Q1 2022 KAR Auction Services Inc Earnings Call
Good morning, Thank you Christina by your conference call will begin momentarily.
Again, please continue to standby thank you.
[music].
Good day, and thank you for standing by.
Welcome to the car auction services Q1, 2022 earnings conference call.
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I would now like to hand, the conference over to your Speaker today, Michael Eliason, Treasurer, and VP Investor Relations. Please go ahead.
Thanks, Amanda good morning, and thank you for joining us today for the car Global first quarter 2022 earnings Conference call today, we'll discuss the financial performance of our global for the quarter ended March 31, 2022, after concluding our commentary we will take questions from participants before.
Peer kicks off our discussion I would 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 kars business prospects and results of operations and such risks are fully detailed in our SEC filings.
In providing forward looking statements the company expressly disclaims any obligation to update these statements.
Let me also mentioned that throughout this conference call, we'll 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 yesterday, which is also available in the Investor Relations section of our website.
Now I'd like to turn this call over to Carb Global CEO , Peter Kelly Peter.
Thank you, Mike and good morning, everybody I'm delighted to be here. This morning, with all of you to provide an update on our performance of car globally.
So on today's call I will detail, our first quarter results and provide you with some guidance a context around our expected performance for the remainder of 2022.
But first I would like to update you on the status of our divestiture of the ADESA U S physical auction business.
The transaction is expected to close within the next week.
It is it is a significant even historic milestone in <unk> history, and a transaction that will be transformative for our company our customers our employees and our stockholders.
And I believe that the rationale for the transaction as we outlined on our Investor call back in February remains intact.
Together with our customers, we are driving a channel shift from physical to digital marketplaces.
Actual allow us to more rapidly develop and deploy the digital solutions that our customers need and value the most.
In doing so this transaction will advance our vision to build the world's greatest digital marketplaces for used vehicles.
Used vehicle market in North America represents a 40 million vehicles per year market at the retail level and over 20 million vehicles per year at the wholesale level.
We believe that our leading digital brands platforms and technologies will help us advance digital transformation of our industry and fuel our future growth.
It was approximately 350000 vehicles sold on our platforms in the first quarter, we have plenty of opportunity to grow.
This transaction will also simplify our business it will enable us to focus our strategy energy and investments on expanding our capabilities growing our volumes and increasing our market share.
We believe this focus will help us generate the greatest benefits for our customers and deliver the greatest value to our stockholders.
And as we outlined in our February announcement, the transaction enhances our financial profile. It helps us streamline our operating structure, becoming a more asset light company.
We believe it will enable us to increase our gross profit margins and our EBITDA margins and drive a faster long term growth rate of car.
The transaction enabled us to pay down debt, creating more flexibility in terms of future capital allocation.
Car will continue to generate strong cash flows going forward.
We look forward to sharing more with you about our strategy at an analyst day update call that we will likely scheduled for June and I'll provide more details around that later on this call.
So with the remainder of our time I'd like to discuss our first quarter results and our outlook for the rest of this year.
Consistent with our earnings release last night, the results that Eric and I discussed today exclude the divested ADESA U S physical auction business, which is treated as a discontinued operation and the financial reports.
Also in my remarks today, I'm going to speak about our business in two segments.
Marketplace segment, which we formerly called the ADESA segment.
The AFC segment.
So the first quarter was challenging our volumes continued to be negatively impacted by the vehicle supply in used vehicle pricing issues that are affecting the broader industry.
This is certainly the case with commercial vehicles, particularly off lease vehicles.
But it's also the case to a lesser extent with dealer consigned vehicles as well.
Notwithstanding all of that we made important gains across many aspects of our business.
Paccar overall and again this does not include the ADESA U S physical auction business the performance highlights in the first quarter include.
We generated $369 million in revenue that was flat with the same quarter of the prior year.
We also increased our auction fee per vehicle sold.
We generated total gross profit of $159 million that was a.
Greece or 4% from Q1 of 2021.
This gross profit represented 49, 1% of revenue excluding purchased vehicles.
We generated 49 million of adjusted EBITDA, a decrease of 36% from same quarter last year. However, it's important to note that our Q1 'twenty 'twenty. One results included a $17 million realized gain on the sale of marketable securities.
Within the marketplace segment, we facilitated the sale of 351000 vehicles. This represented over $6 5 billion in gross auction proceeds.
Those volumes are down 23% versus Q1 of the prior year driven by the continued strain on commercial center volumes for volumes declined by 46% or 146000 units I'll provide more detail on that in a few moments.
In our dealer consignment business volumes increased by 39000 units, representing 28% growth over the prior year.
This positive growth was driven mainly by organic growth the backlog cars and trade Rev and by our acquisition of <unk>.
We generated $285 million in revenue a decline of 6% versus Q1 of 2021.
And we generated $255 and gross profit per vehicle sold in the marketplace segments that was an increase of $7 per unit versus Q1 of last year.
In our AFC segment, we experienced another solid quarter performance with revenue of $84 million in the quarter, an increase of 28% over Q1 of last year.
So as I mentioned, a few moments ago, our first quarter performance was negatively impacted by the ongoing supply chain challenges semiconductor shortages and the lagging new vehicle production in new vehicle sales.
This principally impacted us in terms of off lease transaction.
With used vehicle prices at all time highs consumers have significant equity in their off lease vehicles and this means they are more likely to retain those vehicles than to return them to the <unk>.
This led to a 61% reduction in the number of off lease vehicles returned to open Lynn platform compared to Q1 of 2021.
This reduction in supply at the top of the funnel materially impacted the performance of that business.
I want to be very clear this is not a loss of share or our customers and also conversion rates within the channel remained very strong in fact, it was stronger than one year ago.
We believe that these factors ultimately are temporary.
And while neither we nor our commercial customers can accurately predict when these factors will receive I'm confident that our continued investments in open lane and our off and in our off lease solutions in general position us well to retain and grow share with the new vehicle production increases and when off lease vehicle volumes returned to more normal levels.
Vehicle production shortages and reduced new car sales were also a headwind to growth in our dealer to dealer category.
Pure new vehicle sales by franchise theaters result in fewer trade ins and that flows through to our business.
So while we grew our cellar count on backlog cars car wave and trade Rev. We saw fewer vehicles posted per seller versus the same quarter prior year.
That said, we're pleased with our performance with the performance of our dealer to dealer business in the quarter, where in addition to growing our volume by 28% we increased our revenue per vehicle sold by over 25% versus the same quarter last year.
While significant uncertainty still exists across our industry Theyre now we're now four months into 2022, and we're able to provide guidance that we expect to deliver $265 million and adjusted EBITDA for 2022.
This would represent approximately 11% growth in adjusted EBITDA year on year had we applied the same discontinued operations accounting to our 2021 results.
And had we excluded the realized gains from the sale of market marketable securities during 2021.
I believe that delivering this growth in face of the uniquely challenging set of circumstances.
He is encouraging as we continue to focus on the factors that are within our control and the opportunities that do exist.
The key drivers in delivering this result in 2022 are the following.
As I noted earlier AFC performed well in Q1, given our current visibility into this business I expect to see continued strong performance with AFC throughout the balance of this year.
Although we do not report separately on ADESA candidate, we expect it to contribute meaningfully to our 2022 results two strong market share, it's digital operating model and strong unit economics.
We also expect our digital dealer to dealer business to be a growing contributor in 2022.
We also believe that our diligence and consistent efforts to manage our cost structure will contribute meaningfully towards success in 2022 and to our improved financial performance beyond 2022.
We believe that once the ADESA U S physical auction business transaction closes we will have an additional opportunity to streamline our organization and make meaningful progress towards our cost structure reflective of fully digital business.
We are targeting a material reduction in SG&A.
By the end of 2022, I expect our cost reductions at an annual run rate to be at least $30 million per year.
One important area of our business that we expect to underperform prior years will be the open lane business as well as some of the related services businesses businesses that service the off lease vehicle in particular businesses such as cars arrive in all and all of it.
The fact is it is impossible for these businesses to deliver their historical level of earnings contributions given top of funnel off lease supply is down by approximately 60% versus normal levels.
However, open lane remains a very important and very valuable asset. It represents an essential and deeply integrated capability and is key to some of our largest customer relationships.
I am confident that open lane will be an important driver of our future profits.
As I look past 2022, I'm encouraged by our prospects for growth and I believe that our growth will be driven by a number of important factors.
Firstly by a secular shift towards digital marketplaces across our entire industry, which is driving increased volume in both the dealer and commercial parts of the business.
Secondly by a recovery in commercial volumes given the continued supply chain issues with new vehicles. This will likely take place over a longer timeframe than I would've hoped for six months ago, but I'm confident that ultimately it will recover towards historical levels. So I see it as a question of when not if.
Third the continued strong performance by businesses like AFC in the death of Canada, where we have differentiated offerings and a strong market position will support our performance going forward.
And finally, our continuous focus on cost efficiency and being an asset light company.
I'd like to make a few remarks as regards future capital allocation.
As I mentioned earlier, the completion of our divestiture will allow us greater flexibility in terms of capital allocation.
We expect to pay down a substantial amount of our outstanding debt.
We will continue to invest in the technology and platforms that create the most value for our customers and position us to capture the opportunities ahead and expand our addressable market.
Following this transaction cost capital structure will allow it to be more nimble and more strategic and deploying capital to drive growth.
And if our stock continues to be undervalued as I believe it currently is we have the ability and capacity to repurchase shares Eric will speak to that in a few moments.
As we committed to you when we announced when we announced the adjusted U S. Physical auction transaction, we intend to update our previous investor and analyst day materials to reflect our new company and an updated set of assumptions. We're currently targeting June for this update and we will send a save the date after the deal closes.
During this meeting will go during this meeting in June we'll go more deeply into car strategy and our expectations for growth and our future performance.
Looking forward to that discussion and we will publish details as soon as the dataset.
So in closing my remarks here. This morning, I'd like to summarize some of my key messages for today.
Our ADESA U S physical auction transactions expected to close within the next week.
Transaction will be transformative for car and for our customers and I remain very optimistic for our future.
With a smaller nimbler and more asset light company, we intend to execute a focused digital strategy to capture what we believe to be considerable opportunities for growth both in and beyond our current markets.
This includes meaningful growth across both our commercial and dealer solutions. Both in terms of increased market share and an expanded portfolio of services to support our customers.
For 2022 we expect to deliver tuners $65 million and adjusted EBITDA, representing 11% growth on a like for like basis in spite of a uniquely challenging set of circumstances facing our industry.
And as we look to the future we are excited and energized by the opportunity ahead.
We believe we have a significant opportunity for growth exceeding the 15% adjusted EBITDA CAGR that we spoke to in our analyst day last September .
We have differentiated platforms are diverse and expanding customer base and a large addressable market space of which to innovate and invest.
Ultimately, we believe that the combination of our assets and the opportunities ahead will drive strong revenue growth and margin improvements and we look forward to discussing these opportunities and our strategy to capture them on our call with you next month.
So with that I'll hand, it over to Eric who will provide a more detailed review of the financial results for the quarter, Eric. Thank you Peter.
I would like to start by explaining the basis for the presentation of the ADESA U S physical auction business in various filings.
First we are required by GAAP to treat ADESA U S physical auction businesses as a discontinued operation. This results in removing all activity from the ADESA U S physical auction business from the financial statements for our continuing operations for clarity.
I will refer to our continuing operations as car remain co throughout this discussion.
The first impact of discontinued operations is we remove all detailed activity for the discontinued ops from our income statement balance sheet and statement of cash flows.
As you can see in our financial statements in the press release, the financial information for discontinued operations is presented in aggregate in each of the various statements we.
We do not present line item detail for example revenue cost of services SG&A and so on in the income statement. It is presented in a single net line item.
Come from discontinued operations net of income taxes.
In each category of the balance sheet, we present, the aggregate activity in a single light items asset or liability held for sale.
And in the statement of cash flows we present, the cash flow activity for each category of cash flows as our net cash provided or used by discontinued operations.
In all financial statement presentations link restate prior year financial statements in this manner to reflect the ADESA U S physical auction business as a discontinued operation.
We have completed this restatement for the first quarter financial statements, we will be determining the impact of discontinued operations of each quarter of 2021. After we complete the transaction, we do not have that information to share with you today, but we'll provide it as soon as it is available so you'd have comparisons for each quarter going forward.
We have other financial information that has been provided or discussed as part of the ADESA U S physical auction transaction.
Carve out financial statements for the business was provided to and was published in an 8-K by Carvana.
You will likely notice that the basis of presentation for the carve out financials is substantially different.
Then the presentation of discontinued operations.
The carve out financials include the allocation of costs from car to the U S. Physical auction business that are not part of our transaction with Carvana GAAP requires the statements to reflect the operations of the business from the perspective of car not carvana.
Accordingly, the statement the carve out statements include $42 $6 million and allocated corporate costs in the financial statements.
The allocation of these costs was primarily based on revenue and head count for the ADESA U S physical business in relation to car remain Cup.
Some of these costs will be retained by car remain co for the duration of the transition services agreement with Carvana.
Some of these costs relate to contractual relationships with third party technology providers and the cost will be retained until the termination of existing contracts.
As Peter mentioned, reducing costs at par remain co is a priority in 2022 following the closing of the sale of the ADESA U S physical auction business.
I also want to comment on our outlook for $265 million of adjusted EBITDA for 2022.
This represents our estimate of reported results for continuing operations of car remained go for the full year. This expectation does not include any pro forma adjustments. For example, we have a commercial agreement with Carvana as part of this transaction our expectations include expected revenue from the commercial.
Actually billed and collected from the date of the close of transaction to the end of 2022.
To the extent car remain co encourage any nonrecurring expenses like severance or contract termination payments. These will be included in our reconciliation of net income to adjusted EBITDA consistent with our treatment historically.
We will not be including pro forma activity as if the transaction closed on January one 2022.
Given the expectation that our transaction will close in the near future. Let me summarize this transaction for you.
The total proceeds from the sale of the ADESA U S physical auction business will be $2 $2 billion.
Up to $49 million of this purchase price will be held back until consents to assign leases are received from certain landlords.
We expect to receive these consents on all of the properties before or shortly after the closing of the transaction.
This transaction will result result in a substantial gain we.
We expect the net gain to be taxed at a rate of approximately 26, 5%, including applicable state taxes we.
We estimate that the gain net of taxes fees and expenses will be approximately $1.65 billion.
We expect this gain will be realized in the second quarter of 2022 upon closing of the transaction.
Yeah.
As we have previously disclosed we will utilize the proceeds to repay existing debt upon closing of the transaction our credit agreements require the repayment of term loan b six within three days of closing.
After repaying our senior debt the remaining net proceeds will be used to redeem or repay senior unsecured notes.
We expect within 365 days of closing to apply remaining net proceeds to redeem or repay the senior unsecured notes, we will not be redeeming. These senior unsecured notes prior to June one 2022, as the redemption premium on the notes steps down.
One on June burst.
And our balance sheet as of March 31, 2022, we have classified our term loan b six borrowings as current given the expected timing of the closing of the transaction and the requirement to repay this debt within three days.
The senior unsecured notes are classified as non current as of March 31, 2022, because there is no requirement to repay this debt within one year from the balance sheet date.
We expect a portion of the senior notes to be reclassified as current obligations as of June 32022 in accordance with our expectations and the terms of the senior notes indenture.
As mentioned in our release last night. The board of Directors has increased our share repurchase authorization by $200 million and extended this authorization through December 31 2023.
Following the closing of the Carvana transaction, we expect to have attractive cash generating businesses with an expectation for profitable growth over the next several years, we anticipate.
Purchasing car shares in the open market Opportunistically, we believe the repositioning of our company as a digital marketplace business combined with the growth we expect over the next several years as we increased volumes in our digital dealer to dealer business and experienced the recovery of commercial volumes is not yet reflected in our stock price.
We have the flexibility to repurchase car shares if the market does not properly valued car in the near future.
A few quick comments on our performance in the first quarter first our cash from operations for the quarter was negative both continuing operations and discontinued operations.
This is due to the timing of quarter end as you can see in the balance sheet and a net impact of trade receivables and payables was a use of cash. This is not a change in cash patterns for our transactions, but a reflection of the quarter ending on a Thursday.
Our cash use reversed.
Over the next several days following quarter and.
This was not impacted by the ADESA U S physical auction transaction or any changes in terms with our customers.
Car remain coast marketplace businesses.
Open-line backlog cars car way ADESA, Canada trade route and industrial Europe , all experienced low supply of wholesale vehicles, especially in January and February we saw some recovery in March although supply still remains constrained and our volume disclosed in the earnings release supplement and what will be disclosed in our.
10-Q, only the volume of car remain co is reflected.
Our auction fees per vehicles sold increased 29% in the first quarter a major contributor to this increase was fee increases implemented at backlog cars. In early March. This contributed to an increase in gross profit per vehicle sold to $255 from $248 in the prior year overall performance in our marketplace.
Businesses was challenged by the supply situation. However, we saw March results that were significantly better than January and February to put it in perspective, our March performance represents approximately 45% of the adjusted EBITDA for the quarter.
The improved March performance was driven by the growth in digital dealer to dealer volume combined with fee increases and improved gross profit per vehicle sold.
The AFC business continued its strong performance in the first quarter, although the number of loans trained loan transactions was flat year over year. This was against the backdrop of decreased volumes in all channels of wholesale transactions. The strong performance was driven by strong revenue per loan transaction, including the impact of low credit losses.
And increasing interest rates, the low levels of dealer inventories across all segments of the retail market drives positive performance at AFC.
Continued to see elevated used car prices that drives higher average loan values per car, Florida low inventory levels for dealers drives improved payoffs as cars are sold the challenges in the wholesale supply of vehicles is a positive for our AFC operations.
So that concludes my remarks, I am sure you have plenty of questions. Today, So I will ask Amanda our operator to begin the Q&A portion of our call. Thank you.
Thank you and as a reminder to ask a question you will need to press star and one on your telephone keypad.
Your question. Please press the pound key.
Our first question is from the line of Ryan Brinkman with Jpmorgan. Your line is now open.
Great. Thanks for taking the question this is.
Roger Boockvar entre on for Ian.
Just had a first question on the EBITDA guidance for the year.
Could you give us a sense of the trajectory.
From <unk> to the full year.
In terms of what's driving.
The sequential movement.
How much volume versus GPU.
Our SG&A improvement or and if you could also give us the same question.
How much of the commercial services agreement.
In that guidance as well.
That was the first question.
Sure.
Thank you Roger.
Let me take that question.
Yeah. So in terms of sort of a bridge from our Q1 performance to $2 65 for the full year.
I guess, what I'd say there is a number of.
Factors that I'm that are additive to our Q1 performance. So let me let me outline what those are and I would say that.
The factors inherent in our Q1 performance I expect to continue so I kind of see the Q1 performance of the base with these additive.
That to us.
<unk>.
We expect an improving EBITDA contribution and the digital <unk> businesses.
Eric spoke about some of the changes on the monetization side that we made in March so those werent really fully reflect certainly not fully reflected in Q1, but it will be reflected every month going forward. So that's a that's an importance.
Aspects.
We expect to see some improvements in the open lane performance and corresponding services businesses.
We have a number of new programs going live with certain customers.
And we expect these to have a positive impact starting as soon as me and some of them going live in June and July .
And I'd also say these programs don't require incremental top of the funnel volume.
So we expect incremental positive movement there at open language will be positive for us as well.
There will be a contribution from the Carvana commercial services agreements, it's a I'd say, it's relatively modest but it is incremental unhelpful.
And then as you mentioned SG&A reductions do do play a role although.
Those will tend to ramp up over the course of the second half of the year, but they will be incremental to the Q1 story as well so.
Essentially that provides the bridge resort to the from the Q1 to the $2 65.
And Richard if I could add something if I can add something on the commercial agreement. We have is there is a contract minimum volume in the commercial agreement.
Our guidance assumes only the minimum is achieved so it is.
There is no risk to the number we've assumed in there because of our contractual minimum we will not disclose the specific terms of the transactions, but I wanted everyone to know.
While it is a volume oriented number there is a minimum and we have used the minimum in our expectations.
Understood that's helpful.
Maybe just following up on that.
We've obviously heard of many dealer customers deciding to look at alternatives to the physical platform.
And you also get a lot of public announcements from the OEM partners, So moving away from a desktop.
The physical business can you give us a sense of how much of how this is maybe impacting open lane or backlogs.
No habits, how the customer conversations band you know maybe from the OEM side for open Lane and then get the dealers.
We're already doing anything ADESA I mean are you seeing more of a shift to the digital because of that or.
Are you seeing some kind of a backlash, maybe because a competitor with acquiring the platform.
And maybe just if you could give us an update on that thanks.
Thanks for job obviously by focuses on as Eric described the remain co and the platforms.
Stay with car post transaction saw confine their remarks to that.
And no we havent seen backlash in that regard I think our customers understand the strategy and I think the you know.
I'd say uniformly pretty much our customers see a future where there are more digital transactions not fewer and.
Understand the strategy and very interested to see what we can do for them and the solutions, we can bring to them in that regard, but let me provide a little bit more context on that.
For sure the the announcement of the transaction was the big events in our industry.
I'd take.
A little bit of time to digest and there was some I'd say confusion in the in the very initial stages as to exactly what has been required acquired and divested and all that sort of stuff.
Given all of that it was important for us.
Certainly in those early days and weeks of initial weeks post announcement to spend a lot of time with our customers, which we did and frankly, which I did personally.
And I guess I'd characterize the response as regards remain co as follows our customers understand the strategy.
They understand the rationale.
And I think they are enthusiastic about working with the new car.
They again as I said, whether it's commercial or dealer, whether its seller or buyer most customers see more digital transactions in the future than in the past and.
It's possible this transaction might accelerate that to some extent I am not saying it would but it's it's probably another step along that road.
And I think our customers are very interested to see you know how this transaction enables us to focus our investments on the digital solutions and what are the types of offerings, we can bring to them and we've had some initial discussions with those and I think there'll be exciting.
Product development opportunities in that direction, which I'm excited to start to bring to market. So.
I guess, one other comment I would say if I look at our commercial sellers in particular, you know I talked about how conversion rates have increased through COVID-19 and to the present, even though the top of funnel supply is very low the conversion rates are stronger than they were pre pandemic.
I would say our customers are keen to sustain the strong conversion rates into the future. So theyre looking for opportunities how do we.
Ensure that as volume returns at the top we can still keep high conversion through that channel. So listen I think there's a lot of opportunity and I think there's a good alignment between our strategy and what are customers looking for going forward.
Understood.
A lot for the detail and I'll get back in queue.
Thank you Roger.
Our next question is from John Murphy with Bank of America. Your line is now open.
Good morning, everyone. This is aileen Smith on for John .
Wanted to ask another question around the $65 million outlook on just to make sure I <unk> sure I understood it correctly.
Contact with some of the prior comments you've made.
Thank you last commented was the sale of the death of physical auctions was announced and the transaction is going to reduce 2020 tail adjusted EBITDA by 100 million, which I'm assuming is all else equal.
Outside of any changes in the market or the business more broadly so within that new $265 million outlook is it fair to assume the $100 million reduction from the ADESA physical Bell Hall, and the remaining incremental negative, particularly on a year over year basis versus pro forma results is just due to persistent industry headwinds in the secondary market.
Yes, I think that's it that's a reasonable assumption I think that that indication on the $100 million I think is still valid.
And I would say.
You know candidly.
New vehicle supply issue and and.
The challenges that our OEM customers are facing and addressing that and getting their production back to.
Normal levels lets say I think that's just proven more challenging than perhaps was that we would have expected six months ago. So I think the way you summarized that there is accurate.
Okay, Great and then I wanted to follow up on Roger Second question, and specifically you know whether dealers continue to send vehicles through an auction house, it's owned by a competitor and I wanted to ask instead of whether you are or are not seeing change in traffic or shifts to other alternatives switching and common John but rather how do you actively change the discussion with some of those theaters.
Customers are moving to the online marketplace offer buy a desktop on offer by car.
Theyre, an extensive education process that you need to go through I think you mentioned that your customers are interested and they understand the industry shift that is happening, but is there any incremental costs or time or resources that you need to make the catalyzed customers to shift from physical to digital or is it happening relatively quickly.
Let me.
I'll attempt to answer that here in a second let me just go back to your prior question just for a moment just to kind of give you a little bit more context, I talked about some of the challenges facing open lane on the services businesses.
Those are those are significant I would say.
You know my assessment is that SaaS.
SaaS that off lease decline represents a headwind of something like $100 million in terms of current performance versus normal performance. So I see that as an opportunity to grow back book, but that is maybe indicative of how does this headwind show up in our business and I'm talking about at remain co.
In that regard so to go to your other question on on.
You know does this require additional education or effort on our part I guess I would say no because we have been with our customers. We you know I think part of our company culture is to stay in very close communication in close partnership with our customers. So.
So we've been in communication with them for many years around digital transformation I think our customers understand that we are a company that has helped drive the digital transformation of the industry. Both at the commercial and on the dealer side and on the sell and buy sides of the business. So.
That's something we're obviously very experienced in.
And I think our customers like our digital solutions, they find them very effective a powerful I think in the case of many of our customers.
Our digital solutions represent their highest performing channels.
So I.
I would see it as a redoubling of that efforts.
But I would say the advantage to us is being exclusively focused on that.
<unk> enables us to sort of be fully committed and not to be ambiguous in terms of you know well you could do this or you could do that we're going to have a very focused message of hey. These are the solutions, we bring to market. We think these are the best.
What can we do that would make these solutions better and how would we deliver that so that's kind of the discussion we want to have with our customers.
Okay got it that's very helpful commentary and then one bigger question, if I may on assays and as I'm sure you're going to get a lot I don't how to desktop.
The ADESA physical auctions have any near or longer term implications to ash I IFC that we should be thinking about.
How do you think that the customers that is in any case with dealers that are using ADESA auction services, and then cutting financing from AFC and I'm not even sure if that financing capability is something carvana can offer they acquired at physical auction. So as you divest the physical site is there any risk to <unk>.
Going forward that we should be thinking about from a modeling perspective.
No I don't believe that there is a risk for the DMC will be hurt by the by the sale of the ADESA U S physical auction business and to provide some context on that.
As you mentioned AFC serves independent used car dealers.
We're purchasing cars in the wholesale market.
Including at cars marketplaces at ADESA, but also at our competitors' marketplaces, whether digital or physical.
So you know when AFC establishes a relationship with the dealer is very important that they support the dealer's vehicle purchasing irrespective of where the bureau requires the inventory. So that's very much has always been part of their strategy and as a result of that.
Only a relatively small percentage of.
Amc's total loans.
Were purchased from cars marketplaces or from ADESA Okay.
So you know.
I think AFC really has a sort of a channel agnostic point of view as long as the dealer wants to buy a car AFC will finance vehicles. So.
We don't see any risks.
We haven't seen any risk show up in the numbers, we haven't seen any erosion of the customer base whatsoever.
In the past 60 days since announcing this transaction. So I don't think theres any knock on effects, there and Aileen, let me add as part of our commercial agreement with Carvana. The AFC personnel that are onsite at ADESA U S. Physical auction locations will remain onsite through the duration of that contract at at <unk>.
No rent costs to car remain co. So that's an attractive logistics arrangement for us relative to having the AFC resources still available to the customers at those locations.
Okay fantastic Thanks for taking my questions guys.
Thank you very much.
Our next question is from Gary <unk> with Barrington Research. Your line is now open.
Hey, good morning, everyone.
Hey, Peter Eric If you when you talk about you know.
Overtime, reducing your SG&A as a percentage of sales what what what do you feel would be the optimal.
Percentage number there I mean, it was running at 32% versus 29%.
Year over year, but what would be an optimal number for you.
Gary you know.
I guess, what I'd say is we have two businesses.
You know as I described the segments.
This segment's dfc segments that have sort of somewhat different characteristics. When it comes to sort of SG&A as a percentage of revenue.
You know margin structure, so on and so forth so to some extent.
You know what the total number for car is ultimately how those two blend together.
Might make more sense to two.
Look at them separately, you can look at them separately in terms of that analysis, but I guess, what I'd say is we do see a significant opportunity.
I would say.
Some reduction of SG&A in absolute terms relative to what it is today and then as our revenue and volumes grow which we fully expect they will that SG&A will grow at a much slower rate. So I do have some targets that I'm honestly I'd, rather speak to you in our analyst day.
Okay with the broader group, but I look forward to going into more detail, but what for sure SG&A as a percent of revenue declining.
As part of our expectation and part of our modeling will go into more detail on that in June .
Okay and then just the second question you mentioned in your commentary and some of the growth that you're anticipating some new programs with open lane.
My understanding is you had most of the OEM programs. There. So could you maybe elaborate where those these new programs are coming from.
I would characterize these areas.
New programs with existing customers.
Okay. So you know we've had frankly and I'd rather not go into the specifics, we don't talk about specific customer contracts.
Budd.
You know our customers.
The reality that they're experiencing today in terms of the office portfolio is markedly different to what it was you know certainly two and a half years ago. Okay.
And I would say these programs would be more reflective of okay. How are the vehicle selling today I talked about conversion rates being higher but also the sort of where the vehicles are selling within the channel within the funnel is a little different.
So we've had some programs that address some of those aspects and.
Working with customers in that regard.
Okay. Thank you.
Youre welcome Gerry Thank you.
Our next question is from the line of Bret Jordan with Jefferies. Your line is now open hey.
Good morning, guys.
Quite a run rate could you talk a little bit about the integration of car wave.
Just kind of give us an update as to where that is and maybe how you are seeing emerging into the backlog business.
Thank you yes, good question.
So that that is.
On track.
We.
From a integration perspective, we broke it into we call. The two waves wave one and wave two wave one is now complete.
And wave one in essence had a number of key attributes first one was the deployment of a new common new and improved common inspection format for both backlog and car with so that's the sort of intake point of the vehicle into either channel would be the same and consistent across both so that new inspection platform.
<unk> deployed within the first quarter, we're pleased with how that has gone in desktops and improved inspect.
Inspection capability relative to what backlog Carr said before so it's a it's an improvement and a consistent sort of experience okay. The.
The second aspect was really addressing a lot of the.
I'll call it the policy and the pricing aspects of the programs. So as Eric talked about the improvements in monetization of backlog cars really what that was was.
The deployment of a common sort of.
Policy and revenue framework that.
Sort of can apply to both platforms. So that has been done and that's.
That is a number of impacts one in terms of customer benefit. It provides both the seller and the buyer increased protection in terms of the transaction there are.
You know.
Guarantee type products or increased protection the buyer hazard the seller has.
That is the vehicle is not what was expected there is protection, but then we monetize that protection. Okay. So it's it has the impact of doing both of those things. So wave. One is complete we're pleased with how that's gone it's going to materially positive for our performance past Q1.
Wave two we are currently tracking towards Q3, and that's the deployments of the more integrated technology solution.
And.
So more to come on that we're team is working hard on that and looking to get that done by the end of Q3.
Okay, Great and then I guess you commented that AFC, obviously continues to do well regardless of the ADESA relationship, but just could you give us an idea of maybe what percentage of loan originations at AFC came at physical ADESA sites or was most of this digital or.
It didn't really dependent upon that of desktop salesperson.
Just in general terms spread it's about 30% of their floor planning.
Is from.
ADESA sites I do not have a breakdown that would include Canada, which will still be part of car remained goats.
So it's so 30% from a desktop.
And we don't I don't measure again in that portfolio, Canada versus U S. So although U S would be a substantial amount of that actually Eric can I actually think and.
And maybe when you talk with US I think it's 30% car 30, I'm sorry, you're at 30% car T with some car across all platform adjust the U S is in the low teens.
<unk>, 13% energy generally so sorry, ADESA U S that would be right. Thank you for correcting the data, yes, so to clarify it's about 12% of <unk> 30 per center.
Car properties and car would include backlog cars.
Trade route.
You have very little or an openly so it's more than just the desert Canada, yeah. Okay, great. Thank you.
You're welcome Brett Thank you.
Our next question is from Bob Leduc from CJS Securities. Your line is now open.
Great. Good morning, Thanks for taking my questions.
Morning, Bob.
I wanted to just take a kind of big picture step back in terms of the free cash flow profile of the business now with this transformation can you discuss a little bit the kind of conversion.
From EBITDA to free cash flow what's the.
Capex profile going forward and what's the targeted leverage so what's the kind of interest expense, what we should expect going forward.
A couple of years out.
Now I'm going to let Eric speak to a little more specifics, let me offer just a couple of a couple of perspectives Bob I appreciate the question.
First of all.
I think the strong cash flow generation of the business. Those characteristics will continue the business will continue to be a strong cash flow generator.
So that's a positive story for car.
If I also didn't look at areas where we.
To reduce cash expenses cash outlays.
There is a reduced need for capital investments given that we have a reduced physical auction footprint, which was.
A meaningful amount of our annual annual Capex, so that that has diminished and I'd say also obviously cash to service debt.
Those expenses are reduced as well, although that we are I'll ask Eric to provide a little more color on some of that Bob we have not set a leverage target with our board yet although it's all understood. We've had the discussion it's substantially less than the three times leverage target that we've had for many many years so it would be.
Significantly less than that.
It will take us a little while to get there because of some of the mechanics of repaying the senior unsecured notes that I described and Mike.
Discussion, but also we've disclosed and you'll see it in the 10-Q filed today that our expectations for Capex will be $75 million to $80 million for remain co for 2022 that would be down from $115 million, which was the expectation for car global prior to announcing.
This transaction and that number had been previously disclosed.
The reduction in cash interest expense is likely to be $70 million to $80 million year. Once our bonds have regained and I don't know the timing of that there's several factors that will influence the timing of that redemption.
So as we look at it the free cash flow conversion actually will slightly slightly improved over what it was at par once we get past the transaction.
One qualifier on that I'm, excluding from cash taxes, a substantial tax payment that will be due on the gain from the sale of the ADESA U S physical auction business by not including that in my ongoing cash tax and that's that.
Half life that tax payment in 'twenty, two will likely be in excess of $400 million. So.
So I'm excluding that.
Okay, certainly fair enough and thank you for the details there and then.
To kind of dealer dealer digital people, there's no other questions I'm not sure how much you will say now maybe we have to wait but hopefully you can give us a little insight.
In terms of what is the brand strategy going forward, what are the advantages and disadvantages to having multiple U S dealer to dealer brands in backlog and car wave and just is that going to continue indefinitely or or might you consolidate brands or how should we think about that going forward.
Hum.
Bob I would expect with wave two of the of the integration we consolidate brands.
Okay now we may see the car.
<unk> format live on as a format within the backlog cars model, but.
I think ultimately we have.
Digital marketplace business, we're dealing with network effect.
Both on the seller and buyer side of those marketplaces, so fragmenting the marketplace doesn't make sense.
Okay.
Okay, great absolutely and then.
By the way Bob.
Sorry, sorry to interrupt I would say the strategy goes further than that candidly.
We can speak to this more but.
You know we have.
Dealer to dealer vehicles, we have off lease vehicles, but also flow into an upstream open marketplace.
And we have the potential to get other types of commercial vehicles. As I mentioned are already in platform is used by the vast majority of companies repossessing vehicles across the United States. So as vehicles of any type.
Flow into an upstream digital marketplace, it makes sense to get them into one single marketplace.
So I think youre going to see that's going to be an important part of our strategy going forward and we will provide more details on that.
In our call in June as well.
Okay, Yeah, that's super I appreciate that as well and then maybe last one and maybe.
Again trying to take a little bit from June here, but in terms of the trajectory I think the goal for the digital people would kill or was maybe a million two units by 2025.
And maybe $100 per unit and EBITDA are those still like the general parameters of how you're thinking about the opportunity set.
Okay.
If so.
What's the path to profitability in terms of getting to that 120 <unk>.
Is it linear or is there an investment phase now for market share with the profits turning on at the end or how should we think about the trajectory of growth for the digital pillar to pillar.
I guess, what I'd say, Bob Good question, I think as a target and again, we will provide a more specific update in June , but I would say.
That target I think we're still looking at that as being sort of.
You know in the zone of the target we think is appropriate.
So I think we're still looking at a target very much from a volume perspective in that regard I think the EBITDA per vehicle target is also reasonable I will say that we saw EBITDA per vehicle in our trade Rev marketplace that exceeded that in Q1. So that gives me confidence that that level of EBITDA per vehicle is possible in this marketplace.
And may be even possible to exceed that in this marketplace.
But again, we'll provide more specifics I hope so I think I think as a set of targets.
Generally the right area.
And I think it's plausible and that's what we're aiming for in terms of how we get there.
I think we're at.
Listen we've got to continue to invest in these businesses in terms of product development and so on and so forth, but the business is now we're also generating substantial revenues.
And gross profit so I think we're out of the phase of having.
Losses in <unk>.
You know CAD to being a cash drain so I think.
My expectation is we're going to see more of a linear progression in terms of the profitability, maybe it's not perfectly linear probably it probably sort of ramps up a little bit over time, but.
Frankly, this year certainly at the business unit level, if we exclude sort of a bucket of corporate costs. These businesses will be profitable this year okay.
And I think their contribution in absolute terms will increase from here.
Okay.
Okay Super Thank you very much.
You're welcome Bob Thank you.
Our next question is from Daniel <unk> with Stephens your.
Your line is now open.
Yeah, Hey, good morning, guys. Thanks for taking our questions.
Good morning, guys I wanted to talk about the core ADESA gross margin first maybe excluding purchased vehicles that I think it was down pretty materially year over year. Despite the fee increase can you talk about just the drivers of that and if it was just driven by lower volume is this really the highest 30 is the right way, we should think about core gross margin until.
With the volume more materially pick back up.
Well, Daniel one of the things I'll point out is theres a substantial impact from purchased vehicles. When you look at at net of purchased vehicles. It.
It was down again I'll do this about 49% from 52% net gross profit on a consolidated basis, so but it does look in the ADESA segment, it's much more substantial than that so so as I look at it.
No.
Although I'll say, there's there's.
A lack of scale in the first quarter, especially January and February the gross profit in March was much stronger much more consistent with what we've been experiencing so I don't think theres been a change in the business model. We just suffered from extremely light volumes in the first two months of the quarter. So you know as I look at it I don't know.
And he is broken I think you have a bit of a mix issue in Q1 mix of revenue you have a high impact of purchased vehicles, which was a little bit unusual given the platforms and it did not include purchase vehicles from the ADESA U S. Physical auction business, which is was taken out so all in all.
You know.
Im looking at it and thinking Youll.
Youll start to see what you were experiencing last year as the year moves on and volumes normalize.
Say they'll get back to normal, but normalize from where we were in January and February .
Yeah, if I could add maybe one more comment I'd also say you know the mix shift relative to open lane.
Open Lane is.
Probably our highest gross profit generator across the portfolio and with you know with.
That business volumes being down a set top of the funnel, 60% you know.
That showed up in the aggregate numbers as well.
Got it got it and then a bit more of a conceptual question, Eric I know over the last year, most transactions had been fully digital but but how much of thats a function of just the environment with a lack of inventory just trying to think if prices decline I would think over the last few cycles. You guys have said, how they used to reconditioning and physical assets.
When prices decline, so why wouldn't commercial sellers need reconditioning similar to past cycles or how do you plan to meet those needs for your customers given the pending sale of the ADESA physical locations.
No I guess, what I'd say there is.
Okay.
There is some.
Some continued need for those services that is true.
But I would also say that the fundamental trend the secular trend is towards more and more digital selling.
And.
I think that's consistent across.
<unk>.
All types of sellers in all types of buyers.
So is there a space for that yes, but is that going to diminish over time, yes, that's how I see it and when I look at the.
The types of vehicles, we sell across.
Our portfolio, we sell everything from.
You know high end.
Premium off lease vehicles with very little damage at high prices, all the way down to sub $1000 vehicles that are quite heavily damaged and.
They sell.
No.
And if you're in a purely digital format right. So.
Then there is an element of.
Sort of customer choice, there right, but so I'm not saying there is no need for that but but but I do think that need.
Has been diminishing over time I think ultimately continues to diminish over time, but I don't think it goes away forever.
Goes to zero and I guess, I should say and Daniel let me add out of necessity, we had to look at our.
Capabilities and capacity, we started selling reconditioning services to the buyer we call it retail ready recon.
It would not surprise me if the seller continues to believe that the buyer can handle some of the responsibility for reconditioning. The car. They learn they can get full value for the vehicle, even if it means reconditioning and our marketplace as evidenced by the transaction we're doing.
The buyers are more willing to do reconditioning of the vehicle after they purchase it and I think that will continue.
Got it so it's not just a function of the inventory shortages right. Now that's helpful. And then just a follow up clarifier on the guidance quickly Peter I think you mentioned in the remarks, the $2 65 of EBITDA. This year would be 11% growth if we excluded the equity gains from last year.
The $2 65, excluding the equity gains this year or would that include the <unk>.
$17 million in <unk>, and then any equity gains going forward. Although it does not include any of that there are there are no equity gains in this year's expectations. So the $2 65.
<unk> that.
And on a like for like basis had we excluded that in last year's performance. Then that would then comparing those two numbers is 11% got it.
It does not include the <unk> got it thanks.
You're very welcome. Thank you Daniel Amanda we're out of time I believe there may be one more question. If we could make it one quick question I think we'll try to fit it in.
Absolutely. Our final question comes from Ali for here from Guggenheim. Your line is now open.
Awesome. Good morning, guys. Thanks for squeezing me in so just a more specific question on the implication on open laid off from the sale of the U S physical business to Carvana. So over the years car management has talked about the moat around open lane being the company's physical assets and the ability to offer Oems vehicle reconditioning in storage so.
With the sale of the U S physical auction business to Carvana, how how do you see that impacting your value proposition to the Oems and competitive differentiation versus digital only competitors, who are increasingly focused on the commercial side.
Thanks Ali I appreciate the question I guess.
I guess as a founder of openly I'll comment I don't recall, making the argument that the defense of open Lane was physical assets frankly.
But I would say if I look at the vehicles that actually sell on open later sold on opened late last year.
Close to zero percent of them sold from our physical property or some other auctions physical property.
So I don't know the exact percent 90, 899% plus of them sold from dealership lots.
So I don't think the physical assets are a necessity there.
And frankly, when we looked at when we looked at cars that don't sell and openly where do they.
Go to they get distributed to a wide range of ride wide range of options. We never had the ability to say well less direct all of those to ADESA auctions. So the customer makes the choice as they should.
So I don't think the physical assets are a necessity or a moat on open Lynn I think the moored on openly is.
Build great digital products that work for the seller and work for the dealer and provide a very effective digital marketplace to transact a high percentage of their cars quickly and at low cost and I think that's what open lane is focused on for 20 years.
I think our customers are very pleased with the service we offer and I think this acquisition enables us to redouble, our focus and frankly I hope bring a whole lot more innovations in that channel than perhaps we have done in the past just by being more focused on it so I don't see the dependency.
And I see a lot of opportunity.
With open Lane I think it's an area, where we're clearly differentiated vis vis all of our competitors.
And where we've got our unrivaled set of customers and a compelling and strong value proposition.
Thanks Pierre.
Youre welcome Alex So hey, I appreciate I know, we're a little over I'm going to conclude with the.
A few closing remarks.
Again, the ADESA transaction is expected to close within the next week I believe the transaction will be transformative for car and for our customers and for our stockholders and I remain very optimistic for the future of our company.
With a smaller nimbler and more asset light company, we intend to accelerate a more focused digital strategy to capture what we believe to be the considerable opportunities for growth both in and beyond our current market.
Yeah.
The first quarter was challenging there's no question about that when we are facing a 61% decline in off lease supply relative to the same quarter last year, that's a significant headwinds.
That said I believe we made meaningful progress in many many areas of our business, particularly in our dealer to dealer business ended the FC.
We have guidance to deliver $265 million and adjusted EBITDA. This year that represents 11% growth on a like for like basis and that'd be accomplished in spite of what I'd characterize as a very adverse environment that affects our industry and our business.
I don't love the number but I'm pleased with the performance in the face of the headwinds we have.
As I look past this year I'm very excited and I think the team is very excited about the opportunities that lie ahead for our business. We intend to capitalize on what is a secular shift towards digital marketplaces by both commercial and dealer customers and both on the seller and buyer side of our industry.
And in addition, we expect to see a recovery in commercial center volumes that will play out in the years to come so.
So I believe we have a significant opportunity for growth, we have differentiated platforms, a strong customer base and a large market space in which to innovate and invest.
So I'm looking forward to providing more details on that in our.
And on our future plans in an analyst day update we intend to send out a save the date after we.
Close the transaction and we're targeting sometime in June .
And with that we'll end today's call I look forward to reconnecting on our next conversation and thank you all for attending and thank you all for your questions. This morning.
This concludes today's conference call. Thank you for participating you may now disconnect.
Okay.
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Okay.
Yes.
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