Good day, and welcome to OPENLANE's 2023 Year End Earnings Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mike Eliason. Please go ahead.

Thanks Ed. Good afternoon and thank you for joining us today for the OPENLANE fourth quarter 2023 earnings conference call. Today, I will discuss the financial performance of OPENLANE for the year ended December 31st, 2023. After concluding our commentary, we'll take questions from participants. Before Peter kicks off our discussion, I would like to remind you that this conference call contains forward-looking statements within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties that may affect 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 issued this afternoon, which is also 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?

Thank you, Mike and good afternoon everybody. I'm delighted to be here today to provide you with an update on OPENLANE. Joining me is OPENLANE's Chief Financial Officer, Brad Lakhia, who will cover the majority of our financial and operating metrics later in the call. I will begin by highlighting a few key areas of our 2023 performance, but I will focus most of my remarks on the execution of our company strategy, the broader industry environment, and our positive outlook for the future. In terms of results, it's clear that our business made significant progress in 2023. We are now beginning to see the positive impacts of our strategic investments in innovation and technology, our brand simplification work, as well as our diligence around costs. I believe our solid execution in the fourth quarter and throughout 2023, delivered strong and encouraging results that position OPENLANE for future growth and success. When I look at OPENLANE's consolidated performance for the year, a few things stand out. We grew our volumes, revenue and gross profit. Notably, consolidated gross profit increased by $92 million or 13% compared to the prior year. We beat our 2023 guidance by delivering consolidated adjusted EBITDA of $272 million. That was an 18% increase from the prior year. OPENLANE had another strong year of cash flow performance, generating $237 million in cash flow from operations in 2023. Our Finance business, AFC demonstrated solid performance in 2023, against the backdrop of declining vehicle values and a higher interest rate environment. With the continued focus on risk mitigation, the business grew responsibly and made a meaningful contribution to OPENLANE's bottom-line. Our Marketplace business made significant progress in 2023 and finished the year on a strong note. We grew fourth quarter volumes by 10% to 318,000 vehicles. This is the…

Thank you, Peter and good afternoon everyone. Before I begin, I'd like to remind everyone that all financial metrics I comment on at a consolidated level and a total Marketplace segment level or on a net revenue basis, which specifically excludes the impact of purchased vehicle sales. Let me start with the Marketplace. As Peter mentioned, for the full year, we delivered 3% unit volume growth which drove a 6% increase in Marketplace net revenues. For the year, commercial volumes grew 7% and dealer volumes declined 2%. While our overall dealer volumes declined 2%, we continue to deliver US dealer volume growth that partially offset declines in Canada. Peter highlighted the fact industry fundamentals are normalizing and in Canada, we experienced a more rapid decline in vehicle values in the second half of 2023, which resulted in a headwind to dealer volumes in the third and fourth quarter. That said, we see our geographic diversification as a clear strength. This is reflected in our leading Canadian market position and a growing profitable European business. Combination of these provide us a unique ability to grow profitably in varied market environments. A couple of other additional top line highlights that are important. First, as we discussed in our last call, our US dealer volumes are growing and our US dealer business is profitable. And second, in the fourth quarter, overall Marketplace volumes grew by 10%, which reflects improving dealer wholesale fundamentals and improved volumes and mix within our commercial channel. For the year, auction fees per unit increased 4%, driven by fee increases, which more than offset the impact of declining wholesale used vehicle values and the impact of a higher proportion of commercial vehicle volume. As we've discussed previously, our digital fees are lower compared to physical auctions, and therefore, our…

Thank you. We'll begin the question-and-answer session. [Operator Instructions] And the first question today comes from Rajat Gupta with JPMorgan.

Great. Thanks for taking the questions. Just wanted to follow-up on the off-lease commentary. What's going to be the key driver of the commercial business this year? And do you see the net impact of perhaps increased return rates on the leases versus the lower off-lease returns in the second half being a net positive or a headwind for the company? And then where is the incremental volume growth going to come from on the commercial side? And I have a follow-up. Thanks.

Thank you, Rajat. So, I think the off-lease segment, obviously, is a historical strength of the company. It's been really challenged in the past few years because of what I call the equity gap vehicles being heavily in positive equity at the end of lease and getting bought out by the consumer, by the grounding dealer. So, that cures been a challenge over the past couple of years. But we've seen that equity gap really decline pretty steeply and rapidly over the course of the last nine to 12 months. And it's now at the lowest it's been certainly for the last, I'd say, 18-plus months. We are seeing increased volumes of off-lease vehicles being returned at this point and entering the marketing funnel. So, that is a positive for us in terms of volume. We're also seeing those vehicles flowing more deeper into the remarketing funnel. They're not all getting purchased by the grounding dealer. So, that is another positive. That impacts mix and ARPU. So, a little bit of that was evident in Q4. I think there's more of it probably happening in 2024. And again, we would expect, over the long run, this will look much more like normal and normal would be most off-lease vehicles at the end of the lease do not have any positive equity. They have negative equity. They get returned and they enter the remarketing process. So, to your question on, could that trend, which we're now seeing, offset the sort of top of funnel impact of fewer vehicles maturing because of lower lease originations. Rajat, it's possible, I -- it's difficult to model it with precision because we don't know the exact residual value status of all those vehicles. But at the present moment, I'd say I'm encouraged by what I'm seeing and I take that as a positive. We're going to have to see how it trends in the second half of this year. Probably the most positive thing, before I wrap-up on off-lease vehicles here, is the increased lease originations, a 20%-plus increase in lease originations last year and a 40%-plus of lease originations in the fourth quarter. This really tells me that leasing is going to be an important part of the way vehicles are brought to market in the US as it has always been. And it's going to be a very important part of our business going forward. So, it's very encouraging for me to see that trend I know we're going to have to wait a couple of years for some of those vehicles to mature, but I still think it's a significant positive as we look to the future.

Got it. That's helpful color. And just on the full year guidance, I think you mentioned that the EBITDA improvement is going to be primarily driven by the marketplace. I mean, should we expect AFC to grow in 2024? Or do you think given like the exit rate on the credit losses should we model that business down in 2024 or flattish? Just curious if you can give us a little more color on the AFC outlook for 2024?

Yes, hey Rajat, thanks for the question. So, yes, I would say for AFC, I certainly wouldn't want you to model it down here to just to head that off directly. We actually see that business going forward year-over-year, in terms of how we're kind of modeling it and planning it ourselves. But going forward modestly, as I said in my comments, first half losses -- on a loss rate, but in terms of dollars, we expect that to be fairly similar to the second half of 2023. And we, as you can imagine, have a pretty good line of sight to that right now. And we expect that -- those loss rates to moderate in the second half of 2023, which year-over-year should provide us a benefit. And then I would also just say, as we alluded to in our comments, we're going to continue to look to grow that business. We're going to do it in a very disciplined manner, very conservative manner. We have a -- it's a high-performing business from a cash flow and an earnings contribution, and we'll continue to look to grow that business.

Got it. Great. Thanks for the color and I'll jump back in queue.

And the next question comes from Craig Kennison with Baird.

Hey, good afternoon. Thanks for taking my question. I wanted to follow-up on the prior topic. Just, Peter, you're talking about off lease and the equity gap and that seems to be narrowing. I'm curious, based on the work you've done, how long until we get to that normal environment where a car comes off lease and there's actually negative equity if car prices stay about where they are today?

Craig, it's a good question. It's hard for me to predict it with precision. But I do -- I'd say a number of things are relevant as we think about that. One is where used car prices trending. It's been interesting in the first few weeks of this year, they've continued to trend slightly downwards. So, I still think there is, for the most part, more downward pressure on used vehicle pricing than upward at the present time. Although I'm not expecting a significant decline over the course of 2024. And then the second point is where are the residual values on the leases -- these contracts written. And when I think of that, you got to think -- now we're starting to lap leases that were written in early 2021, mid-2021. That's a period where we saw a rapid run-up in new vehicle transaction prices. So, that would tend to correlate with higher residual values on those contracts. So, I think the equity gap is being compressed from both directions, and I expect it to normalize in the not-too-distant future, but I hesitate to put a specific time on that.

If you were to look at the cohort of leases made in late 2022 when used car prices really peaked, is it fair to look at those that cohort in particular and say, those look to be candidates for having significant negative equity?

Craig, I can't really sort of shed more light on that than I've already shed in my answer. I think -- I guess there's one possible complication, Craig, that if there's fewer off-lease vehicles at the top of the funnel, there could be increased demand and the prices in those vehicles could -- that could sort of lift the prices on those vehicles and that could cause that equity gap to not narrow as steeply as one might like. So, there's just a lot of moving pieces here, Craig. And I think here's what I would say. We've seen the equity gap come down a lot. We're seeing more vehicles enter the remarketing funnel. And based on my conversation with our commercial customers, they expect those trends to continue and that percentage of vehicles entering remarketing to go up. And that has the potential to offset the top of the -- that we are aware of.

Yes, thank you very much Peter. And then maybe if I could. On the dealer side, I believe it was down just a little bit versus last year. I'm wondering if you're still adding dealers. And if so, are you seeing fewer transactions per dealer for any reason?

Yes, we've seen -- as Brad mentioned, we saw some headwinds in the second half of last year on dealer volumes in Canada. In the very strong market of the prior year, there was a lot of export volume from Canada into the US and that drove strong demand in Canada and drove liquidity in the dealer segment. So, that kind of went away, I'd say, largely in the second half of last year. That was a little bit of a headwind. Well, we continue to add customers. Our customer base on D2D continues to grow. Our US D2D volumes grew in the fourth quarter. And I'm again, as I mentioned in my remarks, very pleased with the very positive feedback that I've gotten from dealers who are active customers and using our dealer-to-dealer solutions, both on the sell and the buy side. So, I feel very encouraged about our offering and I think it's very competitive vis-à-vis all other offerings that are out there and very sticky with its customer base as well.

Yes. Peter, let me just -- I would just add, Craig, on the Canadian point, what we're seeing in Canada is not unique to us. The data the market intelligence that we have suggest that's more broad-based. So I just want to make it clear that it's not unique to our business there.

Great. Hey thank you.

Thanks Craig.

The next question from John Murphy with Bank of America Merrill Lynch.

Hey, good evening guys. Just first question, Peter, you guys talked about the dealer-to-dealer business in the US being up a lot, but I mean total was down. So, I'm just curious how much dealer business was up in the US? And then also, conversely on the commercial side, where the strength is really coming from? I know we're talking about off lease, but there's rental government and commercial, commercial on the fleet side of the business. Was there any kind of particular strength there where these companies are finally getting back into auction lanes and selling as opposed to being buyers?

Yes. So, -- thanks, John. So, on the dealer side, I said dealer volumes were up in the US, I didn't say up a lot. I just want to be clear, but they were up in Q4. And I believe based on our analysis, we gained share in the dealer segment in Q4 as well when we compare our dealer volumes versus what we saw in other data sources. In terms of commercial, we're seeing growth in commercial in both the US and Canada. So, I think it's fairly broad-based. I just spoke about off-lease vehicles. We're seeing increased consignment, more vehicles entering the funnel, flowing deeper in the funnel. So, that's a positive for us. It was a positive in Q4, and we think that's the beginning of a trend. In the industry, there's also been an increase in repossession volume, John. Most of those repos are sold at physical auction. I want to be clear on that. So, we don't sell a lot of repos in our digital model yet, although we are piloting with some customers and having some success in that segment as well, but the volumes there for us are still quite small. But repo volumes are up, off-lease volumes are up, and we do sell rental cars as well for some of the major rental brands that you're aware of and those volumes have been quite strong for us as well.

And lastly, is there any potential upside in auction fees as we see the dealer business maybe strengthen in the coming years? Or is this $280-ish, your number kind of the upside -- the upper limit? I mean, how much upside is it potentially from mix and even fee increases over time?

I think there is upside on price. We're competitively priced, I believe, vis-à-vis alternative channels. it's evident to me that buy fees at the physical auction side of the business have increased materially over the past few years. So, I think we're well-positioned there. John, I'd say I like where we're priced right now. I think we give our customers a great value proposition in terms of the speed of sale, the low cost of sale and also the outcomes they've achieved on their vehicles. And as Brad mentioned, well, you see our consolidated results, but our D2D business in the US was profitable. We did increase price a little bit last year in that segment. So, we've got some further opportunity to do that, but we don't have anything immediately planned.

Great. Thank you very much.

Thank you, John.

Our next question comes from Gary Prestopino with Barrington Research.

Hey, good afternoon everyone. Most of my questions have been answered, but -- with the provision for credit losses going up as much as it did. Could you tell me was that more systemic to your Canadian business versus your US business? I know they're having really a challenging economic environment up there. So, could you elaborate on that a little?

Yes, Gary, it's Brad here. Thanks for the question. I would say there's nothing I would say that we're seeing from a loss perspective that's unique to Canada versus the United States or vice versa. There's -- it's fairly -- nothing systemic or unique. I would just answer it that way. I would say as we think about each market, and our underwriting and risk appetite in each one. We do look at them differently as we saw -- as we said, the value -- vehicle value declines in Canada, we're a little bit more severe than what we see in the US. So, from our financing business perspective, that's a factor we look at. And not only our underwriting environment for potential new customers, but also in our risk management processes.

So, in this kind of environment that we are in now, have you done anything to increase your lot checks on a weekly basis just to keep tabs on these vehicles?

Yes. More activity there certainly have stepped that up, and that's been true really throughout 2023, and we'll continue. I would also just add Gary, we have really also driven a lot of advancement in our analytics over the past several years, and our analytics have better positioned us to allow us to move accounts that are signaling higher risk to move them into what we call a wind-down status, which allows us to significantly mitigate losses versus letting them go to a full delinquent status. So, our analytics, our risk management processes are allowing us to lean into some of those cases better than they historically have.

Thank you.

Our next question comes from Bob Labick with CJS Securities.

Yes. Hi it's Pete Lukas for Bob. Most of my stuff has already been addressed here. But just, I guess, as it relates to -- just one question -- to AFC, how do you see net interest income and spread and fee income per unit trending in 2024? And any color you can give there?

Yes. Thanks for the question. I think, Bob, I'll start by just reemphasizing the point here, this business continues to be a strong performer. The portfolios that we have and our yields across the portfolio continue to be strong. If I go back to 2019 and through the years here, the overall yields have been, I would say, fairly consistent overall. That's both on a fee basis and an interest -- kind of a net interest basis. So, the portfolio continues to perform well. I would expect those yields into 2024 to not change materially at this point.

Very helpful. Thanks.

Our next question comes from Daniel Imbro with Stephens.

Yes, hey good evening guys. Thanks for taking my questions. Maybe one, I wanted to ask about maybe on the unit economics side. As we think about the shift back to commercial, historically, those off-lease cars carry a lower revenue per unit, maybe a lower gross profit per unit if they get taken down with the grounding dealer. Curious as you think about the mix shift into next year, maybe a little more commercial in the first half, how do you think about that impacting revenue per unit, but really gross profit per unit, probably more importantly, given those changes in sources?

Yes. Thanks Daniel. So, I'd say in commercial, particularly in our off-lease and those off-lease volumes, as those move down to what we would call the remarketing phases of the funnel, we do get more ARPU. But I would say from a gross profit perspective, it also is more accretive to our gross profits in that channel in that line. It's a more fixed cost-based business for us. And so the incremental revenue that we get from that, particularly as it moves to the remarketing phase of the funnel is more accretive.

Dan, if I could weigh in, just sort of -- I mean, every incremental vehicle is a benefit for our company. So, -- and this part of our business has a very high gross profit as a percent of revenue, which I like a strong gross profit margin. But I guess at a high level, the opportunity here is significant because I'd say unlike the pre-COVID era, we now have much more liquid online buyer base than ever before. We have more active buyers, 24/7 in the Marketplace. I talked about the days to sale for the dealer segment of -- on average about one day. High conversion rates in the dealer segment. There's an opportunity to replicate that on these vehicles that enter the open marketplace on the off-lease side. Historically, the conversion rates there were lower. So, that's a real opportunity for this company. Obviously, working in collaboration with our sellers. The volumes are -- were very, very small. A year ago, they're starting to get bigger. Our sellers see that. They're very focused on how can we work together with OPENLANE to maximize those conversion rates. So, we're exercising the playbooks there. So, this is an exciting area of opportunity for us. And once cars get into that stage of the process, the open sale, those are high ARPU units, high-margin units and very profitable for us as a company.

That’s great. And a follow-up quickly on that one. So, there are higher ARPU even without reconditioning because I feel like for pre-COVID a lot of that higher ARPU when they moved down the funnel was the recon, right? So, are they still higher ARPU even without since you sold the recon assets?

Yes, they're higher sort of buy and sell fee kind of ARPU, auction fees is what I'm talking about, Dan. So, yes, we don't do recon. We do, obviously, the auction fees, the buy and sell fee. These are typically higher-value vehicles, $25,000, $30,000 and up. And there's also transportation revenue. The other thing I would like to add here, I talked about sort of the unique offering that OPENLANE represents in the marketplace. So, now that we have the commercial and dealer volumes together in one Marketplace, and in parallel with that, we're starting to see more of the commercial volumes flowing into that Marketplace, that's having a real positive impact on our buyer base in that Marketplace. Those off-lease vehicles are highly attractive to franchise dealers. So, when I look at the sales report every day and see who's buying those cars, it's much more sort of franchise dealers buying those cars versus -- on our dealer-to-dealer segment, the buyers are typically independent dudes. So, it's broadening the mix. It's increasing the appeal of the Marketplace to a core customer constituency, franchise dealers. And then as those dealers get to experience the power of this Marketplace, they in turn are more interested in, okay, how can I leverage this to benefit my dealership on the sell side. So, again, this goes to the strategy of what we're trying to execute here. But I think we're seeing the evidence of this. I think it's going to be very positive. And again, I think we've got a very, very strong offering and a very differentiated offering out there for our customers at this point.

Appreciate that color Peter. And then a quick follow-up. But did you guys say, I might have missed it, how long do you expect the volume challenges to persist in Canada?

We're seeing some -- I guess what I'll say in Canada, we're seeing increases in commercial volume already, Dan, quite solid increases. We saw commercial volumes through much of last year and that continuing. We have the benefit of the acquisition. So, those are incremental volumes. The challenges in Canada have been on the dealer consignment side of the business. And as best we could determine some dealers are just kind of the industry term is upside down on their inventory. They've got vehicles in inventory. They paid a certain price for them. They're not able to attain that price, but they're hesitant to wholesale them and take the loss. They're trying to retail their way out of the vehicle. So, our dealer -- it's really been in the dealer consignment segment. We started to see it improve a little bit here in the last few weeks. But Canada sometimes a little later to -- for the spring market to really impact up there. So, we'll have to see how it plays out over the next -- over the remainder of this quarter and into April.

Great. Thanks so much guys. Best of luck.

Thanks Dan.

Okay. I think we've got time for one more question.

Thank you. And our final question comes from Bret Jordan with Jefferies.

Hey, good morning or good afternoon guys, evening.

Hey Bret.

2.5% loss rates, is that about as high as we expected to move? I think it was almost back like 2009 Great Financial Crisis levels there. And obviously, they used retail markets challenged right now. But given how short term these are in your control over your borrower, should we expect it to cap out around here?

Yes, Bret. So, listen, I'll kind of just maybe reiterate a little bit of what I said. I think the first half of 2024, where we have pretty clear line of sight at this point will be similar to second half, including that 2.5% that we reported for Q4. So, you'll see something similar in the first half of the year in Q1. So, I think to say that it's going to cap out, difficult to kind of commit to that or say that affirmatively. But if you go back to the great financial crisis, I think the loss rates were a lot higher than. I wasn't with the company then. I don't know that I could quote them off the top of my head, but I think they're quite a bit higher than 2.5%. And even I think if you go to the heart of COVID, mid-2020. They were probably around this level or about 3%. So, we're -- we don't expect them to get back to that point. but it's difficult to predict. I say what I said earlier, the second half of 2024, we do expect it to moderate.

Okay. And then on the physical asset to, sort of, to Daniel's question about as you go down the funnel, were there commercial particularly off-lease sellers that liked having that opportunity to have a car refurbished prior to sale? I guess, as you've converted to digital-only, is there a volume that really does require a physical asset? Or is everybody is pretty much transferable to this platform?

Probably different remarketers would have different opinions on that question. I guess what I would say to that, Bret, is here's what I know is clear. Our sellers are commercial sellers and dealer sellers are really focused on a number of important metrics when it comes to sell a car. How fast can I sell the car? Because that's holding inventory cost is depreciation cost of capital. Well, the digital marketplace wins on that. We sell the car within a day or two or three of it being returned. So, we're a clear winner on that. Second of all, what does it cost me to sell the car? And again, in terms of expenses, the digital channel is the cheapest. There is no transportation cost. You don't pay those higher fees. You don't pay for that recon. And then the third one is, what are the proceeds that I get from the vehicle? And again, I think we look at our dealer segment and we look at, frankly, my discussions with commercial sellers. OPENLANE typically was the highest grossing channel that those commercial customers had. So, I think we're a strong performer on the three core dimensions that customers are concerned about on the sell side. Now, in the past, yes, vehicles went to physical auction because that's where the market was, and when they're at physical auction, it made sense to recondition them because you spend $1, you get $1.50, that type of equation. But the question right now is if there's a liquid demand based online today, that will buy this car today, is it really worth your while to send that car to a physical auction to sell it 21 days from now and potentially get some benefit from recon. I don't know. It feels like a risk that, that customer will take. So, I think different customers will have different points of view. But what I know is many of our customers are keenly interested in how can I drive up conversion in the online channel because that's my highest performing channel. So, we're going to work with our customers on that, and we're going to work with them on not just this quarter, but every quarter and for years to come to maximize these conversion rates and gain share in this industry.

Great. Thank you.

Great. Okay. So, I think that's it. closing remarks here. Okay. So, again, thanks, everybody. I appreciate your time today. I appreciate all the questions as well. As I said at the beginning, I'm pleased with our fourth quarter and full year performance. We delivered volume growth, revenue growth, $272 million of consolidated adjusted EBITDA and more than $237 million in cash flow from operations in 2023. The improvement was driven by the Marketplace business, which increased adjusted EBITDA contribution by $79 million last year to $108 million for the full year. We intend to build on this strong Marketplace performance in 2024, and we also expect our Finance business to be a meaningful contributor to our overall results in 2024. In addition to the financial performance, I'm pleased with the brand and platform consolidation work to be accomplished in 2023. OPENLANE enters 2024 with a highly differentiated offering, one brand, one platform, with dealer inventory and exclusive commercial inventory integrated into one Marketplace. This benefits all of our customers differentiates us versus our competition and strengthens our offering going forward. I'm also pleased with the trends we're seeing in the industry. While we believe that the 2024 industry recovery in wholesale volume will be modest, we see that dealer inventory is increasing, prices are stabilizing, and lease originations are increasing once again. All of this is good news for the future of OPENLANE. We are focused on continued strong execution in 2024, advancing our strategy, making wholesale easy for our customers, and growing the business this year and for many years to come. Thank you all for joining today's call. I look forward to updating you on our continued progress on our next call.

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