Good morning and welcome to the KAR Auction Services Inc. 2022 Year End Earnings Conference Call. All participants will be in a listen-only mode [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mike Eliason, Treasurer and Vice President Investor Relations. Please go ahead.

Thanks Kate. Good morning. And thank you for joining us today for the KAR Global fourth quarter 2022 earnings conference call. Today, we will discuss the financial performance of KAR Global for the quarter ended December 31, 2022. 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 forward-looking statements within the meaning of the Safe Harbor provisions for the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks 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 measures 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's 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'll provide you additional information and detail relating to the following items; our fourth quarter and full year 2022 performance, our view of the current market factors impacting our industry, our outlook for 2023 and beyond, and a summary of our capital allocation activities. I'm going to speak about our business in two segments, our marketplace segments which we formally call the ADESA segment and a finance segments which we formerly called the AFC segments. To begin Q4 with our second full quarter as a more asset like digital marketplace company. Against the backdrop of an unusual and still very volume constrained industry environment, we increased revenue and total gross profit on reducing our overall cost structure. We made significant progress to position our company for improved performance in 2023 by simplifying our business and consolidating a number of our platforms and operations. And we positions our company for growth in 2023 and beyond. So let me touch on some of the specific highlights of the fourth quarter and full year performance. For the fourth quarter, we generated $373 million in revenue, a 4% increase versus the same quarter of the prior year. Purchase vehicle revenue represented 12% of total revenue in the quarter. We generated a total gross profit of $171 million, an increase of 4% from Q4 of the prior year gross profit representative 62.1% of revenue excluding purchase vehicles. This resulted in adjusted EBITDA of $56.5 million in Q4. For the full year 2022 KAR generated over 1.5 billion in revenue, that was a 5% increase compared to 2021. Purchase vehicle revenue represented approximately 12% of total revenue for the year.…

Thank you, Peter. As Peter has already commented on many of our financial metrics, I only have a couple of additional areas to review. We made one disclosure change. We will no longer be providing on-premise and off-premise vehicle sold amounts for a marketplace segment because we have moved to a digital business model we believe the break down is no longer needed to measure the success of our business. Looking at the fourth quarter, consolidated revenues excluding purchase vehicle sales increased 7% in the quarter to $327.8 million. Marketplace segment revenues excluding purchase vehicle sales were flat with the prior year at $227.1 million and generated approximately 69% of the consolidated amount. Marketplace vehicle sold declined 15% to 289,000 units due to the market conditions Peter highlighted. Auction fees per unit declined approximately 5% to $280 as a result of lower vehicle values. Service revenues increased 16% due to increases in repossession, transportation and technology services provided. Not only did attachment of these marketplace services increase but it's important to note that not all services are attached to our marketplace transactions. For example, repossession services provided through our RDN empower platforms grew and generally do not attach to the marketplace transaction. Increased service revenues generated in a challenging industry environment, highlight our diversified revenue streams that can be generated in varied market conditions. Service revenues generally are lower margin compared to auction fees and therefore our consolidated gross margins excluding purchase vehicle sales declined to 52% from 54% in the fourth quarter of 2021, largely due to increases in the lower margin services provided. In addition, finance segment revenues accounted for $100.7 million or 31% of consolidated revenues, excluding purchase vehicle sales. Finance segments, segment revenues increased 27% in the quarter due to strong volume fee and interest income…

We will now begin the question and answer session. [Operator Instructions] The first question is from Rajat Gupta, JP Morgan. Please go ahead.

Great, thanks takings the questions. This is Rajat on for Orion. Maybe first question on the fourth quarter, the gross profit per unit took a step down sequentially more than the revenue per unit declined. Would you be able to elaborate on the drivers of that? How should we think about that trajectory into 2023 and have a follow up. Thanks.

Yes. Rajat. I think gross profit I mentioned it was a declining used vehicle value environment. So, in that environment as vehicle price came down there was some negative on by feed revenue, so that probably flowed through into gross profit per unit. So I think that was a factor. We had also some other, more technical accounting items that impacted gross profit in the fourth quarter, but I don't think would recur. But I think I'd say vehicle values would be the principal one, and then when you have lower conversion rate this is another factor, it puts pressure on gross profit, because if you think about you're inspecting a greater number of vehicles per every vehicle sold, for example when it comes to lower conversion rates, so that we generally find when conversion rates are lower, which they were gross profit per unit would be a little bit under pressure. The other metric I look at on gross profit, though, is the greater than 50% of consolidated net revenues if anything, maybe a more important metric that we use internally to manage the health of the business. And I was pleased that we delivered gross profit above the 50% target for the quarter.

Got it. Got it. Thanks for that color. You mentioned 15% to 20% EBITDA CAGR going forward, can you help us like the confidence of that how should we think about volume recovery, you're expecting that flows through that, and also how that volume recovery is slowing to gross profit and the SG&A annual average on that. And maybe just on SG&A based on the cost savings, action, and just the overall cost actually just taken, how much of that should now be treated as fixed versus variable in nature? Thanks.

Rajat, there is a lot packed into that question there. So first, if I look at the sort of go forward growth, yes, I believe a 15% to 20% consolidated adjusted growth and adjusted EBITDA over multiple consecutive years is what we believe this business can deliver. And we're focused on delivering that organically. I think the company has opportunities for growth across the entire business. If I look at our commercial volumes, we've got a strong presence with commercial as you know, as those volumes have been under pressure. We see opportunities to see volume growth in that category, but also, I think, strong conversion rates in that category over the long term as well. So opportunities there, I think in digital dealer to dealer. My fundamental belief is that there is a secular shift on your way from physical towards digital, off site, off-premise channels. We're strong in that category. We intend to grow in that category and frankly, intended great gain share in that category. So I think we're going to grow in that segment. I think our services, businesses, inspections, logistics, etc, have been under a lot of pressure, the last couple of years. Some of them losing money, because of very low volumes. We've been addressing that, I think there's a chance for those businesses to get back towards and frankly, ultimately, above historical levels of profitability as well over time. And even AFC which has been a strong performer, as you know, for the last number of years. I think there are opportunities for growth there. I think it's going to be more modest growth in that part of the business. AFC will be a smaller percentage of our total earnings over time, because the marketplace business we expect to grow much faster. But…

Thanks for all that color.

The next question is from John Murphy of Bank of America. Please go ahead.

Good morning, guys. Peter I mean, as you think about this I mean, I think there's a lot going on in the industry and in the flow of vehicles is hotly debated and what may happen with the recovery. Many folks are looking for '23 and '24 to the sort of flattish years in remarketing. It might be better than that. But as you think about this transformation, what are the KPIs that you look at to sort of gauge the progress? Because I think a lot of investors may be frustrated because the vines might not recover, I mean, debatable point and progress, it may be tough to see in that kind of environment. Is it simply the EBITDA, CAGR of 15% to 20%, that people should be looking at? Are there other KPIs that you think you're going to be able to show us over the next year or two in what might be a tough industry backdrop, sort of people can really understand the progress that you're making?

Yes. Thank you, John. Yes, a couple of things, I would say all of our modeling is based on the industry volumes remaining below normal for the next number of years. The growth I'm talking about is in the context of an industry that remains below normal. I would say wholesale industry volumes are still down 30 plus percent, maybe as much as 40%, from pre-pandemic levels. And our assumptions on volume inherent in our guidance are essentially flat volumes relative to last year. I think, if we see faster recovery, or an acceleration, or a digital dealer to dealer that would represent upside versus our guidance, as I said. So I think we're being conservative in our remodeling. Our realistic, or however you want to call it my personal belief is we're at the bottom in terms of industry volumes, and we're going to see a gradual but sustained recovery over time over multiple years. But that'd be a positive for us. In terms of KPIs in the marketplace business our results correlate more than closer, the volume sold per quarter is a key driver. So volume sold, obviously, is the critical KPI in our business. Volume sold is consumer volume offered two times conversion rate. So we obviously look at both of those metrics. And then volume offered is a function of participation, participating sellers and conversion rate participating buyers. So we look at seller and buyer participation in our digital marketplaces. And we also then look at what sort of results our customers are achieving beyond conversion rates, so price attainment or marketplaces indexed against some benchmarks. So we look at all these metrics and many others as functions of the health of our business. I mentioned sort of simplification earlier and trying to have a simpler…

Right. And just two quick housekeeping can you just remind us what the service is agreements and the expectation from what you're offering, or what you're getting to Carvana on the tech side? And what kind of feeds you're getting here in sort of your guidance for 2023? And then also, you mentioned AFC losses would stay under 2%. But 2% sounds like it's a reasonable, like normal level, when do you think we re-creep up there? And should you be taking more risk in AFC if those losses stay lower to grow the business significantly more than greater than where it is right now?

Thanks, John. Yes, I don't want to comment too much on the Carvana arrangement, but it's the same arrangement as we had last year. We provide some services, there's some fees attached. It's a small percentage of our total revenues. But obviously, we're very focused as well on the separation activities that continue and that's generally going well. On AFC, the 2% would be above or historical mean or median for that losses number. So 2%. is higher than historical. Our budget, it doesn't reflect 2% this year, but I think Scott said it in any given we may, in a quarter see the 2%. But for the year, we expect it to be less. I think when it comes to our AFC business, we've always been cautious and conservative in our approach to growth. And that's where I'd like to continue. Simply put, I just, we just want to be cautious in terms of yes, there's a bigger opportunity to grow. But we like to run this business conservatively. Keeping the losses below that level, I think is important for us in terms of our stewardship of the business.

Great, thank you very much.

The next question is from Gary Prestopino of Barrington Research. Please go ahead.

Good morning, Peter. Hey, just a couple of questions here. Could you maybe comment on the year-over-year change in conversion ratios? I mean, how much were they down versus last year at this time? And if they had stayed at the level where they were may you have hit the low end of your guidance. I'm just trying to get an idea of what the impact on these conversion ratios are having on your volume portfolio?

Yes. Gary, thank you. The conversion rates they are very important. I'd say you could argue that in a digital business, they're more important even than in the physical. Because if you think of the way that physical auction works, often when a car goes in the gate, it ultimately doesn't come out the gate until it's sold. The conversion rates may be low, one week, but the seller is going to run the car next week, or run it for four more weeks and ultimately sell it. In a digital marketplace if you don't sell the car, then maybe it's going to move on to the physical channel. So we're kind of taking a slice of chunk of the cars out before they move through that process. Conversion rates were down across the entire industry. In fact, I was looking at convert, I think conversion rates of physical auctions in Q4 were the lowest they were since Q2 of 2020. So the depths of the pandemic. So it was a very weak quarter from conversion rates in our industry. And I'd say generally conversion rates were down 5 to 10 points across our markets, I'm being that's a bit of a wide range area, I don't have specific numbers in front of me here, but 5 to 10 points, from say, a 55-ish level to a 45 to 50-ish level, something like that, based on some of the marketplaces I'm thinking about, and you can you can do the math yourself and how that impacts in sales. If you've got a market converting at 50%, and that drops to 40%. That's effectively an 20% drop in sales. So conversion rates were weak that I think if conversion rates had been the same as the prior year, yes, we would probably would have hit the lower end of the range. The one thing I will say, though, is we have been it's been interesting, but as soon as we turned into 2023, it's almost like a page turned in the book and conversion rates, demand has really picked up and conversion rates are back again at strong historical levels. Some of that is the spring market. We have a spring market effect in this industry most years. So I think we're seeing a strong spring market this year. With strong demand from buyers and increase conversion rates across the board. How long that will continue remains to be seen. But certainly in the current moment in the spring market, we're seeing strong conversion rates.

When you say it's back to historic levels, is that somewhere close to 60%? Or is that too high?

I'm just because we have these different venues, I'd say in some of our marketplaces is 60%. And in a couple it's probably a little below that. But I'd say that in that 50 to 65 range or something like that.

Okay. And then lastly, could you just comment on with your digital dealer to dealer platforms both companies and now with the consolidation that's going on. How far are you penetrated into the franchise dealer market overall with this product?

Well, I'd say our industry is past the early adopter phase. We're into the broad market where many dealers are using these types of platforms and channels. But at the same time, when we look at the total volume of dealer consigned vehicles, they're still physical auctions would still be approximately three times the total volume of the combined digital channels. I would say in the dealer to dealer segment. So a strong penetration in terms of number of dealers using the platform and continuing to increase. But still a minority of all the vehicles being sold in the marketplace. But that said, Gary, there's no question in my mind, but the digital channels have gained share over the last if you just look over the last number of years digital has gained share, I expect that to continue. It seems to me that this if you think of our digital offerings, we will inspect the car at your dealership. It will be on our marketplace immediately. Likely sold within certainly within 24 hours, moved pretty much immediately after that funds flow, tidal flow. It's a very efficient process. And with that, you have this national buyer base. You immediately offered to a national buyer base who are online ready to bid right now as opposed to waiting for some scheduled sale and for the buyers that just happened to be showing up at that location. So I think the digital offerings very strong. I think it's going to gain share. I think we're going to gain share with that.

And then what just one last quick question. I'll jump off. I mean, on the digital dealer to dealer typical auctions that are out there are you guys what kind of price differential you're seeing on realization on digital to digital versus what's out there in the physical market?

Well we've benchmarked every car we offer and sell in the channel versus market. We believe our digital offerings perform extremely well. And obviously, we're continuing to execute the strategies to further improve that, because that's mission critical for sellers. They have to get the best price. So I would say, yes, I think digital channels perform very, very well, on that metric as good or better than the alternative. So making that apparent to our customers is a key part of our sales and marketing process.

Right. Okay. Thank you.

Thank you, Gary.

The next question is from Bob Labick of CJS Securities. Please go ahead.

Hi, good morning. It's Pete Lucas, for Bob. You guys covered a lot just wanted to touch on you talked about platform consolidation in terms of the dealer to dealer strategy. Have you settled on the single type of auction? And in terms of what types of cars are better for timed auctions versus the bid ask market? And is that something that's segregated by price of vehicle? Or how do you think about that?

Pete, thank you, that is a very interesting question. And there are absolutely some things are become apparent now that we have these both of these offerings in the market. So if I look back at our cars today, essentially, there are two offerings. There is the 24/7 marketplace. And so vehicles is kind of a bid of a marketplace where the buyer and seller interact, and they come to a tear in price and the vehicle sells that's what BacklotCars has been historically. That performs really, really well. It tends to have very strong conversion rates, and strong price attendance. And I would say it's particularly strong on lower value vehicles. And I would say sub 15,000, certainly sub $10,000 vehicles, that model seems to work really, really well. Its weakness, frankly has been with higher value vehicles, $15,000 and greater performed quite well, but just not quite as strong. Now that we've got the auction format live, currently we're running that auction two days a week. It's a purely digital auction. Cars are inspected. They are available in a pre auction process and then visible bidding takes place over to our window on currently Mondays and Thursdays. I imagine that will over time, we'll increase the frequency of that. We made have different days in different markets, different days for different sellers. So we've got a lot of flexibility in how we go to market with that. But currently, it's two days a week. What we're seeing there is very strong conversion, but a tiny bit below what we're seeing in the marketplace, or we're seeing very, very strong price attainment. So if anything even better price attainments in the marketplace, and we're also seeing it perform really, really well on the higher value vehicles. Okay. So I think we've got an offering here that's very compelling, addresses all different types of vehicles. And I think the other big differentiation that we have here at car is we have a deep, deep footprint with commercial sellers. Currently, those vehicles first of all, there hasn't been as many of them over the last year or so. They've been selling and private label sites, etc. But as more and more cars, those vehicles flow into open sale channels, which I believe they will, we're going to integrate that volume into one combined marketplace. So our buyers will go to one venue where they're going to see a tremendous number of dealer owned vehicles, and also a tremendous number of commercially owned vehicles with very easy to use digital tools, digital checkouts, etc. I think that's going to create a unique differentiation for us in the marketplace. I think it's going to be very, very compelling to all of our customers. So I'm excited about that and that's really very strategy.

Very helpful. Thanks. And just one more for me in terms of the open lane outlook. What are you seeing? You talked a lot about the market volumes and what you've seen there. But what are you seeing in terms of mix change at auction? Meaning are the dealers auctioning lower priced cars and hang on to the higher priced ones and how is that helping or hurting you?

I guess what I say is on open lane the cars were selling an open lane are commercially owned vehicles and by far the majority are new off lease. So what we're seeing is currently volume is similar in levels to last year, but we're actually seeing a slightly better mix. By that I mean, we're seeing a little lower percentage of them selling to the grounding dealer. Last year was in the high 90s. So we're seeing that percentage is dropping, the grounding bidder is buying a lower percentage. And consequently, more vehicles are flowing a little deeper into their marketing funnel, where we generate greater revenue per vehicle. Okay. So we're seeing that it's nothing close to normal. But it started to move away from its unusually distorted position that it's been in for the last 12 months. Okay. So we're seeing that. The other thing is, as I mentioned in my remarks, a number of our commercial sellers have indicated we should expect significantly more volume later this year. We haven't reflected that in our models. I am being very cautious around that because I really want to see it. There have been false dawns before in this in this journey we've been on. So I'm going to be cautious. But I do believe over time, that absolutely should happen. And when it happens, we will benefit from that for sure.

Very helpful. Thank you.

You are welcome.

The next question is from Bret Jordan of Jefferies. Please go ahead.

Hey, guys, this is Patrick [indiscernible] on for Brett Jordan. Thanks for taking our questions. Could you talk a little bit more about the cadence of how you see the marketplace progressing in '23? Just trying to model out auction versus finance contributions throughout the year? And if we should expect finance to continue being the main driver at the bottom line there?

Thanks, Patrick. appreciate that question. If we think about our guidance, for this year, we expect AFC to continue to be a strong contributor, but slightly lower than its contribution in 2022. Okay. We expect AFC to grow its volumes. But vehicle values may be lower than last year. ARPU may be in line or slightly lower than last year. But we're expecting some level of higher risks. So AFC contribution while remaining strong, slightly lower than last year so the growth is all on the marketplace side of the business. And again, it's driven by on commercial I think volumes similar to last year, maybe I think we've modeled a very slight decline but a stronger mix. On D2D we've modeled a slightly small level of growth let's say. I hope we can do better, but we've modeled a small level of growth and then coupled with that reasonably strong margins in line with what you've come to experience with the business and lower SG&A overall.

Got it. That's helpful. Thank you. And then I guess a little bit more on the AFC side of things there. What have been the primary drivers of growth beyond [indiscernible] and loan counts? And I guess a little bit more how do you see those progressing in '23?

Yes. Good question, Patrick. AFC is the number two in its industry and has been that the positions occupied over many, many years. So it's been a consistent strong number two in the industry. But we do believe that over the last three or four years AFC has gained share. So the gap between AFC and the number one has reduced somewhat over the last number of years. Okay. I would say AFC has done that well, it's been by increasing its dealer base. It's number of dealers using AFC has been the principal driver of that. And I say AFC it differentiates itself, I'd say on strong service, a strong culture of service to the dealer. We try not to compete on price, although obviously price matters, but service and also expansion of its product portfolio to take on certain activities that benefit the independent dealer which is AFC's core customer, and turn those into revenue and profit generating opportunities for AFC.

Got it. That's very helpful. Thanks, guys.

Thank you. Kate I think we've time for one last question.

Okay, last question will be from Daniel Imbro of Stephens Inc. Please go ahead.

Hey, guys, this is Reed] on for Daniel. Appreciate you all for squeezing me in. With the return of off lease in the coming year, how do you foresee your ability to handle those units as the market normalizes and units need more reconditioning work?

Yes, Dainel, sorry [Reed]. Okay, so I think one of the good things about a digital business is it scales. So as volume returns I think scaling the business is not really a challenge for us. We have to process more titles, more funds, but from a technology platform standpoint we don't have to build a second technology platform. So I think the business will scale really, really well. I'm not worried about that. There are some parts of our business like our audit and inspection business, we may have to hire some inspectors if volumes increase there. We'll deal with that as and when it comes. To your question on reconditioning. I guess the way I view it Reed is that in a typical [indiscernible] portfolio, yes there are some vehicles that probably benefit from reconditioning before they're sold. But it's a very small percentage, in my view is probably 20% of the vehicles that mature. Now, that's not a very scientific number, but just to put some facts on that, like before the pandemic started, the off lease conversion rate on our marketplaces was about 55%. So those 55% none of them are reconditioned. Okay. Those conversion rates in the pandemic and over the last number is increased up into the low 80% levels. And again, none of those 80% vehicles are getting reconditioned. So my thesis is that as off lease volumes returned, I think conversion rates will drop back from the 80% level. But I don't think they'll ever go back to where they were pre-pandemic. I don't think our sellers want to start sending that volume of vehicles back into physical channels. I think they want to find ways to increase upstream conversion and reduce the remarketing costs. So every off lease vehicle is inspected, it gets the condition grade. In my view, the only vehicles that really need reconditioning that the dealers themselves can provide are some of the more damaged grades. Now, that's my personal view. Other people may have different ones, but I guess we'll see over time, but I'm expecting a strong conversion rates going forward in the off lease channel, stronger than we saw pre-pandemic.

Okay, very helpful. Thank you for the color.

You are welcome. So, again, I think that's all the questions we have time for. So thanks, everybody for your time this morning for those questions. I just want to close out my remarks by reinforcing some of the key messages from earlier today. First of all, by 2022 was a challenging year across our entire industry. I'm pleased about the team of KAR accomplished, and how we positioned ourselves for success in the future. We are a digital marketplace leader. We have differentiated offerings and a strength that is unique with both commercial sellers and dealers. We have simplified our business, consolidated platforms and improved our customer experience. We have meaningfully reduced our cost structure. And we've set ourselves up to operate more efficiently in the future. And we paid down over $1.5 billion in debt and repurchased approximately 10% of our outstanding common stock. The progress made in 2022 should help us deliver improved performance in 2023 even if industry volumes remain weak. Our guidance is deliver adjusted EBITDA of $250 million to $270 million in 2023 and the management team and I are fully committed to achieving that goal. As we look to the future, I believe that the secular shift to digital will continue and the digital platforms will continue to gain share. That will be to our benefit. However, we're not waiting around for this to happen. We are charting our own course and we have many initiatives in play that we believe will enable us to grow our customer base, increase our market share, and expand our product and service offerings for our customers. I look forward to updating you on our progress and future calls. So if you look past 2023 I believe KAR has a compelling opportunity to deliver top line growth and improve bottom line performance. I believe we can grow a consolidated adjusted EBITDA by a compound annual growth rate of 15% to 20% over the next several years. I'm excited and energized by the opportunities that lie ahead for this company. We have a differentiated offering a diverse and expanding customer base and a large addressable market in which to innovate and invest. With that we'll end today's call. I look forward to reconnecting in less than 90 days to update you on our first quarter performance. Thank you all very much.

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