OPENLANE, Inc.

Good day and thank you for standing by. Welcome to the Car Auction Services, Inc. Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during this session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star then 0. I would now like to hand the conference over to your host today, Mike Eliasson, Treasurer and Vice President of Investor Relations. Please go ahead.

Thanks, Michelle. Good morning, and thank you for joining us today for the CAR Global third quarter 2021 earnings conference call. Today, we'll discuss the financial performance of CAR Global for the quarter ended September 30th, 2021. After concluding our commentary, we'll take questions from participants. Before Pierre 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 CAR'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 last night. which is also available in the investor relations section of our website. Now, I'd like to turn this part over to Carglobal CEO, Peter Kelly. Peter?

Thank you, Mike, and good morning, everybody. I'm delighted to be here this morning with all of you to provide an update on our performance at Carglobal. So on today's call, I plan to speak about our third quarter results. I'll provide an update on the commercial seller volumes and what we expect to see between now and the end of next year. I'll also provide updates on the continued growth in our dealer-to-dealer business with a focus on our digital dealer-to-dealer businesses, Backlot Cars and TradeRev. I'll provide an update on our acquisition of CarWave and the solid performance of our finance business, AFC. And I'll close out with some updates relating to our cost structure. So I'd like to start with the third quarter. And there's no question but that the third quarter was a challenging quarter, and the challenges were volume-related and principally tied to the commercial seller category, specifically to off-lease vehicles. These industry-wide volume challenges are tied to the disruption of new vehicle production. And I spoke to these dynamics in detail at our Analyst Day event back in September. I don't plan to repeat all that here this morning. However, I will say that the situation remains largely as I described it at that time. So in the third quarter, despite operating in an environment of very constrained vehicle supply from commercial sellers, we achieved the following results. For car overall, we generated $535 million in revenue, which was a decline of 10% from Q3 of last year. We generated total gross profit of $222 million, representing 50.1% of revenue excluding purchased vehicles. We generated 96.6 million in adjusted EBITDA, Cash generated from operations for the quarter was $57 million. Within the Odessa segment, we facilitated the sale of 586,000 vehicles, representing over $9 billion in gross auction proceeds. Now, these volumes were down 33% versus Q3 of last year. Within that, our total commercial volume was down by 51% versus Q3 of last year, and our total dealer consigned volume actually increased by 20%. Fifty-one percent of our sales in the third quarter were from off-premise locations, and this is similar to our experience in the first half of this year. We sold 118,000 vehicles on the TradeRev and Backlot Cars platforms on a combined basis. We also set new records in terms of total active sellers and total active buyers on these digital dealer-to-dealer platforms in both the U.S. and Canada in the third quarter. We generated $274 in gross profit per vehicle sold in the Odessa segment. This was driven in part by strong auction revenue per vehicle sold and is higher than the gross profit per vehicle generated in the first half of this year and 10% greater than the same statistic from Q3 of last year. SG&A for car overall was $134 million for the quarter and SG&A for the ADASA segment was $126 million and that was down $14 million from Q1 of this year. I continue to be pleased with the performance of our AFC business segment. AFC had 351,000 loan transactions in the quarter. This was an increase of 8% versus the same quarter last year, and it was in line with the levels that we'd expected. Revenue per loan transaction was also higher, 20% higher than Q3 of last year, at $215 for the quarter. Key drivers of this were higher vehicle values and lower credit losses. AFC continues to experience lower than normal levels of risk, driven by the current market conditions combined with strong operations. AFC continues to grow its volume of business as well as re-engineer its business processes to have a more efficient service delivery. And for all those reasons, I expect to see continued strong performance from AFC given the current environment. So I'd like to speak for a few moments about the supply dynamics of used vehicles within our marketplaces, particularly supply from commercial sellers. So as I see it, our challenges in the quarter were tied to the lack of commercial seller volumes across our marketplaces. As I mentioned, commercial seller volumes were down by 51% versus the same quarter last year. In our last Air News call and subsequently in our analyst day, I went into quite a lot of detail on the drivers of commercial vehicle supply within our industry. My fundamental assessment has not changed. I do believe that we're at the bottom in terms of the disruption, with the supply of off-lease vehicles and rental vehicles at physical auctions being very close to zero in both categories. Most meaningful to CAR is the disruption in the off-lease volumes, which historically have represented approximately 60% of our total commercial seller volumes. Now volumes of repossessed vehicles also remain below normal. I would say that repossession volumes are relatively stable at about 70% of normal levels right now. And our analysis of the quarter's results indicate that we have maintained our market share with commercial sellers in the quarter. So while we may be at the bottom, I still believe we should expect to remain here for some time. In order for the volumes in our marketplaces to increase, we need to see an increase in new vehicle production sufficient to reduce the very high used vehicle values and allow more off-lease vehicles to flow into the wholesale channel. In our analyst day, we said that we expected new vehicle production to start to improve towards the end of the first half of next year and to continue to improve in the second half, but that we expected it to remain below normal throughout 2022. Based on our continued analysis, as well as our ongoing conversations with customers, that assessment has not changed. What that implies for our business is that we expect the current commercial seller volume constraints to continue through the first half of next year, and we expect to see a small improvement in the second half. We expect to see an acceleration in the volume recovery in 2023 and beyond. So now I'd like to provide an update on our progress in the dealer-to-dealer vehicle category. So first of all, if we look at our total dealer consignment volumes of car, and by which I mean digital and physical combined, we sold 274,000 dealer consigned vehicles in the third quarter. That represented an increase of 20% compared to car's total dealer volume in Q3 of last year. Some of that increase is driven by the acquisition of backlog cars, but I'm pleased that we were able to increase our overall volume by 20% given the tight supply dynamics that exist across our industry. If we look at the digital dealer-to-dealer category only, our Q3 volume was 118,000 vehicles sold. The comparable metric for Q3 of last year was 58,000, so we grew our total digital dealer-to-dealer volume by 105%. However, backlogged cars was not part of CAR in Q3 of last year, and if we include backlogged cars in last year's number, the growth is approximately 19%. We saw record numbers of participating sellers and buyers on our digital dealer steer platforms in both the U.S. and Canada in Q3. We also saw continued growth in average vehicle value sold on both TradeRev in Canada and Backlot Cars in the U.S. And finally, in Canada, our TradeRev business continued to perform very well, delivering strong volumes in the second consecutive quarter of solid profitability. I'd like to spend a few moments on the acquisition of CarWave. We closed on the acquisition of CarWave in early October, so our Q3 volumes do not reflect any volume from CarWave. The CarWave acquisition had approximately 100,000 vehicles sold per annum. CarWave originated in California and is the leading platform for dealers in that market. California, as you might imagine, is a large automotive market. If we look at new vehicle registration statistics, there are more new vehicle registrations in California each year than in the smallest 20 states combined. Also, California has almost as many new vehicle registrations as the next two largest markets, which are Texas and Florida, combined. Based on our diligence, the CarWave platform delivers excellent performance for the sellers and buyers. The average vehicle value sold on CarWave is higher than that sold on backlot cars, and it also generates a higher revenue per vehicle sold and is profitable. And, of course, the acquisition of CarWave also brings a strong team. I believe the acquisition strengthens our map and increases the network effect for a digital dealer-to-dealer business in the U.S. CarWave's strength out west and BacklotCar's strength in the middle of the United States means that we now have a stronger footprint than ever before in terms of both geography and depth within any given market. Ultimately, we see an opportunity to combine the two businesses, bringing the best of both and creating an ever more powerful offering for sellers and our buyers. We also see an opportunity to continue to move up market, and sell a larger number of higher value vehicles. This in turn will help drive further increases in revenue per unit sold and stronger margins. So our integration planning is ongoing, but ultimately we envision a single solution in the market, a solution that aligns with the needs and preferences of our dealers, and that leverages the best technology, features, functionality, and economic model of both platforms. Now, given the strength of both businesses and the positive momentum that both businesses have, we will likely take a little longer to execute this than was the case with the trader of migration. We want to make sure that we don't disrupt our customers and that to the extent we make changes, we're delivering an experience that is better than before for all of our customers. And finally, the addition of CarWave means that our current run rate with digital dealer-to-dealer transactions is now very close to 600,000 vehicles sold per annum and continuing to grow. So we are well on our way towards achieving the target that I established on our analyst day of 1.2 million digital dealer-to-dealer transactions annually by 2025. So I'd like to spend a few moments talking about our cost structure. On recent earnings calls and again on the analyst day event, we've discussed our strategic focus on reducing our cost structure to reflect our transition to a more digital marketplace. The reality of lower than normal commercial seller volumes likely persisting through much of 2022 means that a continued focus on cost remains a top priority for me and for the management team. So I'd like to provide an update on that. During this last quarter, we initiated a project aimed at prioritizing and accelerating key areas for growth while refining our operating model towards a more digital future and also to address the lower than normal commercial seller volumes that we're currently experiencing. We've committed significant resources toward that initiative and there are four principle work streams. I refer to these in our analyst day, but to recap them here, they're as follows. Our sales and go-to-market opportunities, the evolution of our service operations, our technology investments, and the overall management of our SG&A. So I believe we've made very good progress on this project, and we're now nearing the end of the assessment phase. In fact, it will be completed within the next couple of weeks. Now, I expect that you will be all interested to know the scale and the timing of all this. Rather than committing to a number before I have the full report, I'd like to allow our team the opportunity to complete their work, and I look forward to providing a more in-depth assessment on our future call. However, I am comfortable enough with the preliminary analysis to report the following. First, in terms of the sizing of these opportunities, our analyst day materials pointed to an SG&A opportunity of $30 million. I'm confident that our SG&A opportunity will be at least that amount. However, SG&A is just one part of the mix. We're also looking at opportunities to reduce our direct costs. I believe that we have opportunities to do so and that these will be in addition to that number. And finally, we're also looking at opportunities to improve revenue and improve the monetization of our services while also accelerating growth in key areas. These will be an important part of the overall target as well. In terms of the timing, First of all, I want to be clear that what I'm describing here are not short-term or temporary cost cuts. What we're looking at are permanent changes in our operating model and our cost structure, re-engineering the way we do business, and ultimately reducing our cost to serve over the long term. I don't expect to see an impact from this in the current quarter, but I do expect to see positive impacts in 2022 and in all of the years following from that. And finally, in terms of our strategy to manage and communicate these initiatives, we will be setting specific goals And there will be a clear process in place to measure the impact to make sure we stay on track. And of course, I expect myself and the management team to be held accountable to those. So I look forward to providing greater detail and more precise metrics in a future call. My last point is to make a few remarks on our expectations for the current quarter. As discussed in September, it is difficult to predict the supply of vehicles in the wholesale market at this time. We withdrew our guidance in September, and I'm not providing guidance until our visibility into volume improves. With that said, we typically experience some seasonal impacts in the fourth quarter, and I would expect that our fourth quarter performance, by which I'm referring to adjusted EBITDA, will be less than our Q3 levels. So to summarize my key messages from today, clearly the commercial volume challenges continue. I believe that we're at the bottom now, but I think the volume challenges will continue well into next year. However, I also expect we will see some improvement before the end of next year. My longer-term view has not changed. I believe that the outlook for off-lease, repossessed, and rental vehicles will be one of increasing volume over time, ultimately returning to historical levels. The recovery will take time, but it's clear to me that we should be a strong beneficiary of this when it happens. In terms of dealer-to-dealer, we are growing our volume with our combined digital and physical volume up 20% versus the same quarter last year. In terms of our digital dealer-to-dealer platform, we delivered solid growth in transactions, and we had a record quarter in terms of marketplace participation in both the U.S. and Canada. The addition of CarWave means that we're now at an annual run rate of close to 600,000 vehicles sold per annum and growing. I'm pleased that despite low volumes, we were able to deliver our best quarter yet in terms of gross profit per vehicle sold. We also saw solid profitability for TradeReven Canada and a strong performance at AFC. Notwithstanding the growth levers that exist for us, we continue to be very focused on costs. We have initiated a significant initiative and we are committed to following through on it. We look forward to providing more updates going forward. Finally, before I hand things over to Eric, I just want to officially welcome Sanjeev Mehra to the Carr Global Board of Directors. Sanjeev became an observer on our board through Purpose Capital's participation in our 2020 pipe transaction. And he previously served on our board from 2007 to 2013. You can read more about Sanjeev's background in our 8K. We are very fortunate to have his deep industry knowledge and his strategic mindset on our board, and I'm confident he will continue to be a vocal advocate for Carglobal and for our stockholders. So with that, Eric will now provide a more detailed review of our financial results for the quarter. Eric?

Thank you, Peter. I have a few things to add to Peter's commentary today. First, I would like to point out some bright spots in the current situation we are facing. We all know that the supply of wholesale vehicles is constrained primarily for our commercial vehicle business. However, this has led to strong used car pricing. Gross auction proceeds are at record levels in all segments of our business. The average selling price in our commercial off-premise segment, primarily open lane, was $21,500 in the third quarter compared to $19,400 per vehicle in the third quarter of 2020. Digital dealer-to-dealer representing back-plot cars and trade rev had an average sale price of $10,400 in Q3 compared to $8,900 last year. And our on-premise auctions, which includes a mix of commercial and dealer consignment, had an average selling price of $15,000 per vehicle compared to $13,300 one year ago. This strong pricing situation has led to higher auction fees per transaction across all of our marketplaces. The only marketplace that has seen a significant decline in fees is the open lane private label programs. The high percentage of transactions being grounding dealer purchases caused auction fees per transaction on this platform to decline 20% year over year in the third quarter. Another positive in the third quarter was the gross profit per vehicle in the Odessa achieving $274 gross profit per car sold in Q3 compared to $249 in the prior year, and this was a strong performance. This reflects a positive mix of revenue, with more of our revenue coming from higher margin auction services than other lower margin services. The lack of commercial supply, especially off-lease vehicles, reduces revenue from lower margin services like transportation and end-of-lease inspections. I want to be clear, though. While we are very focused on improving our cost structure and increasing gross profit per unit over historical levels, our business prospers when there are more transactions, even if gross profit per unit were lower than $274. The third quarter did benefit from royalty revenue received from insurance auto auctions based on the number of non-insurance vehicles sold by IAA over the previous 12 months. And a positive in Q3 was performance at AFC. Consistent with the growth in volume in the dealer-to-dealer channel at Adesa, AFC saw an increase in the number of loan transactions, 8%, an increase in revenue per loan transaction, 20%, and an increase in adjusted EBITDA, 63%. The AFC segment was able to improve all of its key performance metrics and reduce SG&A as compared to last year. While the current supply situation has put pressure on the wholesale used car remarketing industry, These same factors have made floor plan lending perform at very high levels of profitability. Average loan values are increasing due to higher used car prices. Low used car inventories at retailers means faster turns, and our floor plan lending has a majority of its revenue in fees and not interest earnings. And most importantly, loan losses are at very low levels. In fact, in the third quarter, recoveries of previously written off loans exceeded the loan losses experienced during the quarter. As a reminder, our floor plan lending business is collateralized by the vehicles and typically all assets of the dealer principals. We obtain personal guarantees on substantially all floor plan lines. When losses are realized, we seek judgments for recovery of the losses when assets, including real estate, are monetized by the dealer principals. We are currently benefiting from the strong real estate market and high real estate values. This allows us to recover past losses. Most recoveries are losses that occurred one to three years prior to the actual recovery. Now, despite the positives in our performance that I have highlighted, our overall performance was still challenging due to the low number of transactions completed. As Peter pointed out, the pressure is on our commercial volumes as we have begun to see year-over-year growth in our dealer-to-dealer volumes due to the strong growth in digital dealer-to-dealer. Even though gross profit per unit at Odessa was $274, the gross profit as a percent of revenue, excluding purchased vehicles, declined to 43% in Q3 as compared to the prior year's 49% gross profit. My first concern is to determine this is not a change in our cost structure going forward. After analyzing our costs, I have determined that most of the decrease relates to fixed direct costs that just could not be leveraged with the low volumes in Q3. The largest contributor to the decline in gross profit percent was supervisory labor and facilities costs that is included in cost of services. We also experienced increased losses on purchased vehicles, primarily inherited vehicles, which are acquired through arbitration activities. We believe the increased losses were unique to Q3 as we pushed to sell these vehicles quickly to meet customer demand. The one item that will be a permanent increase in our costs as compared to the last 18 months is the loss of the Canadian employee wage subsidy. We have been benefiting from the Canadian program since early 2020, and approximately $1.5 million to $4 million of direct cost per quarter going back to the second quarter of 2020 were subsidized in Canada. Changes in the requirements to receive these subsidies were made effective July 1, 2021. and our Canadian businesses no longer qualify for the subsidy. This represents about a 70-bip increase in cost or decrease in gross profit percent that will be recurring. I do expect the impact on gross profit to be less, though, as volumes begin to increase going forward. Turning to our balance sheet and capital allocation, our total leverage is at 3.2 times adjusted EBITDA. This has moved above three times due to the low performance over the past 12 months. Our last 12 months adjusted EBITDA is $404 million. We continue to have a leverage target of three times or less. Subsequent to quarter end, we completed the acquisition of CarWave. We funded the $450 million purchase price with cash on hand. We did not purchase any car shares in Q3. We have $109 million remaining on our share repurchase authorization that was set to expire at the end of October. The Board of Directors has extended our existing share repurchase authorization through December 31, 2022. We have used a substantial amount of our available cash for the car wave acquisition, and our total net leverage is temporarily above three times. Even after funding the car wave acquisition, our cash balances remain strong, though, In times of supply constraint, the free cash conversion of our business generally improves. That concludes my remarks, so I will turn it back to our operator, Michelle, to begin the Q&A portion of our car. I thank everyone for joining us today.

Hi Michelle, can you queue up the first caller?

Hi Michelle, can you queue up the first caller?

Can you hear me? Yes, we can. Yes, we can. Hey, it's John Murphy from Bank of America. I didn't get announced. I'm sorry, guys. I guess she turned me on and didn't make an announcement. So I guess just a first question. When we think about the CarWave acquisition, you know, a skeptic could say, hey, you know, you're making these acquisitions. They may be a little bit duplicative or overlapping, and an optimist may argue, you know, it's building – a very significant network effect that you need to get this flywheel going. How do you think about the network effect versus the potential duplication or overlapping of customers? And how much of this do you think, Peter, is purely incremental to what the core business will be as it normalizes over time?

Thank you, John. I appreciate the call, the question rather. Sorry for the technical difficulties there. But I guess, John, my point of view on it, I think when you're looking at digital marketplace businesses, the network effect is real and very, very important. And when you have a digital marketplace model, you really want to be number one or number two in your market. Because if you're outside of that set, generally it's not as attractive a proposition. So I think scale really matters and I think scale gets formed early on and customer habits can be quite sticky and quite persistent over time. So I think the market has been evolving. There was an early stage of a lot of disruption, a lot of new entrants. I think we're through that stage now in the market. I think there's a number of players in the market. They have established customer relationships, established areas of geographical strength, and those patterns are becoming more defined. So I lean heavily towards these are additive and it's not duplicative. It's actually more of a one plus. If I just look at, say, backlot cars and car wave together, I think you combine them and you get more than the sum of the parts. So, for example, if we think of car wave, very very strong in california but doesn't really have a very strong buyer base outside of that market well backlog cars does so by bringing those platforms together you now get a new buyer audience onto the vehicles of those sellers in california which in theory creates greater liquidity and improved outcomes for those customers and also obviously brings more inventory supply to those buyers so i think those types of things really really matter in digital marketplaces and you often see sort of an acceleration of those positive dynamics over time as you get scale. So that's kind of where I lean on this. And then I think the other thesis on, you know, what are these digital marketplaces doing? Are they bringing new vehicles into our industry, into a formal sort of marketplace industry? Or are they just disrupting what was happening, you know, in the traditional physical auction world? Candidly, and I think I've been clear on this all along, I think they're doing both. I think there's data that says they are bringing new vehicles in and greater opportunity for businesses like us as we move in a more digital direction. But they're also competing some vehicles out of the legacy channels as well. And I think that will continue.

Okay. And then just a second question. You made a very interesting statement that you believe that your commercial market share was consistent in the quarter. I'm just curious, I mean, that's a great debate, whether you're maintaining, gaining, or losing market share, and it's very opaque because the denominator is difficult to call. and what's happening in the market is difficult to call on a real-time basis. How are you ascertaining that analysis? I mean, what are you doing there to figure that out? And how comfortable are you that you're going to be able to maintain or maybe even gain some market shares as the commercial market comes back?

Yeah, and I think, John, again, if we go back to our analyst day, our thesis around commercial market share was, We'll see a recovery in commercial volumes, and we will maintain our market share, and that delivers our 2025 results, at least as it relates to commercial volumes. So you're right. The data sources are not great, but let me sort of give you some insight into how we do our assessment. If we look at our upstream world, obviously we know the customers that are contracted with us on our open lane platform. We know the nature of those relationships, if they're exclusive or not, and most of them are exclusive. And we know if we've lost any customers. We haven't lost any, right? And then we can also look at what are those customers converting at in that channel. And frankly, those conversion rates are at an all-time high given the current dynamics. So when I say maintain, we've probably actually increased our share a bit because we're selling proportionally more in that channel where we already have strong share. But then in the physical world, obviously, we know our own commercial physical volumes. right so that's a statistic that's known to us and we have insight into commercial volumes across our industry through an independent third-party data source um so we can we've got a you know a numerator and a denominator there that we can track and we obviously look at that very closely i guess john i'll say neither of those are perfect data sources right um are there some potential edge cases that don't get caught in either data set there are but i think we have a pretty good picture on the industry once we do that analysis, and that's how we can make the statement we made. Okay. And then just lastly... On the recovery, sorry, John. I'm confident we can maintain our share as volumes come back. I am absolutely confident on that, yes.

Then just lastly on repos, because they might not be as dependent on the recovery and new vehicle production. They're dependent on repos. activity picking up. And I'm just curious if you can give us an update of where you think repo activity is right now, where it'll go through 2022, and if that could create a little bit of relief maybe before we're all waiting for this production ramp to really kick in.

John, I think that's a very good insight, and I agree with you. I do think the one commercial segment that is potentially independent of the production situation is the repossession segment. And as I mentioned to you, that is about 70% of normal so 30 below normal um it has been so for you know the last 12 months or 15 months um it's been sort of stable at that level um what that means is you know to get back to normal it it it can grow another 40 from its current level so there's a good upside there for our industry if that were to happen and i expect it will happen over time um you know we we do track Repossession assignment volume through RDN, we have seen a small uptick, you know, 10-ish percent or so in assignments through that platform over the last five or six weeks. That I view as a positive, but it's also possible that that might be somewhat seasonal, so I don't want to count on that yet. But I agree with your comments that I think repo has the potential to recover sooner than other segments.

But those repo units would come directly to auction. It's not like they would get stuck at a grounding dealer like a lease could, right? I mean, they would more fluidly go directly into your auctions. Is that a fair statement?

Absolutely. John, yeah, absolutely. Sorry, I didn't mean to cut you off there. But you're absolutely right. And I tried to make that point as well on Analyst Day. Repossessed vehicles sell pretty much exclusively through the physical downstream channel for a whole bunch of reasons that I went into. So, yeah, they would flow directly to auction.

Okay, great.

Thank you very much, guys.

Thank you, John.

Thank you. And our next question comes from a line of Gary Pespino with Barrington Research. Your line is open. Please go ahead.

Hey, good morning, everyone. Hey, Peter, with what you've done in the digital space at this point, do you have coverage now of the majority of the franchise dealers in the U.S. as, you know, for listing cars and And then, you know, just really the majority of dealers within the U.S. and Canada on your digital platform.

Gary, thank you. So, yes, specifically a question relating to our digital dealer platforms, I would say absolutely yes. We have, well, when I say nationwide coverage in the U.S., I really mean the lower 48 states. We're probably not as strong in the U.S. But coast to coast in the 48 states, absolutely. We have, I would say, a strong presence in all states, and we can serve any dealer in any state. And the same is true of Canada with the TradeRev platform. So the short answer to that question is yes, we have full coverage. And maybe if I can just add a little bit more detail, I did speak to the fact that we saw record marketplace participation in the third quarter. I was very pleased about that, growing our our number of sellers and buyers in both the US and Canada to record levels in the quarter. So I feel really good about that. You know, I would say the supply constraints that we've talked about in commercial also actually has a negative headwind on dealer. Okay. So we track average number of vehicles posted per seller. And we saw that number a little below normal, or I won't say a little, but below normal in the third quarter. relative to the prior four or five quarters. And I attribute that to the fact that there's just a real sort of supply constraint out there in the industry. Dealers are getting fewer trade-ins. and those trade-in vehicles that they're getting, they're more likely to want to keep some of them or more of them for the retail business. So I think, you know, I'm generally pleased with what we've seen in terms of the growth of our customer base and the results we delivered in the third quarter in spite of those kind of, you know, market attributes out there. Thank you. Thanks, Gary. Thank you.

Thank you, and our next question comes from the line of Stephanie Moore with Truist. Your line is open. Please go ahead.

Hi, good morning. I wanted to touch specifically on the off-lease vehicles. Do you find that there might be a longer change in just dealer behavior as they're just getting so accustomed to kind of grounding and keeping these off-lease vehicles in this near-term environment, and we might not see as much of a shift down the traditional auction channels when and if new vehicles do improve? And then can you just walk us through maybe expectations due to lower new leasing in this environment and how that can impact your model in years to come as well? Thank you.

Thank you, Stephanie. So two questions there. Let me take the first one first. You know, first of all, Stephanie, it is true we're seeing record high conversions on OpenLane. I just referenced that in one of my questions earlier. Generally, we've seen that conversion rate trend up over time as online became a bigger and bigger part of dealership buying and our seller's habit for selling. So, you know, viewed over multiple years, the online conversion rate has trended up. But then there was a step function change with COVID or post-COVID with this supply constraint. I do think that as production increases and prices normalize, those very high conversions that we're currently seeing will fall back. And my guess is they probably won't fall all the way back to where they were pre-COVID because I do believe there's an ongoing sort of digital transformation going on, you know, on multiple dimensions in our industry. But I do think they'll fall back quite a bit from where they are right now. A big part of it is really driven by the pricing environment. And, you know, when we talk about very high grounding dealer penetration today, a lot of that is driven by the interrelationship between the residual value and the market value of the vehicle. Because a lot of dealers, grounding dealers, get the opportunity to buy the cart residual in the same way as LSE does. So as those sort of two numbers start to move close together and often, you know, more usually we see residual values being above market in a more normal environment. So I think that will impact the conversion rate as well. And then I'd say the last comment I'd say on that is obviously when it comes to our upstream open channel, we actively try to drive up that conversion rate anyway because those vehicles, they flow off the private label into Odessa.com, and that's sort of exclusively an exclusive channel to us. So we're really trying to maximize conversion in that channel where we get very high conversion you know, gross profit per car sold and a real opportunity for market share gain there as well. And then your second question on expectations with respect to leasing. The numbers I'm looking at say that leasing continues to be, leasing penetration as a percent of new vehicle sales continues to be strong. So the issue right now is more to do with lower volumes of vehicles being sold overall, not the leasing penetration rate. But I think leasing is definitely a factor in our industry and part and parcel of the way OEMs and dealers and retailers want to do business. And then I think what's going to matter more than the absolute volume of vehicles leased, again, is the relationship between the residual value and the market value of the vehicles in those portfolios. And I guess I'd say, Stephanie, that over time, I think those we'll get back to the sort of more normal relationship that we see between those values. Because at the end of the day, OEMs compete with each other to win market share, and they set residuals as aggressively as they can in order to reduce their monthly payment and have a compelling offer for consumers. So I think that dynamic drives the OEMs to be more aggressive around residual, and that will ultimately drive the long-term dynamics around off-lease vehicles.

Got it. No, thank you, Peter. That was a really thoughtful answer and thorough. Thanks so much.

Thank you, Stephanie.

Thank you. And our next question comes from the line of Daniel Ambrose with Stevens Inc. Your line is open. Please go ahead.

Yeah. Hey, good morning, guys. Thanks for taking our questions. I wanted to start on the Carwave acquisition. First, congrats on closing that deal. I think at the time of the deal, Eric, you guys said it brought you kind of the profitability in the dealer-to-dealer business. That would imply some pretty strong incremental margins of profitability at that asset for 100,000 cars. So can you provide any more color on what kind of EBITDA contribution you expect from that? And then on these implied stronger margins, is that more of a stronger gross margin or better SG&A leverage since it's in just one market? Thanks.

Daniel, thank you. Daniel, I'm not going to give specific numbers here, but I'll give you just – directionally how i see it um you know as i mentioned carwave performing very well in a more regional market right but a big a big one right california um selling a higher value vehicle with i would say strong unit economics okay strong uh monetization of the transaction and you know one of the things we really liked about carwave was a very efficient cost of service and cost of delivery model. And we see a potential to leverage that more broadly, not only in our digital dealer to dealer channels, but potentially beyond that too. So, you know, those all contributed to, you know, a profitable and growing business. In some respects, similar sort of performance to what we're now seeing in our trade rep platform in Canada. You know, so I kind of look at You could look at the two P&Ls side by side. They look quite similar to each other in many respects. So we see a lot of interesting opportunities in addition to the sort of network effect type situation that I talked about on an earlier answer here. An opportunity to further accelerate backlot cars transition up market to higher value vehicles, which is well underway. We're seeing that already at backlot cars. significant growth in the average vehicle value. Hopefully an opportunity to further accelerate backlot cars, monetization of the transaction, which was part of our strategic intent all along. So we see it, you know, additive to that. And then sort of, you know, really looking at this sort of cost to serve and efficiency around the fulfillment of the transaction. By the way, backlot cars is also very strong in that dimension. But I do think, you know, there is an opportunity to really put the best of the best together here and deliver a very good outcome, both for our customers, but also for, for our business. All right. Thanks.

Thanks.

Yeah.

Daniel, this is Eric. Let me add to that. It really comes down. Can I lower, can I lower my cost to support the transaction in Canada? The dealers typically self-inspected vehicle, eliminating a labor cost around inspection in car wave. They have a lower cost support infrastructure, uh, using an offshore resource that is very attractive to us. And I think taking those two platforms and taking advantage of them across the network, I'm very, very pleased with this acquisition. And as we mentioned when we did the transaction, we expected that this would put us in a profitable situation across our dealer-to-dealer digital offerings. And I'm confident that's where we've landed ourselves here early on.

Got it. And Eric, you mentioned net leverage at end of the quarter at 3.2 times. But you bought CarWave, I think, here quarter to date. Can you provide us on just what pro forma leverage would be when you account for the cash you spent on CarWave, a pro forma net leverage? And then lastly, are there any leverage covenants? I mean, I think it used to be three and a half times. How are we looking there? And then how does that impact capital allocation? Thanks.

Yeah. We could potentially see a tick up in proforma leverage in the fourth quarter, although I would expect adjusted EBITDA LTM to go up a little bit based upon a very low adjusted EBITDA number in Q4 of last year. And there will be additional EBITDA added by this actual, not proforma. But in terms of our leverage calculations, I don't expect it to be a meaningful tick up from 3.2. We've been building cash since quarter end as well, Daniel. And I do, you know, I have incurrence tests on my revolver, but there's no issue with total net leverage. My senior secured leverage is still, I think it's right now just below two times, but right around two times, and it'll stay there. And that's really the major test in the total leverage. limitation is much higher than 3.5 relative to ongoing. It could impact a future acquisition if I went above 3.5, but that's not an issue I'm worried about.

Got it. And then just last clarifier, Peter, I think my audio cut out a little bit earlier. You were providing some commentary on preliminary future cost cuts. Could you just repeat quickly what you said about that and then the impact of the fourth quarter? I think I heard you mention 4Q EBITDA, but it was kind of cutting out. Thanks.

Okay, apologies, I didn't realize that. You know, what I talked about is we have a initiative underway. We're nearing the end of the assessment phase, and we will provide more specific detail on a future call, but I think we have significant opportunities across the company, and obviously they'll be in this transcript. On the quarter, we didn't provide specific guidance, Daniel, and don't plan to. Typically, we have some seasonal effects in our industry, and based on those, I would expect our EBITDA performance in the fourth quarter to be less than the EBITDA performance in the third quarter, but I'm not providing guidance beyond that. Got it. Thanks so much for all the color, guys. Best of luck. Thank you. Thank you, Daniel.

Thank you. And our next question comes from the line of Bob Lebec with JCF Securities. Your line is open. Please go ahead.

Good morning. It's Bob Lavik from CJS. Thanks for taking the questions. I wanted to start with a digital dealer, but really kind of overall. Could you talk about maybe where you've been, where you are now, and where you're going with your inspection and inspection reports and how your investment and partnership with Raven and AI is impacting this product and ultimately how this impacts your volumes and your P&L?

Yeah, thanks, Bob. That's a good question. You know, as we think about being a more digital business and what are the sort of ingredients for success, there's no question the inspection report is critical. You know, when we poll our customers, whether typically buyers, but also sellers, but for sure buyers, it's typically the number one item. And it makes sense that, you know, buyers are trying to de-risk. You're looking at a screen. How can they be confident that the vehicle is going to show up when it's delivered, right, given it's a used vehicle? So we continue to invest in that and we do have some initiatives underway right now at Backlot Cars and obviously with the CarWave acquisition we're sort of including that in the solution design here as well to sort of further improve the condition report for these digital dealer-to-dealer platforms. So there's initiative underway on that. One of the objectives of that redesign or evolution i should call it of the inspection report is to also make it more um to enable us to syndicate the inspection more easily across our own infrastructure so we can push vehicles seamlessly from backlog into the odessa marketplace and and things like that so we can flow the data without having to move the car or re-inspect the car So, some work there and, frankly, leveraging some work we've already done with TradeRev in Canada that's proving to be quite successful. You mentioned Raven. You know, our initial focus with Raven has been more on the commercial seller side of the business, leveraging some opportunities that Raven already had. We're obviously a minority investor in that business. They already had some opportunities locked down with a number of commercial sellers. So we are supporting them in the delivery of that. We've introduced them to some new commercial customers. And we do have an initiative teed up, but certainly not yet live, to bring some of that you know, AI and machine learning capabilities into other aspects of our inspections, such as, you know, the digital dealer to dealer channel as well. But again, I'd say the focus over the first six months of the investment, and this is really led by Raven themselves, has been on a number of, you know, commercial seller captive finance type opportunities.

Okay, great. That's really helpful. And then just one other quick one for me. You mentioned at the analyst day, you know, piloting some physical locations, running cars again. And could you just remind us what you're up to now or how many locations you're up to now? And is the process the same or different from pre-COVID, meaning you're running the same number of lanes, same hours? And how has it impacted revenues and profitability for you?

Yeah, thanks, Bob. Good question. We are up to approximately 30 locations in the U.S., I do not have plans at the current time to expand beyond that. We are not running all the cars at those locations. We're focusing on principally dealer consignment and repossession vehicles at those locations, so trying to maintain that focus. What we're seeing, and I don't recall if I touched on this on Analyst Day or not, we're Certainly it is helping us win back some volume at those locations. So we've seen an increase in particularly dealer consignment at those locations relative to when we were in a purely digital model. That's contributing to our numbers. And we're not doing it exactly like we used to. We've put some additional sort of checks in place to further increase safety. And the other thing I would say is even with running these cars in lane, what's been interesting to me is the dealers that migrated towards digital, for the most part, are staying digital. And even at these auctions where we're running cars in lane, the majority of the vehicles selling are selling to online buyers who do not come to the sale. But other dealers who, and it's a smaller number of dealers, who just never adopted the digital technology and just kind of just didn't adopt it, they are now sort of coming back into the lane and providing some additional buying power for those markets. So I think we view it as success. We're trying to keep it somewhat limited, but in areas where we can demonstrate it adds value and our sellers like it, then we are obviously supporting it. Great. Thanks so much.

Thank you. And our next question comes from the line of Brett Jordan with Jefferies. Your line is open. Please go ahead.

Hey, good morning, guys. Morning, Brett. Can you talk about the time of integrating CarWave with Backlot? I think you said it might be a while, but as far as being able to show inventory across systems, it seems like that's where the real leverage of the incremental volume might be.

Yeah, I guess what I'd say, Brett, is certainly We're deep in the planning process of that right now. You know, owing to the way approvals work and HSR, you can't really get into that discussion pre-closed. So, I think we're having a very good, very positive, collaborative discussion, a lot of enthusiasm. I don't want to commit to a specific timeline. You know, when we when we acquired Backlot, our strategy on the trader of migration was really almost akin to a hard shutdown. And let's just move it across, you know, and take some risk. And and the customers that work really well for us, by the way. But I kind of feel with the two platforms we have right now, we've got established customer bases on both platforms who really like both platforms. And I want to make sure that when we bring these together, we're really giving the customer on whatever platform they are on today, a better solution going forward. So it just requires being a little thoughtful and maybe taking a little more time. But we're moving expeditiously. I will say that. And we're committed to, you know, one brand, one platform, one set of policies, one pricing model. You know, all the key fundamentals like that are part of the long term plan. So listen, I think we're. Looking at, I would say, doing most of this work between now and the middle of next year would be my expectation, but I don't want to give a more specific timeline to that.

Okay. And then on your target to 1.2 million cars by 2025, does that assume organic growth from here, or is there more to buy to get to that number?

Brett, my focus is on organic growth for sure. I think this marketplace is now somewhat stable with, you know, from a – we know the industry – we know the players – um we these businesses are growing we want to continue to grow them hopefully accelerate the growth um so our focus is principally organic um there's nothing uh outside of that i'm contemplating right now but you know i never want to be closed-minded to any opportunity either but but organic is clearly the focus that's right thank you thank you brett michelle i believe

One more person for the question, and then we'll take his question and then go to closing remarks.

All right. And our last question comes from the line of Ali Fari with Guggenheim. Your line is open. Please go ahead.

Good morning, and thanks for taking my questions and squeezing me in. So first I wanted to ask about your market share on dealer consignment. I mean, previously you had mentioned some share losses in that segment, and I'm hoping you could help us quantify those. How much of that do you think also is driven by share losses maybe to digital competitors and how much to maybe other physical competitors due to your decision not to run cars through the auction lanes?

Yeah, Ali, clearly there was some share loss, and it's tied specifically to that decision. You know, post-COVID, not running cars, particularly when independent auctions and then ultimately our other competitor started running cars, we did see some erosion there. and our physical lanes, and that was the principal driver of the share loss. I guess what I'll say is over the last couple of quarters and looking purely at our physical market share and using similar data sources to what I talked about, we've seen that stabilize and a slight increase in our share again over the last, I think, relative to where we were, I think, in Q1. I don't have the data in front of me right now, but my recollection is if I look at Q1, Q2, Q3, we've seen a slight upward trend in our physical market share. So I think it's stable. I think obviously our decision to run cars at some locations has enabled us to win back some volume there. I've already commented on that. So I think it's stable and we're focused on, you know, building it back up where we can. But obviously growing our digital dealer to dealer volume is the principal driver of our 2025 plan.

Got it. That's helpful, Peter. And if I have a quick follow-up here on the commercial consignment side specifically, you had mentioned you haven't lost any customers, but I've been getting some questions because there was some public news earlier this year that Volkswagen Credit had selected Mannheim for their upstream remarketing, and I believe they were an open lane customer before, unless I'm mistaken. So I'm hoping you can help me square that with commentary that you haven't lost any commercial customers. Thank you.

Yeah, so that was a 2020 event, Ali, so I'm talking specifically 2021. But let me just comment on that customer. Volkswagen Credit renewed its agreement with us for Canada earlier this year, despite having access to other platforms and knowledge of how other platforms perform. So I felt that was a positive thing. a vote of confidence from that customer. And we're excited to continue to serve that customer in Canada. So what I'm saying, Ali, is there have been no customer losses since, you know, in the time period I'm talking about here, which is 2021.

Got it, got it. That's helpful. And then last one here on your spending outlook. You know, you've taken out a lot of costs out of the business and are talking about potentially further cost cuts and potentially being EBITDA positive, I think, in your digital dealer-to-dealer business. But you have your digital competitors out there who are talking about spending significantly in coming years. In fact, one recently IPO-ed and is talking about potentially getting more aggressive on incentives to take market share in the U.S. specifically. And so I'm wondering how you can ensure that you're going to be able to compete effectively in a backdrop where it seems like your digital competitors are planning to spend aggressively in coming years. Thank you.

You know, I think we'll just have to watch the competitive environment, Ali, as we go. I think our trend, if we look at our trend line at CAR, we've seen those platforms go from heavily loss-making, if I go back a couple of years, our digital dealership platforms, to essentially, I'd say, break even in the current year. We're very close to that. So we've seen some very positive steps in the direction towards profitability with TradeRev Profitable in Canada, CarWave Profitable, And my expectation is that with further organic growth and some of the things we talked about, we can execute our plan and deliver. But obviously, we always watch the competition. I think dealers, at the end of the day, they're more focused on what are the results these platforms deliver for me and for my business. If you're a seller, are these platforms delivering good values in an efficient way? with an easy process. If you're a buyer, am I getting good inventory selection and on-time delivery and those types of attributes? I think they're actually less focused on this month's incentive. But nonetheless, listen, we've dealt with competition all through our history. We'll be dealing with competition as long as we're in business. So that's just part and parcel of managing our business.

And Ali, let me add, our focus is really just on providing those services efficiently. And I don't know that anybody providing incentives has ever proven that it's a long-term strategy to win unless you have efficient services offering that will keep a consistent cost of the transaction going forward. And that's what we're focused on. I don't think anyone is out there offering a more economical transaction than we are. I think we're very competitive on pricing right now across our digital platforms in total. Right, Peter?

Yes. Great, thank you so much for taking my questions. Thank you, Ali.

Thank you, and this does conclude our question and answer session, and I would like to turn the conference back over to CEO Peter Kelly for any further remarks.

Thank you, Michelle, and thank you all, ladies and gentlemen, for your time this morning and for your questions. So I'd just like to close out just reinforcing what myself and the team here are most focused on as we move forward. I'll start with dealer-to-dealer. We're focused on continuing to grow our digital dealer to dealer volumes towards our goal of 1.2 million vehicles sold by 2025. This, in turn, will drive a significant increase in our overall profitability. To help drive this, we're focused on increasing our marketplace participation by sellers and buyers in the U.S. and Canada, as well as ensuring a successful integration of car wave and backlog cars in the U.S. If I look at commercial volumes, clearly the current supply situation has been a challenge. However, we believe the disruption is temporary in nature and we're focused on getting through the disruption, but also I would say using this time as an opportunity to re-engineer our business, lowering our cost of service. And our goal ultimately is that as the volumes return, we can support increased volumes with a lower cost delivery method than we've had in the past and be more profitable even at lower volumes than we've been in the past. And most importantly, we remain focused on our customers. Our purpose at the end of the day is to make wholesale easy so our customers can be more successful. And I believe that if we do that well, our customers reward us with their business and our company will have a bright future. So with that, we'll end today's call and I look forward to reconnecting early in 2022. Thank you all very much.

This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone have a great day.