Q3 2021 KAR Auction Services Inc Earnings Call
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Good day and thank you for standing by welcome to the car auction Services, Inc. Third quarter 2021 earnings Conference call. At this time all participants are in a listen only mode. After the speaker's presentation. There will be a question and answer session to ask a question. During the session you will need to press star one on your telephone please be advised.
Today's conference is being recorded if you require any further assistance. Please press Star then zero I would now like to hand, the conference over to your host today, Mike Eliason, Treasurer, and Vice President of Investor Relations. Please go ahead.
Thanks, Michele good morning, and thank you for joining us today for our global third quarter 2021 earnings Conference call. Today, we will discuss the financial performance of our global for the quarter ended September 32021, after concluding our commentary we will take questions from participants before pure kicks off our discuss.
I'd like to remind you that this conference call contains forward looking statements within the meaning of the safe Harbor provision of the private Securities Litigation Reform Act of 1995 investors are cautioned that such forward looking statements involve risks and uncertainties that may affect our business prospects and results of operations and such.
<unk> are fully detailed in our SEC filings.
Providing forward looking statements the company expressly disclaims any obligation to update these statements.
Let me also mentioned that throughout this conference call, we will be referencing both GAAP and non-GAAP financial measures reconciliations of the non-GAAP financial measures to the applicable GAAP financial measure can be found in the press release that we issued last night, which is also available in the Investor Relations section of our website now I'd like to turn this.
Part over to Clark Global CEO, Peter Kelly Peter.
You, Mike and good morning, everybody on.
I'm delighted to be here. This morning, with all of you to provide an update on our performance at car global.
So on today's call I plan to speak about our third quarter results I'll provide an update on the commercial center volumes and what we expect to see between now and the end of next year.
I'll also provide updates on the continued growth in our dealer to dealer business with a focus on our digital dealer to dealer businesses backlog cars and trade Rev.
Ill provide an update on our acquisition of Kerr ways and the solid performance of our finance business AFC.
And I'll close out with some updates relating to our cost structure.
So I'd like to start with the third quarter.
Theres no question, but that the third quarter was a challenging quarter and the challenges were volume related principally tied to the commercial center category, specifically to off lease vehicles.
These industry wide volume challenges are tied to the disruption of new vehicle production.
And I spoke to these dynamics in detail at our analyst day events back in September.
To repeat all that here. This morning, However, I will say that the situation remains largely as I described at that time.
So in the third quarter, despite operating in an environment of very constrained vehicle supply from commercial sellers, we achieved the following results.
The car overall, we generated $535 million in revenue, which was a decline of 10% from Q3 of last year.
We generated a total gross profit of $222 million.
Representing 51% of revenue excluding purchased vehicles.
We generated $96 6 million and adjusted EBITDA.
Cash generated from operations for the quarter was $57 million.
Within the ADESA segment, we facilitated the sale of 586000 vehicles, representing over $9 billion in gross auction proceeds.
Now these volumes were down 33% versus Q3 of last year.
Within that our total commercial volume was down by 51% versus Q3 of last year and our total dealer consigned volume actually increased by 20%.
51% of our sales in the third quarter were from off premise locations.
And this is similar to our experience in the first half of this year.
We sold 118000 vehicles on the trade Rev and backlog cross platforms on a combined basis.
We also set new records in terms of total active sellers in total active buyers on these digital dealer to dealer platforms in both the U S and Canada in the third quarter.
We generated $274 in gross profit per vehicle sold in the ADESA segment.
This was driven in part by strong auction revenue per vehicle sold and is higher than the gross profit per vehicle generated in the first half of this year and 10% greater than the same statistic from Q3 of last year.
SG&A per car overall was $134 million for the quarter and SG&A for the ADESA segment was $126 million and that was down $14 million from Q1 of this year.
I continue to be pleased with the performance of our AFC business segments.
<unk> had 351000 loan transactions in the quarter. This was an increase of 8% versus the same quarter last year and it was in line with the levels that we would expect us.
Revenue per loan transaction was also higher 20% higher than Q3 of last year, a $215 for the quarter.
Key drivers of this were higher vehicle values and lower credit losses.
AFC continues to experience lower than normal levels of risk driven by the current market conditions combined with strong operations.
As he continues to grow with volume of business as well as re engineered business processes to have a more efficient service delivery and for all those reasons I expect to see continued strong performance from AFC given the current environment.
Yes.
So I'd like to speak for a few moments about the supply dynamics of used vehicles within our marketplaces, particularly supply from commercial centers.
So as I see it our challenges in the quarter were tied to the lack of commercial center volumes across our marketplaces as I mentioned commercial seller volumes were down by 51% versus the same quarter last year.
In our last earnings call and subsequently in our analyst day I went into quite a lot of detail on the drivers of commercial vehicle supply within our industry.
My fundamental assessment has not changed I do believe that we're at the bottom in terms of the disruption with the supply of off lease vehicles and rental vehicles at physical auctions being very close to zero in both categories.
Most meaningful to car is the disruption in the off lease volumes, which historically have represented approximately 60% of our total commercial center volumes.
Now volumes of repossessed vehicles also remained below normal I would say that repossession volumes are relatively stable at about 70% of normal levels right now.
And our analysis of the quarter's results indicate that we have maintained our market share with commercial sellers.
In the quarter.
Yes.
So while we may be at the bottom I still believe we should expect to remain here for some time.
In order for the volumes in our marketplaces to increase we need to see an increase in new vehicle production sufficient to reduce the very high used vehicle values and allow more off lease vehicles to flow into the wholesale channel.
At our analyst day, we said that we expected new vehicle production to start to improve towards the end of the first half of next year and to continue to improve in the second half.
But we expected it to remain below normal throughout 2022.
Based on our continued analysis as well as our ongoing conversations with customers that assessment has not changed.
What that implies for our businesses that we expect the current commercial seller volume constraints to continue through the first half of next year and we expect to see a small improvement in the second half we expect to see an acceleration in the volume recovery in 2023 and beyond.
So now I'd like to provide an update on our progress in the dealer to dealer vehicle category.
So first of all if we look at our total dealer consignment volumes of car and by which I mean digital and physical combined we sold 274000 dealer consigned vehicles in the third quarter.
That represented an increase of 20% compared to cars total dealer volume in Q3 of last year.
Some of that increase was driven by the acquisition of backlog cars, but I am pleased that we were able to increase our overall volume by 20% given the tight supply dynamics that exist across our industry.
If we look at the digital dealer to dealer category only our Q3 volume of 118000, what was 118000 vehicles sold the.
The comparable metric for Q3 of last year was 58. So we grew our total digital dealer to dealer volume by 105%. However backlog cause was not part of car in Q3 of last year and if we include crude backhaul cars in last year's number the growth of approximately 19%.
We saw record numbers of participating sellers and buyers on our digital platforms in both the U S and Canada in Q3.
We also saw continued growth in average vehicle value sold on both trade Rev in Canada and backlog cars to the U S.
And finally in Canada, our trade Rep business continued to continued to perform very well delivering strong volumes in the second consecutive quarter of solid profitability.
I'd like to spend a few moments on the acquisition of <unk>.
We closed on the acquisition of car. We are in early October So our Q3 volumes do not reflect any volume from car with a.
The car we acquisition has approximately 100000 vehicles sold per annum.
<unk> originated in California, and is the leading platform for dealers in that market.
California, as you might imagine as a large automotive market.
If we look at new vehicle registration statistics, there are more new vehicle registrations in California, each year and on the smallest 20 states combined.
Also California has almost as many new vehicle registrations at the next two largest markets, which are Texas and Florida combined.
Based on our diligence the car we platform delivers excellent performance for the sellers and buyers. The average vehicle value sold on car, where it was higher than that sold on backlog cars and it also generates a higher revenue per vehicle sold and is profitable.
And of course, the acquisition of <unk> also brings a strong team.
I believe the acquisition strengthens our map and increases the network effect for digital dealer to dealer business in the U S.
<unk> strength out west and backlog car strength in the middle of the United States. It means that we now have a stronger footprint than ever before in terms of geography and depth within any given market.
Ultimately, we see an opportunity to combine the two businesses, bringing the best of both and creating an ever more powerful offering for sellers under buyers.
We also see an opportunity to continue to move upmarket and sell a larger number of higher value vehicles.
This in turn will help drive further increases in revenue per unit sold and stronger margins.
So our integration planning is ongoing but ultimately we envision a single solution in the market a solution that aligns with the needs and preferences of our dealers and that Leverages. The best technology features functionality and economic model of both platforms.
Now given the strength of both businesses and the positive momentum that both businesses have we would like to take a little longer to execute this than was the case with the trader of migration.
We want to make sure that we don't disrupt our customers and that to the extent, we make changes we're delivering an experience that is better than before for all of our customers.
And finally, the additional car ways means that our current run rate with digital dealer to dealer transactions is now very close to 600000 vehicles sold per annum and continuing to grow.
So we are well on our way towards achieving the target that we established in on our analyst day of $1 2 million digital dealer to dealer transactions annually by 2025.
So I'd like to spend a few moments talking about our cost structure.
On recent earnings calls and again on the analyst event, we've discussed our strategic focus on reducing our cost structure to reflect our transition to a more digital marketplace.
The reality of lower than normal commercial center volumes likely persisting through much of 2022 means that a continued focus on cost remains a top priority for me and for the management team.
So I'd like to provide an update on that.
During this last quarter, we initiated a project aimed at prioritizing and accelerating curious for growth on refining our operating model towards a more digital future and also to address the lower than normal commercial center volumes that we're currently experiencing.
We've committed significant resources towards that initiative and there are four principal work streets I refer to these in our analyst day, but to recap them here there were as follows.
Our sales and go to market opportunities.
The evolution of our service operations are.
Our technology investments and the overall management of our SG&A.
So I believe we've made very good progress on this project and we're now nearing the end of the assessment space in fact, it will be completed within the next couple of weeks.
Now I expect that you will be all interest and all the scale and the timing of all this.
Rather than committing to a number before I have the full report I'd like to what our team the opportunity to complete their work and I look forward to providing a more in depth assessments on our future call. However, I am comfortable enough with the preliminary analysis to report the following.
First in terms of the sizing of these opportunities.
Our analyst day materials pointed to an S G.
SG&A opportunity up $30 million.
I'm confident that our S G and opportunity will be at least that amount.
However, SG&A is just one part of the mix. We're also looking at opportunities to reduce our direct costs.
Believes that we have opportunities to do so and that these will be in addition to that number.
And finally, we're also looking at opportunities to improve revenue and improve the monetization of our services.
While also accelerating growth in key areas.
These will be an important part of the overall target as well.
In terms of the timing.
First of all I want to be clear that what I'm, describing here are not short term or temporary cost cuts what we're looking at a permanent changes in our operating model and our cost structure.
The engineering the way, we do business and ultimately reducing our cost to serve over the long term.
I don't expect to see an impact from this in the current quarter, but I do expect to see positive impacts in 2022 and in all of the years following from that.
And finally in terms of our strategy to manage and communicate these initiatives, we will be setting specific goals and there will be a clear process in place to measure the impacts to make sure we stay on track.
Of course, I expect myself and the management team to be held accountable to those.
So I look forward to providing greater detail and more precise metrics in a future call.
My last point just to make a few remarks on our expectations for the current quarter.
As discussed in September it is difficult to predict the supply of vehicles in the wholesale market. At this time, we withdrew our guidance in September and I'm, not providing guidance on sort of visibility into volume improves with that said, we typically experienced some seasonal impacts in the fourth quarter and I would expect that our fourth quarter performance by which I'm, referring to adjusted EBITDA will.
Less than our Q3 levels.
So to summarize my key messages from today.
The commercial volume challenges continue I believe that we're at the bottom now, but I think the volume challenges will continue well into next year.
However, I also expect we will see some improvement before the end of next year.
My longer term view has not changed I believe that the outlook for off lease repossessed and rental vehicles will be one of increasing volume over time ultimately returning to historical levels.
The recovery will take time, but it's clear to me that we should be a strong beneficiary of this when it happens.
In terms of dealer to dealer, we're growing our volume with our combined digital and physical volume up 20% versus the same quarter last year.
In terms of our digital dealer to dealer platform, we delivered solid growth in transactions and we had a record quarter in terms of marketplace participation in both the U S and Canada.
The addition of car wave means that we're now at an annual run rate of close to 600000 vehicles sold per annum and growing.
I am pleased that despite low volumes, we were able to deliver our best quarter, yet in terms of gross profit per vehicle sold.
We also saw solid profitability for trade Rev in Canada, and a strong performance at AFC.
Notwithstanding the growth levers that exist for us we continue to be very focused on costs. We have initiated a significant initiatives and we are committed to following through and it.
We look forward to providing more updates going forward.
Finally, before I hand things over to Erik I, just want to officially welcome Sanjeev Mehra to the car Global Board of directors.
<unk> became an observer on a board through purpose capitals participation in our 2020 type transaction and.
And you previously served on our board from 2007 to 2013.
You can read more about <unk> background in our 8-K, we are very fortunate to have his deep industry knowledge and strategic mindset on our board and I'm confident he will continue to be a vocal advocate for car global and for our stockholders.
So with that Eric will now provide a more detailed review of our financial results for the quarter Eric.
Thank you Peter I have a few things to add to Peter's commentary today first I would like to point out some bright spots in the current situation we are facing.
We all know that the supply of wholesale vehicles is constrained primarily for our commercial vehicle business.
However, this has led to strong used car prices.
Gross auction proceeds are at record levels in all segments of our business.
The average selling price in our commercial off premise segment, primarily openly was $21500 in the third quarter compared to $19400 per vehicle in the third quarter of 2020.
Digital dealer to dealer, representing backlot cars and trade growth at an average sale price of $10400 in Q3 compared to $8900 last year.
And our on premise auctions, which includes a mix of commercial and dealer consignment.
At an average selling price of $15000 per vehicle compared to $13300 one year ago.
This strong pricing situation has led to higher auction fees per transaction across all of our marketplaces. The only marketplace that has been has seen a significant decline in fees is the open lane private label programs.
A high percentage of transactions being grounding dealer purchases caused auction fees per transaction on this platform to declined 20% year over year in the third quarter.
Another positive in the third quarter was the gross profit per vehicle in the ADESA segment.
Achieving $274 gross profit per car sold in Q3 compared to $249 in the prior year and this was a strong performance. This reflects a positive mix of revenue with more of our revenue coming from higher margin auction services than other lower margin services.
Lack of commercial supply, especially off lease vehicles reduces revenue from lower margin services like transportation and end of lease inspections.
I want to be clear, though while we are very focused on improving our cost structure and increase in gross profit per unit over historical levels. Our business prospers. When there are more transactions, even if gross profit per unit were lower than $274.
The third quarter did benefit from royalty revenue received from insurance auto auctions based on the number of non insurance vehicles sold by IAA over the previous 12 months.
And a positive in Q3 was performance at AFC.
Consistent with the growth in volume in the dealer to dealer channel at ADESA and AFC saw an increase in the number of loan transactions 8%.
An increase in revenue per loan transaction, 20% and an increase in adjusted EBITDA.
63%.
Yossi segment was able to improve all of its key performance metrics and reduced SG&A as compared to last year.
While the current supply situation has put pressure on the wholesale used car remarketing industry. These same factors have made floor plan lending perform at very high levels of profitability.
Average loan values are increasing due to higher used car prices low used car inventories at retailers means faster turns and our floorplan lending as a majority of its revenue in fees and net interest earnings and most importantly loan losses are at very low levels. In fact in the third quarter recoveries of previously written off.
Loans exceeded the loan losses experienced during the quarter.
As a reminder, our floorplan lending business is collateralized by the vehicles and typically all assets of the dealer principals.
We obtain personal guarantees on substantially all floor plan lines when losses are realized we seek judgments for recovery of the losses when assets, including real estate are monetized by the dealer principles we.
We are currently benefiting from the strong real estate market and high real estate values. This allows us to recover as losses. Most recoveries are losses that occurred one to three years prior to the actual recovery.
Now despite the positives in our performance that I have highlighted our overall performance was still challenging due to the low number of transactions completed.
As Peter pointed out the pressure is on our commercial volumes as we have begun to see year over year growth in our dealer to dealer volumes due to the strong growth in digital dealer to dealer.
Even though gross profit per unit at ADESA was $274. The gross profit as a percent of revenue excluding purchased vehicles declined to 43% in Q3 as compared to the prior year's <unk>, 49% gross profit.
My first concern is determined this is not a change in our cost structure going forward.
After analyzing our cost I have determined that most of the decrease relates to fixed direct costs that just cannot be leveraged with the low volumes in Q3.
The largest contributor to the decline in gross profit percent was supervisory labor and facilities costs that is included in cost of services.
We also experienced increased losses on purchased vehicles, primarily inherited vehicles, which are acquired through arbitration activities.
We believe the increased losses were unique to Q3 as we push to sell these vehicles quickly to meet customer demand.
One item that will be a permanent increase in our.
And our costs as compared to the last 18 months is the loss of the Canadian employee wage subsidy.
We have been benefiting from the Canadian program since early 2020, and approximately $1 5 million to $4 million of direct cost per quarter going back to the second quarter of 2020 were subsidized.
In Canada.
Changes in the requirements to receive these subsidies were made effective July one 2021, and our Canadian business is no longer qualify for the subsidy.
This represents about a 70 bps increase in growth.
Increase in cost or decrease in gross profit percent that will be recurring I do expect the impact on gross profit to be less though as volumes begin to increase going forward.
Turning to our balance sheet and capital allocation. Our total leverage is at three two times adjusted EBITDA.
This has moved above three times due to the low performance over the past 12 months or.
Our last 12 months adjusted EBITDA is $404 million.
We continue to have a leverage target of three times or less.
Subsequent to quarter end, we completed the acquisition of <unk>, we funded the $450 million purchase price with cash on hand.
We did not purchase any car shares in Q3, we have $109 million remaining on our share repurchase authorization that was set to expire at the end of October.
The board of directors has extended our existing share repurchase authorization through December 31, 2022.
We have used a substantial amount of our available cash for the <unk> acquisition and our total net leverages temporarily above three times.
Even after funding the <unk> acquisition, our cash balances remain strong well in times of supply constraints.
Free cash conversion of our business generally in groups.
That concludes my remarks, so I will turn it back to our operator, Michelle to begin the Q&A portion of our car.
To everyone for joining us today.
Okay.
Michelle can you.
The first caller.
Okay.
Hi, Michelle can you queue up the first caller.
Can you hear me.
Yes, we can yes, we can.
Hey, John Murphy from Bank of America, I didn't get enough I'm, sorry, guys. I, just think I guess she turned me on <unk>.
Making announcements.
I guess just a first question when you think about the <unk> acquisition.
A skeptic would say hey, youre, making these these acquisitions they might be a little bit duplicative or overlapping and an optimist may argue it's building a very significant network.
The fact that you need to get this flywheel going.
How do you think about the network effect.
Versus the sort of potential duplication or overlapping.
Of customers and how much of this do you think Peter it's purely incremental to what the core business will be as it as it normalizes over time.
Thank you John I'm pleased to call the question, rather sorry for the technical difficulties there.
I guess.
John My point of view on it I think when Youre looking at digital marketplaces.
Digital marketplace businesses. The network effect is real and very very important and when youre in a when you have a digital marketplace model you really want to be number one or number two in your market.
Because if you're outside of that.
Generally it's not as attractive.
Our proposition so I think scale really matters and I think scale gets formed early on in <unk> and in customer habits can be.
Quite sticky.
Quite persistent overtime.
So I think we.
I think the market has been evolving there was an early stage of a lot of disruption a lot of new entrants I think we're through that stage now in the market I think there's a number of players in the market. They have established customer relationships established areas of geographical strength and those patterns are becoming more defined so.
I lean heavily towards these are additive and it's.
It's not duplicative, it's actually more of a one plus if I just look at the backlog cars and car way together I think you combine them and you get more than the sum of the parts because by so for example, if we think of car with very very strong in California, but doesn't really have a very strong buyer base outside of that market well.
Claude cars does so by bringing those platforms together, you know get a new buyer audience onto the vehicles of those sellers in California, which in theory creates greater liquidity and improve outcomes for those customers and also obviously it brings more inventory supply to those buyers. So I think those types of things really really matter and digital marketplaces.
And the market is difficult to call on a real time basis.
Ascertaining that.
That analysis.
Are you doing there to to figure that out and how comfortable are you that youre going to be able to maintain or maybe even gain some market shares as the commercial market comes back.
Yeah, and I think John or again, if we go back to our analyst day, our thesis around commercial market share was.
We will see a recovery in commercial volumes and we will maintain our market share in that delivers a 2025.
Results at least as it relates to commercial commercial volumes. So you are right. The data sources are not great, but let me sort of give you some insight into how we do our assessment.
If we look at our upstream world. Obviously, we know the customers that are contracted with us.
On our open learning platform.
We know the nature of those relationships, if they are exclusive or not and most of them are exclusive.
And we know what we've lost any customers. We haven't lost any right and then we can also look at what are those customers converting at in that channel and frankly those conversion rates are at an all time high given the current dynamics. So that when I say maintained we probably actually increased our share of it. So because we are selling proportionately more in that channel, where we already have strong share, but then in the physical.
World.
Obviously, we know our own commercial physical volumes right. So that's a statistic that's known to us and we have insight into commercial volumes across our industry through an independent third party data source.
So we can we've got.
The numerator and denominator there that we can track and we obviously look at that very closely.
I guess, John I'll say neither of those are perfect data sources are there some potential edge cases that don't get caught in either data set there are but I think.
We have a pretty good picture on the industry. Once we do that analysis and that's the that's.
That's how we.
We can make the statement we made.
And then just lastly.
Yes on the recovery.
Sorry, John.
I am confident we can maintain our share as volumes come back.
Absolutely confident on that yes.
And then just lastly on repos, because they might not be as dependent on.
The recovery in new vehicle production Theyre, just theyre dependent on repos activity picking up and I'm. Just curious if you can give us an update of where you think.
Repo activity is right now where it will go through 2022, and if that could create a little bit of relief maybe before we're all waiting for this production ramps are really.
John I think that's a very good insight and I agree with you I do think the one commercial segments that is potentially independence of the production situation is the repossession segment.
As I mentioned to you that is about 70% of.
Normal so 30% below normal.
It has been so for the last 12 months or 15 months.
Been sort of stable at that level.
What that means is.
To get back to normal.
It can grow another 40% from its current level. So there's a good upside there for our industry if that were to happen and I expect that will happen over time.
We do track repossession assignment volume through already and we have seen a small uptick.
10 ish percent or so in assignments through that platform over the last five or six weeks that I view as a positive but it's also possible that.
That might be somewhat seasonal so I don't want to count on that yet but.
I agree with your comments that I think repo has the potential to recover sooner than other segments.
But those repo units would come directly to auction, it's not like they would get stuck at a grounding dealer like elite Alicia right. I mean, they were more fluid. The go directly into your auctions is that a fair statement.
Yes, absolutely sorry didn't mean to cut you off there but.
Youre, absolutely right and I tried to make that point as well on analyst day repossessions.
Repossessed vehicles sell.
Pretty much exclusively through the physical downstream channel for a whole bunch of reasons that I went into so yes, they would flow directly to us.
Okay, great. Thank you very much guys.
Thank you John.
Thank you and our next question comes from the line of Gary Pest piano with Barrington Research. Your line is open. Please go ahead.
Good morning, everyone, Hey, Hey, Peter with.
What you've done in the digital space at this point.
Do you have coverage now of the majority of the franchise dealers in the U S as for for listing cars.
And then just really the majority of the dealers within the U S and Canada on your digital platform.
Gary Thank you.
So, yes, specifically questioning.
Relating to our digital platforms I would say absolutely, yes, we have.
Well when I say nationwide coverage in the U S are willing in the lower 48 states were probably not as strong.
But our coast to coast in 48 States, absolutely we have I would say a strong presence in all states and we can serve any dealer in any state and the same is true of Canada.
With the trade Rep platform so.
The short answer to that question is yes, we have full coverage and.
Maybe if I can just add a little bit more detail I did speak to the fact that we saw record marketplace participation in the third quarter is very pleased about that growing our number of sellers and buyers in both the U S and Canada to record levels in the quarter. So I feel really good about that.
I would say the supply constraints.
That's what we've talked about in commercial also actually has a negative headwind on dealer okay.
So we track average number of vehicles posted per seller.
And we saw that number a little below normal.
I won't say, a little bit below normal in the third quarter relative to.
The prior four or five quarters.
And I attribute that to the fact that there's just a real sort of supply constraints out there in the industry.
Dealers are getting fewer trade ins.
And those trade in vehicles that they're getting they're more likely to want to keep some of them are more of them for the retail business. So.
I think.
I am generally pleased with what we've seen in terms of the growth of our customer base and the results we delivered in the third quarter.
In spite of those kind of.
Market attributes out there.
Okay. Thank you.
Thanks, Gary.
Thank you and our next question comes from the line of Stephanie more with Trust. Your line is open. Please go ahead.
Hi, Good morning, I wanted to touch specifically.
<unk> do you find that there might be a longer change and dealer behaviour.
Getting a custom to kind of grounding in keeping these off lease vehicles.
Near term environment, and we might not see as much of a shift down the traditional auction channels win and Thats new vehicles do improve and then can you just walk us through maybe expectations.
Due to lower.
New leasing in this environment and how that could impact your model it in years to come as well. Thank you.
Thank you Stephanie.
So two questions there let me take the first one first.
First of all 70, it is true we're seeing record high conversions.
On open late I, just referenced that in one of my questions earlier.
Generally we've seen that conversion rate trend up over time.
As online became a bigger and bigger and bigger part of dealership buying and our sellers habit for selling so.
Viewed over multiple years the online conversion rate has trended up but then there was a step function change with COVID-19.
Covid with the supply constraint I do think that as.
Production increases in prices normalize that.
Those very high conversions that we're currently seeing will fall back.
<unk>.
And my guess is they probably won't fall all the way back to where they were pre COVID-19 because I do believe there is an ongoing sort of digital.
Transformation going on on multiple dimensions in our industry. So I think that but I do think they'll fall back quite a bit from where they are right now.
<unk>.
A big part of it is really driven by the pricing environment and when we talk about very high grounding dealer penetration today, a lot of that is driven by the interrelationship between.
The.
The residual value in the market value of the vehicles, because a lot of dealers grounding dealers get the opportunity to buy the car residuals in the same way the lessee to us so.
Those sort of two numbers start to move closer together and often more usually we see residual values being above market in a more normal environment. So I think that will impact the conversion rate as well and then I'd say the last the last comment I'd say on that is.
Obviously when it comes to our upstream open channel, we actively to try to drive up that conversion rate any way because those vehicles. They slow off the private label into ADESA dot com and thats sort of exclusively exclusive channel to us. So we were really trying to maximize conversion that channels, where we get very high.
Gross profit per car sold and a real opportunity for market share gains there as well.
And then your second question on expectations with respect to leasing.
The numbers I'm looking at say that leasing continues to be leasing penetration as a percent of new vehicle sales continues to be strong.
So.
The issue right now is more to do with lower volumes of vehicles being sold overall not the leasing penetration rate.
But I think leasing is definitely a factor in our industry and part and parcel of the way Oems and dealers and retailers want to want to do business.
And then I think.
Going to matter.
More than the absolute volume of vehicles leased again is the relationship between the residual value and the market value of the vehicles in those portfolios and I guess I'd say, Stephanie that overtime I think those.
We'll get back to the sort of more normal relationship that we see between those values because at the end of the day Oems compete with each other to win market share and they set residuals as aggressively as we can in order to reduce their monthly payments and have a compelling offer for consumers. So I think that dynamic drives.
The OEM has to be more aggressive around residual and that will ultimately drive the long term dynamics around on off lease vehicles.
Got it no no. Thank you Peter that was a really thoughtful answer zero. Thanks, so much.
Thank you Stephanie.
Thank you and our next question comes from the line of Daniel <unk> with Stephens, Inc. Your line is open. Please go ahead.
Yeah, Hey, good morning, guys. Thanks for taking our questions.
I wanted to start on the <unk> acquisition first congrats on closing that deal I think at the time of the deal. Eric you guys said are brought you kind of the profitability and the dealer to dealer business that would imply some pretty strong incremental margins or profitability at that asset for 100000 cars. So can you provide any more color on what kind of EBITDA contribution you expect from.
And then on these implied stronger margin is that more of a stronger gross margin or better SG&A leverage.
Just one market.
Daniel Thank you.
No I am not going to give specific numbers here, but I'll give you.
Just directionally.
Directionally, how I see it.
As I mentioned car wave performing very well in a more regional markets right, but a big a big one right, California.
Selling a higher value vehicle.
I would say strong unit economics, Okay. It's strong.
Monetization of the transaction.
And one of the things, we really liked about car wave was a very efficient cost of service and cost of delivery model.
And we see a potential to leverage that more broadly not only in our digital dealer to dealer channels, but potentially beyond that too.
So those all contributed to.
No.
Profitable and growing business.
In some respects.
Similar sort of performance.
What we're now seeing in our Treasury platform in Canada.
So.
I kind of look at you could look at the two P&L side by side, they look quite similar to each other in many respects.
So we see a lot of interesting opportunities. In addition to the sort of network effects type situations that I talked about on an earlier answer here.
Ah.
An opportunity to further accelerate backlog cars transition upmarket to higher value vehicles, which is well underway. We are seeing that already have backlog cars a significant growth in the average vehicle value.
Hopefully an opportunity to further accelerate backlog cars monetization of the transaction, which was part of our strategic intent all along.
So we see it.
Additive to that.
And then sort of you know.
Really looking at this sort of cost to serve and efficiency around the fulfillment of the transaction by the way backlog cars is also very strong in that in that dimension, but I do think.
There is an opportunity to really put the best of the best together here and deliver a very good outcome both for our customers, but also for our business.
Alright, Thanks, Patrick Daniel This is Eric let me add to that it really comes down can I lowered can I lower my cost to support the transaction in Canada.
The dealers typically self inspect the vehicle, eliminating a labor cost around inspection and car ways. They have a lower cost support infrastructure.
Use it using an offshore resource that is very attractive to us.
Think taking those two platforms and taking advantage of them across the network.
Very very pleased with this acquisition.
And as we mentioned when we did the transaction we expected that this would put us in a profitable situation.
Across our dealer to dealer digital offerings and I'm confident that's where we landed ourselves here early on.
Got it and Eric you mentioned net leverage ended the quarter at three two times, but you bought car wave I think here quarter to date can you provide us on what pro forma leverage would be when you account for the cash you spent on on highway they pro forma net leverage.
And then lastly, what is are there any leverage covenants I mean, I think 335 times.
How are we looking at there and then how does that impact capital allocation. Thanks.
Yes.
We will we could potentially see a tick up in pro forma leverage.
In leverage in the fourth quarter, although I.
We would expect adjusted EBITDA LTM to go up a little bit based upon a very low adjusted EBITDA number in Q4 of last year and there will be additional EBITDA added by this actual not pro forma but in terms of our leverage calculations I don't expect it to be a meaningful pick up tick up from $3. Two we've been building cash.
Since quarter end as well, Daniel and I do have incurrence tests on my revolver, but.
There is no issue with total net leverage my senior secured leverage is still.
It is right now just below two times, but right around two times and it will stay there and that's really the major tests and the total leverage limitation is much higher than three five.
Relative to ongoing it could impact the future acquisition at above if I went above three five but that's not an issue I'm worried about.
Got it and then just one clarifier, Peter I think my audio cut out a little bit earlier.
You're providing some commentary on preliminary future cost cuts could use.
Quickly what you said about that and then the impact of the fourth quarter I think I heard you mentioned for Q EBITDA, but it was kind of cutting out thanks.
Okay apologies hasn't been realized.
When I talked about is we have a initiative underway. We are nearing the end of the assessment phase.
And we will provide more specific detail on a future call, but I think we have significant opportunities across the company and obviously there'll be in this transcript.
On the on the quarter.
We didn't provide specific guidance, Daniel and don't plan to.
Typically we have some seasonal effects in our industry.
And based on those.
I would expect our EBITDA performance in the fourth quarter to be less than the EBITDA performance in the third quarter, but im not providing guidance beyond that.
Got it thanks, so much for all the color guys best of luck. Thank.
Thank you Dennis.
Thank you and our next question comes from the line of Bob Leduc with Jcs Securities. Your line is open. Please go ahead.
Good morning, it's Bob <unk> from CJS, Thanks for taking my questions.
I want to start.
I wanted to start with.
Digital dealer to dealer, but really kind of overall could you talk about maybe where you've been where you are now and where you're going with your inspection inspection reports and how your investment and partnership with Raven AI is impacting this product and ultimately how this impacts your volumes in your P&L.
Yes, Thanks, Bob Thats a good question.
As we think about being a more digital business and what are the sort of ingredients for success. There is no question the inspection report.
This is critical when we pull our customers weather typically buyers, but also sellers, but for sure buyers. It's typically the number one item.
And it makes sense that buyers are kind of de risks you're looking at a screen how can be confident that the vehicle is going to show up when it's delivered <unk> given us a used vehicle.
So we continue to invest in that and we do have some initiatives underway right now at backlog cars.
And obviously with the car with acquisition.
We're sort of.
Including that in the in the solution design here as well to sort of further improve the.
The condition report for these digital dealer to dealer platform. So Theres initiative underway on that one of the.
Objectives of that.
Redesign our evolution I should call it the <unk>.
Section report is to also make it more.
To enable us to syndicate, the inspection more easily across our own infrastructure. So we can push vehicles seamlessly from backlog into the ADESA marketplace and things like that so we can slow the data without having to move the car are we expect the car.
So.
Some work there and frankly, leveraging some work we've already done with trade revenue, Canada, that's proven to be.
Quite successful.
You mentioned Raven.
No.
Our initial focus with Raven has been more on the commercial seller side of the business.
Leveraging some opportunities that Raven already had.
Sort of.
Obviously, a minority investor in that business. They already had some opportunities locked down with a number of commercial sellers. So we are supporting them in the delivery of that we've introduced them to some new commercial customers and we do have an initiative.
<unk> teed up but not yet sort of.
Certainly not yet live to bring some of that.
AI and machine learning capabilities into other aspects of our inspections, such as digital either Studer channel as well.
But again I'd say the focus over the first six months of the investments and this is really led by Raven themselves has been on a number of.
Commercial set our captive finance type opportunities.
Okay, Great. That's really helpful. And then just one other quick one for me you mentioned at the Analyst day.
Piloting some physical locations running cars again.
Can you just remind us what youre up to now or how many locations are up to now and is the process.
The same or different from pre COVID-19, meaning youre running the same number of planes same hours.
How has it impacted revenues and profitability for you.
Yes, Thanks, Bob.
Good. Good question, we are up to approximately 30 locations in the U S.
I do not have plans at the current time to expand beyond that.
We are not running all the cars are those locations we're focusing on.
Principally dealer consignment and repossession vehicles at those locations so.
Trying to maintain that focus.
But we are seeing and I think I don't recall, if I touched on this on analyst day or not we're seeing.
Certainly it is helping us win back some volume at those locations. Okay. So we've seen an increase in particularly dealer consignment.
At those locations relative to when.
When we were in a purely digital model.
That's contributing to our numbers and we are also we're not doing it exactly like we used to.
Sure.
<unk>.
We've put some additional sort of checks in place to further increase safety.
And.
The only thing I would say is.
Even with running these cars in lane, what's been interesting to me is the dealers that migrated towards digital for the most part are staying digital.
And even if these auctions, where we're running cars and lane the majority of the vehicles selling or selling to online buyers, who do not come to the sale.
But.
Other dealers who it is.
Smaller number of dealers who.
Never adopted the digital technology, and just kind of.
Just just didn't adopt as they are now sort of coming back into the lane and providing some additional buying power.
For those markets. So I think we view it a success.
We're trying to.
Keep it somewhat limited, but in areas, where we can demonstrate it adds value and our sellers like it then we are obviously supporting.
Great. Thanks, so much.
Thank you and our next question comes from the line of Bret Jordan with Jefferies. Your line is open. Please go ahead.
Hey, good morning, guys.
Morning, Brett.
The only bright at the time.
Integrating car waves with backlog I think you said it might be a while but as far as being able to show inventory across systems. It seems like that's where the real leverage the incremental volume might be.
Yes, I guess, what I would say Brett is certainly.
We're deep in the planning process of that right now.
Owing to the way approvals work in HSR, you can't really get into that discussion pre close.
So I think we're having a very good very positive collaborative discussion a lot of enthusiasm I don't want to commit to a specific timeline.
When we win.
When we acquired backlog our strategy on the trader of migration was really almost akin to a hard shutdown and let's just move it across and take some risks and the customers.
That work really well for us by the way, but I kind of feel with the two platforms. We have right now we've got established customer bases on both platforms, who really like phone platforms right and.
Yes.
Want to make sure that when we bring these together, we're really giving the customer.
On whatever platform. They are on today are better solutions going forward. So it just requires being a little thoughtful and maybe taking a little more time, but we're moving expeditiously I will say that and we're committed to.
One brand one platform one set of policies one pricing model.
All the key fundamentals like that are a part of the long term plan. So this is <unk>.
I think we're looking at I would say doing most of this work in the between.
Between now and the middle of next year would be my expectation, but I don't want to give a more specific timelines of that.
Okay, and then on your targets of $1 2 million cars by 'twenty five does that assume organic growth from here or is there more to buy to get to that number.
Brett My focus is on organic growth for sure I think this marketplace is now somewhat stable with from.
We know the industry, we know the players.
We these businesses are growing we want to continue to grow them hopefully accelerate the growth.
So our focus is principally organic.
There is nothing.
Outside of that I'm contemplating right now but.
I never want to be close minded 'twenty opportunity, either but organic is security the focus.
Alright, thank you.
Thank you Brett.
Michel I believe.
I have one more person for the question and then we'll go to will take his question and then go to closing remarks.
Alright, and our last question comes from the line of Ali <unk> with Guggenheim. Your line is open. Please go ahead.
Good morning, and thanks for taking my questions and squeezing me in so first I wanted to ask about your market share on your consignment. I mean previously you had mentioned some share losses in that segment and I'm, hoping you can help us quantify those how much of that do you think also was driven by share losses, maybe digital competitors and how much to maybe other physical competitor.
Due to your decision not to run cars to the auction lanes.
Yes, I mean, clearly there was some share loss and it's tied specifically to that decision.
Post COVID-19 not running cars, particularly when independent auctions and then ultimately our other competitor started running cars, we did see some erosion.
And our physical lanes and that that that was the principal driver of the share loss I guess, what I'll say is over the last couple of quarters.
And looking purely at our physical market share and using similar data sources to what I talked about we've seen that stabilize on a slight increase in our share again over the last I think relative to where we were.
In Q1.
Don't have the data in front of me right now, but my recollection is if I look at Q1 Q2, Q3, we've seen a slight upward trend in our physical market share. So.
I think it's stable I think obviously.
Our decision to run cars at some locations has enabled us to win back some volume there.
I've already commented on that.
So I think it's stable and we're focused on.
Building it back up where we can but obviously growing our digital dealer to dealer.
Volume is the principal driver of our 2025 plan.
Got it that's helpful. Peter and if I have a quick follow up here on the commercial consignment side. Specifically you had mentioned you haven't lost any customers, but I've been getting some questions. Because there was some public news earlier this year that Volkswagen credit had selected manheim further upstream of our marketing and I believe they weren't open lane customer before unless I'm mistaken.
I'm, hoping you can help me square that with commentary that you haven't lost any commercial customers. Thank you.
Yes. So there was that was a 2020 event Ali so I'm talking specifically 2021.
But let me let me just comment on that customer Volkswagen credit renewed its agreement with us.
For Canada.
Earlier this year.
Despite having access to other.
Platforms and knowledge of how other platforms.
Perform so I felt that was a positive vote of confidence from that customer.
We're excited to continue to serve that customer in Canada, So what I'm, saying Ali as there were no there have been no customer losses.
On the time periods I'm talking about here, which is 2021.
Got it got it that's helpful. And then last one here on your spending outlook, you've taken out a lot of cost out of the business and are talking about potentially further cost cuts in and potentially being EBITDA positive I think in your digital dealer to dealer business, but you have your digital competitors out there who are talking about spending significantly in <unk>.
Yes in fact, one recently IPO and is talking about potentially getting more aggressive on incentives to take market share in the U S. Specifically and so I'm wondering how you can ensure that you are going to be able to compete effectively.
Backdrop, where it seems like your digital competitors are planning to spend aggressively in coming years. Thank you.
I think we'll just have to watch the competitive environment Ali as we go I think our trend if we look at our trend line.
At car, we've seen those platforms go from heavily loss, making if I go back a couple of years, our digital leaders of their platforms to essentially I'd say breakeven in the current year or the very close to that.
So we've seen some very positive steps.
In the direction towards profitability with trade Rev profitable in Canada car way profitable and my expectation is that would further organic growth in some of the things we talked about we can we can execute our plan and deliver but we obviously, we always watch the competition.
I think dealers at the end of the day, they're more focused on what are the results of these platforms deliver for me and for my business, if you're a seller or these platforms delivering good values.
<unk> way.
It was an easy process. If you are a buyer getting good inventory selection and on time delivery and those types of attributes.
They are actually less focused on.
This month's incentives, but but but nonetheless listen we've.
Dealt with competition also our history, we will be dealing with competition as long as we're in business. So that's just part and parcel of managing our business and Ali Let me add our focus is really just on providing those services efficiently.
And I don't I don't know that anybody providing incentives as ever proven that it's a long term strategy to win unless you have efficient services offering that will keep a consistent cost of the transaction going forward and that's what we're focused on.
I don't think anyone is out there offering a more economical transaction. Then we are I think we're very competitive on pricing right now across our digital platforms adult right Peter.
Yes.
Great. Thank you so much for taking my questions.
Thank you Ali.
Yes.
Thank you and this does conclude our question and answer session and I would like to turn the conference back over to CEO, Peter Kelly for any further remarks.
Thank you Michelle and thank you all ladies and gentlemen for your time this morning.
And for your questions. So I'd just like to close out just reinforcing.
Sales from the team here are most focused on as we move forward.
I'll start with dealer to dealer.
We're focused on continuing to grow our digital dealer cedar volumes towards our goal of $1 2 million vehicles sold by 2025.
This in turn will drive a significant increase in our overall profitability.
To help drive this we're focused on increasing our marketplace participation by sellers and buyers in the U S and Canada as well as ensuring a successful integration of <unk> and backlog cars in the U S.
If I look at commercial volumes purely the current supply situation has been a challenge. However, we believe the disruption is temporary in nature and we're focused on getting to the disruption, but also I would say using this time as an opportunity to reengineer our business.
Lowering our cost of service.
And our goal ultimately is that as the volumes return, we can support increased volumes with a lower cost delivery methods and we've had in the past and be more profitable even at lower volumes than we've been in the past.
And most importantly, we remain focused on our customers our purpose at the end of the data to make wholesale easy so our customers can be more successful and I believe that if we do that well our customers reward us with their business and our company will have a bright future.
So with that we'll end today's call and I look forward to reconnecting early in 2022. Thank you all very much.
This concludes today's conference call. Thank you for participating you may now disconnect everyone have a great day.
Okay.
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