KAR Auction Services, Inc. (NYSE:KAR) Q3 2023 Earnings Call Transcript
KAR Auction Services, Inc. (NYSE:KAR) Q3 2023 Earnings Call Transcript November 1, 2023
Operator: Good day, and welcome to the OPENLANE Third Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note today's event is being recorded. I would now like to turn the conference over to Michael Eliason, Vice President of Investor Relations. Please go ahead, Sir.
Michael Eliason: Thanks, Rocco. Good afternoon, and thank you for joining us today for the OPENLANE Third Quarter 2023 Earnings Conference Call. Today we'll discuss the financial performance of OPENLANE, for the quarter ended September 30, 2023. After concluding our commentary, we will take questions from participants. Before Peter kicks off our discussion, I'd like to remind you that this conference call contains forward-looking statements within the meaning of the safe harbor provision of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties that may affect OPENLANE's 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 mention 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 just issued, which will also be available in the Investor Relations section of our website. Now I'd like to turn this call over to OPENLANE's CEO, Peter Kelly. Peter?
Peter Kelly: Thank you, Mike, and good afternoon, everybody. I'm delighted to be here today to provide you with an update on OPENLANE. And joining me on today's call is our Chief Financial Officer, Brad Lakhia. I'm going to begin with OPENLANE's third quarter performance. And as usual, I will speak about our business in two segments, our Marketplace segment and the Finance segment. I'm pleased with our Q3 performance, and I'm particularly encouraged by the improved performance of our Marketplace business despite the challenging industry environment. I believe our Q3 results present compelling evidence that we are successfully evolving our business model to meet the realities of today's market, while positioning OPENLANE for continued growth and expansion in the future.
During the third quarter, we grew our transaction volumes in both our Marketplace and Finance segments. We grew total revenue and gross profit. We reduced our SG&A. We invested in technology innovation and product development, and we continue to generate strong cash flows in the business. And while adjusted EBITDA has declined slightly, driven mainly by a return to historically normalized loan losses in our Finance business, OPENLANE's Marketplace business delivered its best quarter since the divestiture of the U.S. physical auctions. Brad will provide more detail around our specific performance later in the call, but I would like to highlight a few key results from OPENLANE's third quarter. First, growth in both commercial and dealer transactions increased total marketplace volumes by 8% to 339,000 vehicles, with a total gross merchandise value of approximately $6 billion.
We generated year-on-year revenue growth of 6% to $416 million, with contributions from both our Finance and Marketplace segments. Auction fee revenue in the Marketplace segment grew by 15%. Gross profit in the quarter was $200 million, that was an increase of 9% from Q3 of last year. Gross profit represented 56% of revenue, excluding purchased vehicles. And I'd like to specifically call out the Marketplace segment here again, where we increased gross profit by 17% year-on-year, representing 46% of revenue, excluding purchased vehicles. OPENLANE generated adjusted EBITDA of approximately $68 million in Q3. $27 million was from our Marketplace segment, this was a 51% increase versus the third quarter of last year, and $41 million was from our Finance segment.
I'm very pleased that the Marketplace business is now operating at an adjusted EBITDA run rate of over $100 million per year, and significantly stronger than one year ago. Also, it's notable that our Marketplace segment delivered approximately 40% of our total adjusted EBITDA performance in the quarter, significantly higher than last year. Over time, I expect the Marketplace segment will represent over 50% of the total adjusted EBITDA performance for OPENLANE. Brad will discuss cash flow generation and capital allocation later in the call, but I do want to highlight the strong cash flow characteristics of our business that were again evident in Q3. OPENLANE generated cash flows of $74 million from operating activities in the third quarter. And as I mentioned last quarter, the company has a strong balance sheet, an improved leverage ratio and ample liquidity to invest in innovation and growth, while still delivering profits and strong cash flows.
I'd now like to update you on our efforts to simplify our business. OPENLANE is committed to making wholesale easy, easier for customers to do business with us and also easier for our company to innovate and grow. A cornerstone of this strategy is a rebrand to OPENLANE and the corresponding work to consolidate our marketplace platforms. And I'm very pleased that we're already seeing improvements to the customer experience, accelerated product development time lines and meaningful reductions in cost. To support this work, we performed extensive market research during the second and third quarters, with more than 1,000 dealers across the United States and Canada, and the results are very strongly aligned with our vision for OPENLANE Lane. First, inventory selection is very important to our customers.
Our combined OPENLANE marketplaces will offer a highly differentiated mix of off-lease inventory that is not available on any other digital or physical marketplace, and dealer-to-dealer inventory at every age condition and price point. Another key theme from our customers was ease, and we are pleased to hear that our buyers and sellers find our platforms very easy to use. Once combined, the OPENLANE marketplace will offer the most flexible, multi-format marketplaces in North America, including time sales, bid-ask listings and live bidding auctions that take place nearly every day of the week. And finally, trust remains an important factor with our customers. So we're highly focused on providing the most reliable condition reports, the most responsive customer service and the most dependable supporting services such as financing and transportation.
I believe we're operating from a position of strength in these areas, but we will continue to invest to ensure our customer experience, like our inventory remains a positive differentiator for OPENLANE. So I believe that our one marketplace strategy is highly aligned with the preferences of our customers, and I'd like to share some specific milestones that we achieved in the third quarter. Starting with Canada. Our combination of the ADESA and TradeRev platforms into a single OPENLANE-branded marketplace is now complete and has been successful. The migration was initiated late in the second quarter. And in Q3, our year-on-year volume growth in Canada outpaced the growth rate in our Marketplace business as a whole. Since launch, we have implemented additional enhancements to our search and filter capabilities, as well as to vehicle images, our buy and sell functionality and other aspects of the marketplace.
I'm very encouraged by how quickly we were able to develop, test and deploy these updates. And I think this provides evidence of the direct relationship between simplifying our business and our ability to innovate and quickly respond to the preferences of our customers. Another benefit of consolidation is our ability to leverage the best products and features from across our different platforms. For example, today, first of November, in Canada, we launched OPENLANE Pro, a successful TradeRev dealer program that will now be available to all Canadian dealers on OPENLANE. Participating dealers receive volume-based rebates and access to OPENLANE's digital pricing guides and other exclusive tools. And for OPENLANE, this expands a highly successful offering that generates non-transaction subscription-based revenue streams and also increases stickiness with our customers.
Shifting to United States. We are now only weeks away from launching our consolidated OPENLANE-branded marketplace in the U.S. This will combine the off-lease open sale inventory from our U.S. commercial sellers, with a broad-based dealer-to-dealer inventory currently available on backlog cars. This will be a single, simplified online experience, with a number of sales formats to align with the buying habits of our dealers. By connecting these two marketplaces, buyers will have access to more diverse inventory and sellers will have even more confidence that they're obtaining the best possible outcomes on their vehicles. One of the most promising benefits is directly connecting buyer experience on open -- to buying experience in OPENLANE, with the ease of selling vehicles in our marketplace.
A significant portion of the franchise dealers who have purchased inventory through our private label programs and our open sale, do not yet sell vehicles with OPENLANE at the same volume levels. Through the new unified experience, those dealers can now purchase off-lease inventory, while also seamlessly listing their own wholesale vehicles directly from their lot. And we're excited to get this off the ground and believe this combined marketplace will be well received by our customers. And then finally, in our international business, our rebrand to OPENLANE in Europe and the U.K. is also on track to launch towards the end of this month. This rebrand builds on the consolidation of our Europe and U.K. technology platforms that was completed earlier this year.
Our European business continues to perform well, and we believe that OPENLANE has an opportunity to capture share by delivering a unique differentiated model to our growing base of customers in Europe. So in summary, I'm looking forward to beginning 2024 with all of our marketplaces, and all of our buyers, all of our sellers and all of our inventory, together under the OPENLANE brand. As I mentioned earlier, platform consolidation is not just about improving the customer experience and set accelerating innovation. It also affords us a meaningful opportunity to reduce our costs by eliminating duplicative technology, and avoiding the costs associated with maintaining older and sometimes outdated back-end systems. We're very focused on this and have appointed leadership to advance this consolidation effort.
We're optimistic about what we can achieve in terms of cost reductions, efficiency and also a more streamlined customer experience. Beyond platform consolidation, our cost management efforts now extend to every department and team across our organization. During the third quarter, we reduced our total SG&A versus the prior year as well as sequentially, and we continue to work through our pipeline of cost-saving initiatives. It's clear to me that our focus on this area is positively contributing to overall performance, particularly the improvement in gross margins and our overall adjusted EBITDA growth. And ultimately, our cost-conscious culture will help create the financial headroom for innovation, which in turn will further accelerate growth and improve our overall performance.
I'd now like to provide some updates on the macro environment and our perspectives on the industry outlook for the fourth quarter, 2024 and longer term. Our third quarter results were delivered against a backdrop of industry volumes that are still well below normal and well below pre-pandemic levels. However, we believe there is increasing evidence that industry volumes have bottomed out and are beginning to rebound, particularly as it relates to commercial center volumes. I believe this is supported by the following factors: new vehicle production, new vehicle sales and new vehicle inventory on dealership lots continue to increase. In fact, they continue to increase in the third quarter despite some disruptions from the industry labor actions late in the quarter.
And while each individual metric remains below pre-pandemic levels, their collective improvement will help balance supply and demand in the used vehicle market over time. Shifting to used vehicle values, we continue to see downward pressure on prices in the third quarter, although the rate of price decline slowed, perhaps driven in part by the industry labor actions that I referenced just a moment ago. Now that those labor actions appear to have been resolved, we expect continued pressure on used vehicle prices through the end of the year. I remain optimistic about the resiliency of our asset-light model and our ability to deliver strong results, irrespective of the environment. Based on our conversations with commercial customers and on the data that we analyze, we believe that new vehicle lease originations increased by double-digit percentages in the third quarter compared to the same period last year.
This is very encouraging as increased volumes of off-lease vehicles will be a tailwind for us in the future, as those leases mature. I would also point out that the level of lease originations in the third quarter was still well below pre-pandemic levels. So we expect to see further increases in this over time. Despite the overall price decline for wholesale used vehicles, the majority of off-lease vehicles that are maturing today still remain in a strong equity position versus their residual values. However, this gap is narrowing. We saw a modest increase in off-lease volume supply in the third quarter, and this contributed to our overall results. Looking to the future, we expect to see a decline in the percentage of vehicles that are in a positive equity position.
Should this happen, it will result in a lower percentage of vehicle has been purchased by consumers over time, and consequently, more volume flowing into our OPENLANE marketplace. The precise timing around this is hard to predict, but it is something we are watching carefully. In summary, I believe that the set of facts that I described here points to a slow but steady improvement in wholesale supply and an improving environment for OPENLANE. As I said last quarter, I believe that the two primary theses of our growth equation remain intact. First, we believe that digital channels will continue to gain share. Our recent dealer surveys support this and we believe that our technology, inventory and customer experience will position us well to gain more of that additional share over time.
We also believe that all signs point towards a recovery in commercial volume, which given our existing market share and deep commercial seller relationships, will result in increased off-lease commercial vehicles in our marketplaces in the future. So in terms of our performance outlook for the remainder of this year, in our Marketplace segment, I expect OPENLANE's volumes in the fourth quarter to increase compared to the fourth quarter of last year. This volume growth, coupled with the strong unit economics that we're currently demonstrating should drive improved financial performance in the Marketplace segment. In the finance segment, we expect continued strong volumes and revenue. Our Q3 loan loss ratio at AFC was at the higher end of what we believe to be the normal range, and generally aligned with the range experienced before the pandemic.
We continue to manage this risk very closely across the portfolio, and we have been very deliberate about growing responsibly, to ensure that new business we take on at AFC is very stable. Overall, we expect continued solid performance from AFC, even though AFC's full year results will be below last year's record levels. Brad will provide a more detailed update on how those factors impact various aspects of our guidance for the remainder of 2023. As we look beyond this year, we will continue to execute a focused strategy and take actions to control the things that we can control. We expect to build on our 2023 performance, in 2024 and beyond. We believe that the majority of our growth will be driven by our Marketplace segment, but that our Finance segment will also grow over 2023 levels, and will remain a very strong contributor to our overall results.
So to conclude my remarks this afternoon, I want to reiterate that I believe OPENLANE has a unique and differentiated offering to the market, a compelling business model and a sound strategy for growth. We are a pure-play digital marketplace leader with deep strength with commercial sellers and in the dealer's figure business. We have access to a large addressable market in North America and in Europe. We intend to grow our share in these markets. I believe that the macro factors point to an improving outlook for commercial off-lease volumes. I expect the recovery will take time, but it will come and this recovery plus the continuing secular shift towards digital, all points to an exciting future for OPENLANE. We have a robust pipeline of innovation that supports our growth strategy.
By consolidating our platforms, we will get greater leverage from our technology and product investments, and we will focus our energy, resources and investments on doing the greatest digital marketplace for our customers. We are profitable and we deliver strong positive cash flows. Our third quarter and year-to-date results clearly demonstrate that our profitability and cash flow characteristics have improved, in spite of the lower than normal volume environment. And I'm confident that they will improve further as we grow our volumes. Our strong cash flows allow us to invest in our business while generating additional capital that can be used to pay down debt, return capital to shareholders and make strategic investments. So with that, I will now turn the call over to Brad Lakhia, who will provide additional detail on our third quarter financial performance.
Brad?
Brad Lakhia: Thank you, Peter, and good afternoon, everyone. I'll start with our Marketplace segment. As Peter mentioned, we had strong unit volume growth, which drove a 3% increase in marketplace revenues, excluding purchased vehicle sales. We've also delivered volume increases in both our commercial and dealer channels. Auction fees per unit increased 6% driven by select fee increases and the introduction of new auction-related services. Marketplace service revenues declined 3%, largely due to lower transportation services and the receipt of a royalty payment in the third quarter of last year. The overall improvement in the Marketplace revenue resulted in a 17% increase in gross profit. This represents a 530 basis point improvement versus the third quarter of last year, again, excluding purchased vehicle revenues.
It also represents a 200 basis point improvement sequentially when compared to the second quarter of this year. In addition, gross profit benefited from improved mix in our service-related businesses, and cost-saving initiatives. As Peter highlighted earlier, our Marketplace adjusted EBITDA for the quarter was $27 million, $9 million higher than the third quarter of last year. And also as discussed earlier, this was driven by improvements in volume, price, mix and cost savings initiatives, including lower year-over-year and sequential SG&A. Looking at year-to-date, our Marketplace adjusted EBITDA was $85 million, a $63 million improvement compared to last year. And for added context, our dealer-to-dealer business is profitable, and meaningfully contributed to this year-to-date improvement.
This improvement also supports the $100 million adjusted EBITDA run rate we highlighted in the second quarter call, and Peter mentioned earlier in his comments. It also reflects our pricing and cost management actions are materializing, and provides a window into the volume scalability of the segment. Turning to our Finance segment. Revenues in the quarter were $100 million, a 1% increase over the prior year. This was driven by a 2% increase in loan transactions, improved fee income per unit and interest rate yields. Finance segment adjusted EBITDA in the quarter was $41 million compared to $52 million last year. This decrease is explained by a $10 million increase in credit losses, which equates to a 2% loss rate for the quarter. And as discussed in prior calls, this represents a more normalized rate when compared to very favorable fundamentals that enabled a much lower loss rate over the last two years.
And with regard to credit loss management, I'd like to highlight and emphasize a couple of things we have noted in prior calls and disclosures. First, our Finance business has a very strong service offering that leverages the combination of a high-touch customer relationship model and a data-driven risk management process that we believe is industry leading. This combination allows the business to deliver growth while prudently managing risk. And second, as we move through the remainder of this year and into next year, we will be faced with changing used car fundamentals, and therefore, we will continue to manage a conservative portfolio. Over time, we continue to expect the loss rate to be 2% or lower annually. However, actual losses in any period could deviate from this range.
Turning to SG&A. Consolidated SG&A declined 2% or $25 million compared to the third quarter of 2022, again, reflecting the successful execution of our ongoing cost savings initiatives. And as we've previously mentioned, the implementation of some of these initiatives include duplicative costs that will roll off throughout the course of 2024 and will help us offset ongoing inflationary pressures. I would also like to highlight that we expect fourth quarter SG&A to be higher than the fourth quarter of 2022, due to a $9 million reduction in noncash compensation expense that occurred last year. Turning to the balance sheet and capital allocation. Consistent with the first half of the year, we continue to generate strong cash flow. Cash flows from operating activities now stand at $216 million year-to-date.
This level of cash generation demonstrates the value-creating potential of our asset-light, digitally-focused strategy and business model. Our cash generation has notably improved our overall liquidity position, and further strengthen our balance sheet. This is evidenced by a $131 million reduction in net debt since the end of 2022, and a meaningful improvement in our consolidated net leverage ratio which now stands at approximately one turn of adjusted EBITDA. Given the current macro and industry environment, we will continue to focus on managing a prudent balance sheet, while maintaining and improving our liquidity position. We will continue to prioritize capital to fund organic investments in our core, digitally-focused business, while also ensuring we have flexibility for high-return, complementary strategic investments and shareholder returns.
During the quarter, we completed $22 million in share repurchases, and we increased and extended our share repurchase program authorization to $125 million through the end of 2024. I'll wrap up my comments by addressing a few annual guidance items. We're confirming our prior adjusted EBITDA guidance of $250 million to $270 million, and as we said last quarter, we continue to believe we are trending to the higher end of this range. We're also confirming our expected operating adjusted net income per share of between $0.60 and $0.70. And finally, capital expenditures are now expected to be $55 million compared to our previous expectation of $60 million. With that, I'll turn the call back over to Rocco for questions.
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