CARMEL, Ind. -

In a conference call Wednesday to discuss second quarter performance, KAR Auction Services’ chief executive officer Jim Hallett probably spent more time outlining the company’s immediate future — especially at ADESA.

In breaking down the expectations of KAR’s major segments, Hallett shared upbeat projections for Insurance Auto Auctions and Automotive Finance Corp. But for ADESA, Hallett’s commentary to investment analysts was cautionary to say the least.

“At IAA and AFC, we believe our visibility is pretty good, and we have a pretty good understanding of where these businesses are headed and how they’re going to perform,” Hallett stated. “At ADESA, I would term it as being extremely cloudy, as cloudy as I’ve ever seen.”

That cloudy outlook stems from ADESA’s second-quarter volume slipping 14 percent year-over-year, a figure higher than what the National Auto Auction Association reported for the industry as a whole.

The performances at Insurance Auto Auctions and AFC have served to offset ADESA’s drop . IAA’s revenue and gross profit moved 10 percent higher in the second quarter. At AFC, revenue and gross profit shot up 22 and 25 percent, respectively.

Meanwhile for ADESA, revenue was off 8 percent, resulting in gross profit sliding 11 percent.

“In the first half of 2011, we mentioned the shortfall at ADESA was covered by Insurance Auto Auctions and AFC,” Hallett said. “I’m hopeful that’s also going to be the case for the second half of 2011. I would remind you that the tight supply challenges we see at ADESA are truly a benefit to IAA and AFC performance.

“I think it would be prudent of me to caution you that there’s no assurance the strong performance of Insurance Auto Auctions and AFC will continue at the same levels for the remainder of the year and offset the impact of these lower volumes at ADESA,” Hallett pointed out.

The KAR boss said it has “become clear” that whole-car auction volume industry wide likely will be below 8 million units this year.

“Are we faced with some challenging conditions? Absolutely, yes. But I believe our consolidated performance our businesses remains our strength.” Hallett stressed.

Beyond IAA and AFC buoying KAR’s bottom line, Hallett emphasized each of the company’s segments are strong generators of cash. Furthermore, the CEO believes KAR’s early extinguishment of its 8.75 percent Senior Notes, 10 percent Senior Subordinated Notes and former Term Loan B credit facility, which  turned the company’s second quarter results into a net loss, will be extremely beneficial going forward.

“We’re definitely going through some challenging times here,” Hallett acknowledged after being peppered by analyst questions. “This certainly isn’t the first challenge that we’ve dealt with as you think about what we’ve been through in the first half of this year and the last three or four years as a management team.

“I would remind you that this is very talented management team,” he added. “They’re very passionate about this business. We’re a scrappy bunch. We find a way to get things done. I can tell you we will fight to the bitter end to deliver on our goals and expectations.”

Specifics of Future Outlook

Before getting on the call, KAR officials shared some ledger specifics about how they expect the company to fare through the rest of this year.

KAR continues to project 2011 adjusted EBITDA of approximately $500 million. Additionally, the company anticipates achieving net income per share of 45 cents to 50 cents, which reflects the affect of the company’s early extinguishment of debt and related expenses in the second quarter and adjusted net income per share of $1.20 to $1.25.

The company pointed out adjusted net income per share represents GAAP net income per diluted share excluding excess depreciation and amortization and stock-based compensation, both resulting from the 2007 merger, net of taxes, as well as other items shown on the attached reconciliation table.

Additionally, KAR projected its 2011 cash taxes to be in the range of $40 million to $50 million, its effective tax rate to be approximately 25 percent and its capital expenditures to be approximately $85 million.

More Explanation of Cloudy ADESA Future

When Hallett described ADESA’s imminent future as cloudy, call participants wanted to learn more about how that’s connected to the company’s primary customer — used-vehicle dealers. Hallett, an industry veteran with years of experience within all segments of the remarketing and retail marketplaces, tried to frame the changes.

“There’s no question there’s a lot of things going on that are causing unusual behavior, as I would term it,” Hallett began. “I think dealers have changed the profile of the used cars they sell. The dealer who hasn’t typically sold a 5- to 7-year-old car with 120,000 miles on it is now holding onto that car and selling it. Dealers are going greater lengths to acquire cars whether they be from wholesalers, swapping between dealers or going to auctions. I think there’s just a lot of uncertainty.

“It’s just so difficult for dealers to get enough inventory to fill their requirements that they’re just hanging on to more cars,” Hallett continued. “They’re going more places to get cars and perhaps in some cases they’re getting their hands on these cars before they get to the physical auction.”

With dealers using any way possible to find vehicles that will turn, Hallett again repeated the importance of ADESA’s dealer consignment initiatives, something he has highlighted in previous quarterly calls, too.

Hallett mentioned dealer consignment comprises more than 40 percent of ADESA’s current business and is up by double-digits year to date. The CEO also acknowledged that more dealer consignment units going through the ADESA lanes have hurt conversion rates. In the second quarter, ADESA’s conversion rate slid to 60.8 percent from 64.9 percent in the year-ago period.

“Dealer consignment cars convert at a lower rate so we have to get a lot more of these vehicles in order to convert them,” Hallett said.

“We feel there’s more runway and opportunity on the dealer side of the business,” he added. “We feel with the team we have in place at ADESA, we think that will continue to get better as we go forward.”

More ADESA & IAA Synergy

As another avenue of controlling cost and streamlining services, Hallett touched on how KAR is looking into more ways ADESA and Insurance Auto Auctions facilities can operate at the same location.

The KAR boss indicated consolidation is ongoing to merge the business units in Montreal. Furthermore, Hallett noted a pilot program was launched where the same general manger oversaw both ADESA Edmonton and the Insurance Auto Auction location in the province.

Going forward, Hallett said KAR will consider whether to roll out similar initiatives at U.S. locations. He did not give any specific timetable for decisions.

Overall Second-Quarter & First-Half Performance

While so much of Wednesday’s call focused on where KAR might be going, the company did reveal its second-quarter performance.

The company’s second-quarter revenue was $470.6 million, and adjusted EBITDA came in at $132.1 million. In the second quarter a year ago, those figures were $470.0 million and $131.0 million, respectively.

As mentioned previously, due to the early extinguishment of the company’s 8.75 percent Senior Notes, 10 percent Senior Subordinated Notes and former Term Loan B credit facility, the company reported a net loss for the second quarter of $14.3 million or 11 cents per diluted share.

For reference, in the second quarter of 2010 KAR posted net income of $28.6 million or 21 cents per diluted share.

Looking at its performance for the first half of 2011, KAR reported $953.3 million in revenue, up from $928.4 million during the same period a year ago. That difference translated into an increase of 3 percent.

The company computed its adjusted EBITDA also climbed by the same percentage year-over-year, from $251.1 million to $259.4 million.

Turning Back to ADESA

Hallett acknowledged again when talking about ADESA, “at the risk of sounding like a broken record, it’s more of the same.”

Despite the declines in revenue and gross profit, Hallett specifically mentioned how ADESA managed a minimal change in gross margin. The second-quarter reading was 44.2 percent, while a year ago it was 45.4 percent.

ADESA’s revenue generated during the first six months of 2011 slid 5 percent to $525.8 million from $553.7 million.

New Rental Car Program Bolsters IAA

Part of the reason Insurance Auto Auctions watched second-quarter revenue climb to $173.2 million and gross profit tick up to $72.2 million is a new program IAA rolled out with rental car companies.

“As you know, these rental cars companies are for the most part self-insured. There are a number of vehicles that are damaged and are less than perfect,” Hallett stated.

“In the past, these cars were sold at a whole-car auction. We’ve now piloted a program with the rental car companies to sell these rental cars at Insurance Auto Auctions,” he continued.

“We’ve had very good success. We’ve been able to get these cars in front of a better buyer base. We’ve been able to increase the proceeds for these rental car companies. As a result, we’re getting more and more of these rental cars coming to Insurance Auto Auctions.”

Along with deeper relationships with rental car companies, Hallett also pointed out its vehicle remarketing division is also growing. Hallett explained this IAA division “focuses on selling those low-end cars that don’t typically make it to a whole-car auction. I often refer to these as the push, pull, drag sleds that are sitting in the back row of a dealer’s lot.”

Hallett indicated about 50 percent of Insurance Auto Auctions’ site have a vehicle remarketing division with plan to increase that penetration in the future.

All of these programs could help IAA generated even more revenue and gross profit. During the first half of 2011, IAA’s revenue came in at $349.1 million, and gross profit settled at $147.7 million.

What about AFC?

As Hallett highlighted, AFC’s performance also is helping KAR overcome any shortfall from ADESA.

AFC’s second-quarter revenue was $39.9 million, creating $31.8 million in gross profit. Through the first half of the year, the segment’s revenue was $78.4 million, and gross profit was $62.6 million.

Thanks to a portfolio that is more than 99 percent current and KAR restructuring its debt to increase AFC lending capacity by more than $100 million, Hallett indicated the segment likely will embark on flooring motorcycles, RVs, boats and other powersports equipment along with vehicles.

“AFC has exceeded our expectations,” Hallett concluded.