Q3 2022 KAR Auction Services Inc Earnings Call

Ladies and gentlemen, thank you for standing by the conference will begin shortly please continue to hold and thank you for your patience.

[music].

Good day and welcome to the car auction services third quarter 2022 earnings conference call. All participants will be in a listen only mode should you need assistance. Please signal a conference specialist by pressing Star then zero.

After todays presentation, there will be an opportunity to ask questions to ask a question you May Press Star then one on a touchtone phone to withdraw your question. Please press Star then two please.

Please note. This event is being recorded I would now like to turn the conference over to Mike Eliason, Treasurer, and Vice President of Investor Relations. Please go ahead Sir.

Thanks, Matt.

And thank you for joining us today for the car Global third quarter 2020 earnings conference call today.

The financial performance of our global for the quarter ended September 32022.

After concluding our commentary we will take questions from participants before gear 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 1985.

Investors are cautioned that such forward looking statements involve risks and uncertainties that may affect our business prospects and results of operations and such risks are fully detailed in our SEC filings you 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.

It is also available in the Investor Relations section of our website.

Now I'd like to turn this call over our global CEO , Peter Kelly Peter.

Thank you, Mike and good morning, everybody I'm delighted to be here. This morning to provide you with an update on car global <unk>.

During today's call I'll provide you with additional information and details related to the following.

Our third quarter performance.

Our view of the current market factors that continue to impact the automotive industry and.

And a summary of our capital allocation activities.

I'm going to speak about our business in two segments, our marketplace segment, which we formerly called the ADESA segment, and our finance segments, which we formerly called the AFC segment.

To begin Q3 was an important quarter in the history of our company.

He was our first full quarter since we completed the divestiture of the Augusta U S visit blocks of business may.

What's the true beginning of what I believe will be a bright future for car, that's a more asset light digital marketplace company.

I'm pleased with the results that we produced across the organization, especially given what continues to be a very challenging industry and economic environment.

During the quarter, we increased revenue total gross profit and adjusted EBITDA, We met our cost reduction targets and we reinvested in the platforms and technologies that will accelerate car and our customers into the future.

And while these results do not reach the level of performance that we anticipate delivering a more normalized industry environment.

I do believe that the clearly demonstrates the strength of our business and our ability to execute a highly focused strategy.

So let me touch on some of the specific highlights in our third quarter results.

Paccar overall, we generated $393 million in revenue that was a 13% increase versus the same quarter of the prior year.

Revenue, excluding purchased vehicles increased 18% versus same quarter prior year.

We generated a total gross profit of $183 million.

This was an increase of 14% from Q3 of last year and this gross profit represented 52, 8% of revenue excluding purchased vehicles.

This resulted in Q3, adjusted EBITDA of $69 5 million.

That was an increase of 4% from Q3 of last year. However.

However, I would note that Q3 of last year included $10 million in realized gains from the sale of securities. If we were to adjust for this the adjusted EBITDA increase would have been $12 $9 million for the quarter or 23% over the third quarter of last year.

Q3 also represented a sequential improvement in adjusted EBITDA compared to Q1 and Q2 of the current year.

Specific to our marketplace segment, we sold approximately 314000 vehicles in the quarter.

Top of funnel supply remaining relatively strong versus our expectations with the number of vehicles offered by sellers in the quarter exceeding 2021 levels.

However conversion rates were lower than a year ago. This reflected the fact that used vehicle values were in decline for most of the quarter and buyers were less willing to pay the higher priced sort by many sellers.

Notwithstanding these dynamics, we were able to increase occupancy revenue per unit sold by 12% to 280 $283 and we also increased gross profit per vehicle to $320. This was an increase of 14% over the third quarter of last year.

And our finance segments, we experienced another solid quarter performance as AFC continues to grow its floorplan snacks business, our finance segment generated revenue of $99 million in the quarter, an increase of 31% over Q3 of last year.

This was driven by 13% growth in the number of transactions and a 16% increase in revenue per transaction, which increased $250 for the quarter.

Interest income represented 54% of AFC revenue for the quarter that is 700 basis points of an increase from Q3 of last year and is consistent with the higher interest rate environment that we see today.

This also demonstrates that a higher interest rate environment can be positive for AFC.

So overall I think there's a lot to be pleased about in the third quarter performance, particularly in light of what has continued to be a challenging environment.

The steps, we have taken to transform our operating model reduce our cost structure and adventure advance our digital vision beginning to take shape within our results.

To be absolutely clear I do not believe that our third quarter results reflect the high level of performance that I'm confident this company is capable of delivering in the future. However.

However, I do believe we are demonstrating our ability to execute on the fundamentals of our business.

And as a whole I believe our results provide an outline of even stronger performance as the industry turbos settled and as we continue to advance our digital strategy.

So now I'd like to highlight a few areas of progress in the quarter, where we are advancing that strategy and I believe will benefit our performance in the future.

The first is platform consolidation.

One of our primary objectives is to simplify the customer experience and increase engagement across our marketplaces.

In the United States, we have now successfully combined the backlog cars the car week marketplaces into one digital venue and.

In October we deployed a new auction format within the backup cars platform, which builds upon the previous par with format complements the existing marketplace formats within backlog cars.

So we now offer our sellers and buyers the choice and flexibility are two distinct formats. Our marketplace format for vehicles can be offered in purchased throughout the day immediately as they are loaded in an auction format for groups of vehicles are set for time sales, which.

Which are currently scheduled for twice every week.

We are focused first on deploying the auction format in the markets for car we've already existed.

Once this is complete we expect to get began a national rollout of this format to all remaining markets in United States.

In Canada. We've also made significant progress on our efforts to consolidate the trade Rev and a dearth of market places, we launched a beta version of that combined marketplace in July to a limited number of customers and the feedback has been positive.

Tober, we began expanding that beta to a broader base of dealers with additional new features and capabilities added.

As these consolidation efforts progress we expect increased engagement from our dealers increased efficiency within our technology development and operations and improved results across our marketplace business.

The second strategic focus area I'd like to cover its pricing.

We continue to make some adjustments to pricing in the third quarter and we were successful in getting a number of fee increases in new revenue streams put in place in both our dealer and commercial business.

Some of these had a positive impact in Q3 and are reflected in our unit economics, we expect others to become effective in Q4.

To be clear regular price increases are not a key component of our strategy for growth.

The fact that we've been able to make these price increases demonstrates the strength of our offerings and the strength of our longstanding customer relationships.

The last focus area I would like to speak to is cost management.

The ADESA transaction created a catalyst to restructure our business to reflect a more asset light digital operating model and to help respond to the current realities of our market.

We made a commitment to reduce our annual SG&A run rate by $30 million and we are on track to achieve that goal ahead of schedule.

This positions us to exit the year below $400 million in terms of an annual SG&A run rate we.

We do expect some quarter over quarter fluctuation of certain cost reduction initiatives may require short term cost increases to help achieve sustained savings thereafter.

Yeah.

It's also important to note that achieving our 2022 cost savings target was was only a starting point there.

Disciplined cost management and a focused investment strategy will remain a priority for this business going forward, we have a roadmap in place for continued improvements in our efficiency and effectiveness and these will deliver first of further cost reductions in Q4 and into 2023.

Those savings should help us continue to focus our investments into the technology talents and resources necessary to power cars long term vision and strategy.

I'd like now to look towards the future and provide some details around the industry outlook the macro environments, particularly in the areas of new vehicle production used vehicle pricing wholesale used vehicle supply as well as the outlook for commercial volumes.

And my comments are based on our assessment of public publicly reported data as well as recent discussions with some of our largest customers.

New vehicle production and supply continues to be a challenge and it's taking oem's longer than expected to solve their supply chain issues.

In Q3, some Oems did show increased production and new vehicle sales.

But a significant number of them still have fewer sales in a year ago.

My assessment remains but the supply side issues appear to have bottomed out when viewed on an industry wide basis.

However, I also think the recovery in production will be more gradual than most experts have predicted.

Increased new vehicle production, coupled with a higher interest rate environment, and a weakening economy will likely put downward pressure on new and used vehicle pricing.

Over the course of Q3, we observed a steady decline in used vehicle values in the industry and the industry and at a rate that is above normal for this time of year.

We expect this decline in used vehicle values to continue through at least your apps.

Ultimately I believe that a decline in used vehicle pricing will be a long term positive for our business as I believe it will allow more vehicles to flow into the wholesale channel.

In the near term however, a declining market is often characterized by lower conversion rates and this can be a near term headwind to the business.

Yeah.

And industry wide lack of wholesale used vehicle supply also remained evident in Q3.

For example, physical auction volumes, which remain a good proxy for industry volumes were down 8% below the third quarter of last year and were 37% below the pre COVID-19 levels of Q3 2019.

In fact Q3 of 2022 was the second lowest quarter for physical auction volume since the pandemic began.

So I'm very encouraged by the fact that we can deliver a strong performance in this environment, where industry volumes are still well below normal levels.

I do expect those volumes to increase over time, although I think it's prudent to expect that this will be a gradual increase not a step function.

And I believe that our focus on being a digital marketplace will enable us to grow faster in the longer term as volumes recover in our industry.

A key driver of the anticipated volume increase will be the supply situation relating to the volume of vehicles being offered by commercial sellers, particularly in the off lease segment.

We continue to see fewer off lease vehicles being returns compared to one year ago, but the level of that decline is lessons.

From our own analysis, the equity gap, which is the difference between the market value of maturing lease and the residual value of the lease contracts has declined meaningfully in the third quarter How's.

However, a further decline is likely needed in order for more of those vehicles to start to flow into the wholesale channel.

I am confident that leasing will remain an important element of OEM and dealer sales strategies and that our strong footprint with off lease vehicles will be a significant positive for this company in the years to come.

So my ongoing discussions with our customers I believe that in the future our customers will seek to sell an even larger percentage of their portfolios digitally than they did pre pandemic.

Okay.

I also want to comment on how the current environment impacts AFC.

As you as used vehicle prices continue to decline and as interest rates increase this may tend to increase risk within our finance business. However, AFC has best in class safeguards and processes in place that utilize all of the data that we capture the flag dealers that may be under stress within their business.

So while we do anticipate some level of increased risk as we enter 2023, we do not expect it to return to pre COVID-19 levels and we believe that AFC will continue to produce strong results.

Through year end and into next year.

I'd now like to provide some insight on my expectations for the fourth quarter relative to Q3.

On the positive side, we expect to benefit from the full quarter impact of our cost and pricing actions that we took in Q3.

We also have this additional cost and pricing actions that will become effective in Q4.

On the negative side Q4 industry volumes have historically been weaker than Q3 volumes.

Also foreign currency was a negative in Q3 and that is expected to be even more evident in Q4.

Irrespective of the Q4 outcome I'm highly focused on executing our strategy building on the positive momentum of the third quarter and positioning the company for growth in 2023 of the ops.

Okay.

I'd now like to provide a recap of our capital allocation activities.

As I mentioned on the last call. The ADESA transaction itself generated approximately $1 $7 billion of cash net of taxes and fees.

In the second quarter, we utilized over 900 million to repay our term loan b as well as amounts outstanding on our revolver at that time.

During the third quarter, we repurchased through a tender offer 600 million of our senior notes.

This leaves us with $350 million in senior notes that are still outstanding.

Also since the closing of the ADESA transaction, we have repurchased approximately $12 6 million shares of car stock at a total price of $192 million.

I want to emphasize that our projections show that car will continue to generate cash going forward with an asset light model and considerably more debt, we have less need to use our cash for capex that is tied to physical facilities are for servicing our debt.

This should be a positive for us given the current macro environment.

So to summarize my key messages for today.

In Q3, we delivered an improved performance compared to a year ago and also compared to Q1 and Q2 of this year.

I was generally pleased with this performance and I believe that it begins to outline what this company is capable of delivering as volumes recover.

In our marketplace segment, we increased revenue and gross profit compared to one year ago. We also increased our revenue per unit and our gross profit per unit sold.

We experienced another solid quarter performance and our finance segments with AFC meaningfully growing revenue and revenue per unit.

In addition to the financial results, we made significant progress in areas of platform consolidation pricing and addressing our cost structure.

Volumes continue to be a challenge in our industry. However, as we look to the future. We expect new vehicle production to increase used vehicle pricing to decline and a gradual increase in wholesale used vehicle volume overtime I.

I believe that our digital focus will enable faster growth and that type of environment.

I am excited and energized by the many opportunities ahead and I believe that we have a significant opportunity for long term growth, we have a differentiated offering a diverse and expanding customer base and a large addressable market in which to innovate and invest.

So with that Eric will now provide more provide you with a more detailed review of the financial results for the for the third quarter Eric.

Thank you Peter.

First I would like to point out that foreign currency had a negative impact on our third quarter results revenue was negatively reduced by $12 million net income was reduced by approximately $1 million and.

<unk> EBITDA was reduced by one and a half million dollars in the third quarter as compared to the prior year.

I would also like to give more color on our SG&A and the evidence of improvement in our cost structure that is not obvious in the third quarter financial statements.

We have provided a schedule of SG&A by quarter for 2022. This schedule provides additional detail for SG&A by segment, what SG&A was added due to the acquisition and the noncash and other costs that are recorded in SG&A that do not impact our reported adjusted EBITDA.

When we speak of eliminating over $30 million in annual SG&A, we're focus on adjusted SG&A.

All add backs in computing adjusted SG&A are the same as the add backs for computing adjusted EBITDA.

We have provided a schedule of adjusted SG&A for our continuing operations in the Q3 earnings slides that were posted yesterday.

The headline result is we have reduced the adjusted SG&A run rate in Q3 to $96 million per quarter from $104 million in Q2 and $102 million in Q1.

We are excluding noncash compensation in this analysis of SG&A as you can see in the earnings Slide there was an increase in noncash compensation in Q2. This relates to the recognition of the impact of a gain of the gain on the sale of the U S. Physical auction business on the expected award of the 2020 and 2012.

One P. R. S. <unk> grants to employees there have been no increases in total annual noncash equity grant value. However, the timing of recognizing extension of our financial statements was impacted by the timing of our financial performance.

We also have significant severance associated with the termination of certain employees as a result of the sale of the U S physical auction business and the realignment of our organization to match the asset light digital marketplace business that remains at car.

This severance was recognized in the other adjustments included in the SG&A reconciliation I expect we will have additional severance going forward as well.

Wherever that chevron's will be related to additional cost savings actions and not the impact you see in the Q3 run rate.

In addition, the severance we also incurred consulting fees and contract termination costs in the second and third quarter related to separation and reorganization activities. Following the sale of the U S physical auction business.

Fees and expenses are included as SG&A, but we have included them in other adjustments in the Reconciliate reconciliation of adjusted SG&A in our earnings slides.

One major initiative that has been announced to our employees and will provide additional savings and adjusted SG&A in future quarters is related to establishing a global shared services organization.

We have recently agreed to terms with two offshore firms to provide resources to support our back office functions for car global.

This will impact over 300 positions in the U S and Canada.

We have notified the affected employees and provided appropriate severance packages that are payable upon transition of their roles to the global shared services organization. We expect to begin the migration of these roles over the next three quarters. The impact of this initiative is not included in our realized savings in SG&A for two.

22, the fact that our marketplaces are digital and generally not tied to a specific location allows us to move a number of support functions offshore without impacting the customer experience. In fact, we believe the use of our global shared services organization will improve the efficiency and consistency of handling transactions.

And ultimately improve the customer experience. Our initial global shared services program is expected to generate over $10 million in annual savings from our current cost structure. We expect this to be realized as we migrate to the offshore model in 2023.

Another topic I would like to cover in more detail is the amendment and extension of our securitization facilities at AFC.

In September we completed the amendment of the U S and Canadian securitization facilities as part of the amendment, we increased the capacity of the U S securitization by $300 million to a total of $2 billion.

The Canadian facility remains at 225 million Canadian dollars.

The amendment to extend its the securitization facilities to January 31 2026.

As part of this process, we successfully negotiated changes to terms that allowed us to reduce the company's funding of certain receivables. Although the funding did not occur until the first week of October this reduce the on balance sheet portion of loans by $70 million freeing up additional working capital that was locked up at AFC, while the credit.

Markets overall are quite challenging right now.

Performance of the AFC portfolio and the discipline demonstrated by the AFC team made the amendment process fairly easy.

Most importantly, the financial terms of the agreement remained consistent with the terms prior to the amendment. The sizing of the facility is sufficient to fund the growth expected in the portfolio over the next two to three years.

As Peter mentioned and we disclosed in our earnings release, we have purchased $100 million of car stock in the open market over the past four months earlier. This year, we put in place a <unk> five one plan as part of our existing share repurchase program in October we completed the remaining approved purchases under that.

That can be five one plan as of today, we have $126 $9 million remaining on our share repurchase authorization that expires on December 31 2023.

Given the challenges in the debt capital markets and our previously disclosed intent to repurchase or redeem an additional $150 million in car bonds, we do not expect to acquire additional shares over the next quarter or two.

At this time, we are focused on building, our cash balances and conserving capital.

We'll be looking for opportunistic windows in the debt markets to extend our revolver maturity date and put in place a more permanent debt structure for the company going forward and most importantly, we continue to focus on maintaining minimal net debt that is more appropriate for an asset light business like car.

As we continue to rightsize, our business and align with the asset light marketplace business that is car today I am pleased to announce that on Monday of this week, we closed on the sale of 57 acres of excess land in Montreal. This.

This transaction will result in a gain of approximately $32 million U S. This gain will be taxed at 50% of the statutory rate in Canada or about 13%.

This transaction will generate approximately $35 million of net cash proceeds after income taxes.

The realized gain will be reflected as a separate line item in operating expenses in our financial statements in the fourth quarter for clarity this will be a reduction in operating expenses.

Also there is not a requirement that the net proceeds from this transaction be used to reduce debt.

As I wrap up my comments, let me reiterate our focus as we are faced with a challenging supply situation in a period of transformation for our industry and our company.

Cars right sizing its operations with a focus on being asset light.

Drawn cash generating digital marketplace focused businesses.

As we continue to transition away from the ADESA U S. Physical auction business, we will have opportunities to further reduce our overhead cost structure, we have paid down over $1.5 billion in debt this year, reducing our annual cash interest payments by approximately $70 million. This is particularly important as we face a period of increasing <unk>.

Crist rates had we not repaid our term loan b in its entirety, we would've been looking at an increase in cash interest expense next year of nearly $30 million.

Having our balance sheet in a great spot transforming.

Our business to focus on digital asset light marketplaces.

And reducing the SG&A to support these businesses is timely given the changing economic environment. We are facing I am confident car is prepared for the road ahead.

That concludes my prepared remarks, Peter has one more item to cover before we go to Q&A.

Thank you, Eric and before we get to Q&A I want to formally announce that Eric will be retiring at the end of 2022, making this his last earnings call as Chief Financial Officer of cargo book.

Eric has been an incredible leader and CFO for more than 15 years. He has led the company through many complex acquisition and divestitures and advanced our capital investment strategy that has helped helps car navigate change captured great opportunities and create meaningful shareholder value.

Eric has also always been a positive culturally cultural leader here at car, our skills and transparent financial operator, and a tireless advocate for the interests of our investors and shareholders.

We are conducting a national search for Eric's replacements and hope to fill the rule prior to Eric's retirement.

If these timelines do not a line we have a strong internal bench strength a car to lead the function on an interim basis until a permanent CFO is named.

We will provide additional details and updates in due course.

But for now let me just thank you Eric for your incredible service to this company and to our investors I wish you all the best for relaxing and enjoyable retirement Sir.

The earned it and with that let's turn to the group for questions. Thank you.

We will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone.

You were using a speaker phone please pick up your handset before pressing the keys.

At any time. Your question has been addressed and you would like to withdraw. Your question. Please press Star then two at this time, we will pause momentarily to assemble our roster.

And our first question will come from John Murphy with Bank of America. Please go ahead.

Good morning, guys and Eric Congratulations I hope you get to a risk because I know you've been working hard for a long time so congratulations.

Thank you John .

A first question here.

There's a lot there's a lot going on here in the industry and there's a lot going on in the transition of the company. So it's a lot of moving pieces. So it's I think a bit tough as people are looking at this to try to get a sort of a constant variable or something to kind of work off of to understand exactly how the company and the industry is going to look in 2023 plus.

When do you think we're going to get an outlook for 2023.

And what do you think that's sort of the major sort of focal points are going to be for you as you communicate that.

Not looking for specific answers, but you know as you communicate this.

People are looking for sort of some guidepost in ways to think about things structurally for this company and the industry going forward and there's a lot of moving parts. So when will we get that and how do you think about that.

Well, thanks, John I appreciate that question and I guess you are correct. There is a lot going on we've got.

A pandemic that led to production issues, which the industry. It seems to be struggling to recover from in terms of new vehicle production.

Mining used vehicle values everything is going on with off lease and so on and so forth.

You know obviously, we're deepen our planning efforts for 2023.

I remain optimistic for the prospects for the business.

I don't plan to go into specific detail on this call, but I would expect to provide more detail in.

Our next earnings call, which I think in early February .

We talk about expectations for 2022 at that point.

Again, I think if I look at our Q3 results in my view they demonstrate.

An underlying level of performance.

In a challenging environments that I think we can build on for the future that's kind of how I view. It we've got a finance business is performing well I expect that to continue to perform well in the future.

Through all of 2023.

And we've got a marketplace business that has obviously faced significant volume challenges.

I expect that over time, those volume channel challenges will ease, but I expect it to be a gradual change.

And then in the midst of that we've obviously got platform consolidation, we've got cost actions pricing actions, where I think we're building in sort of.

Sure.

We're taking actions that will benefit us quarter after quarter after quarter as we look to the future. So I see it as kind of you know.

At least endeavoring to build upon that and obviously growing the business sustainably over time, but I think when I look to the macro perspective, I think the new vehicle production impacts the recovery wholesale volumes those changes will be.

I would say gradual changes not a step function.

Okay, and then just a follow up on your question on your comment on pricing.

The backdrop of those kind of constraints on wholesale volumes and the automakers clearly not being able to ramp up production, even as much you might have thought a couple months ago.

Supply will remain.

Constrained on the new vehicle side, and we'll see the one to six year old car fleet shrink probably for the next three or three or four years. So I'm just curious as you as you look at that backdrop, how do you think about.

Pricing.

First.

It seems like it Shouldnt go down if there's that kind of supply constraint and then second your opportunity set in that kind of environment to gain incremental revenue.

Per unit as well as maybe gain market share.

Yeah.

Again, Thanks, I think John by pricing, you mean, the pricing for our services not the not the value of used vehicles.

Actually both both opportunity I mean.

Maybe first on the on the vehicle pricing I'm, sorry, and then second your opportunities to drive revenue through pricing and other actions sorry, Okay got it so in terms of used vehicle values.

We've seen a fairly substantial decline in used vehicle values in the wholesale market in Q3 prices declined at pretty much every single week of the quarter.

If anything the rate of decline accelerated later in the quarter continues to continues to decline here in Q4.

And we're seeing that pricing decline now show up in your first to start to show up in used vehicle pricing at the retail level and now I believe it's beginning to show up in new vehicle pricing at the retail level. So I think the combination of a slight increase in production, but also increased interest rates has been putting downward pressure on vehicle values I think that will continue.

Okay, I don't expect used vehicle values to fall down to pre pandemic levels.

The constraints, you've talked about but I do think they'll continue to decline at least till the end of this year and then we'll see what happens after that.

You know as those values decline that creates an opportunity for more vehicles to start to flow into our channels again, particularly off lease.

You've got to assume the equity gap, which is the difference between the residual value in the market value of the vehicle as those numbers come closer together I think incrementally more vehicles can start to flow and again I expect that to be very gradual.

So again I think you know.

I think you used vehicle prices continue to decline gradually at least through the end of this year in terms of the pricing for our services.

Obviously, we've taken some actions there.

We have a mix of commercial and dealer business. Some of this requires.

Negotiation with some customers in conversations with some customers.

Say generally John Hope, we look for first is there an opportunity for us to potentially do more for the customer in exchange for.

<unk>.

A greater revenue opportunity right. So when we look at those types of opportunities and I think some of them some of it reflects that.

We just look at how what is the appropriate pricing given current volumes.

And that might be different to what it was three years ago when volumes were higher so we have that discussion.

So again, we've been I think strategic and disciplined around that but I've been pleased with the progress we've made.

Okay. Thank you very much.

Thank you John .

Our next question will come from Ryan Brinkman with Jpmorgan. Please go ahead.

Hi, good morning, Jonathan.

Project on for Ryan.

Eric I wanted to convey my best wishes as well.

Thank you Roger So maybe yes.

So maybe like two starting to open lane.

It looks like just following up on John's comments.

The outlook for volume there.

And is likely to be tough for a while.

Cox automotive Spinouts estimates where they.

We expect another step down monthly volumes before growing again.

So curious if you if you think that's the case as well.

And is there an opportunity to right size, our restructure that business, even further going forward or has some of that already happened.

Any thoughts on that would be helpful and I have a follow up thanks.

Yes, I guess.

Thanks, Roger first of all and as I mentioned in my remarks.

<unk> volumes declined in the third quarter, but the rate of decline was less than prior quarter. So I expect.

I expect that to.

To bottom out here is my expectation.

<unk>.

I'd say on the you know we've talked about cost action security, we've looked at businesses like open lane and other businesses. So some of the cost actions that we've taken are in those in those parts.

The organization.

So that's something we continue to look at.

Obviously, that's also an area, where we had comp we've had conversations with customers with respect to pricing and services. So.

That's the situation with respect to that I would say that.

I think.

The key determinant of the future performance of that business I would say there are two factors. One is the rate of decline of used vehicle values and do off lease vehicles start returning into the marketing funnel and greater volumes.

I'd say, we're seeing the very very beginning of some evidence of that but it's very small it's not yet material, but it but it certainly has started to trend in that direction as vehicle values have come down.

And the second one is the new new leases new lease originations and obviously 2025, there will be fewer leases sorry, 2022, there'll be fewer leases written in 2022, then the war in prior years and that reflects I'd say two things one is fewer new vehicles produced and manufacturers feeling that they don't need to put incentives on vehicles, which all.

Often drive.

Attach rate.

Again, I expect both of those things to start to change as well I expect production of new vehicles to start to increase.

Albeit more slowly than experts have predicted I also expect that in a more challenging economic environment that environment manufacturers will.

At some point have to start increasing their incentive spend on vehicles as well and that will likely I think start to drive an increasingly lease attach rate over time.

So again I think leasing will remain a very important.

Area for our business I think it's one where we are significantly differentiated vis vis our competition given our strong footprint with wood that segments.

I would agree that that's not impacting.

Impacting our financial performance today like it was when the volumes were stronger, but I think we're sort of.

At our very very close to the bottom and I think it will improve over time.

Got it that's clear and maybe just on you know on.

On the GPU increased in the quarter.

You cited mix as a factor as well, but you also cited some price actions.

Could you give us some more color on that.

Or are there any other factor also that drove the uptick from <unk> to <unk> on the GPU in it.

And how should we think about the GPU trends you know.

The fourth quarter or maybe early next year based on all the price action.

Mix changes that happened.

Yes.

Oh, Thanks, Rajat GPU was various gross profit per unit sold in the marketplace business is very strong in Q3 $320.

That's well above the sort of the target we established at our analyst day presentation, which was in the sort of 260 ish kind of range.

I'd say a couple of things when the volume of transactions is low.

The GPU tends to increase because of service revenue on vehicles that we're not we have other services that aren't attached to actually selling vehicles.

So that that can drive.

Some of the GPU increase.

I think the pricing actions as well, obviously have a positive impact there. So that's that's for sure.

I guess, what I would say is the strong GPU performance in Q3 gives me confidence that the numbers we put in place in our analyst day are very very achievable and sustainable over time, although.

I don't necessarily necessarily expect that they would stay at the sort of $320 per unit level that we saw in the third quarter.

But I think we're sort of we have a significant cushion above the range that we discussed in our analyst.

Got it.

Okay. Thanks for all the color.

Back in queue.

Thank you rich.

Our next question will come from Gary <unk> with Barrington Research. Please go ahead.

Hey, good morning, everyone.

Morning, Gary couple of questions here can you can you give us some.

Level of the decline in conversion rates in the quarter and how it is.

The conversion rates were the same as last year, what would that have done to you lifted vehicles sold.

Good question, Gary I like that question. Thank you for that.

I spoke on the last earnings call about our conversion rates, which were lower and so what I would say in essence is that situation for the most part continued through all of Q3, we did see I think a little bump in conversion rate in August but for the most part it has been below last year.

I would say you know conversion rates vary by channel, but I would say.

Something like 10% below.

So if a channel had 60% last year its 50% this year okay.

And as a sort of a rough order of magnitude of it I also would say that is very consistent with what I've seen.

Certainly when I've looked at sort of physical auction data conversion rates have been low.

Low there as well pretty much for all of the quarter lower than normal.

Gerry you May know, we also see typically higher conversion rates on commercial versus dealer. So some of it may be mix related but what I would say roughly 10 points. If you think of a channel where you know conversion rate was 60%.

And that has declined to 50% and that is.

Is that something like 18% headwind to sales volume something like that so it's pretty significant now I would also say <unk>.

Candidly with the benefit of hindsight.

Last year's conversion rates were characterized by a very tight market for used vehicle supply and significant used vehicle depreciation.

So I.

I would I would say last year's conversion rates were somewhat above normal and this year's conversion rates are below normal and a normal conversion rate is somewhere in between and I'll.

Say close to halfway between the two would be my best guess.

Okay. Then just a couple of more you talked about what youre doing with backlog cars and car wave two formats, one of which I wrote down as a marketplace and then you go to an auction could you just maybe elaborate on that or are you gaining our buyers the opportunity pre auction to buy these cars.

Through our listing service and if so how is that price determined.

Yeah, So I guess to sort of provide a little bit more detail on that the car ways business.

Their sales format was an auction format had ran two days a week.

And vehicles were sort of pre loaded into the auction where dealers could view them.

Research them place advanced bids, but they actually couldnt buy them, Okay, and then the bidding opens for a two or three our window.

On a Monday and a Thursday and then the cars are sold at the end of that window that that's essentially how the format works.

Works very very well.

<unk> really liked it and got great results for their customers and we felt it was important to replicate that capability in our platform. So that's what we've done okay in that complements the existing <unk>.

Backlog cars bid ask marketplace. So now when a dealer loads a car they choose which format that they want a loaded into this one and loaded into the <unk>.

The marketplace, where it's available immediately can be bought at any time or they want to put it in the next scheduled auction okay.

That's the choices they make.

And.

Obviously, if the car is unsold at the end of the auction they can push it over into the marketplace.

But that's essentially how it works and again as I said, our focus right now is <unk>.

Consolidating that migration in the markets, where car we have already existed as principally California, Arizona and Texas.

And then we look to.

Roll that format.

Across the remaining 48 states.

In 2023, so we're excited about that we think this will be a positive for the business and will enable us to address an even bigger segment of the market.

And then just one last question here I just want to make sure in terms of what you had guided before for EBITDA at $2 45 to $2 65.

Given what you how you discussed you think.

The impacts of what's going on will impact Q4 is that range still good and more tended towards the low end of that range.

I guess Gary.

No.

First of all I'd, just say our policy is not to provide quarterly guidance, but I will provide some remarks here just on.

How I see the situations. So if I think about the year overall 2022 overall.

Clearly the environment the environment has been a challenge for the entire year.

And again I believe our Q3 results show, we're responding well to those challenges.

I would also say you know in most years there was some seasonality in Q4 is often weaker from a volume perspective in Q3, that's not unusual.

You know it doesn't always happen, but it is it is more common that that's the case.

And there is also reported we had foreign currency headwinds in Q3, we expect those to continue in Q4, they may even be a little bit more materials was in Q4 than they were in Q3 to be honest.

Now I'd also say, helping offset those are fourth quarter will benefit from the cost the full quarter impact of the cost savings taken in Q3 as well as the pricing actions taken in Q3.

And we'll also have further cost and pricing actions that become effective in Q4, okay.

Finally, as Eric mentioned, our digital strategy has enabled us to take advantage of some ex real estate in Montreal and divest.

Some excess land up there with a gain of $30 million. So.

Yes, with this gain included I'm very comfortable with our previously issued guidance.

I will say, we are focused on finishing the year strong and I look forward to reporting the final numbers in the new year, and obviously, we'll do that with them without the gain.

Okay. Thank you.

Youre welcome Barry.

Our next question will come from Bob <unk> with C. J S Securities. Please go ahead.

Good morning, Thanks, and congratulations to Eric from Us as well.

Thank you Paul I wanted to.

Absolutely I wanted to talk about what you're seeing at the dealer level of provision for credit losses at AFC has remained low it's been low throughout the pandemic and everything.

You mentioned you may not expect it to get back to the typical kind of one and a half or 2% long term expectation, maybe give us a sense of.

You know what you expect I guess over the next you know year or two for those provisions and where you see that trending and what the drivers are there.

Yes. Thank you Bob Good question and there's no question in the past couple of years AFC has been a very strong performer.

And I'd say, we have seen lower than historical levels of risk.

Both in terms of frequency and severity in that business.

I'd say, given the changing macro environment, I'd say, specifically higher interest rates and also declining used vehicle values I think it's prudent to expect some increase in the risk environment there but.

But I will say that our expectations are that that would be relatively moderate and something that's manageable in the context of the numbers and projections that we've shared previously.

And as you mentioned historically AFC.

The historical risk with somewhere in the range of one 5% to 2% of the outstanding loan balance we have been well below that this year.

I think with a more digital model in what I would say greater access to data and I think stronger controls I think it's possible that the new normal will be below that historical range.

<unk>.

Time will tell we'll have to see how it plays out exactly we are modeling a modest increase in risk in our preliminary 2023 projections, but we think it can be very manageable and we think it will also be offset by just the underlying growth in the business.

Okay, great that makes a lot of sense. Thank you and then.

Just trying to get a sense I know, there's a lot of.

Moving parts from the macro but excluding if you can for a second there kind of a used car.

How you index, so to speak impact on G.

G M. P. How are the mix of units trending or where where is the sweet spot for backlog car wave and how.

How are those units relative to kind of pre COVID-19 on <unk>.

Normalized.

Our used car value index.

Bob. Thank you just wanted to clarify your question are you talking about the vehicle values themselves are you talking about the mix in our volume between dealer and commercial.

The vehicle values at dealer, if youre still youre, saying a car a pre COVID-19 was you know I think the numbers, but we have been for five to $7000.

G M B a pre.

Pre COVID-19 backlog and then you've added both.

The value of the vehicle with the used car prices going up and an increased mix issue.

Move the mix of the dealer vehicles in that marketplace. So trying to get a sense of the mix of the vehicles within the dealer to dealer marketplace and how thats trending.

Adjusting for the massive change in used car values.

Oh, well. Thank you Barb appreciate that so.

I guess, what I'd say generally we have seen in all of our marketplaces and appreciation in the value of the vehicles themselves.

Really kicked off early last year, it sort of peaked out in.

Probably March of this year and has then Flatlined and ultimately started declined from about.

Made to the present.

And I'd say today rule of thumb, probably vehicle values are still 30 ish percent, maybe a little more above their pre COVID-19 levels. So that is sort of generally increased <unk> in all of our marketplaces.

From a mix.

Perspective difference.

Market places have had a different mix of vehicles, so backlog cars probably.

Due to the way it sort of.

Started and also specific format.

That that had a real focus on I'd say sub 15000 dollar vehicles, okay with probably edge me, a median GMB today of around nine or $10000. Okay.

Whereas trade Rev and car waves would probably have a broader a broader mix of vehicles and a median GMP that's higher.

I don't know 15, 16 and $17000. Okay. So with the emerging of trade Rev backlog cars and power ways. We're now combining those that will bring up the median GMB there as well so.

That maybe will give you a sense of the sweet spot of these marketplaces.

You know when I look at our dealer to dealer business.

One of the interesting facts as the vast majority of vehicles that are sold between dealers are in that sort of sub 15000 dollar category that is where most of the volume is so I think we're very well positioned in that marketplace and really deliver exceptional.

<unk>.

The exceptional outcomes to those customers in that in that segment, but I will say we are in time.

Also focused in increasing.

The GMT and bringing more high value vehicles interest into that channel.

Okay. That's great. Thank you very much.

Youre welcome Bob.

Our next question will come from Daniel <unk> with Stephens. Please go ahead.

Hi, guys. This is Joe on for Daniel Thanks for taking our question.

Thank you Joe.

So I was wondering about the strength in the services revenue line saw a $12 million sequential increase this quarter I was wondering if you could provide any color there and if this was driven by the Carvana services agreement.

Joe Thank you.

Yeah, I'll, let Eric take that question Joe Yes. The services revenue is driven a couple of things first I would I would point to repo volumes.

While we are selling the repos in the U S through our digital marketplace at the same level. We used to we are already in and par is key.

<unk> to the growth in the revenue and that's really helped us as.

As they've begun.

The captive finance companies and banks have become processing more delinquencies and there are more defaults on an auto loans second we did see some increases in transportation and I would argue that that little of it was probably related to the Carvana commercial agreement most of it was related to.

Tax rates and how we've been able to penetrate more on the dealer to dealer space and have some strong growth in the transportation revenue during the quarter compared to a year ago. Those were the two big drivers.

Got it. Thank you and then as a follow up as volumes recover next year.

Wondering if you have to bring back any of that head count you've temporarily reduced whether it's in support staff or at AFC or should the offshoring of some of that back office functions take out the need for this.

Yeah. Thank you Joe.

Listen I think one of the great advantages of a dig more digital model is the scalability you get from a digital platform.

So I don't foresee that.

In the context of the assumptions, we're making about about the industry.

I think these businesses will scale incredibly well and we've got Evans as evidence of that from the past and unfortunately, we've been hurt on the downside of that as volumes have declined over the last couple of years I think as those volumes come back they'll slow through a business model that is.

More scalable and more efficient than it ever has been before so.

I don't foresee that happening and I would view the GSS initiatives as Eric said incremental savings versus our current sort of run rate.

That's super helpful. Thank you guys. That's all for me.

Thank you Joe.

Again, if you have a question. Please press Star then one.

Our next question will come from Ali <unk> with Guggenheim. Please go ahead.

Hi, Yeah. Thanks for taking my questions and first aric congrats on the retirement and that was a lot of miles between Chicago and car mouth, so well deserved.

Ali.

So actually I have a few questions on AFC. So loan volumes were up 11% in an environment, where your marketplace volumes were down 12% I think historically AFC loan volumes have at least directionally correlated pretty well with your auction volumes why have they decoupled more recently and what's driving that outperformance versus what we're seeing in the broader wholesale auction industry.

Yeah. Thanks Ali appreciate that question.

<unk>.

Is it true then the passive correlated more with auction volume, but I'd also say that even when we looked at it historically.

The amount of transactions that within AFC that were generated through the car platforms was always a relatively small amount of think it was about 30% of the of their total transactions came from car or even less.

I would say essentially its market share AFC has been focused on expanding its dealer.

Its dealer footprint the number of dealers using the system.

They've been doing that in a very disciplined way and they have been effective at doing that so we kind of win the business at the dealership level right and then.

We.

Mitch to fund those dealers that theatres purchases irrespective of what channel the Peter bias.

So I'd say principally that's the focus now I will also say we have been focused as well on increasing attach rates within our existing digital marketplaces, we've put focused initiatives on that with trade Rev and with backlog cars and those are bearing a positive results, but that's that's not what's driving the significant change that you alluded to so.

I think it's really just a focus on the customer and ultimately increased market share within the segment.

That's helpful color, Peter and then maybe just a follow up on AFC, maybe you could remind us how interest rates benefit the business. It was obviously a sizable tailwind this quarter, maybe a refresh on how you price your loans would be helpful.

Eric Johnson, well first let me speak to the pricing typically is going to be Lee as the prime rate quote plus a spread typically it's three to 400 basis points above Brian and Brian has been moving up and in all the the reason the performances is improved with that because there is a corresponding increase in cost of fund.

<unk> is is we're only.

Funding through the securitization about 70% of the total loans when you look at our balance sheet. So about 30% is in equity and that's where we get the increased performance in.

In the AFC business, there's no corresponding costs equally.

Equally important to that though is that we have.

Have a very efficient structure for the financing it's a cost of funds. It actually is a lower cost of funds than it is charges to our customers in other words.

The prime rate has grown more than our cost of funds. So we've gotten a little bit of spread enhancement on that so those are the two things. One is as we look at today's expectation that interest rates will be.

<unk> increased by the by the fed.

Going forward for the rest of the year that probably becomes a bit of a tailwind in the short term.

But as Peter mentioned it put stress on the dealer so you've got to balance that out with what it does to the risk side of the portfolio Peter anything to add no I think I think you've got there I think I think it's.

You know there are some pros theres some comps I think generally we're confidence.

In the AFC business model and that it will be a strong contributor.

And 'twenty seven between beyond.

Great. Thanks for taking my questions.

Yeah, I think we're pretty much at a time so mass.

Unless there's other question I'll just move to closing remarks.

This concludes our question and answer session. I'll go ahead, and turn the conference back over to management for any closing remarks.

Thank you Matt. Thank you everybody for your time this morning and also for those questions.

I just want to close out my remarks by reinforcing some of the key messages from today again I'm pleased with the Q3 performance, we delivered improved performance versus a year ago and also compared to Q1 and Q2 of this year in a challenging environment.

In our marketplace segment with increased revenue and gross profit compared to one year ago. We also increased our revenue per unit and a gross profit per unit sold.

And our finance segments, we delivered another solid quarter of performance with meaningful growth in both volume and revenue per unit.

In addition to those financial results, we made significant progress in terms of platform consolidation pricing and addressing our cost structure.

Obviously volumes continue to be challenge in this industry. However, as we look to the future. We expect new vehicle production to increase gradually we expect used vehicle pricing to decline and we expect a gradual increase in wholesale used vehicle volume overtime.

And I believe that our digital focus will enable us to grow faster and that type of environment.

I'm excited and energized by the many opportunities ahead I believe we've got a significant opportunity for long term growth of this company, we have a differentiated offering a diverse and expanding customer base and a large addressable market in which to innovate and invest.

So with that we'll end today's call I look forward to reconnecting with you all in the new year.

You're all very very much and again, Eric best wishes for a <unk>.

Very very happy.

Successful retirement.

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