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

Great. Thank you, everyone, as you join -- as we continue to Barclays Global Automotive and Mobility Tech Conference. I'm Dan Levy, I lead autos research coverage at Barclays, and very pleased to have with us OPENLANE. For those of you who may not be familiar, OPENLANE actually is what you may have known in the past as the car auction services, OPENLANE, they focus on wholesale vehicle auctions, vehicle remarketing services, primarily in North America, Europe as well. And so we have with us today, Brad Lakhia, the CFO; Michael Eliason, Treasurer and Head of IR. And I think this will be a good opportunity to get a sense of sort of the core business drivers that they have. And maybe as well, if we can get some sense on, I know for a lot of people, the used vehicle market has been, obviously, a very critical topic here, given sort of the very unique cycle position that we have. So I think OPENLANE can provide us with some interesting insights on where that stands. So with that, Brad, Mike, thank you for joining. Thank you for participating.

Thank you.

Thank you, Dan. Thanks for having us.

Great. So maybe you could just start with a broad overview. I think folks generally have heard in the past, you're focused on the wholesale vehicle auction business. Maybe you can just give us a quick overview on just how the operations are split, what the revenue splits are, et cetera.

Yes. Sure. No. Thanks, Dan. I'll start with maybe just an introduction of who is -- who are we as an OPENLANE as a company and then talk a little bit more, as you suggested, about how we think about our 2 segments, our Marketplace segment and our Finance segment. So OPENLANE is a digital leader in the wholesale used vehicle marketplace. Our purpose, our mission as a company, is to make wholesale easy, make it easy so our customers can be more successful. We are a digital, pure-play volume leader. Dan, as you said, primarily focused in North America. We do have a successful, albeit smaller business in Europe, digital business -- based business in Europe as well. Over the last 12 months, we've sold roughly 1.3 million vehicles and in our most recent quarter have delivered about 8% year-over-year volume growth. About half of our vehicles are sold through our -- what we would describe as our dealer channel, and another half through our commercial channels, which are primarily OE finance captive off-lease vehicles. We also have fleet operators that we sell through -- that sell through our commercial channel as well. We are a co-leader, I would say, and at least from a North America perspective, in the digital dealer-to-dealer space. And we believe this segment will continue to grow on 2 sides. One, a secular shift from physical auctions to digital marketplaces where we are obviously very well positioned. And then also, Dan, which you were alluding to, this used vehicle situation that we found ourselves in here cyclically over the last couple of years, we expect there'll be a cyclical recovery that will support growth over the coming years as well. In Canada, we are a clear #1 from a remarketing platform perspective and again, almost exclusively digitally focused there. We have a leading floor plan finance business, which is our finance segment, have about a #2 market position there. We're profitable as a company. We're profitable in all of our geographies. We're profitable in our digital dealer-to-dealer segment across all of our geographies, generate strong cash flows. Our year-to-date results demonstrate that. We have a strong balance sheet, with low leverage and very strong liquidity position. So Dan, that's just a broad overview of who we are. And I'll pause there and let you take it from there with your additional questions.

Okay. Great. Let's just unpack for a second the dynamics behind off-lease remarketing. So give us a sense here of how exactly this is playing out. This is essentially -- if I just take -- is this primarily OEMs coming to you as leases are coming due and you're simply the marketplace behind all of this?

Yes. No, it's more than that, Dan. Let me maybe explain this business a little bit more for you. We have essentially a platform -- it's what has legacy -- our legacy OPENLANE platform is. Now of course, we've rebranded the company, renamed the company OPENLANE. But that legacy off-lease business was really the original digital disruptor, if you will, from a wholesale perspective. And what that is, is it's largely a private label, white label platform that we've developed over the last couple of decades that is highly integrated into commercial, I'd say, OE captive finance companies, primarily as well as other financial institutions where we provide exclusive, highly integrated platform to manage these captive finance companies' lease inventory, lease portfolio. So well integrated, Dan, into not only their business processes and systems, but also integrated across their franchise dealer network. And so what happens is, consumer is returning a vehicle, leases a vehicle, our platform helps these captive finance companies manage that vehicle kind of end to end. So if you as a consumer are returning your off-lease vehicle, you basically have a choice, you can purchase it off lease or you can return it to the -- what we would call the grounding dealer which would be a franchise dealer. In this case, let's just say it's a Ford product, so you would return your vehicle to a Ford franchise dealer. That franchise dealer, if you as a consumer don't buy it, would have the first rights to purchase that vehicle and resell it as a used vehicle on that particular lot. And if it doesn't -- if that particular dealer doesn't want the vehicle or chooses to not purchase it, it typically goes out to a nationwide network of Ford dealerships for their next -- so they have the next right to that vehicle, and that would play out over a course of a few days. And then if that nationwide network of Ford dealers don't bid on the vehicle or buy it from Ford Motor Credit, then it would go into our open auction platform, which is digital.

Great. Let's -- maybe we could just unpack this dynamic a little further, maybe you could talk about the relationship that you have with dealers. Is there any -- maybe you can give a sense, a, of what percentage of the dealers in the U.S. you're working with? Is there any exclusivity? What's the benefit of dealers coming to you versus other auction channels that they might have?

Yes. Well, I would say on the off-lease side, so we have essentially exclusive relationships with those particular franchise dealers. So we have a majority share of this commercial off-lease business, so we're very well positioned there. And I think you could characterize that as fairly exclusive. Outside of that franchise dealer network, whether it's other franchise dealers or independent dealers, Dan, we have very strong penetration across all of those dealers, whether it's in our financing business or our marketplace business, we would say nationwide or in North America, there's on average, probably somewhere in the neighborhood of 40,000 independent used car dealers. And we have, in our financing business, in any given day, year or month, we have 12,000 to 13,000 of those dealers that we're financing. And then from a marketplace perspective, also have strong penetration there with offering our digital marketplaces for them to be able to buy and sell vehicles.

And I would ask on the other side as well, right? So that gives us a sense of maybe the moat you have on the dealer side. What about -- you said the other half of your vehicle sales are through the commercial channel, this is OE finance captives, et cetera. Again, what's the moat that you might have on that side?

Dan, on the commercial side?

Yes.

Yes. So the moat is our off-lease platform. So we have the overwhelming majority of share with these captive finance companies, OE finance -- captive finance companies, that is our moat. We are well in excess of 50% of that market.

Great. What about virtual dealers marketplaces such as Carvana, are these customers? Are they competitors? What's the relationship on that side?

Yes. I mean Carvana -- and I'd say Carvana and the CarMax players in the market, we see them really as customers more than we see them as competitors, certainly acknowledge that they are in the market more from a direct consumer perspective. They have virtual marketplaces themselves, but they are also customers for us, primarily on the buy side. So they are customers in our digital marketplaces, where they're sourcing vehicles.

Great. So interesting. And what's the sense of how -- what's the sense of what the type of volume that you've seen from Carvana in recent years?

Yes. So I guess I'd step back from it a little bit, Dan, as you alluded to, maybe up front, the used -- wholesale used vehicle remarketing industry has been under, I guess, pressure for last 2 or 3 years. And it really stems from, what we've seen, with the supply chain disruptions that have impacted original equipment manufacturers. So as -- that's limited the number of new vehicles. Obviously, the SAAR that's out there that everyone tracks and follows is starting to recover. But because the population or the availability, supply availability of new vehicles has been limited, what's happened is used vehicle values have really reached record highs over the last 2 years or so. People are holding on to their vehicles longer. So turning them in for a new vehicle. And then as affordability of not only new but also used vehicles has really been under -- kind of been at peak levels, the used vehicle population that's moved through these wholesale channels has been at record lows. And so we're starting to see over the last couple of quarters that used vehicle turn of inventory through these wholesale channels improve the last couple of quarters are the first couple of quarters that we've seen in a couple of years of year-over-year growth, not only at the industry level, but also, of course, in the channels and the markets that we play in. So we're starting to see the grass shoots of that cyclical recovery take hold. And as we look out into the next 2, 3, 4 years, we believe that will be one of the fundamental key elements of our opportunity to capture growth and create value.

Dan, I would just add too, I mean, Brad's talking a little bit about a cyclical recovery. There's a secular shift in our marketplaces as well, where technology can make the transactions in our industry more efficient. As an example, you talked about some of the online retailers, we and some of our competitors as well have built technologies to help the independent dealer source vehicles directly from the consumer just like the CarMaxes and the Carvanas of the world. So as we build technologies and make our customers more successful, we believe we can continue to grow through that secular transformation.

Great. Before -- I want to go back, Brad, to some of the market trends you mentioned. But before I do, just maybe you can give us a sense on the financing side. What's the scope of services you're providing there? It sounds like there's a lot of floor plan financing, what's the benefit of going through you as opposed to other financing providers?

Yes. So I guess let me describe kind of what this business is. We're -- it's an independent floor -- focused on independent used car dealers. And Dan, they tend to be smaller, more family, entrepreneur-based dealers. So 1, maybe 2 lots that they may own. So small, independent used car dealers. And so we're focused on that. So we're not after like large franchise dealers. We're not really targeting that market. And the revenue model and the reason why we can play in this space is really because we are able to offer a financing that other financial institutions, they don't tend to play in this space. It has a little bit more of a niche to it. It requires an operating model that is higher touch, where we have branch locations in over 90 locations throughout North America, we were able to make sure we understand these customers very well, their operating needs, their inventory needs and of course, their financing needs. So our model is high touch. Our risk management and underwriting processes are tailored and have been developed over 20, 30 years to really play very competitively in this space. And so through underwriting fees and the interest income that we earn on these floor plans, we're well positioned, our return on assets, our return on equity, we believe -- we're confident and proud to say, we believe we have a fairly leading position here and pretty well advantaged to continue to play very competitively in this space.

From a near-term standpoint, what's been the impact of higher rates on the business?

Yes, higher rates, obviously, have had an impact. I mean, again, going back to some of the dynamics of the ecosystem, the auto ecosystem as a whole, when supply was -- or sorry, demand was well outstripping supply, our loss rates in this business were at record lows. So '21, '22, record loss -- record low losses. This year, we've seen that return more to normal. Normal, we would describe for us as we manage our portfolio is a loss rate on our portfolio of about 1.5% to 2%. Historically in '22, that was below 1%. So we're back to about 2% right now, Dan, which is, again, like I said, normal. So higher interest rates have had an impact on that, used vehicle values being at record highs have had an impact on that. And then just broader inflationary pressures on all businesses, all operating -- all these operators has had an impact on that. But I will say, we're -- we continue to be successful in managing that risk. We are running at about 2% loan loss rate this year. And again, if I compare that -- we compare that to some of our competitors that target the same market, the same independent used car dealer market, we believe that 2% is well below our primary competitors.

And Dan, besides credit losses, from a revenue generation perspective, approximately half of the revenues that we earn are fee-based instead of spread-based. And so we think of ourselves as more of a fee-based model. And on the interest side, we charge Wall Street Journal prime plus a spread. And so as rates increase, we're passing that through to our customers.

And as far as the interest rate piece, to what extent is the asset liability side sort of in sync?

Yes. So we securitize about 70% of our portfolio. So Dan, fairly well in sync overall.

Great. Great. Let's go back to, I think, some of the used car dynamics and maybe how that plays out. So I think as you pointed out, we've been through this period where supply has been incredibly tight and people generally buying out their leases, probably off-lease volumes coming down dramatically. I mean this is really like a far cry from the days pre-COVID when you had 5 million units of off-lease volume. So maybe you can just give us a flavor of to what extent you've had to reposition the business near term as off-lease volume has come down dramatically. And what's the look going forward? And to what extent as a follow-on here, we're talking about off-lease, but then there's another piece of the market as well that if we're in a structurally lower new car market, that could really facilitate the sale of used cars, what is that as an offset if off-lease is maybe structurally lower. Has the ways to go to recover to the day that we saw pre-COVID?

Yes. So let me start with like the dealer side of things and what we've seen relative to pre-COVID, pre-pandemic. First, I would say, we've seen a meaningful shift, the secular -- what we describe as the secular shift to dealers understanding and realizing that buying and selling vehicles through digital platforms, digital channel is more efficient, right? It's more efficient from a financial perspective, it's more efficient from a time perspective. So the realization of what we went through with the pandemic has -- we believe in our -- in the surveys we do with our customers prove this out time and time again, it has demonstrated that buying and selling vehicles digitally is just an easier, more efficient means by which to manage their business. So that -- I think that is one area that I would highlight, Dan, relative to the off-lease fundamentals and the more tougher dynamics that we're experiencing there, that's been a meaningful offset for us. It's also why go back to last year when we sold our U.S. physical auction business, it's why we placed our bets digitally. We believe that this industry, these dealers over time will shift their behaviors and their patterns to buying and selling vehicles digitally through the -- rather than the traditional physical platforms or physical auction means, right. On the -- the other thing I would say is, listen, as we made that strategic decision. We sold the U.S. physical business, our focus is asset-light digital, and we've been very, very focused on cost structure, right? We've made meaningful inroads, meaningful execution of cost improvements over the last 18 months. And that's proving itself out in what you're seeing over the last number of quarters in our marketplace results, what you're seeing in our EBITDA performance and our margin performance there. We've been very focused on cost, we've been focused on being profitable in our marketplace business, in our digital businesses even during this period of record low volumes. So we believe our operating philosophy, our focus on cost, our focus on being profitable, on being cash flow positive is a demonstration that we're running these businesses very effectively while also capturing growth. And you've seen that in the last couple of quarters where we've delivered year-over-year volume growth, both on the dealer side and also on the commercial side.

Can you -- maybe just to unpack and you're talking about you made the strategic decision to exit the physical auction space when you sold ADESA to Carvana. Maybe help us appreciate how significant to transition this was for you because, obviously, this is a very significant physical footprint. Are the dealers on board that now just the way of acquiring vehicles has just -- has completely changed?

Yes. I mean, listen, there's still a population of dealers who have preferences for physical. Some of that, Dan, can be attributable generational patterns and behaviors, just habits, if you will. But we know that whether it's franchise dealers or independent dealers that their preferences are and they see the value and the convenience, the ease, the trust, the availability of liquidity on digital marketplaces is real, it's meaningful. It's just a way more efficient way to transact and run their businesses. So we still know, right, we've said this, and it's just not us, it's other industry sources as well, today in North America, there's still about 70% of the vehicles that are wholesaled physically. So digital, we estimate to be about 30% of that. But if you compare that to pre-pandemic, it was probably 90-10. So that shift has happened, and we believe secularly, it will continue to happen over time, and we're well positioned to capture our share of that.

Great. Maybe we can unpack some of the other trends we're seeing. Dealer consolidation has obviously been something that we've seen as dealers consider some of the different economics in the marketplace. To what extent is dealer consolidation an impact on you? Or is that just the volume is still going to be fairly constant regardless of the number of dealers is just consolidation is going to lead to more volume per dealer?

Yes. We're obviously focused on that shift. We have strategies and initiatives that are tailored to and focused on what we call major dealer accounts. So while that shift is real, I think our estimation is that there's still roughly 80% of the dealer market that is largely independent, not necessarily consolidated at a regional or national level through these major dealers or this consolidation. So there's still a lot of fragmentation out there, Dan. But we're positioned to service both and to meet the trends of both, right? Like I said, we have a strong major dealer account focus, our position with off-lease. And those franchise dealers, we believe, offers us a unique advantage to be at the forefront of that trend in terms of putting our products and services in a position to win and compete for their business.

Within the trend of remarketing, what's the exposure? Or what are your responsibilities? Meaning, are you simply the marketplace? Do you have any sort of residual value risk? Or are you simply getting a spread on what you're selling?

Yes. So we are not -- sorry, sorry, go ahead.

Yes, go ahead.

Yes, we're -- our model is consignment based. So we're not -- in Europe, although it's a small business everywhere, we are taking possession of the vehicle, we manage that financial risk very, very well. But in North America, it's primarily a consignment model. So we are not actually taking whole ownership over the vehicle, we're providing a marketplace for buyers and sellers. We're bringing that inventory to bear. We're making the transaction easy through providing very strong inspection and condition reports and standing behind those condition reports with products and services where in certain cases, Dan, you can have what, we would call, a guaranteed offer. If you're a buyer, you purchase a vehicle, you purchase it, you have a condition report. That vehicle shows up at a buyer's lot. For some reason, that buyer might not be happy with the vehicle. There are cases where we will take that vehicle and then bring it back in and resell it. But again, that's -- we're attaching revenue to that for that feature, for that offer, right?

Great. And the role of maybe other players in your -- other buyers as well, let's think about maybe car rental has obviously been a key set of buyers. Is there any sort of strategic relationship that you hold on the car rental side? What -- how critical is that set of buyers?

Yes. On the rental fleet side, it's part of our commercial volume. I would say that the majority of our commercial volume is the off-lease volume that we talked about earlier. The rental fleet volumes are more limited. We do have relationships, customer relationships with some of these large rental companies. But I'd say, Dan, keep in mind, these rental companies have some of their own proprietary remarketing channels that they preference their own at the retail level and then also through wholesalers. So that's a more limited part of our commercial portfolio.

Great. Just unpacking the trends further here and we're -- there's an idea of the car park that will continue to grow, but at the same time, like I said, maybe the growth pace will be slow. Like I said, new car sales will come down. What's your -- what is the exposure by age that you have? So if we see an aging of the fleet and there's more volume -- or more vehicles moving hands that are on the slightly older side, how much -- obviously, off-lease is your primary area, but what's your exposure to other vehicle age as well or other vehicle segments?

Yes. Well, I think the age of vehicles out there is now approached in North America somewhere around 12. Part of that is a result of the ecosystem not being replenished with new car supply in the last few years. So I think part of it is true. But part of that is, I think, attributable to the fact that vehicles are built to last more, right? They tend to be able to run and operate vehicles for longer periods of time, more mileage. That, I think, fundamentally for us is a good thing, right? So as we think about the life cycle of vehicles, a 12-year-old vehicle might trade and change hands 4, 5, 6 times. And for every one of those turns, there's an opportunity for us presents to move it through our digital marketplace platforms. So we feel like that's positive. But we also feel, Dan, though, and we believe that the new car ecosystem will continue to improve. We've seen that in the last year or 2. SAAR is now approaching close to $16 million. We believe over time, it will revert back to that mean of $16 million to $17 million per year. And that's good for our off-lease business, and it's obviously good fundamentally for the used car fundamentals over time, and that's good for our digital marketplace dealer business.

Let's wrap with a couple on the financial side. And maybe you alluded to some opportunities within cost reduction and cost measures. Maybe you can just walk us through -- give us a little more detail on those efforts. What's the timing? How significant of a financial benefit is the push to digital?

Yes. So I think from a cost structure perspective, tremendous amount of scalability here as those -- the growth in volume secularly and cyclically takes hold. Our business now has much more of a fixed cost structure attributable to it. So as those volumes come back, the need for us to bring in variable costs to be able to meet those volume needs is more limited than it would have been in a more physical-based business that we had previously. So the scalability of that volume and the drop through, if you will, into our margins is fundamentally very strong. So I want to highlight that. Dan, on your earlier point or question around some of the cost initiatives, I would say the results that we're seeing from the cost actions that we've taken over the last year or 2, particularly post separation of the U.S. physical business are showing up in our results. So if you look at our Marketplace segment, in particular, while we have seen relatively flat volumes year-to-date, year-over-year, we've seen some improvement in the last quarter or so, but still relatively flat volumes from an industry perspective. And from our own volume year-over-year '23 versus '22, our margins and our EBITDA, our margins in the Marketplace segment have improved notably. And I think it's fair to say that that's in part attributable to the cost actions we've taken. And we see the opportunity for further cost actions going forward as we have combined our one marketplace platforms. We're going to work to combine the technology platforms that support that one marketplace over the next couple of years. That will make us more cost efficient. It will also actually make us more agile, more nimble in our ability to bring products to bear, to bring features to bear in our digital marketplace. We'll be a lot more efficient and a lot more agile as we consolidate those technology stacks.

Perfect. Let's wrap with one. I know we're at time or almost at time here. But I just want to wrap on one in terms of cash flow and specifically, the opportunity for capital allocation, the return of cash to shareholders, you have a share buyback plan out there. I mean, how should we think about cash flows, the cadence of cash flows, the opportunity on free cash. But then also how aggressive you could be on the share buybacks?

Yes. So let me just talk about capital allocation principles and priorities for us just for a minute before we wrap up. We continue to believe that our business model, asset-light, digitally focused positions us to have strong cash flow characteristics. So in our year-to-date results, cash from operations proves that, right? I think when we look at the balance sheet, we have significantly reduced our debt with proceeds from the U.S. physical sale and also from the cash flow that we generated from operations more recently. So our balance sheet, our debt position, we feel is in a really strong position. We're levered at about 0.5 turn of EBITDA currently just using straight debt. We have a strong liquidity position. So in terms of priorities for capital allocation, Dan, we're going to continue to be focused on investing in our core digital businesses and the capabilities there. So call that organic investment. We'll want to continue to kind of be opportunistic around strategic opportunities. However, I would say a couple of things. One is those strategic opportunities have to be complementary to our digital marketplace core. And second, would have to have fairly high return rates, hurdle rates. So we're going to be very selective, in other words. And then third, it really comes -- would come back to shareholder returns. And like you said, we have $125 million share repurchase plan authorization out there in the second -- sorry, the third quarter of this year, we did repurchase about 20 million of shares. So can't commit on share repurchases, share returns. But we believe our balance sheet fundamentals of our business are well positioned to be able to create value for our shareholders.

Okay. Great. We're at time. But Brad, Mike, thank you so much for the time. I appreciate the color on the business.

Thanks, Dan. Thanks for the opportunity.

Thanks, Dan.

Okay, Great. Thank you.