Good morning, and welcome to the OPENLANE Second Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, today's event is being recorded. I would now like to turn the conference over to Michael Eliason, Treasurer and Vice President of Investor Relations. Please go ahead sir.

Thanks Rocco. Good morning and thank you for joining us today for the OPENLANE second quarter 2023 earnings conference call. Today, we'll discuss the financial performance of OPENLANE for the quarter ended June 30th, 2023. After concluding our commentary, we'll take questions from participants. Before Peter kicks off our discussion, I would like to remind you that this conference call contains forward-looking statements within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties that may affect OPENLANE's business, prospects, and results of operations, and such risks are fully detailed in our SEC filings. In providing forward-looking statements, the company expressly disclaims any obligation to update these statements. Let me also mention that throughout this conference call, we will be referencing both GAAP and non-GAAP financial measures. The reconciliations of the non-GAAP financial measures to the applicable GAAP financial measure can be found in the press release that we issued last night, which is also available in the Investor Relations section of our website. Now, I'd like to turn this call over to OPENLANE CEO, Peter Kelly. Peter?

Thank you, Mike and good morning, everybody. I'm delighted to be here this morning to provide you with an update on OPENLANE. Joining me on today's call is our Chief Financial Officer, Brad Lakhia. I'm going to begin with OPENLANE second quarter performance. And as usual, I will speak about our business in two segments; our marketplace segment and finance segment. I'm very pleased with our solid performance in the second quarter, particularly given an industry environment where volumes remain tight. Compared to the second quarter of 2022, we increased volumes in our marketplace and finance segments, growing our consolidated revenue and total gross profit. We reduced SG&A through our cost management efforts and delivered strong growth in adjusted EBITDA compared to one year ago. It was also another strong quarter in terms of cash flow generation by the business. To summarize some of our key results for the second quarter. Volumes in our marketplace business increased to $344,000 for the quarter, a total gross merchandise value of approximately $6.4 billion. This represented the first year-on-year volume growth since early 2021. Volumes also increased 4% over the first quarter of 2023, making this the first sequential Q1 to Q2 volume increase in any year since before the pandemic. We believe that Q2 volume performance supports our view that volumes have bottomed out and are beginning to grow. We generated approximately $417 million in revenue, a 9% increase versus Q2 of last year. We delivered revenue growth in both marketplace and finance segments. We generated a total gross profit of about $94 million an increase of 13% from Q2 of last year. Gross profit represented 55% of revenue, excluding purchased vehicles. Marketplace gross profit performance was particularly strong, increasing 17% year-on-year and representing almost 44% of revenue excluding purchased vehicles. And…

Thank you, Peter and good morning everyone. Before I comment on our operating and financial results, I'd like to take a moment to briefly share a couple of reflections based on my first 100 days with OPENLANE. First, I share Peter's optimism for the future. Not only do we have significant opportunities to create and capture value, we have an impressive dedicated and industry-leading management team. For me professionally and personally, I feel very fortunate to have assumed my position at a very unique time in the history of the company and our industry. OPENLANE has undergone a tremendous transformation, one that created a highly valuable asset-light digitally focused business model. This, along with the opportunity to work alongside our leading management team is what attracted me to the organization, and my experience, the first few months has only reinforced my confidence that OPENLANE will be well positioned to grow and succeed. And our second quarter and year-to-date results are the best evidence of this reflection. And with that, I'll provide more detail on our segment results. Compared to last year, although volumes were relatively flat in the second quarter, marketplace revenues, excluding purchased vehicle sales increased 5% to $259 million and generated 73% of our consolidated net revenues. Auction fees per year increased 4% driven by select fee increases and marketplace service revenues were up 6%, driven by select fee increases and higher volumes in our repossession and technology-related service businesses. As we've mentioned previously, these service-related businesses provide highly complementary critical solutions to our customers and allow OPENLANE to capture higher share of wallet. Excluding purchased vehicle revenue, the improvement in marketplace revenue resulted in a 17% increase in gross profit or a 250 basis point improvement compared to the second quarter of last year. This also represented…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Rajat Gupta with JPMorgan. Please go ahead.

Great. Good morning and thanks for taking the question. Just trying to first one related to the marketplace business. If we look at -- if you look at the second quarter trajectory relative to the first quarter, volumes were up sequentially roughly 5%. But the adjusted EBITDA, excluding the one-timers, was flat to down slightly. How should we think about that cadence? And the reason I ask that is with volumes expected to recover here in the second half and into 2024. What sort of rule of thumb should we apply in terms of incremental EBITDA per unit as those volumes recover? Getting any helpful clarity on the second quarter versus the first quarter. Can you maybe help us like understand like how we should think about modeling the EBITDA going forward? Then I have a follow-up.

Thanks Rajat. I appreciate that. This is Peter here. Listen, I guess I'm certainly pleased with the performance of the Marketplace business over the entire first half of the year, $45 million EBITDA improvement versus the same period last year. And approximately $25 million adjusted EBITDA in both quarters. So, I think we're seeing some of the things actually your question gets to, which is what is the scalability of this model. That improvement was delivered with, I would say, flattish volumes relative to prior years. So, it's really a focus on how do we optimize the gross profit structure, direct costs, SG&A, et cetera. I think the digital business model is inherently more scalable. That's been my experience since I got in this industry with a digital model at OPENLANE. These business are extraordinarily scalable and I'm seeing that in our results. I'd say one of the differences between Q1 and Q2 is conversion rates were, in general, lower in Q2. That's not unusual. We have -- as we've said on prior calls, the spring market in this industry conversion rates tend to be the strongest in Q1. So, high conversion rates also translate into higher gross profits and overall improvement in results. But I think notwithstanding that, I think the Q2 results are very strong and give me increased confidence in the scalability of this model. Confidence I already had, but they sort of reinforced that. So -- the other thing I'd say, Rajat, is while we've spoken about our cost efforts, some of those costs will not fully realized and evident until 2024. So, for example, in the cloud migration of remaining infrastructure to the cloud, that actually cost us additional money in the first half of the year because not only were we maintaining our infrastructure in one location, we had contractors and employees focused on a big migration effort. Now that that's done, those costs can be reduced. So -- and that's just one example of a number that I could make. So I guess, Rajat, I am confident that in the quarters and years to come, this business will demonstrate excellent scalability. I think digital business models operate on a more fixed cost kind of basis and that the marginal cost per incremental cars sold is actually relatively small. Now, it varies a little bit depending on if it's a dealer car or commercial car, et cetera, but I'm confident we'll have great scalability here.

Got it. Got it. That's helpful color. And then maybe as a follow-up, just in terms of the price increases or the ARPU trajectory going forward? Particularly as used car prices start to move lower here in the second half, how should we think about the ARPU or the auction ARPU. Any way to think about modeling that, maybe layering in the commercial mix coming in as well. Do you think the industry can still have the ability to drive fee increases like every year to offset some of just the headline decline in used car prices? How should we be thinking about that going forward?

Yes. Some fraction of the ARPU is tied to vehicle values because the higher value of the vehicle, as you know, Rajat, the buy fees are often sort of stair stepped in value bands. So, if used vehicle prices decline, there could be some downward pressure on that. Prices on the sell side of the marketplace are more fixed, less dependent upon vehicle value. I guess, we're seeing competitors increase their prices in this industry. So, we think we have room if we needed to. I think we're being cautious about that, but we have certainly tried to optimize pricing in various parts of the business over the last 12 months, and that's been reflected in the numbers. I would say they should increase at a minimum at the rate of inflation. And then Rajat, as you know, there is a mix component to the extent off-lease volumes do come back in considerably greater numbers and sell in that upstream channel, those have a lower ARPU, but obviously a higher gross profit percentage than other types of transactions in our marketplaces.

Got it. So, on a gross profit per unit perspective, like should we expect any meaningful change there with that mix shift? Or is that you think that remains consistent with the lease mix coming in?

I've been very pleased with how that metric has trended. I mean we've done a really good job of gross profit per unit. But Rajat, I will say that we do generate gross profits that are not directly tied to transaction volumes. So as transaction volumes increase, not all those components will increase at the same rate. The number I focus on more candidly, is gross profit as a percent of net revenue in the marketplace. I think that's really sort of insulates the risk -- not the risk, the mix shift. So, there is a mix aspect to this. But from a management perspective, can we optimize and maximize gross profit as a percent of net revenue. That to me is the key sort of KPI that I look at each month.

Got it.

And I think we've been doing a good job with that. Thanks Rajat. Thank you.

Thank you. Thank you.

And our next question today comes from John Murphy of Bank of America. Please go ahead.

Good morning guys. Peter, just three quick ones. First, you mentioned the migration of customers to a single platform and you were doing some training for those customers. I'm just curious if you could talk about that process a little bit more? And if there's any sort of leakage you think as you're kind of transitioning to the single platform or actually you're potentially making some gains of new customers as you consolidate?

Great. Well, so I was speaking specifically, John, to our Canadian migration and the launch of OPENLANE Canada which really happened at the very end of the quarter. So, it was the last, I think, two weeks of June, but there obviously was a lot of planning work and execution work done in the earlier part of the quarter. Listen, I think it went really well. We were delivering a brand-new marketplace in terms of feature and function to market. So we put a lot of effort into training, webinars, all sorts of activities to help our customers sort of understand how the new site works. Obviously, we'll try to make it as simple as we could as well. We migrated the customers in cohorts. We actually started with the TradeRev dealers first because we felt those were probably the more digitally adept. And then once that was done, we then focused on migrating the ADESA customers. But John, it went really well. No measurable leakage I think that was the phrase you used. Our Canadian roads remain strong throughout, and customers are getting the benefit of all the vehicles in one place. So, we've had dealers that in the past, just weren't TradeRev buyers and now they're looking at those cars and saying, hey, I can buy that car, and you'll deliver it to me, and that's great. So, we're very excited about that, excited about what it does for market position in that market. What we planned in the US is a little bit different, John. It's really going to be a rebranding of the backlog cars marketplace to an OPENLANE brand and then the integration of the commercial inventory into that marketplace. So, that actually de-risks our US migration a lot because from a user experience perspective, the thousands of dealers that are logging on to that marketplace every day, the feature function is not going to change. All that's going to change is got the logo on the top left is going to change, some of the color pallet is going to change. But the technology itself, the business process will the same. But in addition, they'll now have access to all these what we believe will be a growing volume of off-lease vehicles that are going to start to flow through that marketplace in 2024 and beyond. So, I think that sort of de-risks that one. But obviously, we still have a lot of execution between now and the end of Q4 when we plan to get that done.

And that flows to my second question. Your expectation is that volumes are bottoming out here and we'll recover, it sounds like somewhat meaningfully in 2024 and beyond. What are the key channels that you're expecting to recover? It sounds like repo is actually recovering right now. Is there kind of a tape delay on lease and other dealer lease returns and then ultimately dealer side? I mean, how do you kind of see the progression of this bottoming out and recovering by segment or by channel coming back?

Yes, I guess, John, thank you. Specifically, what I feel confident of is the volumes in the second half of this year will be higher than the volumes in the second half of last year. And then as we look to 2024 and 2025, we expect further volume growth perhaps accelerating over time as we get into a sort of 2025, 2026 time frame would be my view. But to go sort of segment by segment. Let me start with dealer. With more cars on dealers' lots, dealers are more likely to put a car into wholesale than they were, say, a year ago because a year ago, they had empty lots. They get these cars on trade in and they say, you know what, maybe I'll resell this car. So -- what we're seeing is we're seeing actually growth in the volume being posted by dealers. We're seeing cars posted per dealer starting to increase fairly meaningfully in the second quarter, I'd say. And that's consistent with more new cars on their lot, greater inventory on the lot, et cetera. So, I think we see a positive driver in the D2D space. But it's -- that segment was never too badly impacted by the compression, but still positive. Repo obviously has been up. Now our business services at the repo segment that benefits us, but we don't sell repos in our marketplaces for the most part because they typically sell in a physical model. Now that may have changed over time. But today, John, in the United States, most people sell it physical. We're seeing more sales rental sellers. And I spoke at some length about lease. We didn't see an increase in lease returns, if you like, in the second quarter. Some of our customers are telling us that their models show lease volumes increasing later this year and into next year. But what I pointed out is what I thought very positive news in the second quarter was just to see an increase in lease originations. Lease originations have been down, but we're seeing that start to increase again in a meaningful way. I think that reinforces, John, my view that leasing is going to be an important part of our industry, an important part of the way vehicles are brought to market. We obviously have a very strong position there. I recognize it's going to take some time for those vehicles to reach maturity but -- and passes quickly. And I'm excited to see leasing on a rebound in the retail environment.

And then just one last, how's given the $20 million early termination payment. Can you guys just tell us exactly what that's for in the quarter? And is it kind of one-time? Or is this something should be spread over periods that we shouldn't be backing out? Just want to understand what's going on there?

Yes, a little bit nuance on that. John, it's a one-time early termination of a contract associated with 2019 transaction. And over the past number of years, that contract has generated I would say about $5 million a year, all pay the third quarter of the year. So, that was a fact, and that contract was going to continue through, say, the third quarter of next year. So there's a -- if you like, we're trading a $20 million one-time payment for two $5-ish million payment Q3 of this year, Q3 of next year. That's how I would think about that. Obviously, that was done through mutual agreements and both parties happy with that outcome.

Okay, very helpful. Thank you.

Thank you, John.

And our next question today comes from Bob Labick with CJS Securities. Please go ahead.

Good morning and thanks for all the comprehensive answers. I just have a couple of nuance questions here, too. Now obviously, we've made great progress with the platform consolidation, and that's very exciting. But given the kind of weak industry volumes, how are you going to gauge success? Are there new metrics you can share with us, it's traffic on the new side? Or how are you internally gauging the success of the platform consolidation, given as we say at the bottom end -- the bottom of a cycle.

Thank you, Bob. Good question. Obviously, one of the things I like about a digital business, in addition to being very scalable is you get tremendous data because every customer traction leaves a recordable footprint. So, we look at a tremendous amount of data across this company. I would say the five metrics I look at the most in terms of the marketplace would be volume sold volume posted from that, obviously drive conversion rate, participating sellers, participating buyers and then retention rates of your customer base. So, those are the metrics we look at. Obviously, our results correlate the closest with volumes sold in any given period of time because that's what drives revenue. But the other ones are all inputs into that. So we look at all of those. Listen, I'm pleased with a lot of the metrics we're seeing. We're seeing increased customer participation, as I mentioned earlier, we're seeing increased volume of vehicles posted per selling dealer. That's starting to trend up again. Conversion rates have been strong. Used vehicle prices have been under pressure in Q2. They declined pretty much for the entire quarter. We did see conversion rates drop a bit relative to Q1 but they were quite resilient. I take some comfort from that. And then sort of the retention rates of customers within our platforms is very strong. These are platforms that build a habit with customers who come in daily, weekly, smaller customers might come in monthly. Sometimes a customer might skip a month, not buy any cars, maybe they've got too much inventory or maybe not sell cars because they've got too little inventory. But typically, they're back a month later. So, there's a lot of good fundamentals in these marketplaces, a great customer and a repeat -- a very repeatable customer interaction, which I think is the strength of the business.

Okay, great. That's very helpful and I appreciate it. And then just real quick, I think in the auction fee section of the one of the releases. You mentioned a slight increase in auction fees from a smaller mix of lower fee commercial off-premise vehicles. And I think that's probably either grounding dealer buying it or whatnot. Can you just give us a sense of kind of what drives that and how that trend may change over the next several quarters?

Yes. Good question, Bob. Listen, I'm very much looking forward to an improvement in off-lease maturity volume because what we've really sort of had to sort of work our way through over the last couple of years is not just reduced volume at the top of the funnel, reduced number of cars sort of flowing in, and that was a substantial reduction, down 50%-plus. But also, essentially, the transaction is all kind of migrating up into that top of the funnel grounding dealer transactions, which is our lowest revenue transaction in this entire business, right? So, we have volume compression with revenue compression, you multiply those together, and you got severe compression on that business. And as I look to the future, I see both of those things starting to unwind and reverse. Now, I'm not promising that is going to happen immediately. I think it's going to play out over time. But I'm confident it will happen. And I think that would be a double positive as we see not only volumes increase, but the mixed shift. And I will say we started to see a mix shift first in Q1 used vehicle prices appreciated right? And it was a little unexpected how strong used vehicle pricing was in Q1. I would say in the last month or two, we're starting to see the mix shift more positively again. It was not material in the second quarter, but we're starting to see a more favorable mix in that upstream channel for us as well, which drives ARPU.

Super. All right. Thanks very much.

Thank you. And our next question today comes from Bret Jordan at Jefferies. Please go ahead.

Hey good morning guys.

Good morning Bret.

Could you give us maybe as we look forward two or three years, how you see lease returns, obviously, what's going to get bought out, you can't predict. But I guess, leasing probably troughed in the second quarter of 2020 when dealerships were closed. But how do you sort of see on an annual volume, the cadence of lease returns in 2024, 2025? When is the cyclical growth year?

Thanks Bret. If you look at lease originations, the lease origination percentage declined from 2020 to 2022. And what that means is there are fewer off-lease vehicles in those portfolios. And you can, again, think of the lease rule of thumb, three-year maturity. So, leased in 2022, maturing in 2025. So, that's the very, very top of the funnel. How many vehicles are in the portfolio. And I think what we're going to see there is that number is -- reduces to 2025 and then increases post 2025 would be my view. The second question, which is probably more important right now is of those leases, what percentage actually get returned. And that's driven by the equity position of the vehicle. So, for the last 18 months, the equity position of off-lease vehicles has been extremely strong, so consumers have been hanging on to them and not returning them. And then if they return the grounding dealer buy them. So what I -- so I think over the next two years, we're going to see the intersection of two kind of contradictory forces. On the one hand, there's fewer off-lease vehicles at the top of the funnel. But on the other hand, consumers are going to buy a declining percentage of those and an increasing percentage are going to be returned. And the reason I think that is we're going to see some pressure on used vehicle values, but also the residual values of those leases was written at higher levels because they were sold at higher MSRP. So, I guess in that, I'm expecting a small increase in lease volumes in the coming two years, but a more favorable mix within our market and an accelerating volume and mix picture kicking in towards the end of 2025 and beyond. And I guess I'd say, long-term, I believe leasing will be a very important part of the way vehicles are brought to market. I think it will be back in the 3 million to 4 million units a year leased. We'll see high consumer return rates, and we'll have a very, very good business in the off-lease space, I believe.

Okay. And then a quick question. On the deal of the dealer impairment charge, I think you noted lower long-term revenue growth associated with the cycle. Is the size of that market different than you were projecting back in 2019 when the business was when IAA spun out and TradeRev was sort of a focus? Or is it really just the lack of dealer consignment cars that's impacting that longer term view?

I don't think the size of the market is different on any long-term view. I think in the last couple of years, it's been a little compressed for some of the factors I mentioned. Industry data sources have that dealer to dealer at a low end, $6 million units, but that does not include vehicles that are transacted sort of informally between dealers. So, high-end estimates run 10 or above 10 million units in that market. So, it's a big segment, a big opportunity for us. I like how we're positioned in the market. I think we're on the right side of a physical to digital secular shift, which I think will be positive long-term for the company. I can also say that I spoke about our improved EBITDA performance in the first half of this year. Without question, our digital D2D model was a strong contributor to that improvement. And we had our best ever sort of financial performance from that segment in the second quarter. So, I'm really pleased about that. Seeing strong customer adoption, strong numbers around volumes posted, et cetera, strong conversion rate. So, I kind of look at the goodwill thing is somewhat technical accounting-driven and does not, in any way, impact my view of the long-term opportunity in this space.

Okay, great. Thank you.

I think we have time for one more question, Rocco.

Yes sir. Our final question today comes from Daniel Imbro with Stephens. Please go ahead.

Thanks. Appreciate you guys squeezing me in here at the end. Just a couple of questions. Maybe one, Brad, on the SG&A side. follow-up on Rajat's question earlier. Marketplace SG&A has been pretty consistent kind of low 30% -- but as we add back volume, would you expect to have to add back expenses to handle that volume, Peter said it's scalable. So, should we expect further SG&A leverage into the high 20s? How would you think about SG&A marketplace margin going forward?

Yes, I think -- thanks for the question. I think the way to think about it is essentially what Peter referred to earlier, I mean, we see the marketplace business as being very scalable, very fixed cost base in terms of its structure. So, in terms of the incremental SG&A dollars that we need to support incremental volume, fairly modest.

Got it. And then a quick follow-up on AFC. Peter, last few quarters, loan origination outpaced marketplace volume growth. This quarter, they were closer to parity. How do you feel about the loan origination outlook for AFC? Any change in the health of your core independent used auto dealer? And how do you feel about the 2% charge-offs going forward as you project more used price pressure or maybe more pressure on the independent used dealer out there?

Good question. First of all, listen, I think independent dealers are an important part of this retail ecosystem and will be as far as the future as I can see. They serve -- they provide unique offering in the market, and I think there's a strong demand for that offering. So, they'll be in business and we'll be in business to serve them. In the first and second quarter, loan loss ratio was at the high end, the 2% end of our 1% to 1.5% to 2% range. So, I guess, given that fact, we've just been a little bit more focused on managing risk and running the more conservative business that we've talked about on these calls. Obviously, signing up new customers and generating new loans is important, too. So, we're focused on that. But in this business, it is a balancing act, and we've been -- we've just been focused on making sure we've got a good handle on the risk environment. We believe we do. I think it was clear in my remarks, we expect solid performance in AFC. But there's no question with the benefit of hindsight last year and then probably the prior year, AFC was a beneficiary of historically low risk loss ratios that we should not expect to recur in the foreseeable future.

And anything on the loan origination outlook part of that?

Well, we expect to continue to grow the business, but -- and we expect AFC to continue to be a contributor, but we expect most of the growth in the pro forma to come from the marketplace side of the business. Again, we love the AFC business, but we take a conservative view on the market, and we are growing it. We want to keep growing it, but we also want to make sure we have the right sort of portfolio that we like having in this business.

Great. Appreciate all the color.

Thank you.

Thank you. And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to the management team for any final remarks.

Thank you, Rocco. I appreciate that. And to the participants, thank you all for your time today for your questions. Before we close, I I'd like to leave you with more takeaways from the quarter. I believe our Q2 results demonstrate a significant improvement in the business and I believe they provide me and hopefully, all of us with increased confidence in our digital asset-light model as we look to the future. Again, I'd like to highlight our company has strong cash flow characteristics. It has improved its overall liquidity position in the quarter and now has increased flexibility in terms of capital deployment. I believe our one brand; one marketplace strategy will increase our differentiation in the marketplace and will also enable us to continue to increase our efficiency and reduce our costs. Finally, the macro factors that I see point to an improving outlook for commercial off-lease volumes. I believe that the headwinds of the last two years looks set to become tailwinds in the years to come. So, thank you all for your joining today's call. I look forward to updating you on our progress in our next call three months from now. Thank you very much.

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.