OPENLANE, Inc. (OPLN) Earnings Call Transcript & Summary

Great. Good morning, everyone, and thank you for joining Barclays Autos and Mobility Conference. My name is Mario Lu with the Barclays Research Internet team. With us this morning is Peter Kelly, CEO of KAR Global; and Eric Loughmiller, CFO of KAR Global. KAR is a leading marketplace for North America, used cars and also in Europe. So Peter and Eric, thank you for joining us this morning.

Thank you, Mario. Good morning to you.

Great. Well, let's dive straight in. This is the first time, I believe you guys are at our conference. So I want to give our viewers a bit of background on KAR, specifically your origin nature of your business.

Yes. Great. Thank you. We're delighted to be here, Mario, first of all. So thanks for the opportunity. So just a quick background on KAR. As you mentioned, we're a wholesale or B2B used vehicle marketplace, principally focused on the North American market. But as you mentioned, we also have some business in Europe. To give you a sense of the scale of the business, this year, which is actually a lower-volume year for us because of pandemic-related issues, we'll talk about I'm sure here this morning, we're going to sell about 2.6 million vehicles to our marketplaces. That's over $40 billion in gross auction proceeds as the metric we use or gross merchandise value. We generated about $2.5 billion in revenue from that. We've got between 9,000 and 10,000 employees. EBITDA is in the $400 million this year. Again, I would say EBITDA is depressed this year and last year because of pandemic-related issues, but it will be in the 400s this year. In terms of our customers, as I mentioned, we're B2B, and we're in marketplace. On the sell side of our business, we typically serve large commercial sellers who would be finance -- auto finance companies, motor manufacturers, rental car companies, commercial fleet operators and dealers, those supply volume into our marketplaces. And on the buy side, it's all dealers, franchised and independent automotive dealers, as well as the larger players like CarMax, Carvana, Vroom, et cetera. Our buyers are plate as well. And then just a sense of the history, the business, its origins are in physical automotive auctions. And it grew, I would say, principally through acquisition, although it did some greenfield development over a number of decades, and is the #2 player in the physical automotive auction industry historically, #2 in U.S., #1 in Canada. But in the last decade has moved much more heavily into digital marketplace platforms, and that's actually how I joined the company through a business called Open Lane that I founded. So in recent years, we've trended much more digital in our marketplace model, and I know we're going to talk about that here this morning, well.

Great. That's a very helpful intro. Could you walk us through how you would define your total addressable market? I know you mentioned it's a little bit depressed these days. But in a normalized state, well as you consider your TAM, and you mentioned you're #2 share right now, how has that trended during this time? And how do you see your addressable market changing over time?

Yes, that's a very good question. And by the way, Mario, I will say we did an Analyst Day just less than 2 months ago. So there's a lot of detail on all these questions on our investor part of our website. a detailed presentation and the audio/video of that as well as anybody is interested. But let me attempt to answer it a little briefer than we do on the Analyst Day. We consider our addressable market approximately 20 million to 22 million vehicles that are transacted in a B2B format in North America on an annual basis. And that's in a normal year. Again, they're probably going to be below that volume this year, but that would be a typical volume in more normal times. So [indiscernible] 20-ish million wholesale used vehicle transactions between businesses. If you sort of dive into that a little bit, approximately 8 million of those are from commercial sellers to dealers. And that's probably what has historically been our core business. We focus on the commercial seller market. And our share in that business, we assess somewhere in the 30%, 35% kind of level. okay? And that would put us really sort of a joint #1 in terms of our share in the commercial seller market. The other big part of the addressable market then is approximately 15 million transactions between dealers, okay? Now historically, most of those transactions took place sort of through informal channels off-line directly between one dealer and another, but about 5 million a year took place through physical auctions. And we serve that component of it. But what we're -- what's happening now in our industry is that with the growth of digital marketplace platforms, enabling dealer-to-dealer transactions, a lot of that in formal market is moving on to digital tech. So we see that as a growth opportunity. I will say our total volume in the dealer-to-dealer segment is less than 10% of that 15 million addressable market. So we see that as a significant potential growth opportunity for our business to grow and to penetrate that market more deeply through digital platforms.

Great. That's helpful. And just a follow-up. You mentioned the digital transformation. I guess where do you think you are in terms of that transformation? And then how do you monitor the success of that initiative? Any metrics that you guys are focused on, whether that's volumes, gross profit per vehicle? What kind of metrics are you guys focused on?

Yes. That's another good question there, Mario. The digital transformation, first of all, is very well advanced. Our business has been moving more digitally for well over a decade, and we've accelerated that through acquisitions. And then COVID accelerated it further, and we sort of reembraced that opportunity to really kind of step across the line into what we consider more of a complete digital marketplace model for our business. So to give you some stats, of the vehicles we're going to sell this year, and I mentioned 2.6 million as the rough volume, more than 90% of those are called to sell online buyers, okay? So more than 90% of the vehicles we're selling are purchased online digitally without the dealer showing up in person, okay? And more than 80% of those vehicles are offered exclusively in a digital format, i.e., we're no longer offering those with a come to the auction and see the car drive down the lane aspect to it all. So now we still do that for 20%, okay, today. But I would say our digital transformation is well advanced and our sort of strategic intent is to take those metrics ultimately to 100%. But obviously, we have to serve our customers, too, and some customers still prefer more physical model. So it's well advanced. Some of the metrics you talk about, we do track gross profit per vehicle sold as a key metric because we think, ultimately, the digital channel, we think it offers customer advantages. But we also think it offers lower cost, but it may also -- there may be less opportunity to generate some of the revenue that you generate through physical services as well. So we think the best metric that reflects all of that is gross profit per car sold. And we've been very pleased with how that metric has trended. We just, I believe, in Q3, just announced our best-ever quarter in terms of gross profit per vehicle sold. We're up 10% or so versus last year and I believe versus the prior year also. So gross profit per car sold is a key metric for us, and we continue to want to see that advance through our digital transformation.

Great. And then, Peter, you've been in the seat for a little over 6 months now. So just curious, what are you most proud of, and any unexpected challenges outside of the pandemic and chip shortage. Anything you can give us in terms of what you learned in the past 6-plus months.

Yes, I will. Thanks. It's been an interesting start to the role. In terms of what I'm proud of, I'd say I'm proud of the team that we have at KAR Global and all we continue to deliver in the face of, I'd say, challenges in our marketplace. We'll talk about some of the of those. But our team does a great job of taking care of our customers, maintaining and gaining market share, dealing with, I'd say, fairly significant supply side challenges this year that I've alluded to, and advancing the digital transformation. We have really transformed our business here over the last 24 months, let's say. I was president before I was CEO, so I was part of that, but the team has really sort of dug in and really executed well to do that. So I feel proud of the team, I would say. In terms of unexpected challenges, the big unexpected challenge this year was the impact of the semiconductor shortage, which honestly a year ago wasn't something that was on my radar screen as a business issue. It really started to become a trend [ first ] quarter of this year of the impact of that on new car new vehicle production. And then secondarily, the impact of lack of new vehicles on used vehicle pricing, okay? So used vehicle prices have appreciated massively this year, really massively over the last 2 years. What that has meant for us, particularly in the off-lease segment of our business, which is the biggest segment in our commercial seller category, is that lessees who have vehicles coming off lease, the market value of those vehicles is much higher than the residual value. So they don't return the vehicles at the same percentages that they would in normal times. And that has really led to a supply constraint in a key category for us. So that's been the biggest sort of challenge. We had expected this year as a year where volumes might start weak and then improve. But they started weak, and they actually got a little worse. And I think they now have bottomed out, I believe. We're starting to see some green shoots and -- but it's been a delayed recovery.

Got it. And I believe on your Analyst Day, you guys mentioned that you're thinking sometime midyear next year towards the end of the second half next year for it to recover. But I guess, in the meantime, how would you describe -- like anything you guys are doing, particularly on your end to kind of manage those headwinds? And how should investors think about how you guys are positioned versus the competition during this time?

Yes. Well, I'd say we're -- first of all, I think we're positioned very well. One thing we have been doing throughout is really advancing our agenda on the dealer-to-dealer side of our business. So historically, our business would have been 70% or so commercial to dealer, 30% or so dealer-to-dealer. That was kind of the rough makeup of our business. But as I mentioned to you earlier, we see in the dealer-dealer segments through digital marketplaces the chance to really grow the addressable market and grow our volumes over time. So we've been leaning heavily into that. We've seen strong growth in our digital dealer-to-dealer platforms, and that's now leading to growth in our aggregate total dealer-to-dealer volume as well. And we're seeing that accelerate. We've obviously done some acquisitions to further accelerate that. But I see us as a co-leader in that digital dealers dealer marketplace in the United States. And I think we've got very similar growth rates, very similar unit economics. And maybe I would argue an even better product offering for our dealers than our co-leaders. So I feel really good about that. And that's kind of a growth part of our business. I'd say in the other part of our business, given low volumes, we obviously are looking hard at cost and continuing to sort of very actively manage costs and we see the opportunity through a more digital model to have a lower operating cost and a lower cost per vehicle sold as well. So really continuing to further that agenda, increase our efficiency, improve our systems, so on and so forth. So that when the volumes come back, that our costs don't come back at the same rate. So again, I think we've entered [indiscernible] progress on that, and I spoke a little bit about that on our earnings call just a few weeks ago. I plan to speak in a lot more detail next [indiscernible].

Yes, the mix a lot of sense. And then sticking with the dealer-to-dealer side, you mentioned you have low double-digit penetration currently. With the recent acquisitions of backlog cars and car wave, is that included in that 10%? Or how does that -- how do those acquisitions...

That is included Yes. So the way you might want to think about it is our share in the dealer-to-dealer market that used to come to physical auctions, which again was about 5 million of the 15 million, our share there was about 20% or about 1 million vehicles per year, all right, in normal times. I would say that our share in the rapidly growing digital dealer-to-deter market is higher. If we look at total dealer-to-dealer your transactions, I assess our share somewhere in the 30s, okay? So I feel like we've got a larger share in a faster-growing and ultimately bigger market. That is how I see it, okay? But given that a lot of this market -- so when I talk about the total market share, I'm talking about the 15 million as the denominator. And a lot of that market still hasn't migrated into a formal marketplace here.

Got it. That makes sense. And then in terms of those acquisitions, can you give us a little bit more background in terms of your motivations, how those discussions began? And how you're going to migrate that into the rest of your portfolio?

Yes. Well, thank you, Mario. Our motivation is to be a leader in the digital dealer-to-dealer marketplace. And if possible, #1 would be the goal. But certainly, to be a leader to be strong there in this digital dealer-to-dealer to our marketplace. Obviously, in any sort of disruptive marketplace event, there's a lot of new market entrants. And that happened with the technologies and the business models. There was a lot of innovators that came in with different models, and they got footholds in various parts. So we have adopted to some extent, a bit of a roll-up of some of these digital players. But I think the market has now reached a stage of maturity where players are sort of defined. I think it's much, much tougher for a new entrant to come in and get a foothold because we have real scale at this point with well over 100,000 vehicles being sold on a quarterly basis. So I think from this point, it's accelerating that organic growth with the platforms we have, which is TradeRev in Canada and BacklotCars being ultimately the platform in the U.S.

Got it. Great. And just shifting gears to the D2C side. You mentioned Carvana earlier, but curious to hear your thoughts on the impacts of a growing D2C auto e-commerce retail channel. Do you view them as a partner mainly? Or is it, over time, could they be a threat to your business or both?

I think the growth in those business is interesting for sure. Obviously, CarMax has been not initially an online model, but a simpler model and a KAR Global have a lot of similarities in their business models today. They offer a different used vehicle experience compared to watching what a consumer might get through a typical dealer. Obviously, they're continuing to grow. I would say in response, dealers and other stakeholders, motor manufacturers, et cetera, are trying to create a more digital retail experience for their used vehicle programs as well. So I see ultimately the retail experience around the used vehicle being more digital. So I think that's a fact. Entities like Carvana, CarMax, Vroom, they're very important customers of ours, they're strategic partners, there is an element of channel competition. But I think I'd like to look at them through the lens of, ultimately customer. We have ways to serve them and enable their business. Even though they are large, they're still a relatively small part of the 40 million used vehicle retail transactions that take place at the retail level. We serve them and we serve all our customers and they're important partners for us.

Got it. And yes, just taking a step back, as you look 5, 10 years out, what do you consider as KAR's main growth drivers from here after the new car production normalizes?

Yes. Well, again, we talked at our Analyst Day about our plan. We -- I mentioned 2.6 million vehicles this year. Our growth plan for 2025 is 4.2. So it's a significant growth in volume. Some of that is, I'd say, a recovery from the present disruption, but some of that is growth in share and market share gains in the digital dealer-to-dealer channel [indiscernible] to drive that. I don't think the growth ends in 2025. I think we still have a growing business. We did talk at our Analyst Day about some growth opportunities that we see for our business. We mentioned 3. One was further overseas expansion. As we are more digital, I think we have a platform that can more easily be transferred to other geographies and marketplaces. So that's -- and we have a foothold in Europe already. So that's one opportunity. We talked about retail reconditioning. This future model of direct-to-consumer, we have large facilities in all major metros of North America where we can recondition cars. And today, we're finding use cases for sellers where sellers are [indiscernible]. Some of the businesses we talked about are purchasing vehicles, having us recondition them to fully retail-ready and delivering them direct to the dealer. So we offer those services, okay? Now that's more of a physical than a digital service. And then I think enabling this more digital retail experience for a used vehicle. We've got areas through our data, through our marketplace, where we can help our business partners, our dealers, particularly when it comes to a more digital trade-in experience for consumer's vehicle. So we talked about that at Analyst Day, too. And I don't think it stops there. I think there's many other growth levers as well. But those are some of the top ones we described in more detail.

Got it. And just circling back to the cost side of the business. You guys mentioned you're lowering the cost footprint during this time. A lot of the online travel companies have done the same, right? I guess have you guys quantified once new car production normalizes what the costs or margins will look like at that point versus where it was pre-COVID?

Yes. We did -- again, I don't have the numbers right in front of me here, Mario, at the moment. But on our Analyst Day, we did speak about [indiscernible] sort of last 12 months, our most recent quarters versus a 2025, based on that volume growth and trajectory that I talked about. So there is some data in there. I just don't have it on a screen in front of me. I don't know if Eric is able to speak to that or not. But...

Yes, Peter, we've set a target out of -- we exclude purchased vehicles in this calculation. So we call it net revenue to achieve 50% or greater gross profit. And we've talked in previous calls, Peter, you may recall this, you mentioned when the volume recovers, we were at 2 74 in the third quarter. We think that is a function of the very low volume. You've got a small denominator. But it would be above what we historically had, which was below 2 50, and we would be in that 2 50 to 2 65 range in terms of gross profit per vehicle. We have a very strong contribution from a finance unit, and we believe that would drive EBITDA margins up from where they've been historically. Just in context, Mario, for those that are new to the story. Prior to the pandemic, our gross profit at ADESA would have been in the 43% to 44% range. So that's been moved up. We took about $150 million of labor, a combination of direct labor and SG&A out during the pandemic period, and we're going further than that with some initiatives that Peter has talked about. So Peter, that's the background. Those are the numbers that were in the Analyst Day. I'll let you take that further to talk about where we're focused.

Yes. And thank you, Eric. I appreciate that, and I just didn't have those number on hand. But one number I didn't mention. What that drives, ultimately, Mario, is we have a target of $750 million to $800 million of EBITDA by 2025. So we see a significant EBITDA growth story from the mid-$400 million LCM to $750 million or greater. We talked in quite a bit of detail about the levers for that, the commercial growth, the dealer-to-dealer and the cost management. And I guess I believe that, that growth story is very much intact. And like I said, I don't believe it ends in 2025. I think the opportunity continue from there. We just took that as the appropriate year to benchmark for the purpose of our analysis.

Perfect. Thank you, Peter. Thank you, Eric. Just one last question on my end. Maybe we can talk about real estate a little bit. And then your -- in terms of your incremental value-add services to your marketplace. Anything else that you think could be further rightsized in a more digital world?

Well, I think one of the very interesting assets we have is this nationwide network of physical facilities, which existed historically, primarily to serve the commercial seller side of our business because those were the sellers that as their cars came out of lease or rental or whatever service they were in. They would typically invest some dollars in cleaning and maybe some limited reconditioning of the vehicle before it's sold in the wholesale channel. So our facilities are set up to deliver those services. We have 70 facilities across U.S. and Canada. It's interesting, Mario, I'd say immediately, post-COVID, those facilities were bursting at the scenes because there was a massive sort of defleeting of volume and very little demand. And then contrast that to today where it's kind of the opposite extreme. So we've seen both ends of the spectrum here over the last 15 months, let's say, or 18 months, and I expect it will normalize a little bit over time. But I would also say that from a purely wholesale marketplace perspective, as our industry moves more digital, there's probably incrementally less need for the physical. It's not that the need goes to 0, it just -- it tends to diminish. Now offsetting that, I think this retail reconditioning opportunity is a very interesting one. Because when we think about the future retail model for used vehicles, I think these facilities with their scale, with their location, really -- and their capabilities, really offer a great solution for getting vehicles to fully retail-ready and then sort of doing next-day delivery direct to consumer from those facilities. So -- and we're seeing a lot of demand from some of our customers to help them enable that sort of business model. So we still see a high level of interest and use case for the facilities, I will say that.

And Peter, let me add something here. We own about half the properties in North America. We have had some success here this year and it continues, it will go into next year. Where we find we have excess property, we have been actually marketing that property in very -- achieving very high values because our properties tend to be outside of the major metropolitan area. They tend to have very good road infrastructure around them, because we're moving cars in and out so much. So you can imagine with what's happening in the logistics space. We're an ideal location to have a warehouse next door or whatever. So we've actually been generating some gains on the sale of excess property. That excess property, we're not exiting any location in its entirety, but we're able to rightsize it where we own those. And in the case of our other half that we lease, we can reduce the property we're leasing, eliminate certain leases if we don't need the property. So our model is able to be flexible at this point in time, especially with high real estate values and high demand for that type of real estate, it's fairly easy to be flexible. Again, most leases, while we may go up 15 years, have less than 15 years now, some are 5 years. So we're not stuck in a cost structure that will burden us.

Yes. Great. Well, Peter and Eric, thank you for all the time this morning. It's been very helpful. And thank you, everyone else, for joining us today.

Mario, before you go, there's one thing we didn't cover since this is a new conference for us that I thought I'd highlight. I just want to be clear. We're a consignment business. Peter talks about it. So we talk about the values of cars. That does not put risk on our balance sheet. We do not own the vehicles. And I had the $40 billion in transaction value, while we process that amount of payment, the exposure on the vehicle values belongs typically to the seller of the vehicle or the buyer when he buys the vehicle. It does impact our fee structure because it's a variable fee, especially on the buy fee, but that's very limited. So I just wanted to make that point since we may have some new investors not understanding that as you have high used car values, that does not give us balance sheet exposure because those values do not sit on our balance sheet. That would be something I wanted to clarify.

Got it. Yes. Thanks for the clarification. I'm sure that -- it's been very helpful. Is there anything else that you think investors or new investors are kind of confused about or that we should kind of go over here?

Well, we're all confused about the supply situation, right, Peter. But that will work -- the only thing that I would add is 2008 and '09, we had a disruption for different reasons. There are -- other than what causes it. There are some similar patterns. The recovery in dealer consignment is probably going to be earlier than the recovery in the commercial segment. It probably isn't waiting. High used car values when they start to decline,will probably be a positive for the dealer consignment volume coming to wholesale. And that is likely to happen earlier than the chip shortage of overcoming supply chain issues. Peter, do you want to add anything on it? Because I do think we do not have to wait a year or 2 for off-lease cars to get back before we will see some positives in the supply situation in other segments of our business.

Yes. I guess I'd say it's 2 things. One is if investors want to go deeper in any of these themes, again, I mentioned the Analyst Day, there's a lot of information there. To Eric's point, the supply side challenge has been, I'll say, an unforeseen challenge here in 2022. The extent of it, we're expecting a little bit of a recovery, it didn't happen. But I do believe we're starting to see that turn already. I've seen even in the last 3 weeks some narratives of an easing of semiconductor supply. I believe we've seen inventories at dealerships start to tick up from record low levels. They've been on a sort of a steady decline since the start of the year. But I believe in October, they've ticked up incrementally. And I also believe that retail new vehicle sales ticked up a little bit in October. So I do think we may have hit the bottom, and we may be on the road back to recovery here on volumes. And that will be a real strong driver in our business.

Got it. Well, thank you again for both your time this morning. And yes, feel free to -- we'll keep in touch.

Thanks, Mario.

Thank you so much, Mario. Appreciate it. Thank you.

Bye.