehicle launch, but get the pictures taken and get the photos, get the images up and kind of manage that process for them. And I think at some point in time, we've got to get the dealer doing that from himself, whereas we were providing all that service now which is taking a little bit more time.

That's really helpful. And then just thinking about you versus some of your peers you talked about investing in the space. Can you go over some -- what are your competitive advantages that you bring that make dealers choose you over them? Or on the flip side of that is there something some of your peers do better than TradeRev that you could learn from and improve your offering on that front?

So, good question. First, I would say just TradeRev being part of the KAR organization. We do business pretty much with every one of these dealers today. These dealers are registered and approved to do business with us. So they know who they're doing business with. They know that we have the financial wherewithal and the capability to not only handle title and payment. They know that if there is an issue, if there is a problem that it's going to get solved, it's going to get taken care of. We have a very strong reputation in the market. So I think, the strength of KAR in itself speaks a lot to our dealers, and they are familiar with doing business with us. The other thing I believe is I believe that we have a collection of assets that is for the most part unmatched in the market when you think about the other services that we provide in terms of transportation with KARs arrive, the data and analytics that we're building into the app with -- to help with pricing and valuation. When you think about our inspection services, when you think about AFC financing these vehicles, I mean these products may be accessible to other entrants into the market, but we own these products and we have these products and we can use these products to help facilitate more transactions on TradeRev.

And then last one, quickly shifting gears a little bit, over to IAA, we saw units obviously down due to the CAT events, but up 7% excluding whether that's still a bit lower than we've seen in recent years. Can you talk about what you think could be driving maybe some of the slowdown in the salvage market? Or do you think the market is slowing, and if so, what do you think is driving that kind of structural slowdown in the salvage industry a little bit?

Yes I think we've always said that we feel that this business is 5% to 7% increase in volume on an annual basis, and we don't see that changing. We do believe there is an -- we've seen accident -- we've seen total losses increased as a percent of accidents. And we still believe that these vehicles become more and more complex. There is continued growth opportunities. If I look back, four, five years, total write-offs as a percent of accidents was probably somewhere in that neighborhood of 13%. And as we see it now, those numbers are starting to push in some cases 20%. I think, over the last quarter, we averaged somewhere in the neighborhood of 18.5%. So I think there is still room for this business to grow. But we feel very comfortable with sharing 5% to 7% with you.

And I would add, weather is an impact. I mean, again you go back to last year, we had fewer weather events remembering that those are typically going to be summer to fall weather events that affect the fourth quarter. We all can expect that there's been more activity in early 2019 as the weather has been more severe in the United States in particular. So there is -- we've had this before, I think there is no change in the market, it's just kind of timing.

Got it. Thanks so much for all the color, guys.

You're welcome.

We're running out of time, Krystal. We should probably have time for one more question.

Thank you. And our final question will come from Bret Jordan from Jefferies. Your line is open.

Hey. Good morning, guys.

Good morning.

Question as you look at the market and TradeRev is on a certain number of dealer desks, and obviously, ACV is out there chasing. Are there any incidents where a dealer might use both systems or is it usually exclusive?

No, there are situations where dealers could use both platforms.

Okay. So I guess as you look at your $250 transaction average, would you expect that comes down over time, or is that something that you can you think is defendable?

You know I think it is defendable. I think it's a question of the dealer truly seeing the value in terms of the product and just that in terms of the time and the expense, I think it creates tremendous value, and anytime you're creating value a dealer is interested in talking to you.

Okay. And then a question on, IAA. Eric you were talking about the 1% inventory growth that is ex-CAT or including CAT that the inventory at quarter end?

That's all inclusive of everything.

Okay. All right. Thank you.

Thank you. And that does conclude today's question-and-answer session. I would now like to turn the conference back over to Jim Hallett for any closing remarks.

Okay. Thank you, Krystal. And thank you all for being on the call today. We appreciate your continued interest and investment in our company. I think it's clear that we are in a changing environment and our industry is truly transforming. But I also want to share with you that I'm extremely confident that we are staying ahead of the curve here. We're making the right investments, we're placing the right bets to make sure that we continue to keep up with the change and the transformation is taking place, and we are confident that we can deliver the value. It may come from different sources, but at the end of the day we believe that this business continues to have the opportunity to grow and to meet your expectations. So with that, I'll say thank you, and we'll talk to you in another quarter, and I appreciate you being on today.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a wonderful day.