**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM 10-Q**

**QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**Forthe quarterly period ended June 30, 2006**

**CommissionFile Number 001-32198**

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**ADESA, Inc.**

(Exact name of Registrantas specified in its charter)

| **Delaware**                                                     |   | **35-1842546**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |

 

**13085 Hamilton CrossingBoulevardCarmel, Indiana 46032**

(Address of principalexecutive offices and zip code)

Registrant’s telephonenumber, including area code: **(800) 923-3725**

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Indicate by check mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the Registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.

Yes x    Noo

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one):

| Large accelerated filer  x |   | Accelerated filer  o |   | Non-accelerated filer  o |
|--------------------------------------|--------|--------------------------------|--------|------------------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o    Nox

The number ofshares of common stock outstanding as of July 31, 2006:

| Class  | ** ** | **Number of Shares Outstanding** |
|--------|------------|----------------------------------|
| Common |       | 89,896,060                       |

 

 

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**Index**

|                                      | ** **                                                                                  | **Page** |
|--------------------------------------|---------------------------------------------------------------------------------------------|----------|
| PART I—FINANCIAL INFORMATION    |                                                                                        |     |
| Item 1.                              | Financial  Statements                                                                       |     |   |
|                                 | Consolidated  Statements of Income                                                          |     | 3 |
|                                 | Consolidated  Balance Sheets                                                                |     | 4 |
|                                 | Consolidated  Statement of Stockholders’ Equity                                        |     | 6 |
|                                 | Consolidated  Statements of Cash Flows                                                      |     | 7 |
|                                 | Notes  to Consolidated Financial Statements                                                 |     | 8 |
| Item 2.                              | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |     | 25 |
| Item 3.                              | Quantitative  and Qualitative Disclosures About Market Risk                                 |     | 44 |
| Item 4.                              | Controls  and Procedures                                                                    |     | 45 |
| PART II—OTHER  INFORMATION |                                                                                        |     |
| Item 1.                              | Legal  Proceedings                                                                          |     | 46 |
| Item 1A.                             | Risk Factors                                                                                |     | 47 |
| Item 2.                              | Unregistered  Sales of Equity Securities and Use of Proceeds                                |     | 48 |
| Item 4.                              | Submission  of Matters to a Vote of Security Holders                                        |     | 48 |
| Item 6.                              | Exhibits                                                                                    |     | 49 |
| Signatures                           |                                                                                        | 50       |
| Exhibit Index                   |                                                                                        | 51       |

 

2

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**PART I**

**FINANCIALINFORMATION**

**Item 1.**                        FinancialStatements

**ADESA, Inc.Consolidated Statements of Income*(In millions, except per share data)**(unaudited)***

| ** **                                                     | ** ** | **Three Months Ended  June 30,**          | ** ** | **Six Months Ended  June 30,**            | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                     | ** ** | **    2006    ** | ** ** | **    2005    ** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Operating revenues                                             | ** ** |                                                     | ** ** | ** **                                               |       |   | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |
| Auction services group                                         | ** ** |                                                     | **$**      | **239.7**                                                | ** ** |   |   | $ | 214.3 |   |   | **$** | **490.1** |   | $ | 428.0 |   |
| Dealer services group                                          | ** ** |                                                     | **36.2**   | ** **                                               |       |   | 32.2 |   |   | **71.4** |   | 61.2 |   |
| Total operating  revenues                                      | ** ** |                                                     | **275.9**  | ** **                                               |       |   | 246.5 |   |   | **561.5** |   | 489.2 |   |
| Operating  expenses                                            | ** ** |                                                     | ** ** | ** **                                               |       |   |   |   |   | ** ** |   |   |   |
| Cost of services (exclusive of depreciation and  amortization) | ** ** |                                                     | **137.7**  | ** **                                               |       |   | 115.1 |   |   | **281.9** |   | 229.6 |   |
| Selling, general and administrative                            | ** ** |                                                     | **63.8**   | ** **                                               |       |   | 56.1 |   |   | **130.7** |   | 110.9 |   |
| Depreciation and amortization                                  | ** ** |                                                     | **11.0**   | ** **                                               |       |   | 10.0 |   |   | **21.8** |   | 19.2 |   |
| Total operating  expenses                                      | ** ** |                                                     | **212.5**  | ** **                                               |       |   | 181.2 |   |   | **434.4** |   | 359.7 |   |
| Operating profit                                               | ** ** |                                                     | **63.4**   | ** **                                               |       |   | 65.3 |   |   | **127.1** |   | 129.5 |   |
| Interest expense                                               | ** ** |                                                     | **7.1**    | ** **                                               |       |   | 8.5 |   |   | **14.1** |   | 16.6 |   |
| Other income, net                                              | ** ** |                                                     | **(1.8**   | **)**                                                    |       |   | (2.3 | ) |   | **(3.5** | **)** | (3.8 | ) |
| Income from continuing operations before income  taxes         | ** ** |                                                     | **58.1**   | ** **                                               |       |   | 59.1 |   |   | **116.5** |   | 116.7 |   |
| Income taxes                                                   | ** ** |                                                     | **21.9**   | ** **                                               |       |   | 23.0 |   |   | **44.0** |   | 45.5 |   |
| Income from continuing operations                              | ** ** |                                                     | **36.2**   | ** **                                               |       |   | 36.1 |   |   | **72.5** |   | 71.2 |   |
| Loss from discontinued operations, net of income  taxes        | ** ** |                                                     | **(0.1**   | **)**                                                    |       |   | (0.2 | ) |   | **(0.1** | **)** | (0.3 | ) |
| Net income                                                     | ** ** |                                                     | **$**      | **36.1**                                                 | ** ** |   |   | $ | 35.9 |   |   | **$** | **72.4** |   | $ | 70.9 |   |
| Earnings per  share—basic                                 | ** ** |                                                     | ** ** | ** **                                               |       |   |   |   |   | ** ** |   |   |   |
| Income from continuing operations                              | ** ** |                                                     | **$**      | **0.40**                                                 | ** ** |   |   | $ | 0.40 |   |   | **$** | **0.81** |   | $ | 0.79 |   |
| Loss from discontinued operations, net of income  taxes        | ** ** |                                                     | **—** | ** **                                               |       |   | — |   |   | **—** |   | — |   |
| Net income                                                     | ** ** |                                                     | **$**      | **0.40**                                                 | ** ** |   |   | $ | 0.40 |   |   | **$** | **0.81** |   | $ | 0.79 |   |
| Earnings per  share—diluted                               | ** ** |                                                     | ** ** | ** **                                               |       |   |   |   |   | ** ** |   |   |   |
| Income from continuing operations                              | ** ** |                                                     | **$**      | **0.40**                                                 | ** ** |   |   | $ | 0.40 |   |   | **$** | **0.80** |   | $ | 0.78 |   |
| Loss from discontinued operations, net of income  taxes        | ** ** |                                                     | **—** | ** **                                               |       |   | — |   |   | **—** |   | — |   |
| Net income                                                     | ** ** |                                                     | **$**      | **0.40**                                                 | ** ** |   |   | $ | 0.40 |   |   | **$** | **0.80** |   | $ | 0.78 |   |
| Dividends  declared per common share (Note 11)                 | ** ** |                                                     | **$**      | **0.075**                                                | ** ** |   |   | $ | 0.075 |   |   | **$** | **0.15** |   | $ | 0.15 |   |

 

See notes to consolidated financial statements

3

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**ADESA, Inc.Consolidated Balance Sheets*(In millions, except share and per share data)***

| ** **                                                                                  | ** **   | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------|--------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                  | ** **   | **2006**          | ** ** | **2005**              | ** ** |
| ** **                                                                                  | *** *** | ***(unaudited)*** | ** ** | ** **            | ** ** |
| **Assets**                                                                                  |         |              |       |                  |       |   |   |   |   |
| ***Current assets***                                                                        |         |              |       |                  |       |   |   |   |   |
| Cash and cash equivalents                                                                   | ** **   | ** **        | **$**      | **210.1**             |       |   |   | $ | 240.2 |   |   |
| Restricted cash                                                                             | ** **   | ** **        | **7.0**    |                  |       |   | 5.7 |   |   |
| Trade receivables, net of allowances of $4.7 (2006) and $3.9 (2005)                         | ** **   | ** **        | **248.7**  |                  |       |   | 188.6 |   |   |
| Finance receivables, net of allowances of $3.4 (2006) and $2.4 (2005)                       | ** **   | ** **        | **247.7**  |                  |       |   | 196.7 |   |   |
| Retained interests in finance receivables sold                                              | ** **   | ** **        | **63.6**   |                  |       |   | 56.8 |   |   |
| Deferred income taxes                                                                       | ** **   | ** **        | **19.7**   |                  |       |   | 21.6 |   |   |
| Other current assets                                                                        | ** **   | ** **        | **15.6**   |                  |       |   | 14.5 |   |   |
| Total current assets                                                                        | ** **   | ** **        | **812.4**  |                  |       |   | 724.1 |   |   |
| ***Other assets***                                                                          | ** **   | ** **        | ** ** |                  |       |   |   |   |   |
| Goodwill                                                                                    | ** **   | ** **        | **547.3**  |                  |       |   | 532.6 |   |   |
| Other intangible assets, net of accumulated amortization of $34.9  (2006) and $29.8 (2005)  | ** **   | ** **        | **45.1**   |                  |       |   | 42.0 |   |   |
| Other assets                                                                                | ** **   | ** **        | **66.0**   |                  |       |   | 50.9 |   |   |
| Total other assets                                                                          | ** **   | ** **        | **658.4**  |                  |       |   | 625.5 |   |   |
| Property and equipment, net of  accumulated depreciation of $172.4 (2006) and $155.2 (2005) | ** **   | ** **        | **605.6**  |                  |       |   | 595.9 |   |   |
| Total assets                                                                                | ** **   | ** **        | **$**      | **2,076.4**           |       |   |   | $ | 1,945.5 |   |   |

 

See notes to consolidated financial statements

4

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**ADESA, Inc.Consolidated Balance Sheets*(In millions, except share and per share data)***

| ** **                                          | ** **   | **June 30,  2006** | ** **  | **December 31,  2005** | ** ** |
|-----------------------------------------------------|--------------|-------------------------|-------------|-----------------------------|------------|
| ** **                                          | *** *** | ***(unaudited)***       | ** **  | ** **                  | ** ** |
| **Liabilities  and Stockholders’ Equity**      | ** **   |                    | ** **  |                        |       |   | ** ** | ** ** |   |
| ***Current liabilities***                           | ** **   |                    | ** **  |                        |       |   | ** ** | ** ** |   |
| Accounts payable                                    | ** **   |                    | **$**       | **336.9**                   |       |   |   | $ | 270.3 |   |   |
| Accrued employee benefits and compensation expenses | ** **   |                    | **36.8**    |                        |       |   | 35.0 |   |   |
| Other accrued expenses                              | ** **   |                    | **36.9**    |                        |       |   | 36.7 |   |   |
| Income taxes payable                                | ** **   |                    | **1.6**     |                        |       |   | 3.3 |   |   |
| Current maturities of long-term debt                | ** **   |                    | **70.0**    |                        |       |   | 70.0 |   |   |
| Current liabilities of discontinued operations      | ** **   |                    | **7.0**     |                        |       |   | 6.8 |   |   |
| Total current liabilities                           | ** **   |                    | **489.2**   |                        |       |   | 422.1 |   |   |
| ***Non-current liabilities***                       | ** **   |                    | ** **  |                        |       |   |   |   |   |
| Long-term debt                                      | ** **   |                    | **347.5**   |                        |       |   | 362.5 |   |   |
| Deferred tax liabilities                            | ** **   |                    | **64.3**    |                        |       |   | 63.6 |   |   |
| Other liabilities                                   | ** **   |                    | **7.1**     |                        |       |   | 7.4 |   |   |
| Total non-current liabilities                       | ** **   |                    | **418.9**   |                        |       |   | 433.5 |   |   |
| Commitments and contingencies  (Note 12)            | ** **   |                    | **—**  |                        |       |   | — |   |   |
| ***Stockholders’ equity***                     | ** **   |                    | ** **  |                        |       |   |   |   |   |
| Preferred stock, $0.01 par value:                   | ** **   |                    | ** **  |                        |       |   |   |   |   |
| Authorized shares: 50,000,000  Issued shares: none  | ** **   |                    | **—**  |                        |       |   | — |   |   |
| Common stock, $0.01 par value:                      | ** **   |                    | ** **  |                        |       |   |   |   |   |
| Authorized shares: 500,000,000                      | ** **   |                    | ** **  |                        |       |   |   |   |   |
| Issued shares: 94,868,104  (2006 and 2005)          | ** **   |                    | **1.0**     |                        |       |   | 1.0 |   |   |
| Additional paid-in capital                          | ** **   |                    | **670.9**   |                        |       |   | 668.3 |   |   |
| Retained earnings                                   | ** **   |                    | **539.7**   |                        |       |   | 480.7 |   |   |
| Treasury stock, at cost:                            | ** **   |                    | ** **  | ** **                  |       |   |   |   |   |
| Shares: 4,982,373 (2006)  5,275,585 (2005)          | ** **   |                    | **(104.6**  | **)**                       |       |   | (110.7 | ) |   |
| Accumulated other comprehensive income              | ** **   |                    | **61.3**    |                        |       |   | 50.6 |   |   |
| Total stockholders’ equity                     | ** **   |                    | **1,168.3** |                        |       |   | 1,089.9 |   |   |
| Total liabilities and stockholders’ equity     | ** **   |                    | **$**       | **2,076.4**                 |       |   |   | $ | 1,945.5 |   |   |

 

See notes to consolidated financial statements

5

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**ADESA, Inc.Consolidated Statement of Stockholders’ Equity*(In millions)**(unaudited)***

| ** **                                  | ** ** | **Common  Stock Shares** | ** ** | **Common  Stock Amount** | ** ** | **Additional  Paid-In Capital** | ** ** | **Retained  Earnings** | ** ** | **Treasury  Stock** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total**  | ** ** |
|---------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|--------------------------------------|------------|------------------------|------------|---------------------|------------|-----------------------------------------------------------|------------|------------|------------|
| **Balance  at December 31, 2005**      |       |                          | 94.9       |                          |       |                                 | $          | 1.0                    |       |                |       | $                                                         | 668.3      |       |       |   | $ | 480.7 |   |   | $ | (110.7 | ) |   | $ | 50.6 |   |   | $ | 1,089.9 |   |
| Comprehensive  income:                      |       |                          |       |                          |       |                                 |       |                   |       |                |       |                                                      |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                  |       |                          |       |                          |       |                                 |       |                   |       |                |       |                                                      |       |       | 72.4       |   |   |   |   |   |   |   |   | 72.4 |   |
| Other comprehensive income, net of tax:     |       |                          |       |                          |       |                                 |       |                   |       |                |       |                                                      |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Foreign currency translation                |       |                          |       |                          |       |                                 |       |                   |       |                |       |                                                      |       |       |       |   |   |   |   |   | 10.5 |   |   |   |   |
| Unrealized gain on interest rate swaps      |       |                          |       |                          |       |                                 |       |                   |       |                |       |                                                      |       |       |       |   |   |   |   |   | 0.2 |   |   |   |   |
| Other comprehensive income                  |       |                          |       |                          |       |                                 |       |                   |       |                |       |                                                      |       |       |       |   |   |   |   |   |   |   |   | 10.7 |   |
| Comprehensive  income                       |       |                          |       |                          |       |                                 |       |                   |       |                |       |                                                      |       |       |       |   |   |   |   |   |   |   |   | 83.1 |   |
| Cash dividends  paid to stockholders        |       |                          |       |                          |       |                                 |       |                   |       |                |       |                                                      |       |       | (13.4      | ) |   |   |   |   |   |   |   | (13.4 | ) |
| Issuance of  common stock under stock plans |       |                          |       |                          |       |                                 |       |                   |       |                | 1.4        |                                                      |       |       |       |   |   | 6.1 |   |   |   |   |   | 7.5 |   |
| Stock based  compensation expense           |       |                          |       |                          |       |                                 |       |                   |       |                | 1.2        |                                                      |       |       |       |   |   |   |   |   |   |   |   | 1.2 |   |
| **Balance at June 30, 2006**           |       |                          | **94.9**   |                          | ** ** | ** **                           | **$**      | **1.0**                |       | ** **          | ** ** | **$**                                                     | **670.9**  |       | ** ** | ** ** | **$** | **539.7** |   | ** ** | **$** | **(104.6** | **)** |   | **$** | **61.3** |   | ** ** | **$** | **1,168.3** |   |
| ** **                                  |       |                          | ** ** |                          | ** ** | ** **                           | ** ** |                   | ** ** | ** **          | ** ** |                                                      | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** |   | ** ** |   | ** ** | ** ** |   |

 

See notes toconsolidated financial statements

6

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**ADESA, Inc.**

**ConsolidatedStatements of Cash Flows**

***(In millions)***

***(unaudited)***

| ** **                                                                             | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                             | ** ** | **2006**                                      | ** ** | **2005** | ** ** |
| **Operating  activities**                                                              | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Net income                                                                             | ** ** | **$**                                         | **72.4**   |   | $ | 70.9 |   |
| **Adjustments  to reconcile net income to net cash provided by operating activities:** | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Depreciation and amortization                                                          | ** ** | **21.8**                                      |       | 19.2 |   |
| Bad debt expense                                                                       | ** ** | **2.4**                                       |       | 1.0 |   |
| Deferred income taxes                                                                  | ** ** | **2.0**                                       |       | 2.2 |   |
| Stock-based compensation expense                                                       | ** ** | **3.4**                                       |       | 1.5 |   |
| Other non-cash, net                                                                    | ** ** | **1.7**                                       |       | 1.6 |   |
|                                                                                   | ** ** | **103.7**                                     |       | 96.4 |   |
| **Changes  in operating assets and liabilities, net of acquisitions:**                 | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Finance receivables held for sale                                                      | ** ** | **(20.0**                                     | **)**      | (31.8 | ) |
| Retained interests in finance receivables sold                                         | ** ** | **(6.8**                                      | **)**      | (6.2 | ) |
| Trade receivables and other assets                                                     | ** ** | **(60.4**                                     | **)**      | (137.9 | ) |
| Accounts payable and accrued expenses                                                  | ** ** | **39.2**                                      |       | 117.2 |   |
| **Net cash provided by operating activities**                                          | ** ** | **55.7**                                      |       | 37.7 |   |
| **Investing  activities**                                                              | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Net increase in finance receivables held for  investment                               | ** ** | **(30.6**                                     | **)**      | (23.4 | ) |
| Acquisition of businesses, net of cash acquired                                        | ** ** | **(30.0**                                     | **)**      | (18.7 | ) |
| Purchases of property, equipment and computer  software                                | ** ** | **(16.9**                                     | **)**      | (36.7 | ) |
| Purchase of other intangibles                                                          | ** ** | **(0.4**                                      | **)**      | (0.3 | ) |
| Proceeds from the sale of property, equipment and  computer software                   | ** ** | **—**                                    |       | 0.1 |   |
| Purchase of equity investment                                                          | ** ** | **(12.5**                                     | **)**      | — |   |
| Transfer to restricted cash                                                            | ** ** | **(1.3**                                      | **)**      | (0.9 | ) |
| **Net  cash used by investing activities**                                             | ** ** | **(91.7**                                     | **)**      | (79.9 | ) |
| **Financing  activities**                                                              | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Net increase in book overdrafts                                                        | ** ** | **27.8**                                      |       | 52.6 |   |
| Payments on long-term debt                                                             | ** ** | **(15.0**                                     | **)**      | (18.5 | ) |
| Issuance of common stock under stock plans                                             | ** ** | **6.0**                                       |       | 9.1 |   |
| Dividends paid to stockholders                                                         | ** ** | **(13.4**                                     | **)**      | (13.5 | ) |
| Repurchase of common stock                                                             | ** ** | **—**                                    |       | (43.4 | ) |
| **Net cash provided by (used by) financing  activities**                               | ** ** | **5.4**                                       |       | (13.7 | ) |
| Effect of exchange rate changes on cash                                                | ** ** | **0.5**                                       |       | (0.8 | ) |
| **Net decrease in cash and cash equivalents**                                          | ** ** | **(30.1**                                     | **)**      | (56.7 | ) |
| Cash and cash  equivalents at beginning of period                                      | ** ** | **240.2**                                     |       | 304.5 |   |
| Cash and cash  equivalents at end of period                                            | ** ** | **$**                                         | **210.1**  |   | $ | 247.8 |   |

 

See notes to consolidated financial statements

7

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements**

**Note 1—Summary ofSignificant Accounting Policies**

***Basis of Presentation***

The accompanying unaudited consolidated financialstatements have been prepared in accordance with generally accepted accountingprinciples for interim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, they do not include all ofthe information and footnotes required by generally accepted accountingprinciples for complete financial statements. Operating results for interimperiods are not necessarily indicative of results that may be expected for theyear as a whole. In the opinion of management, the consolidated financialstatements reflect all adjustments considered necessary (consisting of normalrecurring accruals) for a fair statement of the Company’s financial results forthe periods presented. The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets,liabilities, revenues, expenses and related disclosures at the date of thefinancial statements and during the reporting period. Actual results coulddiffer from these estimates. A listing of the Company’s critical accountingestimates is described in the “Critical Accounting Estimates” section of “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” inthis Form 10-Q and in Part II, Item 7, Note 3 and elsewhere in the Notes to the ConsolidatedFinancial Statements included in the Company’s 2005 Annual Report on Form 10-K,which includes audited financial statements.

These consolidated financial statements and condensednotes to consolidated financial statements are unaudited and should be read inconjunction with the audited consolidated financial statements and notesthereto for the year ended December 31, 2005 included in the Company’sAnnual Report on Form 10-K (Commission file number 001-32198)filed with the Securities and Exchange Commission (“SEC”). The 2005 year-endconsolidated balance sheet data included in this Form 10-Q wasderived from the audited financial statements referenced above, but does notinclude all disclosures required by accounting principles generally accepted inthe United States of America. As used herein, the terms the “Company” and “ADESA”shall mean ADESA, Inc. and its consolidated subsidiaries. The term “ALLETE”shall mean ADESA’s former parent, ALLETE, Inc. and its consolidatedsubsidiaries.

ADESA is the second largest used vehicle auctionnetwork in North America, based upon the number of used vehicles sold throughauctions annually, and also provides services such as inbound and outboundlogistics, reconditioning, vehicle inspection and certification, titling,administrative and salvage recovery services. Through its wholly ownedsubsidiary Automotive Finance Corporation (“AFC”), the Company also providesshort-term inventory-secured financing, known as floorplan financing, to usedvehicle dealers. ADESA is able to serve the diverse and multi-faceted needs ofits customers through the wide range of services offered at its facilities.

Included in the resultsfor the six months ended June 30, 2006, was a $2.7 million pretax chargeincurred in the first quarter of 2006, or $0.02 per diluted share, related tothe correction of certain unreconciled balance sheet differences concealed by aformer employee at the Company’s Kitchener, Ontario, auction facility. Thecorrections were recorded in “Selling, general and administrative” expenses anddecreased net income for the six months ended June 30, 2006 by a total of$1.7 million.

***Reclassifications and Revisions***

Certain prior year amountsin the consolidated financial statements have been reclassified or revised toconform to the current year presentation.

8

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements (Continued)**

*DiscontinuedOperations*

In February 2003,management approved a plan to discontinue the operations of the Company’svehicle importation business. In August 2005, ADESA sold ComSearch, Inc.The financial results of the vehicle importation business and ComSearch havebeen reclassified as discontinued operations for all periods presented.

*Revisions Relatedto Cash Flows from Finance Receivables*

AFC sells the majority of its U.S. dollar denominated finance receivableson a revolving basis and without recourse to a wholly owned, bankruptcy remote,consolidated, special purpose subsidiary (“AFC Funding Corporation”). AFCFunding Corporation securitizes a portion of its floorplan receivables using arevolving securitization structure. The securitization agreement allows for therevolving sale of undivided interests in certain eligible finance receivablesby AFC Funding Corporation to a bank conduit facility.

Prior to December 31,2005, ADESA reported an increase or decrease in operating cash flows in theConsolidated Statements of Cash Flows related to the origination and collectionof certain finance receivables that were held for investment. This cash flowtreatment followed AFC’s principal operating activity, originating andservicing floorplan receivables; however, according to Statement of FinancialAccounting Standards (“SFAS”) No. 102, *Statement of Cash Flows—Exemptionof Certain Enterprises and Classification of Cash Flows from Certain SecuritiesAcquired for Resale*, cash receipts and cash payments related tofinance receivables held for investment should be classified within investingactivities in the Consolidated Statements of Cash Flows. Cash flows related tothe origination and collections of finance receivables held for investment arerecorded in investing activities in the Consolidated Statements of Cash Flows.

Consequently, to achieve comparable presentation forall periods presented, the net change in finance receivables held forinvestment in the Consolidated Statements of Cash Flows for the six monthsended June 30, 2005 has been revised. The amounts revised were deemedimmaterial to the Company’s prior financial statements. These revisions had noimpact on the total “Net (decrease) increase in cash and cash equivalents” onthe Consolidated Statements of Cash Flows.

TheCompany has and will revise its presentation of the cash flows from financereceivables held for investment in its Consolidated Statements of Cash Flowsprospectively for the comparable quarterly periods in 2005 in its 2006quarterly reports on Form 10-Q. Prior to December 31, 2005, thecash flows arising in connection with changes in finance receivables held forinvestment were reported as operating cash flows. These cash flows are nowreported as investing cash flows. As a result, operating and investing cashflows for the unaudited interim periods in 2005 have been and will be revisedas follows:

| ** **           | ** ** | **Six Months Ended  June 30, 2005** | ** ** | **Nine Months Ended  September 30, 2005** | ** ** |
|----------------------|------------|---------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **           | ** ** | **Reported**                                            | ** ** | **Revised**                                                   | ** ** | **Reported** | ** ** | **Revised** | ** ** |
| Operating cash  flow |       | $                                                       | 14.7       |                                                          | $          | 37.7 |   | $ | 100.5 |   | $ | 105.0 |   |
| Investing cash flow  |       | $                                                       | (55.6      | )                                                             | $          | (79.9 | ) | $ | (64.1 | ) | $ | (69.3 | ) |

 

The revisions also includereclassifications to operating cash flows of insignificant amounts related topresentation of the financial results of the Company’s former vehicleimportation business as discontinued operations.

9

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements (Continued)**

***Other Assets***

Other assets consist ofinvestments held to maturity, debt issuance costs, notes receivable, deposits,cost and equity method investments and other long-term assets. In February 2006,AFC acquired a 15 percent interest in Finance Express LLC for $12.5million in cash. Finance Express is a financial software and services companyspecializing in software to facilitate the origination and servicing of motorvehicle retail installment loan contracts between independent used vehicledealers and lending institutions. In addition, the Company also receivescertain fees from Finance Express for assistance in marketing its softwareproduct and services to independent used vehicle dealers. Finance Expressqualifies as a variable interest entity (“VIE”) pursuant to FinancialAccounting Standards Board Interpretation No. 46, *Consolidationof Variable Interest Entities, an Interpretation of Accounting ResearchBulletin No. 51* (“FIN 46”). The Company is currently notthe primary beneficiary of the VIE and its risk of loss is limited, in allmaterial respects, to its investment in Finance Express. Finance Express is aLLC that maintains specific capital accounts for each member. Therefore, theCompany uses the equity method of accounting for this investment in accordancewith the guidance in Emerging Issues Task Force (“EITF”) 03-16, *Accounting for Investments in Limited Liability Companies*,Statement of Position (“SOP”) 78-9, *Accounting for Investmentsin Real Estate Ventures*, and SAB Topic D-46, *Accounting for Limited Partnership Investments*. The Company’sshare of Finance Express’ earnings or losses is recorded in “Other income, net”in the Consolidated Statements of Income and was not material for the three orsix month periods ended June 30, 2006.

***Stock-Based Compensation***

Prior to 2006, ADESA applied the intrinsic valuemethod provisions of Accounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees*, and relatedinterpretations, to account for stock-based awards. Accordingly, the Companydid not recognize compensation expense for employee stock options that weregranted in prior years. However, compensation expense was recognized on otherforms of stock-based awards, including restricted stock units and performancebased stock awards. On January 1, 2006, the Company adopted the provisionsof SFAS 123(R), *Share-Based Payment*, using themodified prospective application method, and therefore was not required torestate its financial results for prior periods. Under this method, as of January 1,2006, ADESA will apply the provisions of this statement to new and modifiedawards, as well as to the nonvested portion of awards granted and outstandingbefore the Company’s adoption.

The Company’s stock-based compensation awards,including both stock options and restricted stock units, have a retirementeligible provision, whereby awards granted to employees who have reached theretirement eligible age and meet certain service requirements with either ADESAand/or its former parent, ALLETE, automatically vest when an eligible employeeretires from the Company. The Company has previously accounted for this type ofarrangement by recognizing compensation cost (for both pro forma andrecognition purposes) over the nominal vesting period (i.e., over the fullstated vesting period of the award) and, if the employee retired before the endof the vesting period, by recognizing any remaining unrecognized compensationcost at the date of retirement. Upon adoption of SFAS 123(R), new awards willbe subject to the non-substantive vesting period approach, which specifies thatan award is vested when the employee’s retention of the award is no longercontingent on providing subsequent service. Recognizing that many companiesfollowed the nominal vesting period, the SEC issued guidance for converting tothe non-substantive vesting period approach. The Company has revised itsapproach to apply the non-substantive vesting period approach to all new grantsafter adoption, but will continue to follow the nominal vesting period approachfor the remaining portion of unvested outstanding awards. An 

10

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements (Continued)**

additional requirement ofSFAS 123(R) is that estimated forfeitures be considered in determiningcompensation expense. As previously permitted, the Company recorded forfeitureswhen they occurred. Estimating forfeitures did not have a material impact onthe determination of compensation expense.

On March 9, 2005, the board of directors (the “board”)of the Company accelerated the vesting of certain unvested and “out-of-the-money”stock options previously awarded to employees and officers that have anexercise price of $24 per share. The awards accelerated were made under theADESA, Inc. 2004 Equity and Incentive Plan in conjunction with ADESA’sinitial public offering (“IPO”) in June 2004. As a result, options topurchase approximately 2.9 million shares of the Company’s common stock becameexercisable immediately and the Company disclosed incremental pro formastock-based employee compensation expense of approximately $7.7 million, net oftax, in the first quarter 2005. The options awarded in conjunction with the IPOto the Company’s named executive officers and the majority of the otherofficers would have vested in equal increments at June 15, 2005, 2006 and2007. The options awarded to certain other executive officers and employees haddifferent vesting terms. One-third of the options awarded to the otherexecutive officers and employees vested on December 31, 2004. Theremaining two-thirds of the options awarded to these executive officers andother employees in conjunction with the IPO would have vested in equalincrements at December 31, 2005 and 2006. All of these options expire in June2010. All other terms and conditions applicable to the outstanding stock optiongrants remain in effect.

The Company and its board considered several factorsin determining to accelerate the vesting of these options. Primarily, theacceleration enhances the comparability of the Company’s 2005 financialstatements with those of 2006 and subsequent periods. The options awarded tothe executive officers were special, one-time grants in conjunction with theCompany’s IPO. As such, these grants are not indicative of past grants whenADESA was a subsidiary of ALLETE prior to June 2004 and are notrepresentative of the Company’s expected future grants. The Company and boardalso believe that the acceleration was in the best interest of the stockholdersas it reduces the Company’s reported stock option expense in future periodsmitigating the impact of applying SFAS 123(R).

As a result of adopting SFAS 123(R) on January 1,2006, income from continuing operations before income taxes and net income forthe six months ended June 30, 2006, were $1.8 million and $1.1 millionlower, respectively, than if the Company had continued to account forshare-based awards under APB Opinion No. 25. Basic and diluted earningsper share from continuing operations were both $0.02 lower for the six monthsended June 30, 2006 as a result of the adoption of SFAS 123(R).

Prior to the adoption of SFAS 123(R), tax benefits ofdeductions resulting from the exercise of stock options were presented asoperating cash flows in the Consolidated Statements of Cash Flows. SFAS 123(R) requirescash flows resulting from tax deductions from the exercise of stock options inexcess of recognized compensation cost (excess tax benefits) to be classifiedas financing cash flows. This change in classification did not have an impacton the Consolidated Statement of Cash Flows in the current period as the excesstax benefits recognized for the six months ended June 30, 2006 were notmaterial.

Prior to the adoption of SFAS 123(R), the Companyapplied the disclosure-only provisions of SFAS 123, *Accountingfor Stock-Based Compensation*, as amended by SFAS 148, *Accounting for Stock-Based Compensation—Transitionand Disclosure*, which permitted companies to apply the existingaccounting rules under APB Opinion No. 25 and related interpretations.Generally, if the exercise price of options granted under the plan was equal tothe market price of the underlying common stock on the grant date, noshare-based compensation cost was recognized in net income. As required by SFAS148, prior to 

11

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements (Continued)**

the adoption of SFAS123(R), pro forma net income and pro forma net income per common share wereprovided for stock-based awards, as if the fair value recognition provisions ofSFAS 123 had been applied.

Thefollowing table illustrates the effect on net income and earnings per share ifthe Company had applied the fair value recognition provisions of SFAS 123 toall stock-based employee awards in fiscal year 2005. The fair value of stockoptions was estimated as of the grant date using the Black-Scholesoption-pricing model and the attribution method. The Black-Scholesoption-pricing model does not consider the non-traded nature of employee stockoptions, the lack of transferability or a vesting period. If the model tookthese items into consideration, the resulting estimate for fair value of thestock options could be different. In addition, because of the change to thenon-substantive vesting period approach, the application of estimatedforfeitures, the acceleration of vesting of underwater IPO stock options, thefact that the Company’s options vest over three years and additional optiongrants are expected to be made subsequent to January 1, 2006, the resultsof expensing stock-based awards under SFAS 123(R) may have a materiallydifferent affect on net income in future periods than that presented below.

| **(in millions except per share amounts)**                         | ** ** | ** ** | ** ** | **Three Months Ended  June 30, 2005** | ** ** | **Six Months Ended  June 30, 2005** | ** ** |
|---------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| Reported net  income                                                                        |       |       | $          | 35.9                                                      |       |                                                    |       | $ | 70.9 |   |   |
| Add: stock-based  employee compensation included in reported net income, net of tax(1) |       |       | 0.5        |                                                      |       |                                                    | 0.7        |   |   |
| Deduct: total  stock-based employee compensation expense, net of tax                   |       |       | (1.3       | )                                                         |       |                                                    | (11.4      | ) |   |
| Pro forma net  income                                                                       |       |       | $          | 35.1                                                      |       |                                                    |       | $ | 60.2 |   |   |
| Earnings per  share:                                                                        |       |       |       |                                                      |       |                                                    |       |   |   |
| Basic—as reported                                                                      |       |       | $          | 0.40                                                      |       |                                                    |       | $ | 0.79 |   |   |
| Basic—pro forma                                                                        |       |       | $          | 0.39                                                      |       |                                                    |       | $ | 0.67 |   |   |
| Diluted—as reported                                                                    |       |       | $          | 0.40                                                      |       |                                                    |       | $ | 0.78 |   |   |
| Diluted—pro forma                                                                      |       |       | $          | 0.39                                                      |       |                                                    |       | $ | 0.66 |   |   |

 

(1)*      * Reported amounts include expense associatedwith restricted stock units and performance share awards.

***New Accounting Standards***

In March 2006, the FASB issued SFAS 156, *Accounting for Servicing of Financial Assets*—*an amendment of FASB Statement No. 140*. SFAS 156requires recognition of a servicing asset or liability at fair value each timean obligation is undertaken to service a financial asset by entering into aservicing contract. The standard also provides guidance on subsequentmeasurement methods for each class of servicing assets and liabilities andspecifies financial statement presentation and disclosure requirements. SFAS156 is effective for fiscal years beginning after September 15, 2006. TheCompany will adopt SFAS 156 on January 1, 2007, and is currentlyevaluating the impact the adoption of SFAS 156 will have on the consolidatedfinancial statements.

In July 2006, theFASB released Interpretation No. 48, *Accounting for Uncertaintyin Income Taxes, an Interpretation of FASB Statement No 109*(“FIN 48”).FIN 48 clarifies the accounting and reporting for uncertainty in income taxesrecognized in an enterprise’s financial statements. This interpretation 

12

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements (Continued)**

prescribesa comprehensive model for the financial statement recognition, measurement,presentation and disclosure of uncertain tax positions taken or expected to betaken on income tax returns. FIN 48 is effective for fiscal years beginningafter December 15, 2006. The Company will adopt FIN 48 on January 1,2007, and is currently evaluating the impact the adoption of FIN 48 will haveon the consolidated financial statements. The cumulative effects, if any, ofapplying this Interpretation will be recorded as an adjustment to retainedearnings as of the beginning of the period of adoption.

**Note 2—Stock-BasedCompensation**

***Equity and Incentive Plan***

Certain key employees of the Company and itssubsidiaries participate in the ADESA, Inc. 2004 Equity and Incentive Plan(“the Plan”). The maximum number of shares reserved for the grant of awardsunder the 2004 Equity and Incentive Plan is 8.5 million. There wereapproximately 2.5 million remaining shares available for grant under the Planon June 30, 2006. The Plan provides for the grant of incentive stockoptions and non-qualified stock options, stock appreciation rights, restrictedstock, restricted stock units and other stock-based awards. To date, the grantshave taken the form of stock options, restricted stock and restricted stockunits.

The Company currently uses its treasury stock tosatisfy stock option exercises and stock distributions. At June 30, 2006,the Company holds 4,982,373 shares of treasury stock, and therefore does notexpect to be required to purchase additional shares in fiscal 2006 to satisfystock option exercises and stock distributions.

The compensation cost thatwas charged against income for all plans was $3.4 million and $1.3 million forthe six months ended June 30, 2006 and 2005. The total income tax benefitrecognized in the Consolidated Statements of Income for stock compensationagreements was approximately $1.3 million and $0.6 million for the six monthsended June 30, 2006 and 2005.  Hadthe Company followed SFAS 123 rather than APB Opinion No. 25, anadditional $10.7 million of compensation expense, net of tax, would have beenrecorded for the six months ended June 30, 2005 (as disclosed in the proforma information in Note 1). The Company did not capitalize any stock-basedcompensation cost in the six months ended June 30, 2006.

***Stock Options***

Stockoptions may be granted under the Plan at a price of not less than the fairmarket value of a share of ADESA common stock on the date of grant andgenerally vest in equal annual installments over three years with expirationnot to exceed six years from the date of grant. The weighted average fair valueof options granted was $8.54 and $7.36 per share for the first six months of2006 and 2005, respectively. The fair value of stock options granted wasestimated on the date of grant using the Black-Scholes option pricing model andthe following assumptions:

| **Assumptions**           | ** ** | ** **           | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------|------------|----------------------|------------|----------|------------|----------|------------|
| Risk-free  interest rate  | ** ** | **4.6 – 5.0**   | **%**      | 3.6      | %          |
| Expected  life—years | ** ** | **4**                |       | 4        |       |
| Expected  volatility      | ** ** | **38.0**             | **%**      | 41.0     | %          |
| Dividend yield            | ** ** | **1.15 – 1.18** | **%**      | 1.34     | %          |

 

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements (Continued)**

*Risk-freeinterest rate**—This*is the yield on U.S. TreasurySecurities posted at the date of grant having a term equal to the expected lifeof the option. An increase in the risk-free interest rate will increasecompensation expense.

*Expectedlife**—*years*—This*is the periodof time over which the options granted are expected to remain outstanding. Optionsgranted by ADESA have a maximum term of six years, while the options convertedfrom ALLETE to ADESA have a maximum term of ten years. An increase in theexpected life will increase compensation expense.

*Expected *volatility***—Actual*changes inthe market value of the Company’s stock are used to calculate the volatilityassumption. Based on the Company’s limited time as a publicly traded company, acombination of historical volatility and the volatility of its comparable peergroup was used to calculate expected volatility. An increase in the expectedvolatility will increase compensation expense.

*Dividendyield**—This*is the annual rate ofdividends per share over the exercise price of the option. An increase in thedividend yield will decrease compensation expense.

Thefollowing table summarizes stock option activity for the six months ended June 30,2006:

| ***Options***                        | ** ** | ** ** | ** ** | **Number** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value(in millions)** | ** ** |
|--------------------------------------|------------|------------|------------|------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| Outstanding at  January 1, 2006 |       | 4,482,953  |       |       | $          | 22.09                                  |       |                                                |       |                                              |       |   |   |   |   |   |
| Granted                              |       | 338,507    |       |       | $          | 25.99                                  |       |                                                |       |                                              |       |   |   |   |   |   |
| Exercised                            |       | (269,465   | )          |       | $          | 21.69                                  |       |                                                |       |                                              |       |   |   |   |   |   |
| Forfeited or  cancelled              |       | (15,545    | )          |       | $          | 21.37                                  |       |                                                |       |                                              |       |   |   |   |   |   |
| Outstanding at  June 30, 2006   |       | 4,536,450  |       |       | $          | 22.41                                  |       |                                                |       | 4.4                                               |       |   |   | $ | 5.7 |   |   |
| Exercisable at  June 30, 2006   |       | 3,794,830  |       |       | $          | 22.09                                  |       |                                                |       | 4.3                                               |       |   |   | $ | 5.7 |   |   |

 

The aggregate intrinsic value in the table aboverepresents the total pretax intrinsic value, based on ADESA’s closing stockprice of $22.24 on June 30, 2006, that would have been received by theoption holders had all option holders exercised their options as of that date. Thisamount changes continuously based on the fair value of the Company’s stock. Thetotal intrinsic value of options exercised during the six months ended June 30,2006 and 2005 was $0.9 million and $6.2 million. The fair value of all vestedand exercisable shares at June 30, 2006 and 2005 was $84.4 million and$86.4 million.

As of June 30, 2006,there was $3.8 million of total unrecognized compensation expense related tostock options granted which is expected to be recognized over a weightedaverage term of 2.1 years. This unrecognized compensation expense only includesthe cost for those options expected to vest, as the Company estimated expectedforfeitures in accordance with SFAS 123(R). When estimating forfeitures, theCompany considers voluntary and involuntary termination behavior as well asactual forfeitures. An increase in estimated forfeitures would decreasecompensation expense.

***Restricted Stock Units***

The fair value of restricted stock units (“RSUs”) isthe value of ADESA’s stock at the date of grant, which have ranged between$15.60 and $26.17 per share. The grants are contingent upon continuedemployment and vest over periods ranging from one to three years. Dividends,payable in stock, accrue on 

14

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements (Continued)**

a portion of the grantsand are subject to the same specified terms as the original grants. As of June 30,2006, a total of 3,279 stock units have accumulated on nonvested RSUs due todividend reinvestment.

Thefollowing table summarizes RSU activity, excluding dividend reinvestment units,for the six months ended June 30, 2006:

| ***Restricted Stock Units*** | ** ** | ** ** | ** ** | **Number** | ** ** | **Weighted Average  Grant Date Fair Value** | ** ** |
|----------------------------------------|------------|------------|------------|------------|------------|-----------------------------------------------------------------|------------|
| RSUs at  January 1, 2006          |       | 227,769    |       |       | $          | 23.34                                                           |       |   |
| Granted                                |       | 77,308     |       |       | $          | 26.06                                                           |       |   |
| Vested                                 |       | (2,932     | )          |       | $          | 22.24                                                           |       |   |
| Forfeited or  cancelled                |       | (3,066     | )          |       | $          | 22.75                                                           |       |   |
| RSUs at June 30,  2006            |       | 299,079    |       |       | $          | 24.06                                                           |       |   |

 

As of June 30, 2006,there was $3.2 million of total unrecognized compensation expense related tononvested RSUs granted which is expected to be recognized over a weightedaverage term of 1.7 years. The fair value of shares vested during the sixmonths ended June 30, 2006 was less than $0.1 million.

***Performance Based Restricted Stock Units***

The Company’s 2006long-term incentive plan includes performance based restricted stock unitswhose future award is contingent upon annual 2006 income from continuingoperations performance. If applicable, the date of grant will occur in February 2007and the fair value of the RSUs will be the value of ADESA’s stock at the dateof grant. The potential grants will also be contingent upon continuedemployment and would vest 33 percent in February 2008, 33 percent in February 2009and 34 percent in February 2010. The Company has accrued $0.6 million,pretax, at June 30, 2006 for the performance based RSUs. The amount isincluded in “Accrued employee benefits and compensation expenses” on theConsolidated Balance Sheet. Based on current performance and forfeiture rateassumptions, the Company expects to accrue an additional $0.6 million, pretax,in fiscal 2006.

**Note 3—Acquisitions**

In February 2006, the Company completed thepurchase of certain assets of the N.E. Penn Salvage Company, an independentlyowned salvage auction in northeast Pennsylvania. The purchased assets includedthe accounts receivables, operating equipment and customer relationshipsrelated to the auction. In addition, the Company entered into operating leaseobligations related to the facility through 2016. Initial annual lease paymentsfor the facilities total approximately $0.1 million per year. The Company didnot assume any other material liabilities or indebtedness in connection withthe acquisition. Financial results for this acquisition have been included inthe Company’s consolidated financial statements since the date of acquisition.

In March 2006, the Company completed theacquisition of certain assets of Auction Broadcasting Company’s South Tampaused vehicle auction serving western and central Florida. The Company hasrenamed the auction ADESA Sarasota. The assets purchased included land andbuildings, the related operating equipment, accounts receivable and customerrelationships related to the auction. The auction is comprised of approximately63 acres and includes six auction lanes and full-service reconditioning shopsproviding detail, mechanical and body shop services. The Company did not assumeany material liabilities or indebtedness in connection with the acquisition. Financialresults for this acquisition have been included in the Company’s consolidatedfinancial statements since the date of acquisition.

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements (Continued)**

ADESA acquired the twopreviously mentioned auctions for a total cost of $29.6 million, in cash.Preliminary purchase price allocations have been recorded for each acquisition.The purchase price of the acquisitions was allocated to the acquired assets basedupon fair market values, including $5.0 million to other intangible assets,representing the fair value of acquired customer relationships and non-competeagreements, which will be amortized over their expected useful lives of 9 to 15years. The preliminary purchase price allocations resulted in aggregategoodwill of $11.4 million. The goodwill was assigned to the auction servicesgroup reporting segment and is expected to be fully deductible for taxpurposes. The Company expects to finalize the purchase price allocationsrelated to each of the acquisitions upon receipt and analysis of third partyvaluations. Pro forma financial results for the acquisitions were not material.

**Note 4—Long-TermDebt**

Long-termdebt consists of the following *(in millions)*:

| ** **                              | ** ** | **Interest Rate** | ** ** | **Maturity** | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------|------------|------------------------|------------|--------------|------------|-------------------------|------------|-----------------------------|------------|
| Term Loan A                             |       | LIBOR  + 1.00%         |       | 06/30/2010   | ** ** |                    | **$**      | **120.0**                   |       |   |   | $ | 135.0 |   |   |
| $350 million  revolving credit facility |       | LIBOR  + 1.00%         |       | 06/30/2010   | ** ** |                    | **138.0**  |                        |       |   | 138.0 |   |   |
| Atlanta capital  lease obligation       |       | 5.0%                   |       | 12/01/2013   | ** ** |                    | **34.5**   |                        |       |   | 34.5 |   |   |
| Senior  subordinated notes              |       | 75¤8%             |       | 06/15/2012   | ** ** |                    | **125.0**  |                        |       |   | 125.0 |   |   |
| Canadian line of  credit                |       | Prime  + 0.25%         |       | 12/31/2006   | ** ** |                    | **—** |                        |       |   | — |   |   |
| Total debt                              |       |                   |       |         | ** ** |                    | **417.5**  |                        |       |   | 432.5 |   |   |
| Less current  portion of long-term debt |       |                   |       |         | ** ** |                    | **70.0**   |                        |       |   | 70.0 |   |   |
| Long-term debt                          |       |                   |       |         | ** ** |                    | **$**      | **347.5**                   |       |   |   | $ | 362.5 |   |   |

 

On July 25, 2005, the Company entered into a $500million credit facility, pursuant to the terms and conditions of an amended andrestated credit agreement (the “Credit Agreement”) with Bank of America, N.A.,as administrative agent, and a syndicate of lenders. The Credit Agreementprovides for a five year $150 million term loan and a $350 millionrevolving credit facility. Letters of credit reducing the available line ofcredit were $14.6 million at June 30, 2006. Contractual debt obligationsover the next twelve months are limited to principal payments totaling $30million on the Company’s Term Loan A. The remaining $40 million classified as acurrent liability represents estimated repayments pursuant to the Company’s revolvingcredit facility in accordance with SFAS 6, *Classification ofShort-Term Obligations Expected to be Refinanced.* The creditfacility is guaranteed by substantially all of the Company’s material domesticsubsidiaries (excluding, among others, AFC Funding Corporation), and is securedby a pledge of all of the equity interests in the guarantors and a pledge of 65percent of certain capital interests of the Company’s Canadian subsidiaries.

The Credit Agreementcontains certain restrictive loan covenants, including, among others, financialcovenants requiring a maximum total leverage ratio, a minimum interest coverageratio, and a minimum fixed charge coverage ratio and covenants limiting ADESA’sability to incur indebtedness, grant liens, make acquisitions, be acquired,dispose of assets, pay dividends, repurchase stock, make capital expendituresand make investments.  EBITDA (earningsbefore interest expense, income taxes, depreciation and amortization) adjustedto exclude after-tax (a) gains or losses from asset sales; (b) temporarygains or losses on currency; (c) certain non-recurring gains and losses; (d) stockoption expense; and (e) certain other noncash amounts included in thedetermination of net income, is the principal measure of liquidity utilized inthe calculation of the financial ratios contained in the covenants. 

16

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements (Continued)**

Inaddition, the senior subordinated notes contain certain financial andoperational restrictions on paying dividends and other distributions, makingcertain acquisitions or investments and incurring indebtedness, and sellingassets. At June 30, 2006, the Company was in compliancewith the covenants contained in both the credit facility and the seniorsubordinated notes.

**Note 5—Derivatives**

The Company uses interest rate swap agreements tomanage its exposure to interest rate movements and to reduce borrowing costs. InJune 2004, the Company entered into an interest rate swap agreement with anotional amount of $105 million to manage its exposure to interest ratemovements on its variable rate debt. The interest rate swap agreement containsamortizing provisions and matures in December 2006. In November 2005,the Company entered into an interest rate swap agreement with a notional amountof $40 million to manage its exposure to interest rate movements on itsvariable rate credit facility. The swap matures in May 2008.

The Company designates itsinterest rate swap agreements as cash flow hedges. The fair value of theinterest rate swap agreements is estimated using pricing models widely used infinancial markets and represents the estimated amount the Company would receiveor pay to terminate the agreements at the reporting date. At June 30,2006, the fair value of the interest rate swap agreements was a $1.1 milliongain recorded in “Other assets” on the Consolidated Balance Sheet. At December 31,2005, the fair value of the interest rate swap agreements consisted of a $0.9million gain recorded in “Other assets” and a $0.1 million loss recorded in “Otherliabilities” on the Consolidated Balance Sheet. Changes in the fair value ofthe interest rate swap agreements designated as cash flow hedges are recordedin “Other comprehensive income”. Unrealized gains or losses on interest rateswap agreements are included as a component of “Accumulated other comprehensiveincome”. At June 30, 2006, there was a net unrealized gain totaling $0.7million, net of taxes of $0.4 million. At December 31, 2005, there was anet unrealized gain totaling $0.5 million, net of taxes of $0.3 million.

**Note 6—FinanceReceivables**

AFC sells the majority of its U.S. dollar denominated finance receivableson a revolving basis and without recourse to a wholly owned, bankruptcy remote,consolidated, special purpose subsidiary (“AFC Funding Corporation”),established for the purpose of purchasing AFC’s finance receivables. EffectiveMarch 31, 2006, AFC and AFC Funding Corporation amended their securitizationagreement. As part of the amendment, the expiration date of the agreement wasextended from June 30, 2008 to April 30, 2009. This agreement is subject toannual renewal of short-term liquidity by the liquidity providers and allowsfor the revolving sale by AFC Funding Corporation to a bank conduit facility ofup to a maximum of $600 million in undivided interests in certain eligiblefinance receivables subject to committed liquidity. AFC Funding Corporation hadcommitted liquidity of $550 million and $425 million at June 30, 2006 and December 31,2005, respectively. Receivables that AFC Funding sells to the bank conduitfacility qualify for sales accounting for financial reporting purposes pursuantto SFAS 140, *Accounting for Transfers and Servicing ofFinancial Assets and Extinguishment of Liabilities,* and as a resultare not reported on the Company’s Consolidated Balance Sheet.

At June 30, 2006, AFC managed total finance receivables of $772.7million, of which $690.2 million had been sold without recourse to AFC FundingCorporation. At December 31, 2005, AFC managed total finance receivablesof $655.7 million, of which $581.9 million had been sold without recourse toAFC Funding Corporation. Undivided interests in finance receivables were soldby AFC Funding Corporation 

17

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements (Continued)**

to the bank conduit facility with recoursetotaling $458.0 million and $399.8 million at June 30, 2006 and December 31,2005, respectively. Finance receivables include $62.4 million and $51.1 millionclassified as held for sale and $188.7 million and $148.0 million classified asheld for investment at June 30, 2006 and December 31, 2005,respectively. AFC’s allowance for losses of $3.4 million and $2.4 million at June 30,2006 and December 31, 2005, respectively, include an estimate of lossesfor finance receivables. Additionally, accrued liabilities of $4.1 million and$2.9 million for the estimated losses for loans sold by the special purposesubsidiary were recorded at June 30, 2006 and December 31, 2005,respectively. These loans were sold to a bank conduit facility with recourse tothe special purpose subsidiary and will come back on the balance sheet of thespecial purpose subsidiary at fair market value if they become ineligible underthe terms of the collateral arrangement with the bank conduit facility.

Proceeds from the revolving sale of receivables to the bankconduit facility were used to fund new loans to customers. AFC and AFC FundingCorporation must maintain certain financial covenants including, among others,limits on the amount of debt AFC can incur, minimum levels of tangible networth, and other covenants tied to the performance of the finance receivablesportfolio. The securitization agreement also incorporates the financialcovenants of ADESA’s credit facility. At June 30, 2006, the Company was incompliance with the covenants contained in the securitization agreement.

**Note 7—Earnings PerShare**

Thefollowing table sets forth the computation of earnings per share *(in millions except share and per share amounts)*:

| ** **                                                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,**            | ** ** |
|---------------------------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                          | ** ** | **   2006   **    | ** ** | **    2005    ** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Income from  continuing operations                                  | ** ** |                                            | **$**      | **36.2**                                                 | ** ** |   |   | $ | 36.1 |   |   | **$** | **72.5** |   | $ | 71.2 |   |
| Loss from  discontinued operations, net of income taxes             | ** ** |                                            | **(0.1**   | **)**                                                    |       |   | (0.2 | ) |   | **(0.1** | **)** | (0.3 | ) |
| Net income                                                          | ** ** |                                            | **$**      | **36.1**                                                 | ** ** |   |   | $ | 35.9 |   |   | **$** | **72.4** |   | $ | 70.9 |   |
| Weighted average common shares outstanding                          | ** ** |                                            | **89.86**  | ** **                                               |       |   | 89.69 |   |   | **89.81** |   | 90.19 |   |
| Effect of  dilutive stock options and restricted stock awards       | ** ** |                                            | **0.35**   | ** **                                               |       |   | 0.45 |   |   | **0.42** |   | 0.48 |   |
| Weighted average  common shares outstanding and assumed conversions | ** ** |                                            | **90.21**  | ** **                                               |       |   | 90.14 |   |   | **90.23** |   | 90.67 |   |
| **Earnings  per share—basic**                                  | ** ** |                                            | ** ** | ** **                                               |       |   |   |   |   | ** ** |   |   |   |
| Income from continuing operations                                   | ** ** |                                            | **$**      | **0.40**                                                 | ** ** |   |   | $ | 0.40 |   |   | **$** | **0.81** |   | $ | 0.79 |   |
| Loss from discontinued operations, net of income  taxes             | ** ** |                                            | **—** | ** **                                               | ** ** | ** ** | **—** |   |   | **—** | ** ** | **—** | ** ** |
| Net income                                                          | ** ** |                                            | **$**      | **0.40**                                                 | ** ** |   |   | $ | 0.40 |   |   | **$** | **0.81** |   | $ | 0.79 |   |
| **Earnings  per share—diluted**                                | ** ** |                                            | ** ** | ** **                                               |       |   |   |   |   | ** ** |   |   |   |
| Income from continuing operations                                   | ** ** |                                            | **$**      | **0.40**                                                 | ** ** |   |   | $ | 0.40 |   |   | **$** | **0.80** |   | $ | 0.78 |   |
| Loss from discontinued operations, net of income  taxes             | ** ** |                                            | **—** | ** **                                               | ** ** | ** ** | **—** |   |   | **—** | ** ** | **—** | ** ** |
| Net income                                                          | ** ** |                                            | **$**      | **0.40**                                                 | ** ** |   |   | $ | 0.40 |   |   | **$** | **0.80** |   | $ | 0.78 |   |

 

Basic earnings per sharewere calculated based upon the weighted-average number of outstanding commonshares for the period. Diluted earnings per share were calculated consistentwith basic earnings per share including the effect of dilutive unissued commonshares related to the Company’s stock-based 

18

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements (Continued)**

employeecompensation programs. Total optionsoutstanding at June 30, 2006 and 2005 were 4.5 million and 4.6 million. Stockoptions with an exercise price per share greater than the average market priceper share were excluded from the calculation of diluted earnings pershare for all periods presented as including these options would have ananti-dilutive impact. Approximately 3.2 million options were excluded from thecalculation of diluted earnings per share for the quarters ended June 30,2006 and 2005, respectively. For the six months ended June 30, 2006 and2005, approximately 0.3 million and 3.2 million options were excluded from thecalculation of diluted earnings per share. The Company’s policy for calculatingthe potential windfall tax benefit or shortfall for the purpose of calculatingassumed proceeds under the treasury stock method excludes the impact of proforma deferred tax assets related to partially or fully vested awards on thedate of adoption.

**Note 8—ComprehensiveIncome**

Thecomponents of comprehensive income are as follows (*in millions*):

| ** **                                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,**            | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                    | ** ** | **   2006   **    | ** ** | **    2005    ** | ** ** | **   2006   ** | ** ** | **   2005   ** | ** ** |
| Net income                                    | ** ** |                                            | **$**      | **36.1**                                                 |       |   |   | $ | 35.9 | ** ** |   |   | **$** | **72.4** |   |   |   | $ | 70.9 |   |   |
| Other  comprehensive income, net of tax       | ** ** |                                            | ** ** |                                                     |       |   |   | ** ** |   |   | ** ** |   |   |   |   |   |   |
| Foreign currency translation gain (loss)      | ** ** |                                            | **11.6**   |                                                     |       |   | (2.8 | ) |   |   | **10.5** |   |   |   | (4.7 | ) |   |
| Unrealized gain (loss) on interest rate swaps | ** ** |                                            | **—** |                                                     |       |   | (0.3 | ) |   |   | **0.2** |   |   |   | 0.7 |   |   |
| Comprehensive income                          | ** ** |                                            | **$**      | **47.7**                                                 |       |   |   | $ | 32.8 | ** ** |   |   | **$** | **83.1** |   |   |   | $ | 66.9 |   |   |

 

The composition of “Accumulatedother comprehensive income” at June 30, 2006 and December 31, 2005was the net unrealized gains or losses on interest rate swaps of $0.7 millionand $0.5 million and foreign currency translation adjustments of $60.6 millionand $50.1 million, respectively.

**Note 9—SegmentInformation**

During the second quarter of 2006, the Companyimplemented several organizational realignment and management changes intendedto better position the Company to serve its diverse customer bases, accommodateanticipated growth and realize operational efficiencies across all businesslines. The former auction and related services or “ARS” segment is now referredto as Auction Services Group (“ASG”). ASG encompasses all wholesale and salvageauctions throughout North America (U.S. and Canada). The former dealerfinancing segment is now referred to Dealer Services Group (“DSG”). DSG is theumbrella group that was formed to include the Automotive Finance Corporation(AFC) finance business as well as other businesses and ventures the Company mayenter into, focusing on providing the Company’s independent used vehicle dealercustomers with value-added ancillary services and products.

Prior to the second quarter of 2006, the Company’soperations were grouped into four operating segments: U.S. used vehicleauctions, Canada used vehicle auctions, Impact salvage auctions and AFC andaggregated into two reportable business segments: auction and related servicesand dealer financing. Prior to the second quarter of 2006, the used vehicleauction operating segment consisted of two operating segments (U.S. usedvehicle auctions and Canada used vehicle auctions).

19

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements (Continued)**

As a result of the realignment, the Company combinedthe U.S. and Canadian used vehicle auctions into one operating segment. As ofthe second quarter of 2006, the Company aggregates its three operating segments(used vehicle auctions, Impact salvage auctions and AFC) into two reportablebusiness segments: ASG and DSG. The realignment had no impact on aggregation offinancial information at the reportable segment level.

The holding company is maintained separately from thetwo reportable segments and includes expenses associated with being a publiccompany, such as salaries, benefits, and travel costs for the corporatemanagement team, board of directors’ fees, investor relations costs, andincremental insurance, treasury, legal, accounting, and risk management costs. Holdingcompany interest includes the interest incurred on the corporate debt structure.The majority of costs incurred at the holding company are not allocated to thetwo business segments.

20

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements (Continued)**

Financialinformation regarding the Company’s reportable segments is set forth below *(in millions)*:

| ** **                                                     | ** ** | **Auction  Services  Group** | ** ** | **Dealer  Services  Group** | ** ** | **Holding  Company** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|----------------------|------------|------------------|------------|
| **Three Months Ended June 30,  2006**                          | ** ** | ** **                   | ** ** |                        | ** ** | ** **           |       |             | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Operating revenues                                             |       | $                            | 239.7      |                        |       | $                    | 36.2       | ** **       |       |   | $ | — |   |   |   | $ | 275.9 |   |   |
| Operating expenses                                             |       |                         |       |                        |       | ** **           |       |             |       |   |   |   |   |   |   |
| Cost of services (exclusive of depreciation and  amortization) |       | 130.0                        |       |                        | 7.7        | ** **           |       |             | —     |   |   |   | 137.7 |   |   |
| Selling, general and administrative                            |       | 52.8                         |       |                        | 5.6        | ** **           |       |             | 5.4        |   |   |   | 63.8 |   |   |
| Depreciation and amortization                                  |       | 9.9                          |       |                        | 0.9        | ** **           |       |             | 0.2        |   |   |   | 11.0 |   |   |
| Total operating  expenses                                      |       | 192.7                        |       |                        | 14.2       | ** **           |       |             | 5.6        |   |   |   | 212.5 |   |   |
| Operating profit (loss)                                        |       | 47.0                         |       |                        | 22.0       | ** **           |       |             | (5.6       | ) |   |   | 63.4 |   |   |
| Interest expense                                               |       | 1.2                          |       |                        | —     | ** **           |       |             | 5.9        |   |   |   | 7.1 |   |   |
| Other income, net                                              |       | (1.6                         | )          |                        | 0.4        | ** **           |       |             | (0.6       | ) |   |   | (1.8 | ) |   |
| Income (loss)  from continuing operations before income taxes  |       | 47.4                         |       |                        | 21.6       | ** **           |       |             | (10.9      | ) |   |   | 58.1 |   |   |
| Income taxes                                                   |       | 18.2                         |       |                        | 8.0        | ** **           |       |             | (4.3       | ) |   |   | 21.9 |   |   |
| Income (loss)  from continuing operations                      |       | $                            | 29.2       |                        |       | $                    | 13.6       | ** **       |       |   | $ | (6.6 | ) |   |   | $ | 36.2 |   |   |
| Assets                                                         |       | $                            | 1,642.9    |                        |       | $                    | 399.8      | ** **       |       |   | $ | 33.7 |   |   |   | $ | 2,076.4 |   |   |
| **Three  Months Ended June 30, 2005**                     | ** ** | ** **                   | ** ** |                        |       | ** **           |       |             |       |   |   |   |   |   |   |
| Operating revenues                                             |       | $                            | 214.3      |                        |       | $                    | 32.2       |             |       |   | $ | — |   |   |   | $ | 246.5 |   |   |
| Operating  expenses                                            |       |                         |       |                        |       |                 |       |             |       |   |   |   |   |   |   |
| Cost of services (exclusive of depreciation and  amortization) |       | 108.9                        |       |                        | 6.2        |                 |       |             | —     |   |   |   | 115.1 |   |   |
| Selling, general and administrative                            |       | 46.6                         |       |                        | 5.3        |                 |       |             | 4.2        |   |   |   | 56.1 |   |   |
| Depreciation and amortization                                  |       | 8.9                          |       |                        | 1.0        |                 |       |             | 0.1        |   |   |   | 10.0 |   |   |
| Total operating  expenses                                      |       | 164.4                        |       |                        | 12.5       |                 |       |             | 4.3        |   |   |   | 181.2 |   |   |
| Operating profit (loss)                                        |       | 49.9                         |       |                        | 19.7       |                 |       |             | (4.3       | ) |   |   | 65.3 |   |   |
| Interest expense                                               |       | 1.6                          |       |                        | —     |                 |       |             | 6.9        |   |   |   | 8.5 |   |   |
| Other income, net                                              |       | (1.4                         | )          |                        | (0.1       | )                    |       |             | (0.8       | ) |   |   | (2.3 | ) |   |
| Income (loss)  from continuing operations before income taxes  |       | 49.7                         |       |                        | 19.8       |                 |       |             | (10.4      | ) |   |   | 59.1 |   |   |
| Income taxes                                                   |       | 19.4                         |       |                        | 7.7        |                 |       |             | (4.1       | ) |   |   | 23.0 |   |   |
| Income (loss) from continuing operations                       |       | $                            | 30.3       |                        |       | $                    | 12.1       |             |       |   | $ | (6.3 | ) |   |   | $ | 36.1 |   |   |
| Assets                                                         |       | $                            | 1,704.2    |                        |       | $                    | 345.7      |             |       |   | $ | 41.9 |   |   |   | $ | 2,091.8 |   |   |

 

21

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements (Continued)**

 

| ** **                                                     | ** ** | **Auction  Services  Group** | ** ** | **Dealer  Services  Group** | ** ** | **Holding  Company** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|----------------------|------------|------------------|------------|
| **Six Months Ended June 30, 2006**                             |       |                         |       |                        |       |                 |       |             |       |   |   |   |   |   |   |
| Operating revenues                                             |       | $                            | 490.1      |                        |       | $                    | 71.4       |             |       |   | $ | — |   |   |   | $ | 561.5 |   |   |
| Operating expenses                                             |       |                         |       |                        |       |                 |       |             |       |   |   |   |   |   |   |
| Cost of services  (exclusive of depreciation and amortization) |       | 267.0                        |       |                        | 14.9       |                 |       |             | —     |   |   |   | 281.9 |   |   |
| Selling, general and  administrative                           |       | 108.3                        |       |                        | 11.3       |                 |       |             | 11.1       |   |   |   | 130.7 |   |   |
| Depreciation and  amortization                                 |       | 19.7                         |       |                        | 1.8        |                 |       |             | 0.3        |   |   |   | 21.8 |   |   |
| Total operating expenses                                       |       | 395.0                        |       |                        | 28.0       |                 |       |             | 11.4       |   |   |   | 434.4 |   |   |
| Operating profit (loss)                                        |       | 95.1                         |       |                        | 43.4       |                 |       |             | (11.4      | ) |   |   | 127.1 |   |   |
| Interest expense                                               |       | 2.1                          |       |                        | —     |                 |       |             | 12.0       |   |   |   | 14.1 |   |   |
| Other income, net                                              |       | (2.6                         | )          |                        | 0.6        |                 |       |             | (1.5       | ) |   |   | (3.5 | ) |   |
| Income (loss) from  continuing operations before income taxes  |       | 95.6                         |       |                        | 42.8       |                 |       |             | (21.9      | ) |   |   | 116.5 |   |   |
| Income taxes                                                   |       | 36.9                         |       |                        | 15.8       |                 |       |             | (8.7       | ) |   |   | 44.0 |   |   |
| Income (loss) from  continuing operations                      |       | $                            | 58.7       |                        |       | $                    | 27.0       |             |       |   | $ | (13.2 | ) |   |   | $ | 72.5 |   |   |
| Assets                                                         |       | $                            | 1,642.9    |                        |       | $                    | 399.8      |             |       |   | $ | 33.7 |   |   |   | $ | 2,076.4 |   |   |
| **Six  Months Ended June 30, 2005**                       | ** ** | ** **                   | ** ** |                        |       |                 |       |             |       |   |   |   |   |   |   |
| Operating revenues                                             |       | $                            | 428.0      |                        |       | $                    | 61.2       |             |       |   | $ | — |   |   |   | $ | 489.2 |   |   |
| Operating expenses                                             |       |                         |       |                        |       |                 |       |             |       |   |   |   |   |   |   |
| Cost of services  (exclusive of depreciation and amortization) |       | 217.4                        |       |                        | 12.2       |                 |       |             | —     |   |   |   | 229.6 |   |   |
| Selling, general and  administrative                           |       | 91.4                         |       |                        | 10.2       |                 |       |             | 9.3        |   |   |   | 110.9 |   |   |
| Depreciation and  amortization                                 |       | 16.9                         |       |                        | 2.1        |                 |       |             | 0.2        |   |   |   | 19.2 |   |   |
| Total operating expenses                                       |       | 325.7                        |       |                        | 24.5       |                 |       |             | 9.5        |   |   |   | 359.7 |   |   |
| Operating profit (loss)                                        |       | 102.3                        |       |                        | 36.7       |                 |       |             | (9.5       | ) |   |   | 129.5 |   |   |
| Interest expense                                               |       | 2.9                          |       |                        | —     |                 |       |             | 13.7       |   |   |   | 16.6 |   |   |
| Other income, net                                              |       | (2.0                         | )          |                        | (0.1       | )                    |       |             | (1.7       | ) |   |   | (3.8 | ) |   |
| Income (loss) from  continuing operations before income taxes  |       | 101.4                        |       |                        | 36.8       |                 |       |             | (21.5      | ) |   |   | 116.7 |   |   |
| Income taxes                                                   |       | 39.7                         |       |                        | 14.2       |                 |       |             | (8.4       | ) |   |   | 45.5 |   |   |
| Income (loss) from  continuing operations                      |       | $                            | 61.7       |                        |       | $                    | 22.6       |             |       |   | $ | (13.1 | ) |   |   | $ | 71.2 |   |   |
| Assets                                                         |       | $                            | 1,704.2    |                        |       | $                    | 345.7      |             |       |   | $ | 41.9 |   |   |   | $ | 2,091.8 |   |   |

 

**Note 10—DiscontinuedOperations**

In February 2003, management approved a plan todiscontinue the operations of the Company’s vehicle importation business. In August 2005,ADESA sold ComSearch, Inc. which provides professional claims outsourcingservices, automotive parts-locating and desk-auditing services to the propertyand casualty insurance industry. The financial results of the vehicleimportation business and ComSearch have 

22

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements (Continued)**

been accounted for asdiscontinued operations for all periods presented. Both businesses wereformerly included in the ASG segment.

Revenues from discontinued operations were $1.2million and $2.5 million for the three and six months ended June 30, 2005.Net loss from discontinued operations for the three and six months ended June 30,2006 includes interest on the vehicle importation business adverse judgment of$0.1 million. Net loss from discontinued operations for the three and sixmonths ended June 30, 2005 of $0.2 million and $0.3 million isrepresentative of operating losses at ComSearch and interest on the vehicleimportation business adverse judgment.

At June 30, 2006 and December 31,2005, there were no assets and $7.0 and $6.8 million, respectively, inliabilities related to discontinued operations. Liabilities at June 30,2006 and December 31, 2005 represent the accrual of the importationadverse judgment, currently under appeal, and accrued interest on the awardpursuant to Michigan law. This and other legal matters are discussed in thedescription of legal proceedings in Part II, Item 1 (“Legal Proceedings”)of this report.

**Note 11—Dividends**

On June 15, 2006, theCompany paid a second quarter dividend of $0.075 per common share. On July 25,2006, the Company’s board of directors declared a third quarter dividend of$0.075 per common share payable September 15, 2006, to stockholders ofrecord on August 16, 2006.

**Note 12—Commitmentsand Contingencies**

The Company is involved in litigation and disputesarising in the ordinary course of business, such as actions related toinjuries; property damage; handling, storage or disposal of vehicles;environmental laws and regulations; and other litigation incidental to thebusiness such as employment matters and dealer disputes. Management considersthe likelihood of loss or the incurrence of a liability, as well as the abilityto reasonably estimate the amount of loss, in determining loss contingencies. TheCompany accrues an estimated loss contingency when it is probable that aliability has been incurred and the amount of loss can be reasonably estimated.Management regularly evaluates current information available to determinewhether accrual amounts should be adjusted. Accruals for contingencies includinglitigation and environmental matters are included in “Other accrued expenses”and “Other liabilities” at undiscounted amounts and generally exclude claimsfor recoveries from insurance or other third parties. These accruals areadjusted periodically as assessment and remediation efforts progress, or asadditional technical or legal information become available. If the amount of anactual loss is greater than the amount accrued, this could have an adverseimpact on the Company’s operating results in that period. Legal fees areexpensed as incurred.

The Company has accrued, as appropriate, forenvironmental remediation costs anticipated to be incurred at certain of itsauction facilities. Liabilities for environmental matters included in “Otheraccrued expenses” and “Other liabilities” were $2.8 million at June 30,2006 and December 31, 2005. No amounts have been accrued as receivablesfor potential reimbursement or recoveries to offset this liability.

The Company stores a significant number of vehiclesowned by various customers and consigned to the Company to be auctioned. TheCompany is contingently liable for each consigned vehicle until the eventualsale or other disposition; however, the Company is generally not liable fordamage related to severe weather conditions, natural disasters or other factorsoutside of the Company’s control. Loss is possible; however, at this timemanagement cannot estimate a range of loss that could occur. Individual 

23

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**ADESA, Inc.**

**Notes to Consolidated Financial Statements (Continued)**

stop loss and aggregateinsurance coverage is maintained on the consigned vehicles. These vehicles areconsigned to the Company and are not included in the Consolidated BalanceSheets.

In the normal course of business, the Company alsoenters into various other guarantees and indemnities in its relationships withsuppliers, service providers, customers and others. These guarantees andindemnifications do not materially impact the Company’s financial condition orresults of operations, but indemnifications associated with the Company’sactions generally have no dollar limitations and currently cannot bequantified.

As noted above, the Company is involved in litigationand disputes arising in the ordinary course of business, such as actionsrelated to injuries; property damage; handling, storage or disposal of vehicles;environmental laws and regulations; and other litigation incidental to thebusiness such as employment matters and dealer disputes. Such litigation isgenerally not, in the opinion of management, likely to have a material adverseeffect on the Company’s financial condition, results of operations or cashflows. Certain legal and regulatory proceedings which could be material arediscussed in the description of legal proceedings in Part II, Item 1 (“LegalProceedings”) of this report.

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**Item 2.     Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

**Forward-LookingStatements**

This QuarterlyReport on Form 10-Q contains forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995. Suchstatements are subject to certain risks, trends, and uncertainties. Inparticular, statements made in this report on Form 10-Q that are nothistorical facts (including, but not limited to, expectations, estimates,assumptions and projections regarding the industry, business, future operatingresults, potential acquisitions, and anticipated cash requirements) may beforward-looking statements. Words such as “anticipates,” “expects,” “intends,” “plans,”“believes,” “seeks,” “estimates,” and similar expressions identifyforward-looking statements. Such statements, including: statements regarding:the Company’s future growth; trends and expectations regarding conversionrates; expectations regarding economic conditions and their impact on retailused vehicle sales and the Company; increases in auction volumes; management’sability to capitalize on increasing volumes, if any; anticipated capitalexpenditures; the Company’s competitive position; and acquisition opportunitiesare not guarantees of future performance and are subject to risks anduncertainties that could cause actual results to differ materially from theresults projected, expressed or implied by these forward-looking statements. Factorsthat could cause or contribute to such differences include, but are not limitedto, those discussed in Item 1A “Risk Factors” in the Company’s Annual Report onForm 10-K for the year ended December 31, 2005 and filed on March 16,2006. Some of these factors include:

·       trendsin new and used vehicle sales and incentives, including wholesale used vehiclepricing;

·       economicconditions including fuel prices and Canadian exchange rate and interest ratefluctuations;

·       weather;

·       competition;

·       litigationdevelopments;

·       trendsin the vehicle remarketing industry;

·       businessdevelopment activities, including acquisitions and integration of acquiredbusinesses;

·       investmentsin technology;

·       strategicactions, including dispositions;

·       generalbusiness conditions;

·       changesin applicable tax laws and regulations (including significant accounting andtax matters);

·       vehicleproduction; and

·       otherrisks described from time to time in ADESA’s filings with the Securities andExchange Commission (“SEC”), including the Quarterly Reports on Form 10-Qfiled by ADESA in 2006.

Many of these risk factors are outside of ADESA’scontrol, and as such, they involve risks which are not currently known to ADESAthat could cause actual results to differ materially from those discussed orimplied herein. The forward-looking statements in this document are made as ofthe date hereof and ADESA does not undertake to update its forward-lookingstatements.

The Company’s future growth depends on a variety offactors, including its ability to increase vehicle sold volumes and loantransaction volumes, acquire additional auctions, manage expansion andintegration of acquisitions, control costs in its operations, introduce modestfee increases, expand its product and service offerings including technologicaldevelopment and retain its executive officers and key employees. 

25

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In addition, the Company’sindebtedness will require it to use a portion of its operating cash flow to payinterest and principal on debt instead of for other corporate purposes,including funding future expansion and ongoing capital expenditures. Accordingly,the Company cannot predict whether its growth strategy will be successful. Inaddition, the Company cannot predict what portion of overall sales will beconducted through online auctions or other redistribution methods in the futureand what impact this may have on its auction business.

The interim financialstatements included in this Quarterly Report on Form 10-Q and thefollowing discussion and analysis should be read in conjunction with thehistorical financial statements, related notes thereto, and other financialinformation included in the Company’s Annual Report on Form 10-K, asfiled with the Securities and Exchange Commission, which includes auditedfinancial statements for each of the three years in the period ended December 31,2005.

**Executive Overview**

The volume of used vehicles coming to auctioncontinued to increase in the second quarter of 2006. The Company believes theincrease in used vehicles coming to auction is a positive longer-term trend forthe business. In addition, lease penetration rates, one of the leadingindicators of institutional used vehicles returning to auction, have increasedto approximately 24.6 percent in the second quarter of 2006 from a low 19.3percent in the first quarter of 2004. However, softness in the retail usedvehicle market continued in the second quarter of 2006. In addition to therelatively high retail used vehicle prices, several macro-economic factorsincluding concerns related to interest rates and higher fuel prices continuedto negatively affect retail used vehicle demand. Retail used vehicle sales forthe six months ended June 30, 2006 decreased over 4 percent from thecomparable period in 2005. Weakness in retail demand for used vehicles wasreflected in the Company’s used vehicle conversion percentage which decreasedfrom 62.4 percent in the second quarter of 2005 to 58.2 percent in the secondquarter of 2006. The Company generally expects conversion rates should improveover time as concerns related to economic conditions abate and retail usedvehicle sales improve.

Despite a challenging environment, ADESA’s secondquarter revenues increased nearly 12 percent compared with the second quarterof 2005, primarily due to a 10 percent increase in revenue per vehicle soldresulting from an increase in ancillary services driven by a 7 percent increasein the vehicles entered to the Company’s used vehicle auctions. In addition,the Dealer Services Group segment performed well in the second quarter of 2006reporting a 5 percent increase in loan transactions and 6 percent increase inrevenue per loan transaction. However, increases in costs of services primarilydue to an increase in the volume of lower margin services such astransportation and reconditioning, increased costs associated with handling anadditional 52,000 used vehicles entered for sale and the impact of adopting FAS123(R) negatively affected operating results.

For the quarter ended June 30, 2006, the Companyreported record second quarter revenue of $275.9 million and net income of$36.1 million or $0.40 per diluted share, compared with revenue of $246.5 millionand net income of $35.9 million or $0.40 per diluted share for the secondquarter of 2005. On January 1, 2006, the Company implemented Statement ofFinancial Accounting Standards (“SFAS”) 123(R), *Share-BasedPayment*, which resulted in approximately $0.8 million of pretaxincremental stock-based compensation or nearly $0.01 per diluted share for thequarter ended June 30, 2006.

For the six months ended June 30, 2006, theCompany reported revenue of $561.5 million and net income of $72.4 million or$0.80 per diluted share, compared with revenue of $489.2 million and net incomeof $70.9 million or $0.78 per diluted share for the six months ended June 30,2005. In addition, in the first six months of 2006, ADESA incurred $3.4 millionof pretax stock based compensation expense, of which $1.8 million wasincremental as a result of the adoption of Statement of Financial Accounting 

26

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Standards 123(R), *Share-Based Payment*. Included in the results for the sixmonths ended June 30, 2006, is a $2.7 million pretax charge incurred inthe first quarter of 2006, or $0.02 per diluted share, related to thecorrection of certain unreconciled balance sheet differences concealed by aformer employee at the Company’s Kitchener, Ontario, auction facility acquiredin June 2000. The business continues to generate a significant amount ofcash. Cash provided by operations was $55.7 million for the six months ended June 30,2006, compared with cash provided by operations of $37.7 million for the sixmonths ended June 30, 2005.

During the second quarter of 2006, the Companyimplemented several organizational realignment and management changes intendedto better position the company to serve its diverse customer bases, accommodateanticipated growth and realize operational efficiencies across all businesslines. Brad Todd was appointed as President, Auction Services Group (“ASG”). ASGencompasses all wholesale and salvage auctions throughout North America (U.S.and Canada). Cam Hitchcock, formerly the Chief Financial Officer of ADESA, Inc.,was appointed as President, Dealer Services Group (“DSG”). DSG is the umbrellagroup that was formed to include the Automotive Finance Corporation (AFC)finance business as well as other businesses and ventures the Company may enterinto, focusing on providing the Company’s independent used vehicle dealercustomers with value-added ancillary services and products. Prior to the secondquarter of 2006, the ASG segment was referred to as auction and relatedservices or “ARS”, and the DSG segment was referred to as dealer financing. BothHitchcock and Todd report to A. R. Sales, the newly appointed President andChief Operating Officer of ADESA, Inc. The Company expects that thisorganizational realignment will accelerate its efforts to grow the business,enhance customer satisfaction and improve operating efficiency by moreeffectively cross-selling the Company’s product offerings and improvingoperational best practices and asset utilization across business lines.

The Company continues toinvest in its core information technology capabilities and capacity expansion. Boththe number of vehicles offered and sold on LiveBlock® continues to grow. In thesecond quarter of 2006, the Company completed the roll-out of its customerrelationship management technology, Salesforce.com®. The Company is rolling outits AutoVision® wireless vehicle inspection technology to its used vehicleauction operations. Management believes that these areas of investment arecritical to both maintaining the Company’s competitive position and positioningitself for future growth. In addition, the Company continues to be optimisticabout its acquisition opportunities and remains focused on accelerating itsdeployment of capital.

**Seasonality**

Generally, the volume ofvehicles sold at the Company’s auctions is highest in the first and secondcalendar quarters of each year and slightly lower in the third quarter. Fourthquarter volume of vehicles sold is generally lower than all other quarters.This seasonality is affected by several factors including weather, the timingof used vehicles available for sale from selling customers, holidays, and theseasonality of the retail market for used vehicles, which affect the demandside of the auction industry. Used vehicle auction volumes tend to declineduring prolonged periods of winter weather conditions. In addition, mildweather conditions and decreases in traffic volume can each lead to a declinein the available supply of salvage vehicles because fewer traffic accidentsoccur, resulting in fewer damaged vehicles overall. As a result, revenues andoperating expenses related to volume will fluctuate accordingly on a quarterlybasis, and the Company’s earnings are generally highest in the second calendarquarter. The fourth calendar quarter typically has the lowest earnings as aresult of the lower auction volume and additional costs associated with theholidays and winter weather.

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**Results ofOperations**

Thefollowing table sets forth operations data for the periods indicated *(in millions)*:

| ** **                                                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Change**                                                                       | ** ** | **Six Months Ended  June 30,**                                    | ** ** | **Change** | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|------------|------------|
| **Operations Data:**                                      | ** ** | ** **                                      | ** ** | **      2006      ** | ** ** | **      2005      ** | ** ** | **$**      | ** ** | **%** | ** ** | **2006** | ** ** | **2005** | ** ** | **$** | ** ** | **%** | ** ** |
| Auction services  group revenue                                |       |                                            |       |                                                                             |       |                                                                             |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S.                                                           | ** ** | ** **                                      | **$**      | **181.9**                                                                        |       |                                                                             |       | $          | 166.1      |   | ** ** | ** ** |   |   |   | **$** | **379.1** |   | $ | 335.2 |   |   |   |   |   |
| Canada                                                         | ** ** | ** **                                      | **57.8**   |                                                                             |       |                                                                             | 48.2       |       | ** ** | ** ** |   |   |   | **111.0** |   | 92.8 |   |   |   |   |   |
| Dealer services  group revenue                                 |       |                                            |       |                                                                             |       |                                                                             |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S.                                                           | ** ** | ** **                                      | **33.1**   |                                                                             |       |                                                                             | 29.9       |       | ** ** | ** ** |   |   |   | **65.4** |   | 57.1 |   |   |   |   |   |
| Canada                                                         | ** ** | ** **                                      | **3.1**    |                                                                             |       |                                                                             | 2.3        |       | ** ** | ** ** |   |   |   | **6.0** |   | 4.1 |   |   |   |   |   |
| Total revenue                                                  | ** ** | ** **                                      | **275.9**  |                                                                             |       |                                                                             | 246.5      |       |       | 29.4 |   | 12 | % | **561.5** |   | 489.2 |   | 72.3 |   | 15 | % |
| Cost of services (exclusive of depreciation and  amortization) | ** ** | ** **                                      | **137.7**  |                                                                             |       |                                                                             | 115.1      |       |       | 22.6 |   | 20 | % | **281.9** |   | 229.6 |   | 52.3 |   | 23 | % |
| Selling, general  and  administrative                          | ** ** | ** **                                      | **63.8**   |                                                                             |       |                                                                             | 56.1       |       |       | 7.7 |   | 14 | % | **130.7** |   | 110.9 |   | 19.8 |   | 18 | % |
| Depreciation and  amortization                                 | ** ** | ** **                                      | **11.0**   |                                                                             |       |                                                                             | 10.0       |       |       | 1.0 |   | 10 | % | **21.8** |   | 19.2 |   | 2.6 |   | 14 | % |
| Operating profit                                               | ** ** | ** **                                      | **63.4**   |                                                                             |       |                                                                             | 65.3       |       |       | (1.9 | ) | (2.9 | )% | **127.1** |   | 129.5 |   | (2.4 | ) | (1.9 | )% |
| Net income                                                     | ** ** | ** **                                      | **$**      | **36.1**                                                                         |       |                                                                             |       | $          | 35.9       |   |   | $ | 0.2 |   | 0.6 | % | **$** | **72.4** |   | $ | 70.9 |   | $ | 1.5 |   | 2 | % |
|                                                                |            |                                                 |            |                                                                                  |            |                                                                                  |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing table sets forth operations data as a percentage of total revenue forthe periods indicated:

| ** **                                                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,**                                    | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| **Operations  Data:**                                          | ** ** | ** **                                      | ** ** | **      2006      ** | ** ** | **      2005      ** | ** ** | **   2006   ** | ** ** | **   2005   ** | ** ** |
| Auction services  group revenue                                | ** ** | ** **                                      | **86.9**   | **%**                                                                            |       |   | 86.9 | % | ** ** | ** ** | **87.3** | **%** |   |   | 87.5 | % |   |
| Dealer services  group revenue                                 | ** ** | ** **                                      | **13.1**   | **%**                                                                            |       |   | 13.1 | % | ** ** | ** ** | **12.7** | **%** |   |   | 12.5 | % |   |
| Total revenue                                                  | ** ** | ** **                                      | **100.0**  | **%**                                                                            |       |   | 100.0 | % | ** ** | ** ** | **100.0** | **%** |   |   | 100.0 | % |   |
| Cost of services  (exclusive of depreciation and amortization) | ** ** | ** **                                      | **49.9**   | **%**                                                                            |       |   | 46.7 | % | ** ** | ** ** | **50.2** | **%** |   |   | 46.9 | % |   |
| Selling, general  and administrative                           | ** ** | ** **                                      | **23.1**   | **%**                                                                            |       |   | 22.8 | % | ** ** | ** ** | **23.3** | **%** |   |   | 22.7 | % |   |
| Depreciation and  amortization                                 | ** ** | ** **                                      | **4.0**    | **%**                                                                            |       |   | 4.0 | % | ** ** | ** ** | **3.9** | **%** |   |   | 3.9 | % |   |
| Operating profit                                               | ** ** | ** **                                      | **23.0**   | **%**                                                                            |       |   | 26.5 | % | ** ** | ** ** | **22.6** | **%** |   |   | 26.5 | % |   |
|                                                                |            |                                                 |            |                                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The Company’s revenue isderived from auction fees and related services at its auction facilities anddealer financing services at AFC. AFC’s net revenue consists of gain on sale offinance receivables sold and interest and fee income less provisions for creditlosses. This net presentation of AFC’s revenues is customary for financecompanies. Operating expenses for the Company consist of cost of services,selling, general and administrative expenses and depreciation and amortization.Cost of services is composed of payroll and related costs, subcontractservices, supplies, insurance, property taxes, utilities, maintenance and leaseexpense related to the auction sites and loan offices. Cost of servicesexcludes depreciation and amortization. Selling, general and administrativeexpenses are composed of indirect payroll and related costs, sales andmarketing, information technology services and professional fees.

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**Three Months Ended June 30,2006**

*Operating Revenue*

*AuctionServices Group*
|                                                                                               | ** ** | **Three Months Ended  June 30,** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|------------|------------|
| ***(In millions except volumes and per vehicle amounts)*** | ** ** | **2006**                                        | ** ** | **2005**   | ** ** | **% Change** | ** ** |
| Auction services  group revenue                                                               | ** ** | **$**                                           | **239.7**  |       | $          | 214.3 |   |   | 12 | % |   |
| Vehicles sold                                                                                 |       |                                            |       |       |       |   |   |   |   |
| Used                                                                                          | ** ** | **444,888**                                     |       | 444,787    |       |   | <1 | % |   |
| Salvage                                                                                       | ** ** | **56,719**                                      |       | 49,695     |       |   | 14 | % |   |
| Total vehicles sold                                                                           | ** ** | **501,607**                                     |       | 494,482    |       |   | 1 | % |   |
| Used vehicles entered (excludes salvage)                                                      | ** ** | **764,867**                                     |       | 712,897    |       |   | 7 | % |   |
| Used vehicle  conversion percentage                                                           | ** ** | **58.2**                                        | **%**      | 62.4       | %          |   |   |   |   |
| Revenue per vehicle sold                                                                      | ** ** | **$**                                           | **478**    |       | $          | 434 |   |   | 10 | % |   |

 

Revenue from ASG increased $25.4 million, or 12percent, to $239.7 million for the quarter ended June 30, 2006, comparedwith $214.3 million for the quarter ended June 30, 2005. The increase inrevenue was a result of a 10 percent increase in revenue per vehicle sold duringthe quarter and a 1 percent increase in vehicles sold.

Revenue per vehicle sold increased $44, or 10 percent,for the three months ended June 30, 2006, compared with the three monthsended June 30, 2005. The 10 percent increase in revenue per vehicle soldresulted in increased auction services group revenue of approximately $22.9million. The increase in revenue per vehicle sold was primarily attributable toan increase in lower margin services such as transportation, reconditioning andother ancillary services resulting from a 7 percent increase in the number ofinstitutional vehicles entered as well as a salvage vehicle mix shift. Thesefactors resulted in increased ASG revenue of approximately $11.0 million. Selectedfee increases, driven in part by higher wholesale used vehicle prices, resultedin increased ASG revenue of approximately $6.2 million. The highertransportation, reconditioning, other ancillary services revenues as well asthe change in mix of salvage vehicles sold also resulted in correspondingincreases in cost of services. Fluctuations in the Canadian exchange rateincreased revenue by approximately $5.7 million for the quarter ended June 30,2006, compared with the quarter ended June 30, 2005.

The total number ofvehicles sold increased 1 percent in the second quarter of 2006 compared with2005, resulting in an increase in ASG revenue of approximately $2.5 million. Theincrease in vehicles sold was primarily the result of added volumes from recentacquisitions. The used vehicle conversion percentage, calculated as the numberof vehicles sold as a percentage of the number of vehicles entered for sale atthe Company’s used vehicle auctions, declined to 58.2 percent for the quarterended June 30, 2006, from 62.4 percent for the quarter ended June 30,2005, reflecting a relatively weak retail used vehicle market in the secondquarter of 2006 compared with the second quarter of the prior year. The declinein the used vehicle conversion percentage negatively impacted ASG revenues,cost of sales and operating profit for the three months ended June 30,2006 compared with the three months ended June 30, 2005.

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*DealerServices Group*
|                                                                                            | ** ** | **Three Months Ended  June 30,** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|------------|------------|
| ***(In millions except volumes and per loan amounts)*** | ** ** | **2006**                                        | ** ** | **2005**   | ** ** | **% Change** | ** ** |
| Dealer services  group revenue                                                             |       |                                            |       |       |       |   |   |   |   |
| Gain on sale of finance receivables                                                        | ** ** | **$**                                           | **18.8**   |       | $          | 17.0 |   |   |   |   |   |
| Interest and fee income                                                                    | ** ** | **17.6**                                        |       | 14.5       |       |   |   |   |   |
| Other revenue                                                                              | ** ** | **0.1**                                         |       | 0.1        |       |   |   |   |   |
| Provision for credit losses                                                                | ** ** | **(0.3**                                        | **)**      | 0.6        |       |   |   |   |   |
| Total dealer services group revenue                                                        | ** ** | **$**                                           | **36.2**   |       | $          | 32.2 |   |   | 12 | % |   |
| Loan transactions                                                                          | ** ** | **295,959**                                     |       | 280,649    |       |   | 5 | % |   |
| Revenue per loan  transaction                                                              | ** ** | **$**                                           | **122**    |       | $          | 115 |   |   | 6 | % |   |

 

DSG revenue increased to $36.2 million for the quarterended June 30, 2006, compared with $32.2 million for the quarterended June 30, 2005. The 12 percent increase in DSG revenue was driven bya 6 percent increase in revenue per loan transaction and a 5 percentincrease in the number of loan transactions for the quarter ended June 30,2006, compared with the quarter ended June 30, 2005. The increase in loantransactions was primarily the result of an increase in floorplan utilizationby AFC’s existing dealer base.

Revenue per loantransaction, which includes both loans paid off and loans curtailed, increased$7, or 6 percent, primarily driven by a $3.1 million increase in fee andinterest income as the Federal Funds rate has increased approximately 200 basispoints since June 30, 2005. Increases in both the average values ofvehicles floored as well as the average portfolio duration also contributed tothe increase in revenue per loan transaction. An increase in the provision forcredit losses of $0.9 million compared with the three months ended June 30,2005 partially offset the increase in revenue per loan transaction.

*Cost of Services*

Cost of services increased $22.6 million, or 20percent, for the three months ended June 30, 2006, compared with the threemonths ended June 30, 2005. Weak retail used vehicle demand resulted in adecrease in the used vehicle conversion rate from 62.4 percent for the quarterended June 30, 2005 to 58.2 percent for the quarter ended June 30,2006. Cost of services was significantly impacted by an increase in lowermargin services such as transportation, reconditioning and other ancillaryservices, as well as costs associated with handling an additional 52,000 usedvehicles entered for sale at the Company’s auctions in the second quarter of2006 compared with the second quarter of 2005. Fluctuations in the Canadianexchange rate increased cost of services by approximately $2.8 million.

Cost of services at the ASG segment increased $21.1million, or 19 percent, to $130.0 million for the quarter ended June 30,2006. A $6.1 million increase in transportation costs, which includes fuelcosts, was a leading driver increasing cost of services. Increases inreconditioning and other ancillary services costs totaling $3.5 million,primarily resulting from a 7 percent increase in the number of institutionalvehicles entered, also impacted cost of services for the ASG segment. Cost ofservices was significantly impacted by costs associated with handling anadditional 52,000 used vehicles entered for sale at the Company’s used vehicleauctions in the second quarter of 2006 compared with the second quarter of 2005.The addition of acquired used vehicle and salvage auctions over the last twelvemonths further contributed to the increase in cost of services, along with achange in mix of salvage vehicles sold. Fluctuations in the Canadian exchange rateincreased cost of services at the ASG segment by approximately $2.8 million.

Cost of services at theDSG segment increased $1.5 million, or 24 percent, to $7.7 million for thethree months ended June 30, 2006 primarily due to increased compensationand related employee benefit costs.

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*Selling, Generaland Administrative Expenses*

Selling, general and administrative expenses increased$7.7 million, or 14 percent, for the quarter ended June 30, 2006,compared with the quarter ended June 30, 2005. This increase was primarilydue to compensation and related employee benefit cost increases, the impact of2005 and 2006 acquisitions, and an increase of $1.2 million associated withfluctuations in the Canadian exchange rate. In addition, in the second quarterof 2006, ADESA incurred $1.7 million of pretax stock based compensationexpense, of which $0.8 million was incremental as a result of the adoption ofStatement of Financial Accounting Standards 123(R), *Share-BasedPayment*.

Selling, general and administrative expenses at theASG segment increased $6.2 million, or 13 percent, to $52.8 million forthe quarter ended June 30, 2006 primarily due to increases in compensationand related employee benefit costs totaling $2.6 million, which includedseverance and other separation costs related to the departure of a seniorexecutive. The ASG segment also incurred $0.5 million of incremental stockbased compensation. In addition, there was an increase of $1.1 millionassociated with fluctuations in the Canadian exchange rate.

Selling, general and administrative expenses at theDSG segment increased $0.3 million, or 6 percent, to $5.6 million for thequarter ended June 30, 2006, primarily due to increases in certainprofessional fees, as well as employee training and travel costs.

Selling, general and administrative expenses at theholding company increased $1.2 million, or 29 percent, to $5.4 million forthe second quarter of 2006 relative to the second quarter of 2005, due toincreases in compensation and related employee benefits as well as costs forexecutive and director searches.

As the Company continuesstrategic actions such as corporate development, standardization andcentralization, and dealer consignment sales and training initiatives, selling,general and administrative expenses are expected to increase in the short-term.However, the Company believes the long-term benefits justify the currentinvestments.

*Depreciation andAmortization*

Depreciation andamortization totaled $11.0 million for the three months ended June 30,2006, representing an increase of $1.0 million, or 10 percent, from the $10.0million reported for the three months ended June 30, 2005. The increase indepreciation and amortization was a result of the Company’s capital spending in2005, including over $20 million related to information technology, whichgenerally has a shorter depreciable life. The Company continues to invest inits core information technology capabilities, as well as new technology serviceofferings, relocations and acquisitions.

*Operating Profit*

Operating profit decreased $1.9 million, or 3 percent,for the quarter ended June 30, 2006, compared with the quarter ended June 30,2005. As a percentage of revenue, operating profit decreased to 23.0 percentin the quarter ended June 30, 2006, compared with 26.5 percent in thequarter ended June 30, 2005. This decrease was primarily the result ofincreased operating expenses at the ASG segment driven by a soft retail usedvehicle market and declining used vehicle conversion rates.

Operating profit at the ASG segment decreased $2.9million, or 6 percent, to $47.0 million for the quarter ended June 30,2006, primarily as a result of the 3.5 percent increase in cost of services asa percent of revenues. Cost of services was significantly impacted by costsassociated with an increase in lower margin services such as transportation,reconditioning and other ancillary services resulting from a significantincrease in the number of institutional vehicles entered. Additionally, theadditional handling costs related to the incremental 52,000 used vehiclesentered increased cost of services. Furthermore, 

31

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selling, general andadministrative expenses at the ASG segment increased by $1.1 million due tofluctuations in the Canadian exchange rate.

Operating profit at the DSG segment increased $2.3million, or 12 percent, to $22.0 million for the quarter ended June 30,2006 primarily as a result of the 12 percent increase in revenue and anapproximately 1 percent decrease in selling, general and administrativeexpenses as a percentage of revenues. Increased revenue at the DSG segment morethan offset higher operating expenses associated with processing more loantransactions, which resulted in increased operating profit at the DSG segment.

Operating profit in theASG and DSG segments was offset by a $1.3 million increase in holding companyoperating expenses, consisting of compensation and related employee benefitscosts at the holding company as well as costs for executive and directorsearches.

*Interest Expense*

Interest expense decreased$1.4 million, or 16 percent, for the quarter ended June 30, 2006,compared with the quarter ended June 30, 2005, as the Company is carryingless debt than in the second quarter of 2005.

*Income Taxes*

The effective income taxrate on income from continuing operations was 37.7 percent for the quarterended June 30, 2006, a decrease from the effective rate of 38.9 percentfor the quarter ended June 30, 2005. The second quarter 2006 rate of 37.7percent is fairly consistent with the full year 2005 rate of 37.5 percent,and reflects the anticipated full year 2006 effective tax rate.

*DiscontinuedOperations*

In February 2003,management approved a plan to discontinue the operations of the Company’svehicle importation business. In August 2005, ADESA sold ComSearch, Inc.which provides professional claims outsourcing services, automotiveparts-locating and desk-auditing services to the property and casualtyinsurance industry. The financial results of the vehicle importation businessand ComSearch have been classified as discontinued operations. Net loss fromdiscontinued operations for the three months ended June 30, 2006 includesinterest on the vehicle importation business adverse judgment of $0.1 million.Net loss from discontinued operations for the three months ended June 30,2005 of $0.2 million is representative of operating losses at ComSearchand interest on the vehicle importation business adverse judgment. For afurther description of the importation legal matter see Part II Item 1. “LegalProceedings”.

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**Six Months Ended June 30,2006**

*Operating Revenue*

*AuctionServices Group*

| ** **                                                                                    | ** ** | **Six Months Ended  June 30,** | ** ** | ** ** | ** ** |              |
|-----------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------|------------|-------------------|
| ***(In millions except volumes and per vehicle amounts)*** | ** ** | **2006**                                      | ** ** | **2005**   | ** ** | **% Change** | ** ** |
| Auction services  group revenue                                                               | ** ** | **$**                                         | **490.1**  |       | $          | 428.0             |   |   | 15 | % |   |   |
| Vehicles sold                                                                                 |       |                                          |       |       |       |              |   |   |   |   |
| Used                                                                                          | ** ** | **913,099**                                   |       | 904,745    |       |              | 1 | % |   |   |
| Salvage                                                                                       | ** ** | **120,065**                                   |       | 104,183    |       |              | 15 | % |   |   |
| Total vehicles sold                                                                           | ** ** | **1,033,164**                                 |       | 1,008,928  |       |              | 2 | % |   |   |
| Used vehicles entered (excludes salvage)                                                      | ** ** | **1,471,322**                                 |       | 1,378,223  |       |              | 7 | % |   |   |
| Used vehicle conversion  percentage                                                           | ** ** | **62.1**                                      | **%**      | 65.6       | %          |              |   |   |   |   |
| Revenue per vehicle sold                                                                      | ** ** | **$**                                         | **474**    |       | $          | 424               |   |   | 12 | % |   |   |
|                                                                                               |            |                                               |            |            |            |                   |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Revenue from ASG (“ASG”) increased $62.1 million, or15 percent, to $490.1 million for the six months ended June 30, 2006,compared with $428.0 million for the six months ended June 30, 2005. The15 percent increase in revenue was a result of a 12 percent increase inrevenue per vehicle sold during the six months and a 2 percent increase invehicles sold.

Revenue per vehicle sold increased $50, or 12 percent,for the six months ended June 30, 2006, compared with the six months endedJune 30, 2005. The 12 percent increase in revenue per vehicle soldresulted in increased ASG revenue of approximately $53.2 million. The increasein revenue per vehicle sold was primarily attributable to an increase in lowermargin services such as transportation, reconditioning and other ancillaryservices resulting from a 7 percent increase in the number of institutionalvehicles entered as well as a salvage vehicle mix shift. These factors resultedin increased ASG revenue of approximately $30.6 million. Selected feeincreases, driven in part by higher wholesale used vehicle prices, resulted inincreased ASG revenue of approximately $13.9 million. The highertransportation, reconditioning, and other ancillary services revenues as wellas the change in mix of salvage vehicles sold also resulted in correspondingincreases in cost of services. Fluctuations in the Canadian exchange rateincreased revenue by approximately $8.7 million for the six months ended June 30,2006, compared with the six months ended June 30, 2005.

The total number of vehicles sold increased 1 percentin the first half of 2006 compared with 2005, resulting in an increase in ASGrevenue of approximately $8.9 million. The increase in vehicles sold wasprimarily the result of added volumes from recent acquisitions. The usedvehicle conversion percentage, calculated as the number of vehicles sold as apercentage of the number of vehicles entered for sale at the Company’s used vehicleauctions, declined to 62.1 percent for the six months ended June 30, 2006from 65.6 percent for the six months ended June 30, 2005 reflecting arelatively weak retail used vehicle market in the first half of 2006 comparedwith the first half of the prior year. The decline in the used vehicleconversion percentage negatively impacted ASG revenues, cost of sales andoperating profit for the six months ended June 30, 2006 compared with thesix months ended June 30, 2005.

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*DealerServices Group*

| ** **                                                                                 | ** ** | **Six Months Ended  June 30,** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------|------------|
| ***(In millions except volumes and per loan amounts)*** | ** ** | **2006**                                      | ** ** | **2005**   | ** ** | **% Change** | ** ** |
| Dealer services  group revenue                                                             |       |                                          |       |       |       |   |   |   |   |
| Gain on sale of finance receivables                                                        |       | **$**                                         | **39.4**   | ** ** | $          | 34.1 |   |   |   |   |   |
| Interest and fee income                                                                    |       | **32.8**                                      | ** ** | 27.6       |       |   |   |   |   |
| Other revenue                                                                              |       | **0.2**                                       | ** ** | 0.3        |       |   |   |   |   |
| Provision for credit losses                                                                |       | **(1.0**                                      | **)**      | (0.8       | )          |   |   |   |   |
| Total dealer services group revenue                                                        |       | **$**                                         | **71.4**   | ** ** | $          | 61.2 |   |   | 17 | % |   |
| Loan transactions                                                                          |       | **576,911**                                   | ** ** | 559,626    |       |   | 3 | % |   |
| Revenue per loan  transaction                                                              |       | **$**                                         | **124**    | ** ** | $          | 109 |   |   | 14 | % |   |

 

DSG revenue increased to $71.4 million for the sixmonths ended June 30, 2006, compared with $61.2 million for the sixmonths ended June 30, 2005. The 17 percent increase in DSG revenue wasdriven by a 14 percent increase in revenue per loan transaction and a 3 percentincrease in the number of loan transactions for the six months ended June 30,2006, compared with the six months ended June 30, 2005. The increase inloan transactions was primarily the result of an increase in floorplanutilization by AFC’s existing dealer base and yielded 576,911 loan transactionsfor the first half of 2006.

Revenue per loantransaction, which includes both loans paid off and loans curtailed, increased$15, or 14 percent, primarily driven by increases in interest rates andincreases in both the average values of vehicles floored as well as the averageportfolio duration. These factors contributed to the increase in gain on saleof $5.3 million and increased fee and interest income of $5.2 million. TheFederal Funds rate has increased approximately 200 basis points since June 30,2005.

*Cost of Services*

Cost of services increased $52.3 million, or 23percent, for the six months ended June 30, 2006, compared with the sixmonths ended June 30, 2005. Weak used vehicle demand resulted in adecrease in the used vehicle conversion rate from 65.6 percent for the sixmonths ended June 30, 2005 to 62.1 percent for the six months ended June 30,2006. Cost of services was significantly impacted by an increase in lowermargin services such as transportation, reconditioning and other ancillaryservices, as well as costs associated with handling an additional 93,000 usedvehicles entered for sale at the Company’s auctions in the first half of 2006compared with the first half of 2005. Fluctuations in the Canadian exchangerate increased cost of services by approximately $4.5 million.

Cost of services at the ASG segment increased $49.6million, or 23 percent, to $267.0 million for the six months ended June 30,2006. A $13.0 million increase in transportation costs, which includes fuelcosts, was a leading driver increasing cost of services. Increases inreconditioning and other ancillary services costs totaling $11.1 million,primarily resulting from a 7 percent increase in the number of institutionalvehicles entered, also impacted cost of services for the ASG segment. Cost ofservices increased significantly due to the costs associated with handling anadditional 93,000 used vehicles entered for sale at the Company’s used vehicleauctions in the first half of 2006 compared with the first half of 2005. Theaddition of the acquired used vehicle and salvage auctions over the last twelvemonths further contributed to the increase in cost of services, along with achange in mix of salvage vehicles sold. Fluctuations in the Canadian exchangerate increased cost of services at the ASG segment by approximately $4.5million.

Cost of services at theDSG segment increased $2.7 million, or 22 percent, to $14.9 million for the sixmonths ended June 30, 2006 primarily due to increased compensation andrelated employee benefit costs.

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*Selling, Generaland Administrative Expenses*

Selling, general and administrative expenses increased$19.8 million, or 18 percent, for the six months ended June 30, 2006,compared with the six months ended June 30, 2005. This increase wasprimarily due to compensation and related employee benefit cost increases, theimpact of 2005 and 2006 acquisitions, and an increase of $1.9 millionassociated with fluctuations in the Canadian exchange rate. In the first sixmonths of 2006, ADESA incurred $3.4 million of pretax stock based compensationexpense, of which $1.8 million was incremental as a result of the adoptionof Statement of Financial Accounting Standards 123(R), *Share-BasedPayment.* In addition, selling, general and administrative expensesfor the first quarter of 2006 included a $2.7 million pretax charge related tothe correction of certain unreconciled balance sheet differences concealed by aformer employee at the Company’s Kitchener, Ontario auction facility acquiredin June 2000. The unreconciled differences accumulated and were concealedover a period of five to six years between 2000 and 2006. Approximatelyone-half of the amounts concealed date back to fiscal years prior to 2003. Managementhas implemented changes to its internal control processes and systems and hasconcluded that the matters related to the $2.7 million charge, individually orin the aggregate, did not give rise to or arise from a material weakness due tothe nature of the items and compensating controls. In addition, management hasconcluded that the corrections were not material to either the current or anyprior period financial statements.

Selling, general and administrative expenses at theASG segment increased $16.9 million, or 18 percent, to $108.3 million forthe six months ended June 30, 2006 primarily due to increases incompensation and related employee benefits costs totaling $6.6 million, whichincluded severance and other separation costs related to the departure of asenior executive. The ASG segment also incurred $1.3 million ofincremental stock based compensation and the $2.7 million pretax Kitchenercharge. In addition, there was an increase of $1.8 million associated withfluctuations in the Canadian exchange rate.

Selling, general and administrative expenses at theDSG segment increased $1.1 million, or 11 percent, to $11.3 million forthe six months ended June 30, 2006 primarily due to increases in certainprofessional fees, as well as employee training and travel costs.

Selling, general and administrative expenses at theholding company increased $1.8 million, or 19 percent, to $11.1 millionfor the first six months of 2006, primarily due to increases in compensationand related employee benefit costs as well as executive and director searches.

As the Company continuesstrategic actions such as corporate development, standardization andcentralization, and dealer consignment sales and training initiatives, selling,general and administrative expenses are expected to increase in the short-term.However, the Company believes the long-term benefits justify the currentinvestments.

*Depreciation andAmortization*

Depreciation andamortization totaled $21.8 million for the six months ended June 30, 2006,representing an increase of $2.6 million, or 14 percent, from the $19.2 millionreported for the six months ended June 30, 2005. The increase indepreciation and amortization was a result of the Company’s capital spending in2005, including over $20 million related to information technology, whichgenerally has a shorter depreciable life. The Company continues to invest inits core information technology capabilities, as well as new technology serviceofferings, relocations and acquisitions.

*Operating Profit*

Operating profit decreased $2.4 million, or 2 percent,for the six months ended June 30, 2006, compared with the six months endedJune 30, 2005. As a percentage of revenue, operating profit decreased to22.6 percent in the first six months of 2006, compared with 26.5 percent in thefirst six months of 2005. 

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This decrease wasprimarily the result of increased operating expenses at the ASG segment drivenby a soft retail used vehicle market and declining used vehicle conversionrates.

Operating profit at the ASG segment decreased $7.2million, or 7 percent, to $95.1 million for the six months ended June 30,2006, primarily as a result of the 3.7 percent increase in cost of services asa percent of revenues along with the 0.7 percent increase in selling, generaland administrative expenses as a percent of revenues. Cost of services wassignificantly impacted by costs associated with an increase in lower marginservices such as transportation, reconditioning and other ancillary servicesresulting from a significant increase in the number of institutional vehiclesentered. Additionally, the decline in the used vehicle conversion percentageresulted in additional handling costs related to the incremental 93,000 usedvehicles entered which increased cost of services. Furthermore, selling,general and administrative expenses at the ASG segment were impacted by theKitchener charge and incremental stock-based compensation expense.

Operating profit at the DSG segment increased $6.7million, or 18 percent, to $43.4 million for the six months ended June 30,2006 primarily as a result of the 17 percent increase in revenue and a 0.8percent decrease in operating expenses as a percentage of revenues. Increasedrevenue at the DSG segment more than offset higher operating expensesassociated with processing more loan transactions, which increased operatingprofit at the DSG segment.

Operating profit in theASG and DSG segments was offset by a $1.9 million increase in holding companyoperating expenses, consisting primarily of compensation and related employeebenefit costs at the holding company.

*Interest Expense*

Interest expense decreased$2.5 million, or 15 percent, for the six months ended June 30, 2006,compared with the six months ended June 30, 2005, as the Company is carryingless debt than in the first half of 2005.

*Income Taxes*

The effective income taxrate on income from continuing operations was 37.8 percent for the six monthsended June 30, 2006, a decrease from the effective rate of 39.0 percentfor the six months ended June 30, 2005. The rate for the first half of2006 of 37.8 percent is relatively consistent with the full year 2005 rate of37.5 percent, and reflects the anticipated full year 2006 effective tax rate.

*DiscontinuedOperations*

In February 2003, management approved a plan todiscontinue the operations of the Company’s vehicle importation business. In August 2005,ADESA sold ComSearch, Inc. which provides professional claims outsourcingservices, automotive parts-locating and desk-auditing services to the propertyand casualty insurance industry. The financial results of the vehicleimportation business and ComSearch have been classified as discontinuedoperations. Net loss from discontinued operations for the six months ended June 30,2006 includes interest on the vehicle importation business adverse judgment of$0.1 million. Net loss from discontinued operations for the six months ended June 30,2005 of $0.3 million is representative of operating losses at ComSearch andinterest on the vehicle importation business adverse judgment. For a furtherdescription of the importation legal matter see Part II Item 1. “LegalProceedings”.

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**LIQUIDITY ANDCAPITAL RESOURCES**

TheCompany believes that the strongest indicators of liquidity for its businessare cash on hand, cash flow from operations, working capital and amountsavailable under its credit facility.
|                                           | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-------------------------------------------|------------|-------------------|------------|-----------------------|------------|-------------------|------------|
| ***(Dollars in millions)***     | ** ** | **2006**          | ** ** | **2005**              | ** ** | **2005**          | ** ** |
| Cash and cash  equivalents                | ** ** |              | **$**      | **210.1**             | ** ** |              |       | $ | 240.2 |   |   |   | $ | 247.8 |   |   |
| Restricted cash                           | ** ** |              | **$**      | **7.0**               | ** ** |              |       | $ | 5.7 |   |   |   | $ | 5.8 |   |   |
| Working capital                           | ** ** |              | **$**      | **323.2**             | ** ** |              |       | $ | 302.0 |   |   |   | $ | 333.7 |   |   |
| Amounts available  under credit facility  | ** ** |              | **$**      | **197.4**             | ** ** |              |       | $ | 199.3 |   |   |   | $ | 137.3 |   |   |
| Cash flow from  operations (year-to-date) | ** ** |              | **$**      | **55.7**              | ** ** |              |       | $ | 136.5 |   |   |   | $ | 37.7 |   |   |

 

**Working Capital**

A substantial amount of the Company’s working capitalis generated from the payments received for services provided. In addition,ADESA has a $350 million revolving line of credit pursuant to the amendedand restated $500 million credit facility, from which $138 million was drawn asof June 30, 2006. There were outstanding letters of credit totalingapproximately $14.6 million at June 30, 2006, which reduce the availableborrowings under the credit facility. The Company’s Canadian operations hadletters of credit outstanding totaling $2.6 million at June 30, 2006,which do not impact available borrowings under the credit facility. The CreditAgreement contains certain restrictive loan covenants, including, among others,financial covenants requiring a maximum total leverage ratio, a minimuminterest coverage ratio, and a minimum fixed charge coverage ratio andcovenants limiting ADESA’s ability to incur indebtedness, grant liens, makeacquisitions, be acquired, dispose of assets, pay dividends, repurchase stock,make capital expenditures and make investments. EBITDA (earnings beforeinterest expense, income taxes, depreciation and amortization) adjusted toexclude after-tax (a) gains or losses from asset sales; (b) temporarygains or losses on currency; (c) certain non-recurring gains and losses; (d) stockoption expense; and (e) certain other noncash amounts included in thedetermination of net income, is the principal measure of liquidity utilized inthe calculation of the financial ratios contained in the covenants. Inaddition, the senior subordinated notes contain certain financial andoperational restrictions on paying dividends and other distributions, makingcertain acquisitions or investments and incurring indebtedness, and sellingassets. These financial covenants affect the Company’s operating flexibilityby, among other things, restricting its ability to incur expenses andindebtedness that could be used to grow the business, as well as to fundgeneral corporate purposes. At June 30, 2006, theCompany was in compliance with the covenants contained in the creditfacility.

The majority of the Company’s working capital needsare short-term in nature, usually less than a week in duration. Due to thedecentralized nature of the business, payments for services are received ateach auction and loan production office and are deposited locally. Most of thefinancial institutions place a temporary hold on the availability of the fundsdeposited that can range anywhere from one to three business days, resulting incash in the Company’s accounts and on its balance sheet that is unavailable foruse until it is made available by the various financial institutions. Over theyears, the Company has increased the amount of funds that are available forimmediate use and is actively working on initiatives that will continue todecrease the time between the deposit of and the availability of funds receivedfrom customers. There are outstanding checks (book overdrafts) to sellers andvendors included in current liabilities. Because the majority of theseoutstanding checks for operations in the U.S. are drawn upon bank accounts atfinancial institutions other than the financial institutions that hold theunavailable cash, the Company cannot offset the cash and the outstanding checkson its balance sheet.

AFC offers short-term inventory-secured financing,also known as floorplan financing, to used vehicle dealers. Financing isprimarily provided for terms of 30 to 60 days. AFC principally generatesits funding 

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through the sale of itsU.S. dollar denominated receivables. For further discussion of AFC’ssecuritization arrangements, see “Off-Balance Sheet Arrangements”.

The Company believes its sources of liquidity from itscash and cash equivalents on hand, working capital, cash provided by operatingactivities, and availability under its credit facility are sufficient to meetits short and long-term operating needs for the foreseeable future. Inaddition, the Company believes the previously mentioned sources of liquiditywill be sufficient to fund the Company’s capital requirements, debt service anddividend payments for the next five years.

On July 25, 2006, theCompany’s board of directors declared a third quarter dividend of $0.075 percommon share payable September 15, 2006, to stockholders of record on August 16,2006.

**Summary of CashFlows**

ADESA’scash flow initiatives include growing its vehicle auction and dealer financingbusinesses both internally by expanding facilities, services and operations,and externally through acquisitions.
|                                            | ** ** | **Six Months Ended  June 30,** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------|------------|------------|------------|
| ***(In millions)***                   | ** ** | **2006**                                      | ** ** | **2005**   | ** ** | **Change** | ** ** |
| Net cash provided  by (used by):           |       |                                          |       |       |       |   |   |
| Operating activities                       | ** ** | **$**                                         | **55.7**   |       | $          | 37.7 |   | $ | 18.0 |   |
| Investing activities                       | ** ** | **(91.7**                                     | **)**      | (79.9      | )          | (11.8 | ) |
| Financing activities                       | ** ** | **5.4**                                       |       | (13.7      | )          | 19.1 |   |
| Effect of exchange rate on cash            | ** ** | **0.5**                                       |       | (0.8       | )          | 1.3 |   |
| Net decrease in cash and  cash equivalents | ** ** | **$**                                         | **(30.1**  | **)**      | $          | (56.7 | ) | $ | 26.6 |   |

 

Cash flow from operating activities was $55.7 millionfor the six months ended June 30, 2006, compared with $37.7 million forthe same period in 2005. Operating cash flow was favorably impacted by higherearnings and non-cash charges, primarily related to depreciation andstock-based compensation, as well as lower levels of cash used for workingcapital.

Net cash used for investing activities was $91.7million for the six months ended June 30, 2006, compared with net cashused by investing activities of $79.9 million for the six months ended June 30,2005. This change was primarily the result of a cash investment of $12.5million in Finance Express LLC, an increase in cash used for acquisitions of$11.3 million and a larger increase in finance receivables held for investmentof $7.2 million. The increase in cash used by investing activities waspartially offset by a decrease in capital expenditures of $19.8 million. For adiscussion of the Company’s capital expenditures, see “Capital Expenditures”below. There were no significant investing cash flows related to discontinuedoperations in the periods presented.

Cash provided by financingactivities was $5.4 million for the six months ended June 30, 2006,compared with cash used by financing activities of $13.7 million for thesame period in 2005. The primary drivers for the increase include a decline inthe cash used for the repurchase of common stock of $43.4 million (a sharerepurchase program was in effect during the first half of 2005) and a $3.5million decrease in debt payments, partially offset by a $24.8 million decreasein cash provided by book overdrafts. There were no significant financing cashflows related to discontinued operations in the periods presented.

**Other FinancialData**

EBITDA is defined as earnings before interest expense,income taxes, depreciation and amortization. The Companybelieves that EBITDA is a useful supplement and meaningful indicator ofearnings performance to be used by its investors, financial analysts and othersto analyze the Company’s financial 

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performance and results of operations overtime. In addition, EBITDA is a useful supplement to net cash provided byoperating activities to help investors understand the Company’s ability togenerate cash flows from operations that are available for taxes, debt serviceand capital expenditures. Adjusted EBITDA is also used by the Company’screditors in assessing debt covenant compliance. EBITDA adjusted to excludeafter-tax (a) gains or losses from asset sales; (b) temporary gains or losseson currency; (c) certain non recurring gains and losses; (d) stock optionexpense; and (e) certain other noncash amounts included in the determination ofnet income, is the principal measure of liquidity utilized in the calculationof the financial ratios calculated in determining compliance with the financialcovenants within the Company’s lending agreements.

While the Company believes that EBITDA is an important financial measure,it is not presented as an alternative to cash flow, income from continuingoperations or net income as indicators of liquidity or operating performance,and should not be considered in isolation or as a substitute for measures ofperformance prepared in accordance with generally accepted accountingprinciples (“GAAP”). This measure may not be comparable to similarly titledmeasures reported by other companies.

The followingtable reconciles EBITDA to income from continuing operations and net income (*in millions*):

| ** **                             | ** ** | **Three Months Ended  June 30,**          | ** ** | **Six Months Ended  June 30,**            | ** ** |
|----------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                             | ** ** | **    2006    ** | ** ** | **    2005    ** | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Net  income**                        | ** ** |                                                     | **$**      | **36.1**                                                 |       |   |   | $ | 35.9 | ** ** |   | **$** | **72.4** |   | $ | 70.9 |   |
| Add back:                              |       |                                                     | ** ** |                                                     |       |   |   | ** ** |   |   |   |   |   |
| Loss from discontinued operations      | ** ** |                                                     | **0.1**    |                                                     |       |   | 0.2 | ** ** |   | **0.1** |   | 0.3 |   |
| **Income  from continuing operations** | ** ** |                                                     | **$**      | **36.2**                                                 |       |   |   | $ | 36.1 | ** ** |   | **$** | **72.5** |   | $ | 71.2 |   |
| Add back:                              |       |                                                     | ** ** |                                                     |       |   |   | ** ** |   |   |   |   |   |
| Income tax expense                     | ** ** |                                                     | **21.9**   |                                                     |       |   | 23.0 | ** ** |   | **44.0** |   | 45.5 |   |
| Interest expense                       | ** ** |                                                     | **7.1**    |                                                     |       |   | 8.5 | ** ** |   | **14.1** |   | 16.6 |   |
| Depreciation and amortization          | ** ** |                                                     | **11.0**   |                                                     |       |   | 10.0 | ** ** |   | **21.8** |   | 19.2 |   |
| **EBITDA**                             | ** ** |                                                     | **$**      | **76.2**                                                 |       |   |   | $ | 77.6 | ** ** |   | **$** | **152.4** |   | $ | 152.5 |   |

 

A reconciliationof net cash provided by operating activities, another comparable GAAP measure,to EBITDA for each of the fiscal periods indicated is presented below (*in millions*):

| ** **                                                        | ** ** | **Three Months Ended  June 30,**                      | ** ** | **Six Months Ended  June 30,**                        | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                        | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Net  cash provided by operating activities**                    | ** ** |                                                                 | **$**      | **53.5**                                                             |       |   |   | $ | 35.3 | ** ** |   | **$** | **55.7** |   | $ | 37.7 |   |
| Changes in  operating assets and liabilities, net of acquisitions | ** ** |                                                                 | **(2.2**   | **)**                                                                |       |   | 12.8 | ** ** |   | **48.0** |   | 58.7 |   |
| Bad debt expense                                                  | ** ** |                                                                 | **(0.6**   | **)**                                                                |       |   | 0.7 | ** ** |   | **(2.4** | **)** | (1.0 | ) |
| Interest expense                                                  | ** ** |                                                                 | **7.1**    |                                                                 |       |   | 8.5 | ** ** |   | **14.1** |   | 16.6 |   |
| Income tax  expense                                               | ** ** |                                                                 | **21.9**   |                                                                 |       |   | 23.0 | ** ** |   | **44.0** |   | 45.5 |   |
| Deferred income  tax                                              | ** ** |                                                                 | **(1.0**   | **)**                                                                |       |   | (1.7 | ) |   | **(2.0** | **)** | (2.2 | ) |
| Discontinued  operations, net of taxes                            | ** ** |                                                                 | **0.1**    |                                                                 |       |   | 0.2 | ** ** |   | **0.1** |   | 0.3 |   |
| Stock-based  compensation expense                                 | ** ** |                                                                 | **(1.6**   | **)**                                                                |       |   | (1.1 | ) |   | **(3.4** | **)** | (1.5 | ) |
| Other non-cash,  net                                              | ** ** |                                                                 | **(1.0**   | **)**                                                                |       |   | (0.1 | ) |   | **(1.7** | **)** | (1.6 | ) |
| **EBITDA**                                                        | ** ** |                                                                 | **$**      | **76.2**                                                             |       |   |   | $ | 77.6 | ** ** |   | **$** | **152.4** |   | $ | 152.5 |   |

 

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**CapitalExpenditures**

Capital expenditures(excluding acquisitions and other investments) for the six months ended June 30,2006 and the year ended December 31, 2005 totaled $16.9 million and $55.3million, respectively and were funded primarily from internally generated funds.The Company continues to invest in its core information technology capabilitiesand capacity expansion. Capital expenditures are expected to total between $40 millionand $50 million for 2006. Anticipated expenditures are primarily attributableto ongoing improvements at existing vehicle auction facilities and improvementsin information technology systems and infrastructure. Future capitalexpenditures could vary substantially based on capital project timing and theinitiation of new information systems projects to support the Company’sstrategic initiatives.

**Acquisitions**

In February 2006, the Company completed thepurchase of certain assets of the N.E. Penn Salvage Company, an independentlyowned salvage auction in northeast Pennsylvania. The purchased assets includedthe accounts receivable, operating equipment and customer relationships relatedto the auction. In addition, the Company entered into operating leaseobligations related to the facility through 2016. Initial annual lease paymentsfor the facilities total approximately $0.1 million per year. The Company didnot assume any other material liabilities or indebtedness in connection withthe acquisition. Financial results for this acquisition have been included inthe Company’s consolidated financial statements since the date of acquisition.

In March 2006, the Company completed theacquisition of certain assets of Auction Broadcasting Company’s South Tampaused vehicle auction serving western and central Florida. The Company hasrenamed the auction ADESA Sarasota. The assets purchased included land andbuildings, the related operating equipment, accounts receivable and customerrelationships related to the auction. The auction is comprised of approximately63 acres and includes six auction lanes and full-service reconditioning shopsproviding detail, mechanical and body shop services. The Company did not assumeany material liabilities or indebtedness in connection with the acquisition. Financialresults for this acquisition have been included in the Company’s consolidatedfinancial statements since the date of acquisition.

ADESA acquired the two previouslymentioned auctions for a total cost of $29.6 million, in cash. Preliminarypurchase price allocations have been recorded for each acquisition. Thepurchase price of the acquisitions was allocated to the acquired assets basedupon fair market values, including $5.0 million to other intangible assets,representing the fair value of acquired customer relationships and non-competeagreements, which will be amortized over their expected useful lives of 9 to 15years. The preliminary purchase price allocations resulted in aggregategoodwill of $11.4 million. The goodwill was assigned to the ASG reportingsegment and is expected to be fully deductible for tax purposes. The Companyexpects to finalize the purchase price allocations related to each of the acquisitionsupon receipt and analysis of third party valuations. Pro forma financialresults for the acquisitions were not material.

**Other Investment**

In February 2006, AFCacquired a 15 percent interest in Finance Express LLC for $12.5 million in cash.Finance Express is a financial software and services company specializing insoftware to facilitate the origination and servicing of motor vehicle retailinstallment loan contracts between independent used vehicle dealers and lendinginstitutions. In addition, the Company also receives certain fees from FinanceExpress for assistance in marketing its software product and services toindependent used vehicle dealers. Finance Express qualifies as a variableinterest entity (“VIE”) pursuant to Financial Accounting Standards BoardInterpretation No. 46, Consolidation of Variable Interest Entities, anInterpretation of Accounting Research Bulletin No. 51 (“FIN 46”). TheCompany is currently not the primary beneficiary of the VIE and its risk ofloss is limited, in all material respects, to its investment in Finance Express.Finance Express 

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is a LLCthat maintains specific capital accounts for each member. Therefore, theCompany uses the equity method of accounting for this investment in accordancewith the guidance in Emerging Issues Task Force (“EITF”) 03-16, *Accounting for Investments in Limited Liability Companies*,Statement of Position (“SOP”) 78-9, *Accounting for Investmentsin Real Estate Ventures*, and SAB Topic D-46, *Accounting for Limited Partnership Investments*. The Company’sshare of Finance Express’ earnings or losses is recorded in “Other income, net”in the Consolidated Statements of Income, and was not material for the three orsix month periods ended June 30, 2006.

**Off-Balance SheetArrangements**

AFC sells the majority of its U.S. dollar denominated finance receivableson a revolving basis and without recourse to a wholly owned, bankruptcy remote,consolidated, special purpose subsidiary (“AFC Funding Corporation”),established for the purpose of purchasing AFC’s finance receivables. EffectiveMarch 31, 2006, AFC and AFC Funding Corporation amended their securitizationagreement. As part of the amendment, the expiration date of the agreement wasextended from June 30, 2008 to April 30, 2009. This agreement is subject toannual renewal of short-term liquidity by the liquidity providers and allowsfor the revolving sale by AFC Funding Corporation to a bank conduit facility ofup to a maximum of $600 million in undivided interests in certain eligiblefinance receivables subject to committed liquidity. AFC Funding Corporation hadcommitted liquidity of $550 million and $425 million at June 30, 2006 and December 31,2005, respectively. Receivables that AFC Funding sells to the bank conduitfacility qualify for sales accounting for financial reporting purposes pursuantto SFAS 140, *Accounting for Transfers and Servicing ofFinancial Assets and Extinguishment of Liabilities,* and as a resultare not reported on the Company’s Consolidated Balance Sheet.

At June 30, 2006, AFC managed total finance receivables of $772.7million, of which $690.2 million had been sold without recourse to AFC FundingCorporation. At December 31, 2005, AFC managed total finance receivablesof $655.7 million, of which $581.9 million had been sold without recourse toAFC Funding Corporation. Undivided interests in finance receivables weresold by AFC Funding Corporation to the bank conduit facility with recoursetotaling $458.0 million and $399.8 million at June 30, 2006 and December 31,2005, respectively. Finance receivables include $62.4 million and $51.1 millionclassified as held for sale and $188.7 million and $148.0 million classified asheld for investment at June 30, 2006 and December 31, 2005,respectively. AFC’s allowance for losses of $3.4 million and $2.4 millionat June 30, 2006 and December 31, 2005, respectively, include anestimate of losses for finance receivables. Additionally, accrued liabilitiesof $4.1 million and $2.9 million for the estimated losses for loans sold by thespecial purpose subsidiary were recorded at June 30, 2006 and December 31,2005, respectively. These loans were sold to a bank conduit facility withrecourse to the special purpose subsidiary and will come back on the balancesheet of the special purpose subsidiary at fair market value if they becomeineligible under the terms of the collateral arrangement with the bank conduitfacility.

Proceeds from the revolving sale of receivables to the bankconduit facility were used to fund new loans to customers. AFC and AFC FundingCorporation must maintain certain financial covenants including, among others,limits on the amount of debt AFC can incur, minimum levels of tangible networth, and other covenants tied to the performance of the finance receivablesportfolio. The securitization agreement also incorporates the financialcovenants of ADESA’s credit facility. At June 30, 2006, the Company was incompliance with the covenants contained in the securitization agreement.

**Critical AccountingEstimates**

In preparing the financial statements in accordancewith generally accepted accounting principles, management must often makeestimates and assumptions that affect the reported amounts of assets,liabilities, revenues, expenses and related disclosures at the date of thefinancial statements and during the 

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reporting period. Some ofthose judgments can be subjective and complex. Consequently, actual resultscould differ from those estimates. Accounting measurements that managementbelieves are most critical to the reported results of operations and financialcondition of the Company include: uncollectible receivables and allowance forcredit losses and doubtful accounts, recoverability of goodwill and long-livedassets, self-insurance programs, legal proceedings and other losscontingencies, and income taxes.

Management has discussed the development and selectionof its critical accounting estimates with the Audit Committee of ADESA’s boardof directors. In addition to the critical accounting estimates, there are otheritems used in the preparation of ADESA’s consolidated financial statements thatrequire estimation, but are not deemed critical. Changes in estimates used inthese and other items could have a material impact on ADESA’s financialstatements.

ADESA continually evaluatesthe accounting policies and estimates it uses to prepare the consolidatedfinancial statements. In cases where management estimates are used, they arebased on historical experience, information from third-party professionals, andvarious other assumptions believed to be reasonable. The Company’s criticalaccounting estimates are discussed in the “Critical Accounting Estimates”section of “Management’s Discussion and Analysis of Financial Condition andResults of Operations” in Part II, Item 7 of the Company’s Annual Reporton Form 10-K for the year ended December 31, 2005, as filedwith the Securities and Exchange Commission. In addition, ADESA’s mostsignificant accounting polices are discussed in Note 3 and elsewhere in the Notes to the Consolidated Financial Statementsincluded in Company’s 2005 Annual Report on Form 10-K, whichincludes audited financial statements..

**Adoption of SFAS123(R), *Share-Based Payment***

Prior to 2006, ADESA applied the intrinsic valuemethod provisions of Accounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees*, and relatedinterpretations, to account for stock-based awards. Accordingly, the Companydid not recognize compensation expense for employee stock options that weregranted in prior years. However, compensation expense was recognized on otherforms of stock-based awards, including restricted stock units and performancebased stock awards. On January 1, 2006, the Company adopted the provisionsof SFAS 123(R), *Share-Based Payment*, using themodified prospective application method, and therefore was not required torestate its financial results for prior periods. Under this method, as of January 1,2006, ADESA will apply the provisions of this statement to new and modifiedawards, as well as to the nonvested portion of awards granted and outstandingbefore the Company’s adoption.

The Company’s stock-based compensation awards,including both stock options and restricted stock units, have a retirementeligible provision, whereby awards granted to employees who have reached theretirement eligible age and meet certain service requirements with either ADESAand/or its former parent, ALLETE, automatically vest when an eligible employeeretires from the Company. The Company has previously accounted for this type ofarrangement by recognizing compensation cost (for both pro forma andrecognition purposes) over the nominal vesting period (i.e. over the fullstated vesting period of the award) and, if the employee retired before the endof the vesting period, by recognizing any remaining unrecognized compensationcost at the date of retirement. Upon adoption of SFAS 123(R), new awards willbe subject to the non-substantive vesting period approach, which specifies thatan award is vested when the employee’s retention of the award is no longercontingent on providing subsequent service. Recognizing that many companiesfollowed the nominal vesting period, the SEC issued guidance for converting tothe non-substantive vesting period approach. The Company has revised itsapproach to apply the non-substantive vesting period approach to all new grantsafter adoption, but will continue to follow the nominal vesting period approachfor the remaining portion of unvested outstanding awards. An additional requirementof SFAS 123(R) is that estimated forfeitures be considered in determining 

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compensation expense. Aspreviously permitted, the Company recorded forfeitures when they occurred. Estimatingforfeitures did not have a material impact on the determination of compensationexpense.

On March 9, 2005, the board of directors (the “board”)of the Company accelerated the vesting of certain unvested and “out-of-the-money”stock options previously awarded to employees and officers that have anexercise price of $24 per share. The awards accelerated were made under theADESA, Inc. 2004 Equity and Incentive Plan in conjunction with ADESA’sinitial public offering (“IPO”) in June 2004. As a result, options topurchase approximately 2.9 million shares of the Company’s common stock becameexercisable immediately and the Company disclosed incremental pro formastock-based employee compensation expense of approximately $7.7 million, net oftax, in the first quarter 2005. The options awarded in conjunction with the IPOto the Company’s named executive officers and the majority of the otherofficers would have vested in equal increments at June 15, 2005, 2006 and2007. The options awarded to certain other executive officers and employees haddifferent vesting terms. One-third of the options awarded to the otherexecutive officers and employees vested on December 31, 2004. Theremaining two-thirds of the options awarded to these executive officersand other employees in conjunction with the IPO would have vested in equalincrements at December 31, 2005 and 2006. All of these options expire in June 2010.All other terms and conditions applicable to the outstanding stock optiongrants remain in effect.

The Company and its board considered several factorsin determining to accelerate the vesting of these options. Primarily, theacceleration enhances the comparability of the Company’s 2005 financialstatements with those of 2006 and subsequent periods. The options awarded tothe executive officers were special, one-time grants in conjunction with theCompany’s IPO. As such, these grants are not indicative of past grants whenADESA was a subsidiary of ALLETE prior to June 2004 and are notrepresentative of the Company’s expected future grants. The Company and boardalso believe that the acceleration was in the best interest of the stockholdersas it reduces the Company’s reported stock option expense in future periodsmitigating the impact of SFAS 123(R).

As a result of adopting SFAS 123(R) on January 1,2006, income from continuing operations before income taxes and net income forthe six months ended June 30, 2006, were $1.8 million and $1.1 millionlower, respectively, than if the Company had continued to account forshare-based awards under APB Opinion No. 25. Basic and dilutedearnings per share from continuing operations were both $0.02 lower for the sixmonths ended June 30, 2006 as a result of the adoption of SFAS 123(R).

Prior to the adoption of SFAS 123(R), tax benefits ofdeductions resulting from the exercise of stock options were presented asoperating cash flows in the Consolidated Statements of Cash Flows. SFAS 123(R) requirescash flows resulting from tax deductions from the exercise of stock options inexcess of recognized compensation cost from the exercise of stock options(excess tax benefits) to be classified as financing cash flows. This change inclassification did not have an impact on the Consolidated Statement of CashFlows in the current period as the excess tax benefits recognized for the sixmonths ended June 30, 2006 were not material.

Prior to the adoption of SFAS 123(R), the Companyapplied the disclosure-only provisions of SFAS 123, *Accountingfor Stock-Based Compensation*, as amended by SFAS 148, *Accounting for Stock-Based Compensation—Transitionand Disclosure*, which permitted companies to apply the existingaccounting rules under APB Opinion No. 25 and related interpretations.Generally, if the exercise price of options granted under the plan was equal tothe market price of the underlying common stock on the grant date, noshare-based compensation cost was recognized in net income. As required by SFAS148, prior to the adoption of SFAS 123(R), pro forma net income and pro formanet income per common share were provided for stock-based awards, as if thefair value recognition provisions of SFAS 123 had been applied.

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The Company typicallyissues its annual grant of stock-based awards in the first quarter of itsfiscal year. See Note 2 “Stock-Based Compensation” included in this Form 10-Qfor further details on the Company’s stock-based awards programs.

**New AccountingStandards**

In March 2006, the FASB issued SFAS 156, *Accounting for Servicing of Financial Assets—an amendment of FASBStatement No. 140*. SFAS 156 requires recognition of a servicingasset or liability at fair value each time an obligation is undertaken toservice a financial asset by entering into a servicing contract. The standardalso provides guidance on subsequent measurement methods for each class ofservicing assets and liabilities and specifies financial statement presentationand disclosure requirements. SFAS 156 is effective for fiscal years beginningafter September 15, 2006. The Company will adopt SFAS 156 on January 1,2007, and is currently evaluating what effect the adoption of SFAS 156 willhave on the consolidated financial statements.

In July 2006, theFASB released Interpretation No. 48, *Accounting for Uncertaintyin Income Taxes, an Interpretation of FASB Statement No 109*(“FIN 48”).FIN 48 clarifies the accounting and reporting for uncertainty in income taxesrecognized in an enterprise’s financial statements. This interpretationprescribes a comprehensive model for the financial statement recognition,measurement, presentation and disclosure of uncertain tax positions taken orexpected to be taken on income tax returns. FIN 48 is effective for fiscalyears beginning after December 15, 2006. The Company will adopt FIN 48 on January 1,2007, and is currently evaluating the impact the adoption of FIN 48 will haveon the consolidated financial statements. The cumulative effects, if any, ofapplying this Interpretation will be recorded as an adjustment to retainedearnings as of the beginning of the period of adoption.

**Item 3.**              Quantitativeand Qualitative Disclosures About Market Risk

**Foreign Currency**

The Company’s foreigncurrency exposure is limited and arises from transactions denominated inforeign currencies, particularly intercompany loans, as well as fromtranslation of the results of operations from the Company’s Canadian subsidiary.However, fluctuations between U.S. and non-U.S. currency values may adverselyaffect the Company’s results of operations and financial position. In addition,there are tax inefficiencies in repatriating cash from non-U.S. subsidiaries. Tothe extent such repatriation is necessary for ADESA to meet its debt service orother obligations, these tax inefficiencies may adversely affect ADESA. TheCompany has not entered into any foreign exchange contracts to hedge changes inthe Canadian or Mexican exchange rates. Canadian currency translationpositively affected net income by approximately $0.8 million for the threemonths ended June 30, 2006 and $1.1 million for the six months ended June 30,2006.

**Interest Rates**

The Company is exposed to interest rate risk on borrowings.Accordingly, interest rate fluctuations affect the amount of interest expensethe Company is obligated to pay. The Company uses interest rate swap agreementsto manage its exposure to interest rate risk. The Company designates itsinterest rate swap agreements as cash flow hedges. The earnings impact ofinterest rate swaps designated as cash flow hedges is recorded upon therecognition of the interest related to the hedged debt. Any ineffectiveness ina hedging relationship is recognized immediately into earnings. There was nosignificant ineffectiveness in the first six months of 2006 or 2005.

In June 2004, the Company entered into aninterest rate swap agreement with a notional amount of $105 million to manageits exposure to interest rate movements on its variable rate debt. The interestrate swap agreement contains amortizing provisions and matures in December 2006.In November 2005, the 

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Company entered into aninterest rate swap agreement with a notional amount of $40 million to manageits exposure to interest rate movements on its variable rate credit facility. Theswap matures in May 2008.

The fair value of theinterest rate swap agreements is estimated using pricing models widely used infinancial markets and represents the estimated amount the Company would receiveor pay to terminate the agreements at the reporting date. At June 30,2006, the fair value of the interest rate swap agreements was a $1.1 milliongain recorded in “Other assets” on the consolidated balance sheet. At December 31,2005, the fair value of the interest rate swap agreements consisted of a $0.9million gain recorded in “Other assets” and a $0.1 million loss recorded in “Otherliabilities” on the consolidated balance sheet. In accordance with theprovisions of SFAS 133, *Accounting for DerivativeInstruments and Hedging Activities,* changes in the fair value of theinterest rate swap agreements designated as cash flow hedges are recorded in “Othercomprehensive income”. Unrealized gains or losses on interest rate swap agreementsare included as a component of “Accumulated other comprehensive income”. At June 30,2006, there was a net unrealized gain totaling $0.7 million, net of taxes of$0.4 million. At December 31, 2005, there was a net unrealized gaintotaling $0.5 million, net of taxes of $0.3 million. The Company is exposed tocredit loss in the event of non-performance by the counterparties; however,non-performance is not anticipated. The Company has only partially hedged itsexposure to interest rate fluctuations on its variable rate debt. A sensitivityanalysis of the impact on the Company’s variable rate debt instruments to ahypothetical 100 basis point increase in short-term interest rates for thethree and six months ended June 30, 2006 would have resulted in an increasein interest expense of approximately $0.4 million and $0.8 million,respectively.

**Item 4.**              Controlsand Procedures

**Disclosure Controlsand Procedures**

The Company’s management,with the participation of its Chief Executive Officer and its Chief FinancialOfficer, evaluated the effectiveness of the design and operation of the Company’sdisclosure controls and procedures (as defined in Rules 13a—15(e) and15d—15(e) under the Securities Exchange Act of 1934, as amended (“theExchange Act”)), as of the end of the period covered by this Quarterly Reporton Form 10-Q. Based on the evaluation, management, including theChief Executive Officer and the Chief Financial Officer, concluded that theCompany’s disclosure controls and procedures were effective as of the end ofthe period covered by this report for the information required to be disclosedin reports we file or submit under the Exchange Act to be recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms and for such information to beaccumulated and communicated to management as appropriate to allow timelydecisions regarding required disclosure.

**Changes in InternalControl Over Financial Reporting**

The Company is continuously seeking to improve theefficiency and effectiveness of its operations and internal controls. Thisresults in refinements to processes throughout the Company. However, there wereno changes in the Company’s internal control over financial reporting that occurredduring the period covered by this Quarterly Report on Form 10-Q thathave materially affected, or are reasonably likely to materially affect, theCompany’s internal control over financial reporting.

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**PART II**

**OTHER INFORMATION**

**Item 1.**                        LegalProceedings

The Company is involved in litigation and disputesarising in the ordinary course of business, such as actions related toinjuries; property damage; handling, storage or disposal of vehicles;environmental laws and regulations; and other litigation incidental to thebusiness such as employment matters and dealer disputes. Such litigation isgenerally not, in the opinion of management, likely to have a material adverseeffect on the financial condition, results of operations or cash flows.

Certain legal proceedingsin which the Company is involved are discussed in Note 21 to the consolidatedfinancial statements in Part II, Item 8 of the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2005 and Part I, Item 3 of the sameAnnual Report. The following discussion is limited to certain recentdevelopments concerning the Company’s legal and regulatory proceedings andshould be read in conjunction with those earlier Reports. Unless otherwise indicated,all proceedings discussed in those earlier reports remain outstanding.

***ADESA Importation Services, Inc. litigation***

In January, 2002, Johnny Cooper (“Cooper”), a formermanager of ADESA Importation Services, Inc. (“AIS”), a wholly ownedsubsidiary of the Company, filed suit against the Company and AIS (collectively“ADESA”) in the Circuit Court of the State of Michigan, County of Genesee, CaseNo. 02-72517-CK, alleging breach of contract and breach ofother oral agreements related to AIS’s purchase of International VehicleImporters, Inc. in December 2000. Cooper was the controllingshareholder who sold the business to AIS in 2000. AIS filed a counterclaimagainst Cooper including allegations of breach of contract, breach of fiduciaryduty and fraud. Pursuant to Michigan law, the case was originally evaluated byan independent three attorney panel which awarded Cooper damages of $153,000for his claims and awarded ADESA damages of $225,000 for its counterclaims. Cooperrejected the panel’s decision resulting in a jury trial. In June 2004, thejury awarded Cooper damages of $5.8 million related to the allegation thatADESA breached oral agreements to provide funding to AIS. The jury also foundin favor of ADESA on three of its counterclaims including breach of contract,breach of fiduciary duty and fraud and awarded ADESA $69,000. In July 2004,the Genesee County Circuit Court entered judgment for Cooper in the amount of$6,373,812, netting the amount of the damages and awarding the plaintiffprejudgment interest. In October 2004, the Genesee County Circuit Courtdenied post-judgment motions made by ADESA for a new trial and/or reduction inthe damages. In November 2004, the Company filed a Claim of Appeal withthe Michigan Court of Appeals. Both parties subsequently submitted theirrespective appellate briefs to the Michigan Court of Appeals.

In December 2005, the Company filed a motion forperemptory reversal requesting the Michigan Court of Appeals to reverse thejudgment on the grounds that Cooper’s oral side agreement claim was barred, asa matter of law, by the merger provisions of the asset purchase agreement thatwas entered into in 2000 in connection with the sale of the business to AIS. InMarch 2006, the Company was notified that the Court of Appeals denied themotion on the grounds that it failed to persuade the Court of the existence ofmanifest error requiring reversal without argument for formal submission. In April 2006,the parties presented their respective oral arguments to a three judge panel ofthe Court of Appeals. A decision is expected later this year.

The Company discontinuedthe operations of AIS, its vehicle importation business, in February 2003.At June 30, 2006, the Company has an accrual totaling $7.0 million ($5.8million award plus accrued interest of $1.2 million) as a result of the jurytrial verdict.

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***Hallett Entities***

As previously reported, wholesale vehicle businessesowned or controlled by Sean Hallett, the son of James Hallett, a formerExecutive Vice President of ADESA, were in default with respect to threeseparate lines of credit with AFC and an outstanding loan through a relatedentity totaling $1.7 million at June 20, 2006. The lines of credittotaling $0.4 million are secured with a perfected blanket security interest inthe assets of the wholesale vehicle businesses. The loan iscross-collateralized with one of the credit lines and is secured by certainunencumbered personal property valued between $0.3 million and $0.5 million. Basedon an assessment of recoverability, the Company recorded provisions for creditlosses totaling $1.3 million in 2004 leaving AFC with a net receivableposition of $0.4 million at June 30, 2006 and December 31, 2005.

In November 2004, AFC and Automotive FinanceCanada, Inc. (“AFCI”) initiated legal action and filed a statement ofclaim in the Ontario Superior Court of Justice alleging that Sean Hallett andhis related companies (the “Hallett Entities”) had defaulted on theiroutstanding obligations to AFC and AFCI (Ontario Superior Court of Justice;Case File No. 04-CV-278564CM2). In December 2004, theHallett Entities filed their statement of defense and counterclaim against AFC,AFCI, ADESA, Inc., ADESA Canada and ADESA Auctions Canada (collectivelythe “AFC Entities”) stating that the Hallett Entities had satisfied their debtsto the AFC Entities and alleging that the AFC Entities owed approximately $6million to Hallett in compensatory and punitive damages.

In August 2006, theAFC Entities and the Hallett Entities entered into a settlement agreement whichprovides, among other matters, for the Hallett Entities to transfer title ofthe unencumbered personal property which secured the loan to AFC, to pay theAFC Entities a total of CDN$500,000 and the dismissal of the pendingproceedings.

**Item 1A.**                RiskFactors

**Inaddition to the other information set forth in this report, readers shouldcarefully consider the factors discussed in Part I, “Item 1A. Risk Factors”in the Company’s Annual Report on Form 10-K for the year ended December 31,2005, which could materially affect ADESA’s business, financial condition orfuture results. The risks described in the Company’s Annual Report on Form 10-Kare not the only risks facing the Company. Additional risks and uncertaintiesnot currently known to ADESA or that ADESA currently deems to be immaterialalso may materially adversely affect the Company’s business, financialcondition and/or operating results.**

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**Item 2.**                        UnregisteredSales of Equity Securities and Use of Proceeds

**Issuer Purchases of Equity Securities**

The following table provides informationabout purchases by ADESA of its shares of common stock during the quarter endedJune 30, 2006 (*actual shares*):

**ADESA Common Stock Repurchases (1)**

| **Period**                      | ** ** | ** ** | ** ** | **Total Number  of Shares  Purchased (1)** | ** ** | **Average Price  Paid  per Share (1)** | ** ** | **Total Number  of Shares Purchased  as Part of Publicly  Announced Plan** | ** ** | **Approximate  Dollar Value  of Shares That  May Yet Be  Purchased  Under the Plan** | ** ** |
|---------------------------------|------------|------------|------------|-----------------------------------------------------------|------------|-------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|
| April 1–April 30 |       |       | —     |                                                      |       |                                                  | $          | —                                                                                                        |       |                                                                                                                    |       | — |   |   |   | $ | — |   |   |
| May 1–May 31     |       |       | 365        |                                                      |       |                                                  | $          | 25.45                                                                                                         |       |                                                                                                                    |       | — |   |   |   | — |   |   |
| June 1–June 30   |       |       | 684        |                                                      |       |                                                  | $          | 20.84                                                                                                         |       |                                                                                                                    |       | — |   |   |   | — |   |   |
| Total                           |       |       | 1,049      |                                                      |       |                                                  | $          | 22.44                                                                                                         |       |                                                                                                                    |       | — |   |   |   | $ | — |   |   |

 

*      *(1)*    *Primarilyreflects shares surrendered in the second fiscal quarter to satisfy taxwithholding obligations in connection with the vesting of restricted stockawards issued to employees.

**Item 4.**                        Submission of Matters to a Vote of SecurityHolders

The Company held its 2006Annual Meeting of Stockholders on May 17, 2006 at the Ritz Charles inCarmel, Indiana. The board of directors of the Company solicited proxies forthis meeting pursuant to a proxy statement filed under Section 14(a) ofthe Securities Exchange Act of 1934, as amended. The stockholders’ voted on thefollowing matters for the annual meeting:

***Proposal No. 1—Election of Directors***

Thefollowing nominees for election as directors were elected for a term of threeyears and received the number of votes set forth below:

| **Name**             | ** ** | ** ** | ** ** | **For**   | ** ** | **Withheld** | ** ** |
|----------------------|------------|------------|------------|-----------|------------|--------------|------------|
| Dennis O. Green      |       | 74,306,765 |       | 1,746,790 |       |
| Nick Smith           |       | 75,384,110 |       | 669,445   |       |
| Deborah L. Weinstein |       | 73,973,376 |       | 2,080,179 |       |

 

Following the annualmeeting, David G. Gartzke and A. R. Sales continue to serve as directors withterms expiring at the 2007 annual meeting, and Wynn V. Bussman, Thomas L.Cunningham and Donald C. Wegmiller continue to serve as directorswith terms expiring at the 2008 annual meeting.

***Proposal No. 2—CompanyProposal to Amend the Company’s Certificate of Incorporation to Provide for thePhase-in of the Annual Election of Directors***

Atleast an 80% affirmative vote of ADESA’s outstanding voting stock was requiredto approve the proposed amendment to the certificate of incorporation. Theamendment was approved with the following results:

| For         |   | 74,512,911 |   |
|-------------|--------|------------|--------|
| Against     |   | 1,198,623  |   |
| Abstentions |   | 342,021    |   |

 

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There were no brokernon-votes for this item. Promptly after the annual meeting, ADESA filed acertificate of amendment to the certificate of incorporation with the Secretaryof State of the State of Delaware. This action allowed the proposal to becomeeffective and the phase-in of the declassification of the board will begin in2007.

**Item 6.**                        Exhibits

(a)   Exhibits. TheExhibit Index is incorporated herein by reference.

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                                        | ADESA, Inc.               |
|----------------------------------------|--------------------------------|
|                                   | (Registrant)                   |
| Date:   August 9,  2006 | /s/ TIMOTHY  C. CLAYTON        |
|                                   | Timothy C. Clayton             |
|                                   | *Chief Financial Officer*      |
|                                   | *(Duly Authorized Officer and* |
|                                   | *Principal Financial Officer)* |
| Date:   August 9,  2006 | /s/ SCOTT  A. ANDERSON         |
|                                   | Scott A. Anderson              |
|                                   | *Controller*                   |
|                                   | *(Chief Accounting Officer)*   |

 

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**EXHIBITINDEX**
|             | ** ** | ** **                   | ** ** | **Incorporated by Reference**                                                                                                    | ** ** | ** ** | ** ** |
|-------------|------------|------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| **Exhibit** | ** ** | ** **                   | ** ** | ** **                                                                                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** | **Filing** | ** ** | **Filed** | ** ** |
| **No.**     | ** ** | **Exhibit Description** | ** ** | ** **                                                                                                                                 | ** ** | **Form**   | ** ** | **File No.** | ** ** | **Exhibit** | ** ** | **Date** | ** ** | **Herewith** | ** ** |
|        | 3.1        |                         |       | Certificate of Amendment  of Restated Certificate of Incorporation of ADESA, Inc. dated  May 22, 2006.                      |       |       | 8-K        |   |   | 001-32198 |   |   | 3.1 |   |   | 5/25/06 |   |   |   |   |   |
|        | 3.2        |                         |       | Amended and  Restated By-Laws of ADESA, Inc.                                                                                          |       |       | 8-K        |   |   | 001-32198 |   |   | 3.2 |   |   | 5/25/06 |   |   |   |   |   |
|        | 10.1       |                         |       | Severance  Agreement by and between ADESA, Inc. and Angel R. Sales, dated  May 1, 2006.*                                    |       |       | 8-K        |   |   | 001-32198 |   |   | 10.1 |   |   | 5/4//06 |   |   |   |   |   |
|        | 10.2       |                         |       | Annual Base  Salaries for Named Executive Officers*                                                                                        |       |       | 8-K        |   |   | 001-32198 |   |   | N/A |   |   | 6/2/06 |   |   |   |   |   |
|        | 10.3       |                         |       | Engagement Letter  dated June 19, 2006, between ADESA, Inc. and Emerging Capital.*                                               |       |       | 8-K        |   |   | 001-32198 |   |   | 10.1 |   |   | 6/19/06 |   |   |   |   |   |
|        | 10.4       |                         |       | Amendment No.1 to  Retention and Severance Agreement by and between ADESA, Inc. and Cameron  C. Hitchcock, dated June 19, 2006.* |       |       |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|        | 31.1       |                         |       | Certification  Pursuant to Section 302 of the Sarbanes-Oxley Act of David G. Gartzke                                                  |       |       |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|        | 31.2       |                         |       | Certification  Pursuant to Section 302 of the Sarbanes-Oxley Act of Timothy C. Clayton                                                |       |       |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|        | 32.1       |                         |       | Certification  Pursuant to Section 906 of the Sarbanes-Oxley Act of David G. Gartzke                                                  |       |       |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|        | 32.2       |                         |       | Certification Pursuant to Section 906 of the  Sarbanes-Oxley Act of Timothy C. Clayton                                                |       |       |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|             |            |                              |            |                                                                                                                                            |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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*                    Managementcontract or compensation plan or arrangement

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