Good morning, and welcome to the Q2 FY2022 Earnings Conference Call of KAR Auction Services, Inc. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mr. Mike Eliason. Thank you. And over to you, sir.

[Technical Difficulty] and uncertainties that may affect KAR'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 issued yesterday, which is also available in the Investor Relations section of our website. Now, I'd like to turn this call over to KAR 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 KAR Global. During today's call, I will provide you with additional information and detail in three areas: first, our capital allocation strategy following the completion of our recent divestiture of the ADESA U.S. physical auction business; second, our view of the current market factors that continue to impact the automotive industry; and third, our second quarter performance and outlook for the remainder of this year. Consistent with our earnings release last night, the results that Eric and I will discuss here this morning generally excludes the divested ADESA U.S. physical auction business, which is treated as a discontinued operation in our financial reports. And as I did on our last call, I'm going to speak about our business in two segments, a Marketplace segment, which we formally call the ADESA segment, and a Finance segment, which we formally called the AFC segment. To begin, Q2 was an important quarter in the history of our company as we completed the divestiture of the ADESA U.S. physical auction business. This was a significant and historic milestone in KAR's history, and a transaction that will be transformative for our company, our customers, our employees, and our stockholders. Q2 was also a traditional quarter. The transaction closed on May 9. So we only operated as a company that we now are for approximately half of the quarter. The transaction itself generated approximately $1.65 billion of cash, net of taxes and fees. Over $900 million has already been used to repay our term loan B and amounts outstanding on our revolver. As we announced in our earnings release last night, we will also be conducting a tender offer to buy back up to $600…

Thank you, Peter. I want to spend most of my time talking about our actions around managing capital, separating KAR's continuing operations from the recently discontinued operations, and provide a viewpoint on where opportunities exist to improve our cost structure going forward. I believe our financial results that were released last night do not need a lot of additional commentary. Let me start by pointing out information we are providing this quarter to assist with the analysis of our business. First, we have provided the annual results of continuing operations for 2020. It is extremely complex and costly to restate the individual quarters for 2020, so we will not be providing quarterly information for that year. We have provided the quarterly results for each quarter of 2021 in our earnings materials. This will allow you to make comparisons of our results for the remainder of the year for our continuing operations. We have updated our datasheet for the marketplace business to present key metrics for the continuing operations of KAR Global. There were no changes to the previously reported metrics for the finance segment datasheet. We also have provided line items in our segment reporting for the finance business that separate fee revenue and interest revenue. We believe this additional disclosure will allow the analysis of changes in revenue as interest rates are increasing. We have provided this additional information in our data schedule for the finance segment for all previous quarters. Now, I would like to cover more specifics on our capital transactions following the close of the sale of the U.S. physical auction business on May 9. We received $2.186 billion in cash at closing. We have $14 million of expected proceeds that will be received after receiving consent for two remaining property leases. As part of the…

Jacob, you can open the line for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from John Murphy with Bank of America. Please go ahead.

Good morning, guys, and thanks for all the restatements and info here. I had two questions. First, Peter, as you look at what's going on right now, you alluded to the market being sort of in a disequilibrium at the moment then we certainly would agree and there's a huge issue on the supply side that may not get worked out for another year or two to somewhat normal levels. As you're transitioning the business amidst sort of this mayhem it's really kind of toughly to gauge your progress in how successful you're being in transitioning the business to pure digital or almost pure digital ex-Canada. I mean, what are the key metrics that you're looking at and how are you thinking about understanding progress on KPIs or which direction you should drive into? I mean, there's just a -- there's a lot of moving pieces here, so it's a very difficult time to manage your business. So just curious how you're thinking about KPIs and how to -- how to manage the volatility in the near term?

Yes. Thank you, John, good question. You're right first of all it is a time of a lot -- continues to be a time for a lot of change. I do feel that's, as I mentioned, I think the supply side issues have, kind of, bottomed out, that doesn't mean I expect the recovery in Q3, but I think I'm starting to see a little light at the end of the tunnel, which I do feel encouraged about. But you're right; we have, with the transition of the business, an opportunity to think about our KPIs. Obviously, at a high-level we focus on total volume sold, revenue generated, some of the metrics we talked about here, gross profit as a percentage of revenues are sold, et cetera. When we look a little deeper, obviously, conversion rate is an important metric in the health of any marketplace. And our conversion rates differ by marketplaces. OPENLANE is perhaps our highest converting marketplace certainly right now and given the very great, scarcity of all these vehicles. But conversion rate is a important metric. Customer participation, both on the sale and buy side. Are we growing our customer base, customer levels of participation, et cetera, are important metrics around the health of the business. So we certainly measure and focus on that. And then, obviously, we measure the progress against our initiatives. As I spoke about on this call and another call, we're focused on consolidating platforms. We're focused on migrating to fewer sort of technology stabs -- stacks to addressing our cost structure. So progress on all those metrics is something we're very focused on as well. And I think while it's not perhaps yet fully apparent in our metrics, I think a lot of these, the work we've done around the cost structure that I think will become more apparent here in coming quarters, the work around the consolidation and creating -- ultimately creating greater efficiency in system, I think will be very, very powerful for us as volume starts to recover because again, you know this business, like most businesses has a scale effect. I think the scale effect is even more magnified in a digital model than in a physical or a hybrid model. So I'm very encouraged that the work we're doing and the metrics I'm seeing and the progress we're making is going to really be very, very positive for us as we start to see volumes increase. Now, obviously, we're going to have to prove that out. We recognize that, but ultimately we're trying to lay a foundation to future success.

That's helpful. And then just a second question on pricing. It sounds like you're adjusting from right now or June to August pricing or through September for all your customers. I'm just curious what the receptivity is to this and what you mean? I mean, is it just simply higher auction fees or --I mean how are you going about this? And it sounds like you're not having any real pushback the way you talked about it, so just trying to understand that that's pretty unique?

Well, a couple of things. In late Q1 actually we increased some pricing in our dealer-to-dealer marketplace, so I think we're seeing some of the impacts on that in Q2 results. I mentioned how the volumes were relatively flat, actually slightly down versus Q1, the financial metrics were somewhat improved. So I think we see that showing up there and that will have the benefit of that over the rest of the year. As it -- I referenced in more depth in this call was more on the commercial side of our business. And what I'd say, John, is, and it's actually less related to auction fees if you want to call them that, buy fees and sell fees, it's more related to the services we're providing around inspection, in some cases logistics and other types of services for our commercial sellers. And frankly, as you can imagine, we've had a situation here over the last 12 months where our volumes, in some cases have been down like 90% in certain areas of these services. But it has not been possible to take our cost down to that degree, but we need to continue to provide service on a national basis, and we've addressed the costs where we can. So I think what we've really tried to do is for those services speak to our customers about just the current reality around volumes and how the unit economics don't support these very, very low volumes. And the customers have been very understanding of that. And essentially, what we've put in place are instead of a sort of a fixed price structure at all levels of volume we've kind of converted to a tiered price structure, which has higher pricing at current volumes. And then as volumes increase over time, returns generally towards the pre-existing price if volumes get all the way back. So if you can imagine that type of a scenario, they've been very supportive. I take from that, that they value us as a business partner. They value the services we provide and they completely understand the volume picture that affects their business in ours. So I'm encouraged by that. And these are -- so I would say John, these are meaningful changes at current volumes. What I'm actually perhaps even more encouraged about is that that volumes sort of increase the impact of these changes may actually be more meaningful as volumes start to trend back up towards normal. And as you mentioned, that's probably going to take time. So we may get that benefit over a considerable period of time.

Yes. No, it seems like from a revenue side and a cost side, you're setting up well as volumes recover, there'll be a lot of a tremendous amount of operating leverage. So it seems like you're doing all the right stuff. So we appreciate it. Thank you so much, guys.

Thank you, John.

Thank you. The next question is from the line of Bob Labick with CJS Securities. Please go ahead.

I wanted to start with conversion rate. You gave us some interesting statistics on that and I'm assuming the lower conversion rate relates to the softening of used car prices. And it's kind of seen more broadly than just you guys. And that could last a while if prices continue to soften. So my question is a) is that right? And b) what are you doing to encourage the selling dealers kind of to lower their limit price or to get more in line with reality? And how data driven is this decision on that limit price and how long does it take to normalize to get back to regular conversion rates?

Bob, thank you. Good question. So first, if I can comment on just the metrics themselves and then what are we doing about it. So first, I'd say the decline in conversion rate, if you think about it, so relative to a year ago. There are two factors. One factor is just a straight mix shift. The percentage of vehicles sold from commercial sellers a year ago was higher relative to Q2 of this year. And again, as I mentioned, the conversion rates on like for example, the OPENLANE platform are our highest of our marketplaces right now. So just a straight mix shift, less OPENLANE, more dealer-to-dealer in relative terms will tend to reduce conversion rates. So there's that impact, which is not a market factor. It's just -- it's more of a mix factor. And then I -- and I'd say that has had some impact, but I'd say most of the impact we've seen has been more the market factor of the relative seller and buyer sentiment. And again, if I was to contrast it with Q2 of a year ago, I'd say Q2 a year ago was unusually strong because if you recall, we were in a sort of an environment where prices were running up. Demand was very strong and buyer appetite was sort of higher was increasing every month, right? And we've kind of had the opposite set of facts here over the last three months or so. Where sellers are kind of holding on for high prices and buyers are sort of recognizing that’s the consumer demand is weakening and for that reason their appetite are weakening. So that's a set of facts. I think you are correct that if we're anticipating an extended period of steadily declining prices, conversion rate could remain…

Okay, great. That's super helpful color on that. Very much appreciated. And then just one other and I'll get back in queue. Obviously the shift to digital began before COVID was accelerated by need during COVID. Given the lack of I guess public physical options out there right now, my question is, how is it settling out since we can't really see these volumes? Has there been a partial switch back to physical just by virtue of everything opening up or where are we on what we all believe to be this long journey towards digital? And how are -- how's the share going and where is volume right now?

Yes. Good question. Again, I don't have perfect data, but I do have some data. I think we're still on that journey. Maybe the rate -- the pace of that journey may have moderated a little bit, but through our analysis of some data that's available to us, I believe that there are consigned volumes at physical auctions also declined in the second quarter. And I think on a year-to-date basis have -- I still see evidence of a share shift, sort of, away from physical and towards digital generally in the industry, but the data sources are imperfect. There's other companies that you have to report, so we'll have to see what the totality of that data looks like. But I think that that shift continues, albeit the pace of the shift has moderated a little.

Thank you. The next question is from the line of Bret Jordan with Jefferies. Please go ahead.

On the pricing initiatives, sort of, offset in the lower volumes what are you seeing sort of in the competitive landscape? Are peers basically following the same trend just given their volumes are down as well? I think you commented that you had slightly lower volumes and Q2 from Q1. Is that a competitive issue or just a market issue?

I think the volume issue is a market issue, Bret, is my assessment, again, based on just seeing the volumes, physical were down. I don't have all the competitive data, but I think there's no question that volumes have just been under pressure industry-wide will be my assessment. On the pricing, I mentioned the digital dealer-to-dealer channels we do benchmark our pricing versus competition. We think we're well-positioned there. I think we're competitive. Maybe slightly, very comparable, maybe slightly less on some prices than others, so I feel good about our pricing structure there. And then in terms of what I spoke about on the commercial side of the business, I don't have perfect visibility, but I know the volume challenges aren't unique to us. So I wouldn't be surprised if others are having similar discussions with customers, but I can't comment from a position of knowledge.

Okay, great. And then, obviously, big success with AFC. When you look at the conversion and the other issues you faced this year in the second half, and relative to your guide, in the $245 million to $265 million, what do you see that the credit contribution of that versus the auction operations contribution?

Well, obviously, AFC has been a significant contributor to the overall profit performance in the business here over the last period of time. And we expect continued strong performance from AFC. But we also expect that, and this is I guess similar to the messages on the Investor Day, we expect over time the Marketplace segment to drive the majority of the growth as we look to the future. But I guess, we very encouraged by the performance of AFC. We continue -- we expect to see continued strong performance. We -- the environment's changing a little bit. Interest rates are going up that actually has some benefits to AFC. The risk environment may be -- we need to just stay focused on that. We've had a very low risk experience over the last period of time. But AFC is a strong business and will continue to be a strong contributor we believe.

Thank you. The next question is from the line of Daniel Imbro with Stephens. Please go ahead.

Hopped on late, so apologies if you discussed this, but I wanted to start on the SG&A side. When we look at 2Q, Eric, I appreciate the color on kind of the non-cash in the CARWAVE numbers, but one, were that non-cash number is $10.3 million, is that one-time or is that going to continue is that part of the run rate cost basis here? And then I think at the Analyst Day, you guys talked about $30 million of run rate cost savings that you were targeting this year. How many of those were captured in the second quarter? And how many of those are still on the sum?

Daniel, let me take the first part of that question. The $10.3 million in stock-based compensation is a catch-up, as a result of the gain on the sale transaction, our long-term incentive plan, which is tied to PR issues. Had operating adjusted EPS cumulative get to a point where we have to -- we are accruing a cost. It had been below threshold for the ninth -- for the 2020 grant year and the 2021 grant year. And we're now accruing as our gain has reflected in our EPS. Relative to the other things, as the business has transformed, it's very difficult to see, even for me as to what's the impact of the -- we have made a number of actions that reduce our costs, but at the same time, we've had a transition of a major part of our business where there's costs that's temporarily associated with the activity of breaking things apart. So I don't think it's shown up yet in the cost structure. And as I look forward, I think and Peter mentioned this, you'll see it in the second half of the year, Daniel. Peter, why -- Peter and I have been talking about this, I'll let Peter analyze, how do we look at the $30 million? How do we plan to see evidence of that?

Yes.

As we go into this year, where we were and where we think we'll end the year. Peter, why don't you share that with him.

Yes. I'll comment as well here, but generally to agree with Eric's comments. I don't think it's shown up yet. And frankly, we had a sort of a cost agenda taking shape, but then we entered a negotiation around this transaction and I felt it was -- it would -- we had to sort of get through the transaction because that was going to dictate the shape of cost actions that we could take. We couldn't -- didn't want to take cost actions within the business we were selling. And I also felt we need that transaction to be closed before we could fully address our own operations. So in reality, most of this work sort of started after the deal closed. So mid-May and onwards and these actions have continued since then and will continue. So I expect them to be more visible in the second half. I guess what I'd say is I'm expecting us to end the year with an SG&A run rate, something around $400 million give or take, I don't want to give a precise number, but I think something around that and that, that will be obviously down on what we've seen certainly in a number of a prior quarters. So that's -- that's my expectation and we are very focused on that work.

All right. Thank you guys for that color. And then, Peter, I wanted to ask one of the integration of CARWAVE, began at the Analyst Day, sounded like you were making progress, kind of curious how the integration is going. And I know volume is pressured on the dealer-to-dealer side right now, but have the price increases allowed that portion of the business to remain EBITDA positive in this environment or had anything changed in your outlook there? I think when you bought CARWAVE, you had said that business was now profitable, but things are changing there, just wanted any update there.

Yes. Thanks. Thanks, Daniel. The first of all -- well, first of all, CARWAVE has continued to be profitable. So that is -- that is positive. You're right, volumes in the channel, in B2B, generally has been under pressure and that should correlate, as well, but the business continues to be profitable. And the integration plan is progressing well. We felt -- we thought it was important given the power of the CARWAVE platform and the feedback from customers; we wanted to replicate that experience within the BacklotCars market, another part of building out new technology and functionality within the system. So there's been a lot of focus on that. That is now -- that now exists. It's still in a, I call it, an advance beta, but we held our first sale in the month of July. We migrated cars over, we brought over some buyers and sellers and we have an auction to pressure test the system to get customer feedback and so forth. So again, that was positive, that was a key milestone along the way. And I'd say, we're now in the latter stages of that migration and certainly we expect to complete it this year. So I feel good about that. I feel good about getting to one marketplace, getting all our sellers and buyers into one digital venue, leveraging the network effect, so on and so forth. So we're well on track and feel good about that. And, again, feel good about the long-term prospects for the digital dealer-to-dealer marketplace.

And Peter, if I could add some clarity. Daniel, the combination of our digital -- digital D2D marketplaces would be CARWAVE, BacklotCars and TradeRev, in aggregate, those three businesses are also profitable in aggregate.

Right. That's all I had.

Well, you mentioned CARWAVE. I just want to be clear to everybody, also the total -- totality of D2D is profitable in aggregate.

Appreciate all the color and best of luck going forward.

Thank you, Dan. So I believe that concludes the questions. So thanks -- thank you Jacob; do we have any more questions in the queue?

No. No, sir. This concludes our question-and-answer session. I would like to turn the conference back over to Peter Kelly for any closing remarks.

Thank you, Jacob. Well, thank you again for your questions and for your interest in KAR Global. I'm encouraged by our second quarter results in light of the current market challenges and I believe that we are executing well against the leaders that we control. To summarize, once again, we completed the transaction and are fully committed to our digital marketplace strategy. We've paid down a meaningful portion of our debt. Continue to generate positive cash flows. We've increased revenue and gross profits, despite weaker seller supply, and despite marketplace conversion. And I believe we have a sound strategy in place to reach our 2022 goals and beyond. As I look beyond 2022, I'm also very encouraged by our longer-term prospects for growth. As we outlined in our Investor Day update in June I believe our growth will be driven by a number of important factors. First, the ongoing secular shift towards digital marketplaces across our entire industry. This will drive increased volume in both the dealer and commercial part of our business. Second, a broader recovery in commercial volumes across our industry. Third, the continued strong performance by businesses like AFC and ADESA Canada where we have differentiated offerings in a strong market position. And finally, our continuous focus on cost efficiency and being an asset-light digital company. Together, I believe these factors will help us navigate any short-term challenges while positioning us for accelerated growth in the future. I look forward to sharing our progress towards these goals on our next call. Thank you everybody and have a great day.

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