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Edited Transcript of KAR earnings conference call or presentation 8-May-19 3:00pm GMT

Q1 2019 KAR Auction Services Inc Earnings Call

Carmel May 16, 2019 (Thomson StreetEvents) -- Edited Transcript of KAR Auction Services Inc earnings conference call or presentation Wednesday, May 8, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Eric M. Loughmiller

KAR Auction Services, Inc. - Executive VP & CFO

* James P. Hallett

KAR Auction Services, Inc. - Chairman & CEO

* Michael Eliason

KAR Auction Services, Inc. - VP of IR & Treasurer

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Conference Call Participants

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* Bret David Jordan

Jefferies LLC, Research Division - Equity Analyst

* Christopher James Bottiglieri

Wolfe Research, LLC - Research Analyst

* Craig R. Kennison

Robert W. Baird & Co. Incorporated, Research Division - Director of Research Operations and Senior Research Analyst

* Daniel Robert Imbro

Stephens Inc., Research Division - Research Analyst

* Derek J. Glynn

Consumer Edge Research, LLC - Analyst

* Gary Frank Prestopino

Barrington Research Associates, Inc., Research Division - MD

* John Sykes

Nomura Securities Co. Ltd., Research Division - Analyst

* John Joseph Murphy

BofA Merrill Lynch, Research Division - MD and Lead United States Auto Analyst

* Robert James Labick

CJS Securities, Inc. - President & Director of Research

* Stephanie Benjamin

SunTrust Robinson Humphrey, Inc., Research Division - Associate

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the KAR Auction Services Q1 2019 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your host for today's call, Mr. Mike Eliason, Vice President of Investor Relations and Treasurer. Mr. Eliason, you may begin.

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Michael Eliason, KAR Auction Services, Inc. - VP of IR & Treasurer [2]

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Thanks, Sheree. Good morning, and thank you for joining us today for the KAR Auction Services First Quarter 2019 Earnings Conference Call. Today, we'll discuss the financial performance of KAR Auction Services for the quarter ended March 31, 2019. After concluding our commentary, we'll 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?

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [3]

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Thank you, Michael, and good morning, ladies and gentlemen. Welcome to our call. My agenda for today's call will include reviewing our first quarter financial performance, discuss some of the trends that we're seeing in the first quarter and how we see those playing out throughout the balance of the year, provide you with an update on TradeRev, walk you through our plan and our timing for executing the spin. And then we'll wrap up with discussing capital allocation, including our second quarter dividend.

But before I get started with the financial performance, let me start with telling you that for the quarter, we were on target with our budgets. And from the get-go here, I am reaffirming our full 2019 -- our full year guidance for 2019.

So with that, I'll turn to the financials. Revenue of just over $1 billion was up 10% over the prior year. Adjusted EBITDA was $231 million, up 1%. In terms of how the first quarter matched up against our expectations, we saw revenues come in a little better than our first quarter budget. Our adjusted EBITDA was very much in line with budget.

In terms of the segment performance, we reported 6% revenue growth and 8% adjusted EBITDA growth at Insurance Auto Auctions. We had 6% revenue growth and 3% adjusted EBITDA growth at AFC, and ADESA had 14% revenue growth with a 7% decrease in adjusted EBITDA. About half of the decline in adjusted EBITDA is directly related to the increased losses at TradeRev. The remainder of the decline reflects the mix of revenue in the profitability of various revenue sources for our physical auctions.

Lower sales volumes in all of the ADESA auction channels in the last half of January and all of February was certainly a drag on our performance in the quarter. March was a better month for ADESA, and we saw an improved revenue mix and higher margins. The change in our revenue mix is evident in the high RPU at physical auction and our combined RPU for all cars sold combined with lower gross margins.

While SG&A cost increased in the quarter, $12 million of the $20 million increase relates to increased costs at TradeRev and SG&A for the businesses that were acquired in the first quarter.

We took action in the first quarter to reduce our corporate overhead going forward. In March, we reduced our corporate headcount at multiple locations by over 100 positions. The elimination of these positions did include some severance and a replacement cost that were included in our first quarter performance, and we will see the savings from these moves through the rest of the year.

Turning to Insurance Auto Auctions. We saw volumes increase 1% in the first quarter. Obviously, that is lower growth than what we experienced over the past few years, but I like to point out that our comp was a very difficult comp considering the high volume level in the first quarter of 2018 combined with relatively mild weather experienced in our 2 primary markets, the U.S. and Canada, late last year through the winter months of 2019. We still expect 5% to 7% growth year-over-year at Insurance Auto Auctions for 2019. And the recent weather and increased accident rates have contributed to a 10% increase in our inventory levels at March 31. This is a good leading indicator as we enter the second quarter.

Turning to the ADESA volumes -- commercial volumes, especially the off-lease vehicles continues with double-digit growth. OPENLANE volumes were up 17%. Physical auction commercial volumes were up 6%, and commercial volumes represented 74% of all vehicles sold in the quarter and 62% of vehicles sold at physical auction. I expect commercial vehicles to be the key driver of our volume growth for the remainder of 2019. I also expect strong commercial volume growth to continue in both the OPENLANE and physical auction channels. This will also be a key driver to continuing to see growth in RPU at physical auction.

Despite the decline in total dealer consignment volume in the first quarter, we expect consolidated dealer consignment volume to increase in 2019 over 2018. I expect our growth in dealer consignment volumes will come from TradeRev for 2 reasons. First, the increases in commercial volumes at the physical auctions have put pressure on dealer consignment activity. As dealers see their vehicles being displaced in the physical auction lanes, they seek alternative channels to transact with other dealers. This was exactly what we saw in 2009, the last peak in off-lease returns, and we're seeing it again now. TradeRev has been an excellent alternative for these vehicles. And second, I would point to the 5 million fresh trades that have historically transacted deals to dealer outside of the auction environment. This increase is to our total addressable market, and that's the area that TradeRev continues to focus on.

In summary, we expect ADESA volumes will grow in aggregate in 2019 by upper single-digit percent, and our digital channels will drive this growth. Physical auction volumes will be roughly flat with the prior year as commercial vehicles begin to plateau.

I spoke to the TradeRev volumes, but let me talk more about the overall business. Our TradeRev volumes did not grow sequentially in the first quarter, and I would like to explain why. The TradeRev team started the year seeing a decline in retail activity in the marketplace. As a result, the team looked at its incentives and the effectiveness of these incentives in developing its buyer base in the local markets. For January and February, TradeRev reduced its incentive offerings, recognizing we would see lower volumes as a result. The incentive programs, especially transportation incentives, were repackaged to focus on reducing the cost of TradeRev and reducing the distance vehicles were shipped. The new programs were launched, and we saw increased volumes in March, and we have continued to see growth in April. In fact, I would mention we reached a milestone last week when TradeRev sold over 1,000 cars in a single day.

So we're on target to achieve our objective of selling over 200,000 vehicles on the TradeRev platform in 2019 and stay within the financial parameters that we've given the TradeRev management team. Revenue continues to be strong, and we've seen improvement in gross profit and the new incentive structures. We are on track with our plan despite the slow start that we had to 2019.

Now let me turn to the spin. As we announced in our press release, we have received rulings on our proposed tax-free reorganization in the spin-off of Insurance Auto Auctions. The IRS and Revenue Canada have both provided their rulings, and we are prepared to move forward. We will be launching the financing transaction within the next several days, and I will let Eric walk you through the proposed debt financing for IAA Spinco here in a few moments. We are currently planning to complete the debt financing in May. We will provide an updated Form 10 later this week that will include the first quarter results and additional information on some of the agreements that would be put in place between KAR and IAA Spinco. We expect to complete the spin in the second quarter, subject to receiving SEC and final Board of Director approval. The management team for Insurance Auto Auctions Spinco is now in place. John Kett will be the CEO, and Vance Johnston is now onboard in the role of CFO. Both John and Vance will work with Eric throughout the financing transaction.

Finally, let me address an important component of our capital allocation process. The Board of Directors have authorized a dividend of $0.35 per share for our shareholders of record as of June 3, 2019, payable on June 17. We have moved our typical dividend dates forward due to the expected timing of the spin. We continue to work on a number of potential acquisition opportunities that we believe could enhance our growth profile. Nothing has reached the stage that permits discussion today, but we believe that targeted acquisitions will continue to provide growth for KAR into the future.

With the spin in process and our focus on putting an appropriate capital structure in place for Spinco, we do not expect to repurchase any KAR stock in the open market in the second quarter.

So that concludes my remarks for now. I will turn it over to Eric for some additional commentary, and then we'll come back for your questions. Eric?

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [4]

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Thank you, Jim. I only have a few topics to add to the conversation today. First, let me walk you through our guidance. We expect adjusted EBITDA of $935 million to $970 million for 2019. We continue to expect net income per share of $2.46 to $2.65, and operating adjusted net income per share of $2.90 to $3.09. In our earnings release yesterday, we provided additional items of guidance that I will not walk through on this call. I will let you know there were no changes in any of those items provided in the earnings release.

In terms of our financial performance, we saw a reduction in our gross margins at ADESA that weighed on our consolidated performance. There are 2 major contributors to the decrease in gross margin at ADESA. The first is the accounting for purchased vehicles related to ADESA Assurance and certain cars on the web transactions. The ADESA Assurance program allowed dealers to purchase vehicles online and return the vehicle within a specified period of time, and we return the market value to the dealer. ADESA will then sell the vehicle at auction, and we are required to record as revenue the purchase price of the vehicle plus any buy fees as revenue. We also record the amount returned to the original purchaser as cost of services in our financial statements. The revenue and cost of services for both ADESA Assurance and CarsOnTheWeb are a pass-through, and this caused a 190 bp reduction in gross margin at ADESA. Revenue per unit sold at ADESA increased in the first quarter. We had online only RPU of $144, a 23% increase. This increase was driven by increased TradeRev volume and an increase in open sales on the OPENLANE platform. Physical auction RPU increased 7% to $875 in the first quarter. A majority of this increase was due to increased ancillary and other related services revenue. The ancillary and other related services revenues is lower-margin business. So while this was a driver of growth in ADESA revenue, it also was the cause of a 200 basis point decline in gross margin.

On a consolidated basis, our SG&A increased $20.2 million or 10.8%. TradeRev SG&A increased $8 million, and acquisitions added $4.6 million in the quarter. We also had approximately $3 million in severance in the first quarter related to reductions in corporate headcount throughout the organization. The savings from these headcount reductions will be realized in the remainder of 2019.

Our effective income tax rate in the first quarter was 26.5% in 2019 compared to 22.7% in 2018. We expect our effective income tax rate for the year to be approximately 27% as compared to only 24.7% in 2018.

At March 31, 2019, we had $93.5 million outstanding on our revolving credit facility. These borrowings funded acquisitions completed in the first quarter. We have classified these borrowings as current liabilities as we anticipate repaying borrowings on the revolving credit facility in 2019 from cash generated from operations.

Now let me give you some more details on our progress on the spin. First, we have completed the internal reorganizations of the salvage business. Following receipt of the private letter rulings from the IRS and Revenue Canada, we were able to move the legal entities making up our salvage business under the legal structure of Insurance Auto Auctions. This was the first step in the tax-free transaction that we have proposed. We expect to announce a bank meeting that will begin the financing process for the Insurance Auto Auctions business later this week. We expect this process to take approximately 2 weeks. We are proposing a combination of term loans and unsecured notes. Currently, we are anticipating leverage of 3.5x adjusted EBITDA or less for Insurance Auto Auctions. The funds from this debt will be available to Insurance Auto Auctions upon completion of the spin. The proceeds of the debt net of fees will be distributed to KAR and used to repay existing term loans of KAR.

Following the issuance of the debt, we will update our Form 10 and then determine the final timing of the spin, including declaration date, record date, distribution date and exit date. We expect to complete the spin in June, subject to receiving all necessary approvals. During the when-issued trading period, both Insurance Auto Auctions and KAR will be scheduling spin roadshow meetings to review the businesses that will emerge post spin. I hope this additional color on the remaining steps to complete the spin give you a clear view of our commitment to complete the spin as quickly as possible.

So that concludes my remarks for today. Let's turn it back to the operator, and we can now take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from John Murphy with Bank of America.

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John Joseph Murphy, BofA Merrill Lynch, Research Division - MD and Lead United States Auto Analyst [2]

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So when we look at ADESA, and I appreciate there's a lot of moving parts with the acquisition here. But Jim, you've mentioned that half of the pressure on ADESA or the 7% decline in EBITDA was a result of TradeRev and half was for physical. So it sounds like there was something else going on in physical that may have pressured the margins. But I mean, when we look at this, I mean, as far as the physical volume, the institutional mix, the conversion rate, the RPU, I mean, everything looks very good from the operating metrics standpoint. So it's kind of hard to tease out sort of the pressure we're seeing from Assurance and CarsOnTheWeb. And I'm just -- I don't know if you can give us any more sort of a walk there because, I mean, we're just not getting back up to sort of normal levels that look reasonable there?

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [3]

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John, let me start with the numbers, and then Jim will make some comments about the marketplace. Ironically, the first quarter -- many times in the fourth quarter, we see lower volumes running through our auctions and selling and high use of our facilities as they're preparing vehicles for sale in the first quarter. The slow retail activity in January and February that was experienced throughout the market caused some of that same phenomena. We were getting a lot of off-lease cars in, doing a lot of work on them, which gave us revenue. And those cars are going to sell later, and that's the high-margin business. So that's why we have such strong feelings about the margins improved in March when the cars started selling at a greater pace. And in fact, it's continuing into April.

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [4]

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Yes. John, there is not much that I can add to that. I've always said in the past, I'm not going to use weather as an excuse for performance. But I can tell you, I think we can all recall that the last couple of weeks of January and February, we went into a polar vortex, as they say. And basically, retail really shut down for a good period of time. And we didn't see that come back until sometime in March. And as Eric mentioned, March -- we're very, very pleased with our March, and we're quite pleased with what we see going forward here in April.

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [5]

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If I could clarify, CarsOnTheWeb was not a drain on EBITDA. It did influence revenue. And ADESA Assurance influenced revenue as well but was not a drain on adjusted EBITDA either.

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John Joseph Murphy, BofA Merrill Lynch, Research Division - MD and Lead United States Auto Analyst [6]

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Okay. So if we think about it, it sounds like sort of a backlog of cars on auction lots that are ready to go that will get cleared out. Is there any way to sort of dimension sort of the inventory or the backlog? I mean insurance Auto Auctions, you said there was a 10% increase in inventory. Is there anything like that on the ADESA side that you can give us to kind of understand the magnitude of what might flow out in the coming months?

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [7]

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No. Again, the cars on the lots and ADESA aren't there more than a few weeks, and so we've never focused on that number. I will tell you, our lots are full. Our lots have been full actually for most of this year. We have a number of lots over capacity. But the reason we don't give a specific inventory number, it's only the commercial cars that sit there a long time, many cars come in, it's not a good indicator of volume in the short term coming up. But I will say the lots were full, and that's the evidence. The other thing I'll add to that is we're continuing to see a large number of off-lease cars being returned. And the reconditioning work is very popular. And there were some information in an industry magazine this morning talking about cleaner cars are being sold at auction because the retailers are demanding it.

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John Joseph Murphy, BofA Merrill Lynch, Research Division - MD and Lead United States Auto Analyst [8]

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Okay. And if I could sneak in one follow-up on the spin. The transition costs or the stand-up costs on -- either on the Insurance Auto Auctions side and then what stranded cost might be on the ADESA side, can you put a sort of dimension on those for us just so we could have an understanding sort of as the companies get split, what we should think about there?

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [9]

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Yes. And again, in the Form 10, we provide in the past and it hasn't changed. There is about $15 million in incremental costs to the IAA segment that they will bear. About half of that cost, though, is being allocated to them in the Form 10 from -- with KAR, and that's the cost that in essence will disappear from Remainco once they stand up and we no longer have to provide the support services. So it's roughly half of the $15 million -- is already incurred through KAR. We'll move over to them once they stand it up and disappear from the IAA SG&A.

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Operator [10]

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Our next question comes from Chris Bottiglieri from Wolfe Research.

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Christopher James Bottiglieri, Wolfe Research, LLC - Research Analyst [11]

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Thanks for the color on TradeRev. Want to follow up a little bit there. Is there a way to -- the 200,000 units would still be a pretty massive sequential acceleration throughout the year. So I was wondering if there's maybe a way to contextualize April's growth relative to like the monthly average for Q1 to kind of assess the cadence you're on now.

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [12]

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Well, I think that what you're saying is you're seeing more retail activity, you're seeing more opportunity for inventory through the trade-in process, and also you're seeing us continue to open new markets. I think on the last call, we told you that we're currently at 125 markets, and our goal was to get to 175 markets through 2019. And without getting into the weeds, we're very much on track to continue to open those markets as we go forward. And just a good indicator, I think, was the fact that we actually were selling -- and I know it was one day last week that I mentioned, but when you start selling 1,000 cars a day, it starts to create a lot of confidence within the team. And I think that's really, really driving the enthusiasm for what we see going forward here in April and as it plays out throughout the balance of the year.

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [13]

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And Chris, just to add, the first quarter volume was up 42% over the prior year. It was -- it just wasn't sequential growth. We are seeing in April very strong performance in many of the new markets we've entered. That's what's driving 1,000 cars in 1 day. And the growth rate in April was much stronger than the months we saw in the first quarter.

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Christopher James Bottiglieri, Wolfe Research, LLC - Research Analyst [14]

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That's really helpful. And then just a follow-up to that. You mentioned acquisition activity as part of capital allocation as you think through that. I was wondering kind of maybe you can give us a sense for where you'll be looking with the dealer-to-dealer market, like TradeRev competitors would be one area where you'd be looking to acquire. Any thoughts there would be helpful.

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [15]

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Yes. Chris, I would say that in terms of capital -- or in terms of acquisitions, I would remind you of what we spoke previously about where our focus is. We continue to be focused on the international markets and growing out our international platform. And then the other area that we continue to focus on is this whole area in terms of online and digital selling. That space we will continue to look at acquisition opportunities in that space. With that, I've got nothing to share with you today.

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Operator [16]

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Our next question comes from Craig Kennison with Baird.

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Craig R. Kennison, Robert W. Baird & Co. Incorporated, Research Division - Director of Research Operations and Senior Research Analyst [17]

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I want to start on TradeRev, that 40% growth metric. To what extent is that driven by better engagement for users that have been on the platform for the last year? And to what extent is that a function of adding new dealers? What's the bigger driver?

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [18]

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Yes. So Craig, I think it's kind of a combination of those things that you spoke about. Number one, there is no question that just organically, the longer the dealers are on the platform, the more familiar they become with it and their management teams become with it -- become familiar with it. That certainly helps drive growth. And then getting out and visiting with other dealers, being in the marketplace, introducing the product, sending our people out to teach them how to use it and how to launch it and just getting them more familiar with it, adding new dealers to the platform, adding new markets. I had the opportunity to be in the Florida market this past weekend, I spent some time with some dealers there and really having that discussion, change is difficult. And changing habits and old habits is difficult. And just talking about -- just talking with dealers just about if you need help that we have people that can come in and we can train your people, we can have people come and help you launch your inventory. It's all of those things, I think. You got to understand that we're taking in basically a new product to market here. And dealers are creatures of habit, and we just need to help them break through those old habits.

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [19]

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And Craig, let me be clear on one thing. New markets would be a bigger contributor than adoption rate in existing markets in the growth -- year-over-year growth.

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Craig R. Kennison, Robert W. Baird & Co. Incorporated, Research Division - Director of Research Operations and Senior Research Analyst [20]

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Right. And sort of understanding those 2 big drivers, does it change how you structure your incentives? In other words, do new users respond to different incentives than your existing base?

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [21]

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I think that the big incentive is obviously transportation. It's nice that we can offer the inspections, and we can offer the financing, and we can offer the transportation, but I think the one that dealers are most focused on is transportation. But what the team has done there, the leadership team has really sat down and really tried to understand the transportation in terms of where is it being most effective. And being most effective sometimes, as an example, it may not make sense to ship a car 1,000 miles across the country. And where do you get your best bang for the buck on those incentives, and getting more focused on maybe the local market and maybe shorter distances. Those are some of the things that we've kind of walked through with the TradeRev management team in terms of what are the incentives that are really impactful and then how do you best use those incentives. And it's not a one size fits all.

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Operator [22]

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Our next question comes from Gary Prestopino with Barrington.

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Gary Frank Prestopino, Barrington Research Associates, Inc., Research Division - MD [23]

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Jim, you went through some things that you said you adjusted on TradeRev in terms of the incentives. Can you just go through that again? I didn't quite -- was able to write it all down. So...

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [24]

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Yes. Well -- go ahead, Gary.

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Gary Frank Prestopino, Barrington Research Associates, Inc., Research Division - MD [25]

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No. Go ahead, go ahead.

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [26]

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Okay. So the biggest thing that we looked at is, we've really looked at the incentives, and particularly the transportation incentives and really where was the sweet spot in terms of that transportation. And in some cases, it didn't make sense to be shipping cars, as I said, 1,000 miles across the country. And where is the sweet spot and where are we getting the best return on that? And that's one of the big areas that we looked at. Eric?

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [27]

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Yes. And Gary, what we did is we focused on what's the distance that a car is transported to get the highest value. Obviously, it does no good in a local market to have a dealer buy, shipping a car 2,000 or 3,000 miles if he's not going to be a regular participant in the market. So we focused, and therefore, we may provide some support. But the closer you get to the market, the more we're willing to pay of the total bill for the transportation. And then it weans it off as you get further away. And one of our focuses was actually to control the cost to TradeRev, the high cost going to one-off sales. Let's build a customer base, give a little bit to a lot more transactions rather than a lot to single individual transactions. So it's a very sound methodology they deployed, and looking at the sweet spot provide more if you're transporting, let's say, 200 to 400 miles versus 1,000 to 1,500 miles.

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Gary Frank Prestopino, Barrington Research Associates, Inc., Research Division - MD [28]

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Okay. And you're still seeing the mix of buyers of the TradeRev vehicles as being independent dealers and the suppliers being more of the franchise dealers?

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [29]

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Yes. For the most part, Gary. There are some exceptions to that, but the primary sellers are the franchises and as you mentioned, the independent dealers are -- strong buyers as well as franchisors are buying off the platform as well.

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Operator [30]

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Our next question comes from Stephanie Benjamin with SunTrust.

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Stephanie Benjamin, SunTrust Robinson Humphrey, Inc., Research Division - Associate [31]

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I just wanted to follow up a little bit on ADESA growth margin, and I apologize if I missed some of what you said. But I'm just trying to think through as it gets clear in terms of there was a reduction due to the accounting for ADESA Assurance and a little bit of CarsOnTheWeb and then also the lower-margin ancillary services. That's nothing new. So I'm trying to think through how we should think about gross margin going forward. Is it the fact that we should see lower -- less of an impact from those ancillary services because of maybe a backlog of actual auctions that you mentioned are at the quarter? And then how should we think about that -- the ADESA Assurance impact going forward?

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [32]

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Yes. So Stephanie, good question. The impact of purchased vehicles. Just that ADESA Assurance was the bigger one, but CarsOnTheWeb also has some vehicles where we don't really purchase it, but we are at risk during the period from which the car is bought online before we can begin the processing due to VAT over in the multiple countries we operate in. That was 190 basis points. That will be a permanent change as that's part of our programs, and we'll see the margins decline because we're grossing up revenue and cost of services. The other, the 200 basis points, I think I would call -- I think your industry calls it transitory. It's a temporary situation, and I think you'll see that mix reverse to where we'll see, again, a greater impact from the Auction Services revenues and now to bring the margins back up. And I think that is temporary. With that said, you know our effort to provide additional service even off-premise. We are growing that business separately, but I think the impact on this quarter was more of a temporary. But over time, we are willing to take more revenue at a lower margin as we see the marketplace change with all the fleets and the different ride-sharing and car-sharing opportunities.

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Stephanie Benjamin, SunTrust Robinson Humphrey, Inc., Research Division - Associate [33]

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Great. And then I think you also mentioned that TradeRev's gross margin improved as well during the quarter. And again, I apologize, my phone was going in and out, but could you talk a little bit about that unless I didn't misinterpret it entirely?

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [34]

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Yes. Last quarter, we've made a comment that we see in a mature situation, the TradeRev gross margin as being 75% or better. And that's consistent with the online marketplace. That's what we said. We're not quite there yet, but I will tell you, we're very close. We've brought it up substantially with the change in these incentive programs. And we're seeing margins, again, across all the cars sold that I think -- again, they're greater margin than we see in the physical auction business for a dealer consignment car as a percent of revenue. And the other thing is the revenue per vehicle sold has also increased. It's really a great direction to the point where I would say, if the car sells on TradeRev versus physical auction, I'm not sure there is a difference in the ultimate gross margin dollars we're realizing at this stage.

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Operator [35]

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Our next question comes from Daniel Imbro with Stephens Inc.

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Daniel Robert Imbro, Stephens Inc., Research Division - Research Analyst [36]

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I wanted to follow up on the last few questions. Obviously, mentioning kind of dialing back the incentive program at TradeRev. Have you seen any competitive responses in that market as you've done that? Are your peers dialing that back? And then, Eric, you just mentioned RPU, if I recall part of what drove up RPU, you are taking up some pricing at TradeRev to offset these incentives. Have you been able to hold on to those RPU increases as you dialed back these incentives?

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [37]

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So Daniel, I'll take the first part of that, and then I'll let Eric take the second part of that. In terms of competitors in the marketplace. Certainly, we get the anecdotal feedback and we listen to our dealers, and we talk with our sales reps and people in the field, and we generally know what's going on with the competition. But for the most part, we know there are good competition in the marketplace, but we're really focused on what we're doing and the value that we can deliver to our customer. And it's not just about being in the market with the technology, but it's about building out a real infrastructure to continue to support these -- this market segment going forward. We talk about the 5 million cars. And so it's -- yes, technology gets the transaction done, but we talk about our transportation, we talk about our finance, and we talk about our inspections. We talk about the other services that we offer in terms of how we take care of payment and how we take care of title, how we take care and handle arbitrations. Just -- there is a lot more than just selling the cars off. And those are the areas that we're focused on is, as I said in an earlier comment, I guess with -- in another conversation I said, our goal is not -- this is not a sprint. This is a marathon. And we're looking to win the marathon. We're looking at the long-term value that we can create here, and we think we have the assets that create that value.

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [38]

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And then specifically to RPU. The increase is because the TradeRev team recognized that the dealers value this transaction and were willing to pay more for it. Separately, though, the margin went up in part because we were also then able to package the incentives and reduced our costs on executing the transactions with lower transportation and support that we provide to them. But the RPU is sticking because of the value of the transaction they're willing to pay for it when they find the cars that they want to buy, and then the margin goes up when I can reduce the incentives. It had -- it did not influence what they were paying.

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Daniel Robert Imbro, Stephens Inc., Research Division - Research Analyst [39]

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Okay. Got it. And then just as a quick follow-up to that. We're seeing the RPU sustaining, and I think you mentioned a minute ago, Eric, that we're seeing gross margins already pretty close to that 75%. But we still saw losses, kind of, call it, $17 million in the first quarter, so call it on track for your full year losses. Do you know what's driving that loss? And how that's going to get better as we move through the year? Is it just the scale? Or what's going to drive the improvement in profitability if we're already there on the gross margin side?

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [40]

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It's the cost of the field staff, the TradeRev [kit]. Again, this is hand-to-hand combat, I'd like to say. Where they're out there with people talking to dealers, it's the training, it's the sales support team that's behind the scenes. All the people that are doing the work, entering images and helping the dealers do all of that. So the field team or -- the SG&A cost that I talked about was a big driver of it. And what's exciting is, as the volume picks up, which I am confident it will, that's going to offset some of that cost in future quarters because I think we've had the growth of the expense ahead of what revenue it generates and that's normal in a new business. So we will start to absorb some of that with this increased gross margin on a per-car-sold basis.

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Operator [41]

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Our next question comes from Bret Jordan with Jefferies.

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Bret David Jordan, Jefferies LLC, Research Division - Equity Analyst [42]

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As you got a bit more experience, I guess, pitching against ACV. How's the dealer response to using both of them? Are you seeing that they are open to 2 platforms? Or is it usually focusing on one?

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [43]

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Yes. I think that -- I think where you see it, Bret, is that you see that buyers tend to look at both platforms. I think dealers tend to sell on one platform. And that's just -- again, I don't have a lot of factual information around that, but that's kind of the feedback that we're getting in the market that they'll pick one or the other to sell, but buyers will go anywhere they can to get a car.

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Bret David Jordan, Jefferies LLC, Research Division - Equity Analyst [44]

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Okay. And then as far as dealer ramp goes. Yes, you've got labor out there, you're helping them upload and train them to use it. Are they usually sort of weaning themselves off your labor and doing it themselves? Or do you have to stay with them fairly long now?

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [45]

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Yes. We're finding that we're having to stay with them for a longer period of time. It's different dealer to dealer. And we have some dealers that probably don't need the help quite to the same extent. But for the most part, that was a decision that we made in our strategy with the leadership team at TradeRev over the course of the last year or last 7 or 8 months is really having that person there to, if you will, hold their hand, and assist them and continue to get them through this transformational change.

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Bret David Jordan, Jefferies LLC, Research Division - Equity Analyst [46]

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Okay. And then final, what are you seeing sort of the average profile of a TradeRev car? Maybe what its value is compared to the average ADESA car?

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [47]

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Yes. It's somewhere in the order of $6,000 to $7,000.

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Operator [48]

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Our next question comes from Bob Labick with CJS Securities.

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Robert James Labick, CJS Securities, Inc. - President & Director of Research [49]

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Obviously, a lot of color on TradeRev. So thank you for that. I figured I'd jump over and ask a question on IAA because obviously a big part of the company as well.

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [50]

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It's just a little part of our business we ought to talk about, right?

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Robert James Labick, CJS Securities, Inc. - President & Director of Research [51]

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Yes. Why not. So I guess 2 questions. First, you have very nice price capture, about 5% in the quarter. So I was wondering if you could expand on the thoughts going forward for that. And then, Jim, you mentioned 1% volume obviously in this quarter but then a good inventory growth. And then you mentioned 5% to 7% growth. Was that volume growth you're anticipating, 5% to 7%? Or is that price plus volume? Because you were obviously there with the 1% and the 6%.

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [52]

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Yes. So Bob, we're -- I was talking volume growth of 5% to 7%.

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Robert James Labick, CJS Securities, Inc. - President & Director of Research [53]

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Okay. Great. And then do you think the -- so talk about the drivers of the 5% price, please. And how sustainable that is going forward?

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [54]

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Yes. Well, one of the things that we're seeing is that when you think about the drivers of that business, we're seeing more and more vehicles being written off as a percent of total accidents. As a matter of fact, in the quarter, that was at 19%, right around 19% of all accidented cars were declared in a total loss. And that comes down to what we talked about in terms of the sophistication of these vehicles with all the new technologies, there's a tendency to write-off more -- of more and more of these cars. And it tends to be a higher-dollar car. And as a result of higher-dollar car, that's driving proceeds overall. You think about the other things that drive that business and they all tend to be tailwinds right now. Talking about miles driven, you're talking about our international buyer base, talking about scrap metal prices. All -- to a certain extent, all of those things are kind of playing a role. But when you get these 5 or 6 different drivers, all the kind of tailwinds at your back, they add up to driving the overall proceeds for vehicles. Eric, would you add anything?

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [55]

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The only thing -- and then we realized that through the increased buy fee. The 5% came from buy fee increases as they're paying more on average for the vehicles they're acquiring, to Jim's point.

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Robert James Labick, CJS Securities, Inc. - President & Director of Research [56]

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Got it. Okay. Great. And then if not now obviously, I guess, it would be soon but I guess I'll ask. In terms of capital allocation and dividend and uses of free cash at IAA, how much can you tell us about the expectations going forward?

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [57]

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Yes. So really, we need to wait until the spin actually happens. And we have a Board in place and the management team and the new Board will really set that into motion. And I think it's a little bit too early for us to comment on that. Although, obviously, we're preparing to get those things in place at the time of the execution of the spin. Eric?

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [58]

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Yes. It will be a decision by the new Board as to what dividend policy is. And so until the spin occurs, we will not be providing any information on what they intend to do because we don't know.

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Operator [59]

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Our next question comes from John Sykes with Nomura.

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John Sykes, Nomura Securities Co. Ltd., Research Division - Analyst [60]

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My question is a little bit tied in with the last question. But I was just trying to get -- really get a sense as to what sort of the free cash flow of the existing business will be. And the reason for that is when you look at Moody's, they've got it on watch negative. And I guess they're looking, too. They want to see what ends up kind of happening. But let me ask this. To the degree that you continue to generate a decent amount of free cash flow, how much of that's going to go to deleveraging the existing business versus shareholder initiatives?

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [61]

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So John, this is Eric. The first and foremost, I -- as I mentioned in the comments, the entire proceeds of the capital raised by IAA will be distributed back to Remainco. And Remainco, as part of the tax-free reorganization, we are using all of the proceeds to repay existing debt. So the leverage level at Remainco will be lower than the spin. We have begun the rating process. Again, in the next couple of days, we'll launch the debt transaction and part of that process is they do ratings of Spinco, but they're also looking at Remainco. And I am confident we've answered the questions that might have caused them to put us on credit watch. And we'll see how they come out, but I think we've answered their questions now that they see the proceeds are going to be used to repay debt, I think that's a positive.

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Operator [62]

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(Operator Instructions) Our next question comes from Derek Glynn with Consumer Edge Research.

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Derek J. Glynn, Consumer Edge Research, LLC - Analyst [63]

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Just following up on the commentary around total loss frequency. Just based on the C2C data you've disclosed over the years, total loss has been steadily increasing year-over-year. Just curious if you think there is any level where that total loss rate may actually top out?

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [64]

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Yes. Great question and a question that we often get asked. Quite frankly, we just stepped back 3 or 4 years. Total losses were around 13%. And we watched them grow. And I think Eric and I have had conversations as where does it get to? And we always thought, well, maybe the peak is 20%. But now when you're at 19%, you're knocking on the door of 20%. It's a little bit of a guessing game, but we think there is opportunity for it to continue to grow. But certainly, as you know, from history, I got over that predicting game many years ago. So with that, at 19%, we always felt 20%, maybe make it grow a little bit more than that. Eric?

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [65]

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Maybe a low 20%. Who knows? At some point, though, they will top it out because the value of the car is in the replacement parts, and there needs to be a robust collision repair industry to use those parts. So I still think that there is a level at which there will be more cars repaired by a significant number of than cars totaled.

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [66]

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And I'll just maybe reinforce my earlier comment. As we're seeing these vehicles get more and more complex, more and more technology, and then you start thinking about how they talk about cars into the future, I think it only increases the opportunity to maybe write the vehicle off for 2 reasons. Number one, from a financial repair standpoint, but also I'm sure there's going to be legislation around what can be repaired and what can be replaced. And those sorts of things will play into it as we go forward.

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Derek J. Glynn, Consumer Edge Research, LLC - Analyst [67]

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Got it. And then just separately on AFC. The provision for credit losses came in a little lower than we were expecting. What were the puts and takes there during the quarter? And how should we think about that trend through the remainder of the year?

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [68]

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Yes. I think AFC pretty much operated -- it follows the retail activity. I think -- well, I know our loan losses were at 1.6%. That was pretty much exactly the same as it was a year ago. So loan losses were very much in line with our expectations. I think that AFC performed to the retail market. Eric?

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Eric M. Loughmiller, KAR Auction Services, Inc. - Executive VP & CFO [69]

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Right. And we did get a little growth in the portfolio that was probably a little better than a year ago in the first quarter. And that's not driven by the number of transactions. As you can see, we were down 1%, but the average loan balance has gone up as the value of the vehicles has gone up. And the truth is, that's good for our credit profile because those cars are high likelihood of selling as they get up in value. So I think that's really what's contributed to -- again, it was flat, but despite a 1% decline in volume -- number of loan transactions.

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Operator [70]

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Speakers, I am showing no further questions in the queue at this time. I would now like to turn the call back over to Mr. Jim Hallett for any closing remarks.

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James P. Hallett, KAR Auction Services, Inc. - Chairman & CEO [71]

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Thank you, Sheree. First of all, ladies and gentlemen, I want to say thank you for being on this morning. Thank you for your continued interest in our company. I'll just make a couple of comments. As the -- the first quarter was, as I said at the outset, it was as we expected. However, I would say that there was some choppiness to it that we spoke to. And I also mentioned that TradeRev got off to a slow start, but I want to reassure you that I am extremely confident that we will deliver on what we said we would deliver on, and we will reach our goal of selling 200,000 cars on TradeRev platform in 2019. So early inning, maybe a little bit slow. But I think we're catching up fast as we moved into March and April and going forward. So with that, I'm also pleased to make sure there's no confusion. We are doing a spin. And it's going to happen, and our plans are that, that will happen by the end of June. So thank you for being on, and we'll look forward to catching up with you as things develop. Have a great day.

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Operator [72]

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