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

Hello, everyone, and thank you for waiting. Welcome to the OPENLANE, Inc. 2024 Investor Update Webcast. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Itunu Orelaru, Head of Investor Relations. Please go ahead.

Welcome, everyone. As a quick introduction, my name is Itunu Orelaru, I lead Investor Relations here at OPENLANE. Thank you for joining us today for 2024 investor update. We're super excited for this event. We have great speakers and content that will be interesting to your understanding of OPENLANE and specifically the AFC business. We'll kick off the event with Peter Kelly, our CEO, who will talk about OPENLANE strategy and investment highlights. He will hand over to Will Mitchell, President of AFC, who will give you a foundational overview of AFC. Next, we'll have Brad Lakhia, our EVP and CFO. Brad will discuss our enhanced performance reporting metrics for AFC. Lastly, we'll end with an interactive Q&A session with Peter, Will and Brad. To wrap up, as part of today's presentation, we'll be looking at some forward-looking statements. Such statements involve risk and uncertainties that may cause our actual results or performance to differ materially from such statements. Factors that could cause such differences include those discussed in our SEC filings. Certain non-GAAP financial measures as defined under SEC rules will be discussed on this call. Reconciliations of GAAP to non-GAAP measures are provided in our published materials and available in the Investor Relations section of our website. With that, I'm excited to bring up our CEO, Peter Kelly, to kick off the event. Peter?

Thank you, Itunu, and welcome, everyone. I'm delighted to be with you today and I appreciate your interest in OPENLANE. We have some important and I believe very exciting content to share with you all today and I'm just going to jump right in and get started. I'm going to begin with OPENLANE's purpose, which is to make wholesale easy so our customers can be more successful. This purpose is at the heart of what we do at OPENLANE. And while the words focus mainly on our customers, we also strive to make it easy for our employees, for our business partners and for the investment community. So that's why we're here today, to make AFC easier. We want to make it easier for you to understand AFC's business model, easier to see how it supports our marketplace and how it helps power OPENLANE. Ultimately, we want to make it easier for you to see and model the true value that AFC delivers. So as many of you know, OPENLANE is a digital marketplace company with 2 strong and highly complementary business segments. First, there is the Marketplace segment, our leading digital marketplace and technology business that has deep relationships and market penetration with both commercial and dealer customers. This segment represents approximately 75% of our revenue and about half of our adjusted EBITDA. It's growing, and we're driving that growth through our investments in people and in technology. We're not going to provide much marketplace detail today, but I would refer you back to our recent Q3 earnings call where we covered a lot about our positive growth, our strategy and our market position in the Marketplace segment. The other segment of our business is AFC, and that will be our primary focus here today. AFC is a high-performing, independent dealer floorplan finance business with a leading market position and what I consider to be the very best leadership team in the space. AFC has a broad loyal customer base, a healthy mix of both fee and interest revenue and a best-in-class risk management program. Together, these strengths support AFC's strategy to grow responsibly while helping to fuel the OPENLANE marketplace. AFC is a highly valuable asset to OPENLANE, and we look forward to digging deeper into that value proposition in today's discussion. As I've described on our earnings calls, OPENLANE strategy is grounded in our purpose and is advanced through 3 strategic and differentiating priorities: First, by delivering the best marketplace, more buyers, more sellers and offering the most diverse inventory available; second, by delivering the best technology, innovative products and services that help our customers achieve better business outcomes; and third, by delivering the best customer experience, making it easy for our customers to transact. AFC plays an important role across each of these 3 strategic priorities. From a best marketplace perspective, AFC has relationships with thousands of independent dealers, and these dealers represent a core buying audience for OPENLANE. AFC can help introduce those dealers to the OPENLANE marketplace and also empower them with liquidity. More liquidity in our marketplace equals more buying, higher conversion rates and ultimately more volume sold on OPENLANE. From a technology perspective, you'll learn more from Will Mitchell about AFC's innovative digital-first platform and offerings. Related to that, AFC also generates a lot of data about independent dealer behavior and market conditions. And we funnel that directly into our product development and go-to-market teams. And in terms of delivering the best customer experience, AFC was actually our model when we created the OPENLANE brand 18 months ago. AFC has built their entire business by being passionate about the customer. They maintain deep personal relationships with their customers and their communities. And as AFC likes to say, we fuel the entrepreneurial dream. In fact, most independent dealers are entrepreneurs, and AFC is often their first step towards having an ownership stake in the larger automotive industry. And this mindset has set AFC apart from other competitors for decades. And it builds very strong customer relationships that benefit all of OPENLANE. So Will and Brad will be going into all of this in more detail later today. But before I go, I just want to reiterate the value that I believe OPENLANE delivers through this powerful combination of an industry leading digital marketplace business and AFC. First, we are a digital marketplace leader for wholesale used vehicles. There is a large addressable market with meaningful opportunities for growth. We are leaning into those opportunities across all of our markets. We have a clear strategy to accelerate innovation and extend our lead in technology. We are cash flow positive with a strong balance sheet. And this allows us to invest in our business and deliver shareholder value simultaneously. And the secular and cyclical fundamentals of our industry support what we believe to be a compelling opportunity for near-term and long-term growth in our business. So with that, I will turn things over to the President of AFC, Will Mitchell. And I look forward to seeing you all again for Q&A towards the end of this morning's call. Thank you all very much. Will?

Thanks, Peter. Good morning. I'm Will Mitchell, President of AFC. And by way of a brief background on me, I've been with AFC for over 9 years, serving in a variety of roles prior to becoming President in April of this year, most recently as COO for the past 3 years. I'm excited to demonstrate why AFC is an attractive business in what makes AFC a key complementary piece to the OPENLANE organization. AFC is a leading provider of floorplan inventory financing, primarily to independent used car dealers throughout North America. A quick look by the numbers from our last full year released in 2023, we generated 1.6 million loan transactions spanning 14,000 dealers. We also have relationships with over 1,400 auctions across the U.S. and Canada where our dealers can seamlessly acquire inventory, whereby AFC pays the auction directly on behalf of the dealer. We are directly positioned in some 90 locations. What makes AFC unique is that we operate from a hybrid servicing model that consists of both brick-and-mortar offices in key dealer dense markets paired with digital servicing locations in rural areas where our only assets are our people. This hybrid servicing model provides AFC in unmatched local presence, customized to the needs of the dealers, given local market dynamics. In addition to financing vehicle purchases from physical and digital auctions, AFC will finance non-auction purchases such as consumer or dealer-to-dealer trades. And even going beyond vehicle financing, AFC offers a variety of other fee-based products and services to support our customers operations. The floorplan lifecycle provides a high-level overview of the key customer touch points within our daily business operations, most of which occur digitally. Following a sales efforts, the touch point kicks off in earnest when an independent dealer applies for a line of credit. The quickest and easiest application is completed digitally and routes in the system to our underwriting team. If approved, an established line of credit is made available to the dealer and an e-contract is generated for electronic signature. The revolving credit line can be used to finance an auction purchase or even a trade-in. Over 90% of our floorings happen digitally through API connections or our online dealer portal. The dealer then manages their account online, including adding or requesting ancillary services. And then when the vehicle sells, the dealer pays off principal plus accrued fees and interest using the same dealer portal. From inventory acquisition to disposal, over 90% of our transactions are completed digitally. Our dealer portal is accessible like most traditional banks using both mobile and desktop versions. AFC has built a competitive advantage over the last 37 years, focusing our greatest assets, our people, on building strong relationships with our dealer partners. Your success is our destination, is an aspirational commitment we strive for with each dealer relationship. This focus on the relationship is at the center of everything we do. Permeating from the center is the continual balance between managing risk and smart growth. From a risk perspective, AFC is the leader in loss management in the floorplan industry, and that's a testament to our robust risk management practices that we've refined since our inception. It starts with our seasoned underwriting strategy. We have a veteran credit team evaluating dealers across comprehensive criteria, which is all informed by our credit strategy. Pair this with our proprietary risk models and scoring that leverage AI and machine learning, and we're able to effectively manage the risk on our $2.3 billion portfolio and keep loan loss rates around 1.5% to 2%, irrespective of the macro environment. Our AI risk models and scoring are integrated into our operational processes, which allows our teams to proactively manage risk. We're able to act earlier and faster with more confidence to minimize our exposure on risk issues. From a growth perspective, we have several capabilities that together allow us to build strong relationships with our customers. It starts with our service delivery model, our hybrid approach of physical locations and digital service areas that the right fit, given the local market needs to be present with the dealers in the manner that they most prefer. To allow our field times to spend more time with our customers, we centralize a number of key transactional tasks. And as we continue to free up time for our field teams with centralized efforts, the more time they have to meet with our customers at their place of business and conduct business on their lots. We know our customers are short on 2 things, capital and time. Every day, we do our best to provide the necessary buying power and help save them valuable time. AFC has spent the last 10-plus years digitally transforming our business, but like many others, the pace of change has significantly accelerated over the past 4 years since the pandemic. To support a more dynamic service delivery model, we removed core predictable manual tasks such as inventory audit reconciliation and servicing aspects into our central office. And we also created a state-of-the-art title processing and holding facility in Mesa, Arizona. As a result, we've been better enabled to deliver an omnichannel experience for our dealers to ensure we can support their business, not by our offerings, but rather based on their preferences. We continue to incorporate new data elements into our proprietary risk models and augment with AI to inform areas where opportunities lie in areas where we see beginning signs of stress. The outcome is greater speed in growing existing accounts and accuracy to take action early and limit exposure. To close, let me share a few ways that AFC adds value to the OPENLANE marketplace. First, we're taking advantage of our vast local presence and deep established relationships across the U.S. and Canada to promote the OPENLANE marketplace to our network of independent dealers. Our dealers are always looking for new ways to source the right inventory. We have joint initiatives in place to support this process. Not only are we helping to add buyers to the marketplace, but we are also adding liquidity to bolster their activities. In 2023, AFC financed $1.6 billion in inventory purchases between OPENLANE U.S. and Canada. We know dealers with liquidity bid and buy at a greater frequency. AFC dealers are particularly active and offer credibility in the completion of the buying process with AFC as a payment source. From a product perspective, we're collaborating closely with the marketplace team to deliver integrated products and services aimed at increasing our floorplan attach rate at OPENLANE, such as joint promotions, inventory recommendations and bundled pricing. And lastly, as Brad will go into more detail here in a minute, AFC has a long history of strong financial performance and profitable growth. AFC generates strong cash flow that can be reinvested into the wider OPENLANE organization to fuel innovation. So with that, I'll turn it over to Brad to discuss the financial reporting improvements. Thank you.

Thank you, Will. As Peter and Will have mentioned, we're excited to be here today to roll out a number of enhancements to OPENLANE's and AFC's financial reporting, disclosures and performance metrics. AFC is a core strategic business for OPENLANE that's complementary to our Marketplace business. And AFC is a leader in the independent dealer financing space. It generates strong cash flows that support our capital allocation and our growth plans. To summarize what you've heard from Will, AFC is a leader in the independent dealer floorplan financing space. This market position all starts with AFC's leadership team. This team represents a combination of leaders who have a longstanding independent dealer financing experience and others with broad based industry experiences. AFC serves a large addressable market of approximately 40,000 independent dealers. And we have active business with approximately 14,000, reflecting our strong market position. AFC is a disciplined and leading underwriting and risk management process. This process has been built, improved and successfully tested for nearly 4 decades. This proven model leverages our 90 plus close to the customer branch locations who work in harmony with a centralized team who are enabled by deep, data-rich information and analytics. Our funding model has limited exposure to base interest rate changes resulting in sustained, consistent and leading net interest yields. These combined strengths result in AFC being a leading finance company by nearly all measures and a major contributor to OPENLANE success. So why are we here today? What are we looking to achieve? And what does it mean for you? After extensive analysis and research, including benchmarking AFC's financial performance and operating metrics against several publicly traded peer finance companies, we've concluded that AFC outperforms on nearly all measures. As we went through this analysis and assess the benchmarks, it became clear we have an opportunity to do a better job explaining this business and highlighting AFC's longstanding and sustainable business strengths and performance. What I plan to share with you today are 3 things: first, I will preview the updated financial reporting for OPENLANE and AFC that will be reflected in our 2024 10-K, which we anticipate to file in early 2025; second, I will share enhanced AFC performance metric reporting; and third, I will share the key findings of our benchmarking that demonstrate AFC's leading performance. As a result, what I hope you take away from today are first and foremost, a better understanding of AFC's business and its competitive strengths. Second, a more transparent yet simplified set of financial reporting and performance metrics that should allow you to more easily and accurately value AFC using prevailing finance company valuation methods, which include, amongst others, AFC's value as a multiple of earnings and a multiple of book value. We believe the enhanced reporting and performance metrics that are more directly correlate to finance businesses will show AFC's differentiated financial strength and its value within OPENLANE. I would like to start by summarizing the historical financial reporting we have provided for AFC. As you can see on this slide, AFC has historically been presented in a manner that generally aligns and is more consistent with our legacy businesses, which included a large salvage business and the U.S. physical auction business. As we studied our reporting for AFC and benchmarked it to other companies who have large embedded financing businesses, we concluded that reporting in this manner limits our investors understanding of this business and likely therefore limits one's ability to understand and more accurately value AFC. From the slide, our historical focus has been to report AFC's profitability using an EBIT or adjusted EBITDA metric. Few, if any, financing businesses measure their profitability on an EBITDA basis. Rather, profitability is more typically measured using operating profit, which includes direct interest expense associated with the funding of the loan portfolio. In addition, you will note we have historically reported our provision for credit losses as a reduction to revenue. Credit losses are typically reflected as an operating expense by finance companies, and in our case, including credit losses as a reduction to revenue, risks distorting and understating the underlying revenue strengths and yields of AFC. With that as a backdrop, I will turn to where we are headed. I will do this in 3 steps: first, I will walk through a few slides that set the framework for what is changing and why; second, I will summarize and preview how this will show up in our financial reporting, both at a segment and a consolidated level, including a side-by-side comparison to our historical practices; third and finally, I will show how the metrics derived from enhanced financial reporting showcases AFC's leading performance relative to the publicly traded peers, which are well-known financing companies. Let's start with volume reporting. Historically, we've reported only total loan transaction units, which represent loans paid off and extended or curtailed. Going forward, we intend to provide a breakout of originations and curtailments summing to the total loan transaction units. We believe providing this split better aligns with the revenue-generating transaction of the business and will allow you to better understand the nature of the portfolio, including how it turns over and its quality. As a reminder, AFC's portfolio is short in duration, with an average contracted term of approximately 60 days. Curtailments are important because they create the combination of a new revenue event and a collection event. For an additional fee, dealers can extend the term by an additional 30 or more days. This revenue event is complemented by the collection of partial principal payment and a full payment of accrued fees and interest. Turning to AFC's balance sheet. Historically, we have not provided expansive AFC balance sheet information. We realized this may have limited your ability to measure and appreciate the health of AFC's capital structure, the portfolio funding mix and the strength of AFC's returns. Going forward, for our reporting, we will include total assets, intangible assets, tangible assets, total parent equity and tangible parent equity. Moving to the income statement, as I mentioned earlier, the historical presentation of AFC's income statement has been focused on 2 key metrics, adjusted EBITDA and the provision for credit losses. Going forward, we will continue to provide these 2 metrics. However, within our AFC MD&A, we intend to update our AFC income statement to better reflect the following changes. First, we will report net finance margin rather than gross profit. Net finance margin will be presented and calculated as total finance segment revenue, and this will be calculated as a sum of gross interest revenue and fee revenue, less AFC interest expense. This reflects 2 key changes: first, as I mentioned earlier, we will no longer reduce AFC's total revenue by the provision for credit losses; and second, we will reflect the portfolio interest expense as a direct cost to arrive at net finance margin. Again, both of these changes will better conform AFC's reporting to that of benchmark financing businesses. With the combination of new balance sheet reporting and updated income statement reporting, we believe you will be able to more easily and clearly calculate performance metrics more traditionally associated with financing businesses. Amongst others, key metrics will include return on tangible shareholders equity, return on equity, return on assets, tangible common equity to tangible assets, debt to equity and operating leverage. And as mentioned earlier, we believe you will be more easily to derive -- it will be more easy for you to derive valuation metrics that are common to financing businesses, such as price to earnings and price to book value. This slide attempts to summarize the change frameworks I just discussed. It is a busy slide, so let me try my best to ensure you can understand and follow the changes we are making to the income statement presentation for AFC. The left side of the page reflects our historical presentation using our 2023 reporting, and the right side reflects 2023 recasted using our planned go-forward presentation. I will walk through each plan change from history to go forward. First, as mentioned earlier, we will report the provision for credit losses as an expense item going forward. This increases total finance revenue reporting by approximately $51 million. And of course, you will continue to see the provision for credit losses as a separate line item, but instead reflect it as an operating expense. Second, we will introduce finance interest expense as a new distinct line item. Historically, we did not explicitly report this item in our AFC income statement, and you would have had to search further into our overall OPENLANE reporting to bifurcate the interest expense associated with AFC's securitization program and its total portfolio. Here you will see our 2023 AFC interest expense was approximately $131 million. Again, this will now be shown as an expense just below total finance revenue to arrive at net finance margin. Finally, as mentioned earlier, we will begin to report volumes split between originations and curtailments, and we will continue to report total loan transaction units. Next, we plan to report a summarized set of performance metrics for AFC within our MD&A. Our goal is to make it easier for our investment community to assess the key performance metrics of this business. On a go-forward basis, this table will provide the following. Key portfolio performance metrics, key interest metrics for revenue, margin and loss rate, and finally key AFC balance sheet metrics. With the changes I have described, we will also be updating our OPENLANE consolidated statement of income or loss to be consistent with our AFC presentment. Two changes will be reflected: first, finance related revenue and total OPENLANE revenue will no longer be reported net of the provision for credit losses; second, the finance interest expense associated with AFC's portfolio and securitization programs will be shown as an operating expense and a charge to OPENLANE's operating profit or loss. This will leave OPENLANE's reported interest expense to include the interest and financing costs associated with our revolvers, bonds and other non-AFC related debt instruments. In summary, we believe these geography changes better reflect the nature of our business and our financial performance. And finally, the changes will not alter OPENLANE's reported income or loss from continuing operations, our adjusted EBITDA or our earnings per share. Now I'd like to spend a little time highlighting AFC's leading performance metrics. And I'll do so by comparing AFC's performance metrics to strong, well-known financing companies where we have access to publicly available information. Let me start by describing the benchmarks. We benchmarked 2 categories of publicly traded finance companies. The first was 6 auto finance and consumer-based finance companies, or what I might refer to as B2Cs. And the second category included 4 notable B2B finance companies. The companies in both categories are detailed further in the presentation materials filed today. The first set of metrics we benchmarked were our revenue and net finance margin yields. We calculated these yields using a trailing 12-month average portfolio value. This chart summarizes AFC's relative performance against the combined benchmark categories. AFC's revenue yield over the past couple years has been approximately 19%, and that's compared to the benchmark of approximately 16%. This positive difference reflects a high mix of fee-based revenue and an attractive sustainable interest yield. Of the approximate 18% to 19% revenue yield, 8% to 9% is fee-based, and the balance of approximately 10% is driven by our gross interest revenue. And this interest revenue over time has consistently delivered a net yield -- net interest yield of 4% to 5%. Benchmarking AFC's net finance yield, you can see the portfolio has consistently yielded net margins between 12% to 14%, and this compares the benchmarks of approximately 10% to 11%. Once again, this reflects the strong 8% to 9% fee-related yield, plus a very attractive and consistent yet net interest yield of approximately 5%. The second benchmark we studied was centered around underwriting and risk management, and specifically credit losses. As you have regularly heard us state on earnings calls and in our meetings with you, we are convinced we have a leading underwriting and risk management model in practice, and our benchmarks have further substantiated this point. Our credit loss as a percentage of the revenue -- or sorry, our credit loss as a percentage of our average total managed receivable has ranged from 0.2% to 2.3% over the last 5 years, and we target a range of 1.5% to 2% over the long-term. When compared to our benchmarks, we believe we outperformed by a half to a full percentage point, and it's important to note that AFC has what would primarily be considered a subprime portfolio, while several of the benchmark peers have limited subprime lending. The next set of benchmarks we studied were focused on debt-to-equity and portfolio returns, and we assessed 3 metrics here. First, debt-to-equity. As you can see, AFC, compared its benchmarks has notably lower leverage. Our relative lower leverage is an important feature that drives higher net interest yields and supports the strength of our overall returns. Next, we assessed return on tangible common equity, or ROTCE. For the last couple years, ROTCE has averaged 20% to 22%, and this compares with the benchmark average range of 19% to 20%. And finally, the last metric we'd like to highlight is return on assets. As you can see, AFC has a notably strong ROA, just above 4%, which significantly outperforms our benchmarks, who are closer to 2%. Before I would like to wrap up, I would like to take a moment to remind you about the strength of AFC's funding. Since AFC's start nearly 40 years ago, we've been blessed with the enduring partnership of key strategic banking partners who have supported AFC's growth and success. And this support has been unwavering, whether it be reflected in expanding commitments through periods of rapid growth or during more economically challenging periods where our banking partners have remained committed. And this is anchored on having the full trust in AFC's business model and its leadership teams. In September of this year, we renewed and extended the U.S. and Canadian securitization programs through January of 2028. This renewal and extension provides continued access to competitive capital, it delivered improved terms and fees, and will position AFC to continue to be a meaningful contributor to OPENLANE success. To wrap up, the improved financial reporting and disclosure we presented today confirms AFC is a strategic asset to OPENLANE. And these enhancements better highlight the combined strength of AFC's leadership team, its strong market position and its disciplined competitively advantaged business model. But we don't want to end by you hearing from only us. We will let you hear from our customers. Thank you for your time today. And after this video, we'll be ready to take your questions. [Presentation]

[Operator Instructions] And the first question will come from Bob Labick with CJS Securities.

So I guess, maybe one question would be, what -- you talked about maybe -- you gave us a lot to think about here, but maybe the growth strategy for AFC and how we should think about growth over the next couple of years and how to hold you to the opportunity ahead? Or is that the way to think about this, there's an opportunity to grow this? Or is -- and if so, what is it?

Thanks, Bob. I'll take a first stab and maybe Will can add a little color. At the very high level, listen, I think AFC is a wonderful business, and we expect continued strong performance from AFC in the years to come. AFC is going to continue to keep the independent dealer at the heart of its business model, as its core customer group. And as you know, Bob, that customer, the independent dealer is also a core customer of our marketplace, and that's where a really important synergy exists between these 2 segments of our business. AFC is also going to endeavor to find the right balance between smart growth and risk management. We see AFC as the industry of managing risk, and we intend to continue with that disciplined approach, but also find opportunities to grow. I think that customer segment is going to be robust. Used vehicles are lasting longer than ever before. That creates more transaction opportunities over the life of the vehicle. That's going to be good for independent dealers, and AFC is going to be there helping support those dealers in their business well into the future. So with that as the high level, Will, anything you want to add to that?

Yes. Bob, I would just add, we have 14,000 independent dealer relationships. We have a strong base of dealers to support future growth. We have also revamped our service delivery model over the last few years. So our field assets could be more present with our existing dealers, capture more share, but also expand and traverse new areas to capture new dealers. So we think that there's ample opportunity for growth.

Okay. Great. And then, your largest peer has a higher provision for losses than you guys do. What is, I guess, the reason that 1.5% to 2% is your target for credit losses versus 3% or maybe even a little more from others in the industry and how does that impact the size AFC can be?

Yes, Bob, thanks for the question. I will try my best to address and I'll also probably ask Will to weigh in here. Listen, I think, we do have some insight into where our primary competitor losses are based on some market data that we generally have access to. And you're right, Bob, that we do feel like they're notably higher than where we tend to trend. We also don't feel like we need to go there. So whether it's theirs is 3% or 4%, not entirely sure exactly what it is other than we know it's notably higher than ours. Again, for the reasons we talked about in our remarks, we have an advantage business model. We feel like we have leading underwriting and risk management processes, and none of that inhibits our ability to capture share wallet with our dealers or to grow with new accounts and new dealers. So we just feel really confident that our processes, our business model, and again, close to the customer is an advantage for us and something that's going to continue and enable us to perform at a very high level. Will, I don't know if you want to add anything.

Yes. I mean, Peter mentioned smart growth and risk mitigation. Certainly, we can do both of those at the same time. We're also incorporating new data elements into our proprietary models in AI to help bring down those losses. So we can continue to grow and keep losses within the historical range.

The next question will come from Gary Prestopino with Barrington Research.

Yes. I just want to get to there was a slide there where you were talking about attach rates. Didn't quite get if you mentioned what your attach rate is on AFC loans to actual cars processed over your platform. So if you give us that information, and then is there any difference in the profitability of a loan that's generated to a car that's processed over your platform versus outside of your platform?

Maybe I'll take the first part of that. And then on the profitability, I don't know if Will or Brad can add any color on that. So in terms of the general attach rate, so Gary, first of all, we sell vehicles in the OPENLANE marketplace, they are purchased for the most part by franchise dealers or independent dealers. Franchise dealers, that is not an audience that AFC supports, we don't floorplan or underwrite franchise dealers. So that whole segment is not addressable by AFC. So it's really that the volume of vehicles purchased by independent dealers, that's the addressable component. And the attach rate in there is about 15%, approximately 15% of those vehicles are floored using AFC floorplan. So that's the attach rate. In terms of the profitability of those units, I don't know if Will or Brad can add any color to that.

Yes, I would just say Gary, the -- to the extent that we're able to successfully attach an AFC transaction or an AFC flooring to a marketplace transaction or vice versa, there is the enhancement of the synergy between the 2 businesses from a profitability perspective. Essentially more share of wallets the way we would think about it. So -- but I will also say, and Will does a really good job reminding me and others on the OPENLANE leadership team about this, right, AFC also -- it's important that AFC try to remain somewhat neutral as well, right? I mean, Will highlighted the 1,400 auction partnerships or locations where we're partnered up to provide floorplan financing. We want to be available to those dealers who need to buy vehicles and need to have access to financing. And we really want to remain somewhat neutral from an AFC perspective to those who are buying cars on any platform regardless.

Is there any upside to giving them an incentive that if they floorplan the vehicle if it's purchased through your platform?

We're looking at ways to increase the collaboration and synergies between our AFC go-to-market opportunity and also the OPENLANE one. So we're exploring some ideas, just things like better technology linkages between the platform. So I think you'll see us do more there. We haven't sort of extended it at least in any sort of sustained way into pricing advantages or bundling the 2 offerings as you've just described there, Gary. I wouldn't necessarily rule it out but obviously, trying to find maximizing synergy to the extent we can is obviously something that we're going to continue to try to do.

And then just one last question if I may. With the use of AI over the last couple of years, has that improved your underwriting capabilities to the extent that you don't have to devote as many feet on the street to doing lot checks?

Will, you want to address that one?

Yes, sure. Yes, most of the AI that we've incorporated has been within our risk management. So detecting early fraud and then developing the processes that allow our field people to go out and enact that error and work through those early detections to determine whether it's smoke or it's fire, I would say that's where the focus for our AI so far has been. I do believe that there is opportunity to incorporate dealer self-service audits and other modes that could lessen the need for us to have physical auditors out there inspecting collateral from our dealers. So yes, I do believe that there's additional opportunities there and we're looking at those actively currently.

Yes, couple things I'd add there, Gary. One is we remain pretty committed to our branch model, right? I mean we, as Will highlighted, as we gain efficiencies around risk management through automation, be it through AI or other data-rich analytical tools and processes that we're building and continue to improve, we still remain committed to our branch model. We feel and our customers feel this too. Our ability to service our customers with our branch model is important. It's important not only our risk management algorithm, but it's also important to our growth algorithm. So that's something we remain fairly committed to. And Will highlighted the fact that we're looking to optimize those field resources to be out with the customers more and more rather than in the office doing in some cases some back-office type work. So we're committed to that. On the AI front, we've had some really nice wins on the AI front. In most of our -- almost every customer we collect bank statements from these folks on a monthly basis, we have AI tools that are now taking those bank statements and analyzing them on a host of different parameters, including just looking for unusual patterns of funds flowing in and out of the bank account. And then also including manipulated bank statements where we could detect manipulation of a bank statement and that allows us to flag risk and be more proactive.

The next question will come from Rajat Gupta with the JPMorgan.

Great. I had a couple, first on just the fee income and also just the finance margin overall. Can you give us a sense of how we should be thinking about how that flexes in the evolving rate backdrop with interest rates potentially moving lower? I mean, obviously the yields are up last month, but eventually if it does move lower, how do the different pieces behave? Can we just look at your 5-year average or the 2019 levels that you benchmark? Can you give us a sense of like how volatile it can be over the next couple of years? And then I'll have a quick follow up on the broader P&L.

Yes, Rajat. So I try to summarize your question and do my best to answer it. And then obviously to the extent you need some clarifications, happy to take that. I think your question was really just around the mix of our fee revenue versus our interest revenue and how that plays out over time. So I'll start with the fee revenue. I'll say the fee revenue over time is fairly consistent. It's fee-based where you'll see the yield change. So if you took fee -- if you just looked at the fee yield as a kind of a proportion of our overall revenue, that can change over time, right? Because as we've seen, right, when vehicle values for instance, went up over the last few years, our fee yield would have declined, right? Because fees are usually more of a fixed dollar amount. But again, as vehicle values then would have come down more recently, you would see that fee yield increase a little bit. So fees are fixed, largely fixed over time. And obviously we make adjustments to our fees, pricing whatnot over time as any business would. So that's kind of the fee piece of it. On the interest revenue side, that's largely -- that'll largely move with our -- with just based interest rate changes. So as we've seen '22, '23 interest rates went up. So you would have seen our gross yield on interest increase, right, with that base change. But I think what's more important though, Rajat, is if you look at our net interest margin over time, as I highlighted in my remarks, that's pretty consistent between 4% and 5% over the last 4 or 5 years. And if you went back prior to that, it would be fairly consistent. Because as base interest rates move, we largely have a back-to-back feature in our business model that allows us to adjust those base rate movements with our customers.

Yes. If I could just expand that a little bit...

Got it, that's helpful. Yes, go ahead.

Yes, Rajat. So the base rate that when we price to dealers is substantially similar to the base rate that we get charged. So as one moves, as our costs may move on that base rate, so will the cost to our customers, either up or down.

Got it. So that's pretty immediate. I mean, there's not much of a lag when that happens.

That's right.

Agreed.

That's right.

And just in the broader P&L, thanks for sharing all the return metrics. It's obviously helpful. I'm curious, if we look at the below the line stuff, when you look at the cost of services and the SG&A metrics, how is that different versus 2019 pre-pandemic versus today? You've talked a lot about like, digitization and using more AI. I'm curious, how the productivity of the company has changed over the last 5 years that can just enhance the return profile or just change the return profile. Obviously, the finance margins are not entirely in your control, but just curious, like below the line stuff, how has that changed? Like, what's the opportunity out there going forward to improve your return?

Maybe again, I'll take a first stab at that, and then Will or Brad might add some color. I guess, certainly viewed over the last 5, 6 years, the nature of the AFC branch has evolved. I think originally the AFC branch was the transaction servicing location. There was a lot of paper. There was a lot of information processing, data entry tasks, that was sort of the core activity. And obviously spending time out in the field with dealers and understanding your customer was another critical aspect. But certainly, over the last, I'll say, 6 years, there's been a consistent effort to digitize as much of that process as possible and centralize as much of that process as possible. Will spoke about the title servicing center in Mesa, Arizona, for example, where we've centralized the vast majority of title processing that used to all take place at the branches. So that effort of digitization and centralization has been executed, and I think well executed. And that frees up the branch to be very focused on more of the customer-facing activity, understanding the customer, understanding the risk, growing the volume, signing up that new customer. So that's really how the business has evolved. I think it's been very successful. In terms of how it's shown up on SG&A and other efficiency metrics, I'll perhaps let Will or Brad add color to that.

Yes, we're certainly more scalable, as Peter just mentioned. I would say the main costs, inflations that we've seen have been for outside services, namely shipping and courier costs. So those have had impact on our business as they have any other businesses. But for efficiency of our workforce, we are at a point that we feel very good about as we've centralized a lot of these transactional tasks.

Yes, just final point here, Rajat, just to round this one out. Benchmark operating leverage. I didn't cover that in my remarks. We didn't have a specific slide on it. But in the additional reference material that we filed, you will see we benchmarked operating leverage. Ours is standing around 13.7%. If you compare that to the B2C benchmarks and the B2B benchmarks, I think you'll find it to be either right in line or in some cases slightly advantaged. And I think that we're actually comfortable with our operating leverage, again, because we're committed to the branch kind of model that does create some brick-and-mortar and added people cost. But we feel like we get that back in multiples, really, from a return perspective. So again, we feel like our business model supports the operating leverage and is appropriate for this business and the returns we get.

The next question will come from Wyatt Hulsey with Northcoast Research.

Wanted to dig into something a little bit higher level here. The last couple of quarters, you guys have talked about marketplace contributing 50-plus percent of adjusted EBIT. I just wanted to know your thoughts on that going forward over both the longer-term and then medium-term 12 to 18 months coming up.

Thank you, Wyatt. Appreciate that question. First of all, let me just -- on AFC, it's a strong performer. We expect continued strong performance at AFC. We're going to keep the independent dealer at the heart of what we do. We're going to balance growth, smart growth with risk management, but I expect continued strong performance and growth from AFC. However, I expect the marketplace to grow even faster. We've talked on numerous earnings calls. We didn't go into the depth today, of course, but the combination of secular growth drivers in the marketplace business coupled with the cyclical off-lease volume recovery that we now have increased confidence around, we believe creates an even greater opportunity for growth on the marketplace. So as I mentioned, marketplace is 75% of our revenue, close to 50% of our EBITDA. I would expect as we look to the future, we're going to see that those percentages tend to increase. And obviously, at the same time, AFC's contribution in absolute dollar terms also increasing. So I think there's a very sort of favorable combined growth story here that'll play out in the years to come. That's certainly our goal and expectation.

The next question will come from Bret Jordan with Jefferies.

I guess you talked about important to remain neutral and obviously the AFC, a lot of the branches used to be at physical ADESA locations. Is there an opportunity to span or sell or monetize the AFC business as it is less physically attached to you post the ADESA sale?

Well, I guess what I'd say to that, Bret, is we see AFC as a core strategic asset here of OPENLANE. A strong portfolio of services and products that serve a core customer group, independent dealers, which is also a core customer group of the marketplace. Obviously, we've got transactional synergy between the 2. I talked about the percentage of vehicles purchased on the marketplace that AFC finances. So that's what we're focused on. We're focused on executing that strategy. We think AFC is a wonderful business and we felt it was important to improve the disclosure around AFC so our investors could have greater level of insight, greater level of knowledge as to how this business operates and the contributions that it makes. So that is our focus and that's the core purpose of today was to get that better disclosure out there to our investors around what we believe is an exceptional business that we're obviously delighted to be owners of.

Okay. So you really -- you do think that AFC being partnered up with the OPENLANE business is more valuable than standalone?

Yes, I guess if we look at how these businesses evolved, like AFC and its core competitor have evolved alongside a Marketplace business. Now, originally that Marketplace business was a physical auction business, right? AFC grew up alongside ADESA, its #1 competitor grew up alongside ADESA's biggest competitor. But that sort of synergy between a marketplace and giving this core audience liquidity in that marketplace has been important over time. And we also see some of the newer entrants and even some of the smaller independent auction groups, they also have their own financing businesses within their sort of offering, not at the same scale or even close to the same scale of AFC. So there is that synergy, that's certainly what we're focused on here. And we felt it was important to get as much good disclosure and good information out about this business to enable -- we recognize our company is different, it's changed a lot over the last 5 years, but our AFC disclosures hadn't evolved. So today's exercise really is to put that better disclosure out there for the investment community to really understand what a powerful business this is. So I believe that's our final question. So thank you all for being on the call today. Thank you for your interest in our company. I hope we achieved our goal of making it easier for you to understand and appreciate AFC and easier to see the tremendous value it creates for our customers, for our company and also for our investors. There's no doubt in my mind that this combination of an industry-leading digital marketplace and I think an industry-leading floorplan finance business positions us extremely well for the opportunities that lie ahead for this company. I look forward to keeping you updated on that. Look forward to talking about our Q4 results early in 2025 in the new year on our earnings call. So thank you all very much. I hope you all have a very safe, happy Thanksgiving. And I look forward to finishing this year strong. Thank you all very much.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.