Good day, and welcome to the OPENLANE Third Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note today's event is being recorded. I would now like to turn the conference over to Michael Eliason, Vice President of Investor Relations. Please go ahead, Sir.

Thanks, Rocco. Good afternoon, and thank you for joining us today for the OPENLANE Third Quarter 2023 Earnings Conference Call. Today we'll discuss the financial performance of OPENLANE, for the quarter ended September 30, 2023. After concluding our commentary, we will take questions from participants. Before Peter kicks off our discussion, I'd 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. Reconciliations of the non-GAAP financial measures to the applicable GAAP financial measure, can be found in the press release that we just issued, which will also be available in the Investor Relations section of our website. Now I'd like to turn this call over to OPENLANE's CEO, Peter Kelly. Peter?

Thank you, Mike, and good afternoon, everybody. I'm delighted to be here today to provide you with an update on OPENLANE. And joining me on today's call is our Chief Financial Officer, Brad Lakhia. I'm going to begin with OPENLANE's third quarter performance. And as usual, I will speak about our business in two segments, our Marketplace segment and the Finance segment. I'm pleased with our Q3 performance, and I'm particularly encouraged by the improved performance of our Marketplace business despite the challenging industry environment. I believe our Q3 results present compelling evidence that we are successfully evolving our business model to meet the realities of today's market, while positioning OPENLANE for continued growth and expansion in the future. During the third quarter, we grew our transaction volumes in both our Marketplace and Finance segments. We grew total revenue and gross profit. We reduced our SG&A. We invested in technology innovation and product development, and we continue to generate strong cash flows in the business. And while adjusted EBITDA has declined slightly, driven mainly by a return to historically normalized loan losses in our Finance business, OPENLANE's Marketplace business delivered its best quarter since the divestiture of the U.S. physical auctions. Brad will provide more detail around our specific performance later in the call, but I would like to highlight a few key results from OPENLANE's third quarter. First, growth in both commercial and dealer transactions increased total marketplace volumes by 8% to 339,000 vehicles, with a total gross merchandise value of approximately $6 billion. We generated year-on-year revenue growth of 6% to $416 million, with contributions from both our Finance and Marketplace segments. Auction fee revenue in the Marketplace segment grew by 15%. Gross profit in the quarter was $200 million, that was an increase of 9% from Q3…

Thank you, Peter, and good afternoon, everyone. I'll start with our Marketplace segment. As Peter mentioned, we had strong unit volume growth, which drove a 3% increase in marketplace revenues, excluding purchased vehicle sales. We've also delivered volume increases in both our commercial and dealer channels. Auction fees per unit increased 6% driven by select fee increases and the introduction of new auction-related services. Marketplace service revenues declined 3%, largely due to lower transportation services and the receipt of a royalty payment in the third quarter of last year. The overall improvement in the Marketplace revenue resulted in a 17% increase in gross profit. This represents a 530 basis point improvement versus the third quarter of last year, again, excluding purchased vehicle revenues. It also represents a 200 basis point improvement sequentially when compared to the second quarter of this year. In addition, gross profit benefited from improved mix in our service-related businesses, and cost-saving initiatives. As Peter highlighted earlier, our Marketplace adjusted EBITDA for the quarter was $27 million, $9 million higher than the third quarter of last year. And also as discussed earlier, this was driven by improvements in volume, price, mix and cost savings initiatives, including lower year-over-year and sequential SG&A. Looking at year-to-date, our Marketplace adjusted EBITDA was $85 million, a $63 million improvement compared to last year. And for added context, our dealer-to-dealer business is profitable, and meaningfully contributed to this year-to-date improvement. This improvement also supports the $100 million adjusted EBITDA run rate we highlighted in the second quarter call, and Peter mentioned earlier in his comments. It also reflects our pricing and cost management actions are materializing, and provides a window into the volume scalability of the segment. Turning to our Finance segment. Revenues in the quarter were $100 million, a 1% increase…

[Operator Instructions] Today's first question comes from Craig Kennison with Baird. Please go ahead.

Hey, thanks for taking my questions. The first one is on the repo market. Just wondering if you could comment on the impact on your commercial business?

Craig, thank you for that question. We've seen an increase in repo volume in the industry for sure, okay? So repo, I would say, as a segment is back to, I'd say, very close to pre-pandemic levels at this point. Now the simple fact is, while we have some exposure to repos in our services businesses and in Canada, our repo volumes in Canada are relatively lower. We do not sell many repossessed vehicles in our digital marketplaces in the U.S. So I'd say we see repo volumes have increased materially, say, since 2021. That is for sure. We benefit from that in our services businesses, but we don't benefit in terms of numbers of vehicles sold in our U.S. digital marketplace is to any significant extent today.

And then with respect to your off-lease business, Peter, I take your point about the positive equity that exists today. But when that market comes back, are you confident that you will capture the same very high percentage of that market through your platform?

Well, I guess in a short answer, yes, Craig. I think I am confident. We have -- the seller relationships are intact. We're servicing those customers. If anything, I'd say that the percentage of those vehicles that are selling digital today is higher than pre-pandemic. So the top of the funnel is lower, but the conversion rate is higher. And based on my discussions with those sellers, I think they're very, very focused on trying to maximize the online selling percentage for those off-lease vehicles. Now obviously, it all remains to be seen, but I think there's an argument to say we could capture an even increased share versus pre-pandemic.

Thank you. And our next question comes from Gary Prestopino with Barrington Research. Please go ahead.

Hey, good afternoon all. A couple of questions, Peter, we're conversion rates somewhat abnormally higher because of the impact of the UAW strike in the quarter? Or did that not come into play?

It didn't really -- first of all, it didn't really come into play. The labor action didn't really start until late in the quarter. So it didn't really impact July or August of all. I guess what I'd say, if we look at -- so pricing and conversion rates. Pricing, we saw pricing declining at a fairly fast clip as the quarter started. And by the time we got to the end of the quarter, the rate of decline had fall off. It wasn't declining at the same rate. And I sort of assigned that really to the UAW action, less supply, et cetera. We also saw a little bump in conversion, I'd say, late in the quarter, but probably for the same reason. But it wasn't what I call material. And I'd say conversion rates in the third quarter were generally in line with what we saw in the first half of the year.

Okay. That's good. And in terms -- you still have some pretty good growth in commercial vehicles. I mean, could you maybe highlight what segments of the commercial vehicle market were really strong. And the other thing is with lease penetration, where is that now?

Yes. Okay. So commercial vehicles, lease penetration, so maybe I know the second part of the question, too. So on commercial vehicles, you're right, we did see growth. We actually saw growth in commercial in all of the markets that we operate in. We saw commercial volume growth in Canada, commercial volume growth in the U.S. and in Europe. Obviously, Europe volumes are less impactful to us, but saw strength there as well. I kind of ascribe some of it or quite a bit of to -- the OEMs are able to provide more inventory to those commercial accounts, whether it's rental car companies, fleet operators, things like that. So that's -- there's kind of a -- that has sort of accelerated some defleeting out of commercial business. And there was a -- that was badly needed because those customers weren't getting a lot of supply for the last couple of year's, so some of it is that. We obviously talked about repossession volume on the last question. That's a commercial business. And then in the off-lease space, we did see the equity gap narrow a bit. And while still the majority of cars are being bought out sort of before they get into the marketing process properly. But we did see that percentage decline a bit and more vehicles flow in, in our U.S. off-lease business as well. So I'd say broad based on that front. And then in terms of lease penetration, the numbers I was looking at, Gary, were that, as best I can determine, the volume of leases written in the third quarter is probably up about 30% compared to the volume of leases written in the third quarter last year. Now I've got to stitch together some different data sources to get that. What that means in terms of lease penetration, I can't recall, but I think it's in the 20s -- in the low -- around about 20%, I guess, is what I should say. I also know from talking with customers, some of our commercial accounts, at least I would say a number of commercial accounts have clearly told me that they're leasing significantly more vehicles. They're originating significantly more leases than a year ago. That's not true of all of them. I'd say some of them are kind of flattish, but some of them are absolutely higher. It depends a little bit on how much that brand is sort of incentivizing vehicle sales, because that tends to drive leasing.

Okay. And then just lastly, real quickly. You cited some, the introduction of some new auction-related services that helped to drive increase in auction fees for vehicles. So could you maybe just very briefly discuss what some of these new services are that you're generating fees on?

Yes, Gary. This is Brad. Thanks for the question. I can be a little general with you on where that is. It's in our dealer channel, largely focused in our U.S. business, is where we've introduced some of these new service offerings. And it's really, I guess, really has helped us from a volume perspective for sure. Gives some of our customers a different option or how they want to pay, and also has helped us drive some improvements in working capital as well. So it's really kind of a two-pronged benefit. One, where buyers are able to have a more flexible payment option and then also, from our perspective, we're able to drive some more efficiency in our capital structure.

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

It's actually Lee Jagoda for Bob. I think you already commented a little bit on kind of the lease volumes and where they're going. But can you break it down a little bit more in terms of just talking about lease volumes in general, and then what part of the funnel the off-lease cars are going to today and breaking that down between the lessee, the grounding dealer, closed auctions, or open or physical?

Yes. Thanks, Lee. Let me attempt to do that. I guess I'll say, first of all, that in what I would call a more, a normal or typical lease environment, which I'd say the 20 years pre-pandemic would be examples of. We would typically see something like the following: consumers would buy out maybe 20% to 30% of the maturing volume; and then 70% to 80% would enter the remarketing process; and then you have some component of that would sell to the grounding dealer, some into the franchise dealer network, some on the open sale and the rest go to physical auction. What we've seen really over the last two years and continuing through to today, for the most part, is there's been such a runup in used vehicle values that these vehicles are sort of strongly in an equity position and the consumer -- the percentage of vehicles that the consumer is buying out is considerably higher than before. It's sort of 60%, 70%, in some cases, more than that percent. And to the extent the consumer doesn't buy out the car, a lot of OEMs and captive finance companies give the grounding dealer the same buyout option the consumer has. So if the consumer doesn't buy out the car, it gets returned to the grounding dealer and they exercise that because the car again is in equity. So that has meant that for the last couple of years, the amount of vehicles flowing deeper into the channel has been down, I'd say, by 90% versus what we would have called normal. And obviously, for that to get addressed, the equity gap has to decline and all that sort of stuff needs to play out. So we see that happening. We see the sort of beginnings of that right now. It depends, it varies by brand, by portfolio, right? But what I see happening as we move into 2024 and 2025, first of all, those leases were written against much higher new vehicle transaction prices, okay? Because the vehicles, the sale price of the car was considerably higher. So they tend to have higher residual values written into the contract, right? So the residual value line has trended up. And then on the other side of that, the actual value of the vehicle, we're seeing downward pressure on that. So I think these two lines are going to converge and get back to a more normal type of environment. I hesitate to predict exactly when that's going to happen. But I believe it will happen, and it will be positive for us as it happens. And then the second part of it is obviously the new lease originations and with OEMs getting back to sort of full production again and with consumer demand, being somewhat weaker. We're seeing some increase in incentives. We're seeing an increase in leasing and that points to a strong off-lease volume well into the future.

Great. And I think it's fairly clear that the consensus out there is the secular, that there is a secular shift to online dealer-to-dealer from physical. Presumably, that's going to be a lumpy transition. Can you speak to maybe your best estimate of the physical versus digital volumes in the market and their growth year-to-date? And then how should we think about that going forward into 2024?

Yes. I guess, Lee, what I'd say to that is, based on the data we look at, and obviously, we're public, some of our digital competitors also report public volumes. If I look at the U.S. market, our assessment is that approximately 30-ish percent of the volume has transitioned to sort of fully digital off-site model, and 70% is transacting in a physical or more hybrid model today. Now there's also dealer-to-dealer transactions that don't take place in either of those models, that take place sort of informally through wholesalers and other types of channels. So I'm really just talking about the formal channels. So I think we see digital at 30%. To be honest, it's been fairly steady at that level for the last year or two, because I think there was a little bit of a rebound in the physical coming out of COVID, the pandemic eased and consumers kind of consumers in many industries kind of went back a little bit more to physical and in-store type of thing. But I think if you correct for that and look over a longer period of time, you'll still see that there's a, I believe, a steady secular shift towards digital. And our interviews with customers, our surveys of customers really sort of support that fact, particularly talking to franchise dealers. I think there's a clear preference there from dealers. The majority of those dealers prefer to purchase vehicles online. They do not put a priority on going attending physical auctions in person anymore. And when we look at independent dealers, they're probably not as far along that curve. But I'd say there's no question that digital preference is still very well established there and is, I think, gaining all the time well.

And our next question today comes from Bret Jordan with Jefferies.

In AFC, I guess, as we think about the loss rates and the environment that we see today with obviously, margin pressure for the independent used car dealers and higher floor plan expenses. Is there a risk that it would go above that sort of 2% loss rate in the short term? Or because the loans are short term enough, you can kind of pull the credit back and reduce your exposure to their pressures, I guess.?

Yes. Thanks for the question. I think you nailed it with your latter part of your question. I mean our -- they are short term. As you know, it's about 60 days on average in terms of our portfolio tenor. And we have a lot of a lot of levers, a lot of options to be able to pull that back. I would also emphasize that more recently, over the last year, with those higher risk profile independent dealers, we've been more risk off with those on one hand. And then on the other hand, our credit monitoring and risk management processes have been, I would say, more tuned into them as well to the extent we do continue to have exposure. So but to answer your question, there is, as we said, the chance that periodically we could move above that 2% range. But let's say here over the more immediate near term, we're feeling pretty comfortable with that.

Okay. And then I guess the question, your comment earlier about the potential to gain share in off-lease. And again, then you followed to say that a lot of volume is still serving a hybrid model. Given that you don't really have a physical option anymore, what is the proposition that you have to drive the share gain? Is it economic? Do you it cheaper? What is the off-lease seller getting when they're not getting the physical alternative?

Yes. I think a lot of the benefit of the digital model goes to speed, efficiency and market efficiency, as well as network effects. Even before the pandemic, the conversion rate of off-lease vehicles in our upstream channel was, I think, on average, 55-ish percent among our U.S. customers. So it was already more than half of the volume was selling in a fully digital model. So and it had been trending up over many, many years, from 30% to 40% to 50% and then 55%. So it was already on a long-term upward trend. I think fundamentally, what you offer the seller is, "Hey, these are good quality vehicles for the most part, three-year-old, lower-mileage, single-owner vehicles." You inspect them accurately, you put that up in a digital marketplace where you get a lot of buyers and you get true price discovery through a digital marketplace. And once the car has been purchased, you do that very quickly in a very short space of time, like a few days, one day, perhaps but a few days max, and then you deliver the car immediately to the buyer. And that's a very efficient process that enables us to transact a car at a very low cost, and the seller gets the benefit of network effects, nationwide network of buyers opportunity to sell the car to a franchise dealer network and to a broader network of buyers as well. So if anything, our capability there has just gone up because we've got. Honestly, a lot more buyers online today than we had in 2018 or 2019. So we've got a much more liquid marketplace. And I'd say, I also didn't say, these sellers have kind of got accustomed to not sending many cars to the physical auctions over the last 3 years because they haven't had a whole lot of vehicles making that far in the process. So I think they have a preference to maintain the strongest possible upstream online conversion rate. Obviously, a lot of this remains to be seen, but I think the digital channel has some unique advantages here. And I think those will be very evident that these volumes recover.

And our next question comes from Rajat Gupta with JPMorgan. Please go ahead.

Great, thanks for taking the question. Great. I had one question on just the dealer consignment volumes. It was up 3% year-over-year. I think you mentioned Canada outperformed that number. Would you be able to give us some color on what the U.S. industry did on the D2D side? And any way to characterize like what your market share growth might have been in D2D in the U.S. in the third quarter? And I have one follow-up.

Thanks, Rajat. I appreciate that. So first of all, when I spoke about Canada, I was speaking about Canada in the aggregate, commercial and dealer I actually think in the third quarter, our U.S. dealer-to-dealer year-on-year growth rate in our Canadian were very similar. In fact, I think the U.S. might have been slightly higher than Canada. Just to be clear, so if 3% is the average, I think the U.S. might have been slightly better than that. So the number I talked about was the aggregate commercial and dealer. And then we don't break out the specific numbers by geography, Rajat. But the U.S. is the majority of our dealer-to-dealer volume for sure.

Got it. And just like what -- any way to characterize like what your market share might have been, growth there in the U.S. versus the overall D2D industry? The 3% would compare to like how much for the overall industry in the third quarter?

Rajat, there isn't a number I can share on this call. We do track market share vis-a-vis. We track market share in lots of different ways. I mentioned the 70-30 physical versus digital. So we look at that and our component of that. In total, we also look at our share of just the digital piece. And I also think our competitors haven't reported numbers for the quarter yet. So it's -- I don't have the full set of facts for Q3. I would say that our share has been fairly stable over the past period of time. And obviously, we believe that as a segment, the digital dealer-to-dealer segment will grow, we think we are very well positioned to gain share as part of that as well.

Got it. Got it. That's helpful. And then just on the fourth quarter implied guidance, it implies over $50 million in EBITDA. I wasn't sure if that is just like the seasonal drop that you're expecting from third quarter? And any way to dissect how much of that is coming from the Marketplace versus AFC in the fourth quarter?

Yes, Rajat, thanks for the question. I think, so yes, you have $50 million, it would imply $50 million on the low side. As I mentioned earlier, we're feeling, believing that we would trend more to the high side. So call it, $50 million to $60 million. There is seasonality in Q4. So it does certainly reflect that. And what was, I'm sorry, the second or third part of your question?

Just if it's the $60 million, should we assume that the third quarter ADESA -- sorry, not ADESA,, the Marketplace and AFC trends are similar sequentially? Or was that lower than that?

Yes. I mean, Peter highlighted in the Q3 result, marketplace represented 40% of our total adjusted EBITDA. And I think you could model and assume something similar for Q4.

And our next question today comes from Daniel Imbro with Stephens. Please go ahead.

Good evening everybody. Thanks for taking our questions. Peter, you mentioned maybe some of the benefits of consolidation in Canada. The ability to innovate and grow. You gave some examples. Are those tools you introduced in Canada able to be exported to the U.S., maybe once that consolidation has actually occurred in the U.S.? And maybe if you could give some other examples of, in the U.S., what are some of the opportunities you see that you could actually innovate that you couldn't do before the integration to OPENLANE?

Thanks, Daniel. Good question. So to your -- the first part of your question, are those transferable to the U.S.? I would say, yes, to an extent. It's -- so I would characterize what we've done in Canada right now. We've migrated sort of TradeRev and ADESA to one consolidated platform. And we are obviously doing what we're doing in the U.S., getting to a consolidated OPENLANE platform there, too. We still have to do more of our back-end consolidation to really get to one more unified platform, and I spoke about that in my remarks. So there's, candidly, there's some fairly significant technology lifts to make that happen. We're very focused on that. We've got teams working on that, and I'm confident we'll get there and that will have a lot of benefits for our company. So I'd say today, some of them are easy to transfer. Some of them will take more work. But over time, it will all become more transferable. This is how I would characterize that. When I think about the U.S., I mentioned our dealer survey work. One of the things I found really gratifying about that is the dealers were very positive about how easy our system, and I should say our systems, our OPENLANE private label system, but also our backlog car system. How easy it is to understand. How easy is to navigate. How easy it is to do business on those platforms. And I think that's very encouraging because we put a lot of thought and effort in making sure that there's a lot of technology complexity, we'll try to keep that behind the scenes and not in front of the customer, make it easy for the customer. So I think we've got high marks on that. I'm excited by the opportunity to be able to put the off-lease cars into a much more liquid marketplace, one that has more buyers and also one that has more established, I'll call, auction-type sales formats, because historically, our private label and upstream business kind of operate more like a click-and-buy kind of situation. The car has a certain price, do you want to buy it or not. But there wasn't really a price discovery kind of channel. It more was a, here's the price, take it or leave it. But as we migrate to this new platform, we have that capability, but we also have true sort of auction type formats that are widely used by buyers and sellers. So I know that some of our commercial customers are very excited to start sort of experimenting in that, and trying to drive, again, a higher conversion rate, get more conversion rate through this sort of auction-type price discovery format. So that's one example. There are numerous others, but that would be one that I think could be impactful for us over time.

Okay. That's helpful. And then maybe a longer-term financial question. I know the market's upside down today. But as we think about a return of off-lease, historically, these were ARPU accretive. You maybe got $1,000, including recon in revenue versus 200 in an open online auction. Without the recon maybe on the back end, I guess, should we expect just less ARPU accretion? Or can you maybe help frame out the unit economics between off-lease and dealer-to-dealer, as more of your volume shifts back to commercial in the coming years?

Thanks, Daniel. It's probably hard for me to go into detail on that on this call. But what I would say in general terms is that those commercial off-lease vehicles will tend to be lower ARPU but higher gross profit. So we -- the revenue per car tends to be less, but our touch points on the car is also less. So we don't have as much direct cost against that. What I can also say is that business historically was very profitable. well beyond its current level of profitability. So I'm confident that as those volumes return, it's unquestionably a good thing for our business. Will it change the ARPU metrics a bit? Yes. Will it improve the gross profit margin in percentage terms? I think, yes. But it will absolutely improve the overall profitability of our company for sure. Thank you, Daniel. Appreciate that. So I think that's -- all the questions we've got time for, Rocco.

Yes, sir, that's correct. Please proceed.

Okay. Great. Thank you. So again, I appreciate everybody's time today. I appreciate all the good questions. As I said at the outset of this call, I'm pleased with the third quarter performance, and I believe the results speak for themselves. I will say that we're focused on closing out this year strong, executing our strategy, as I've described it on this call and others, and growing this business in 2024 and beyond. I really appreciate you all joining today's call, and I look forward to updating you on our continued progress in our next call early in the new year. Thank you all very much.

Thank you. This concludes today's call. You may now disconnect your lines, and have a wonderful day.