OPENLANE, Inc.

Good morning. Thank you for standing by. Your conference call will begin momentarily. Again, please continue to stand by. Thank you. Thank you.

Thank you.

Good day and thank you for standing by. Welcome to the Car Auction Services Q1 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question over the phone, you will need to press star and the number one. Please be advised today's conference is being recorded. If you require assistance during today's conference, press star and then zero. I would now like to hand the conference over to your speaker today, Michael Eliasson, Treasurer and VP Investor Relations. Please go ahead.

Thanks, Amanda. Good morning, and thank you for joining us today for the CAR Global First Quarter 2022 Earnings Conference Call. Today we'll discuss the financial performance of Carr Global for the quarter ended March 31st, 2022. 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 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'll be referencing both GAAP and non-GAAP financial measures. Reconciliations of the non-GAAP financial measures to the applicable GAAP financial measure can be found in the press release that we issued yesterday, which is also available in the investor relations section of our website. Now, I'd like to turn this call over to 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 will detail our first quarter results and provide you with some guidance and context around our expected performance for the remainder of 2022. But first, I would like to update you on the status of our divestiture of the Adessa U.S. physical auction business. The transaction is expected to close within the next week. It is a significant, even historic milestone in CAR's history and a transaction that will be transformative for our company, our customers, our employees, and our stockholders. And I believe that the rationale for the transaction, as we outlined on our investor call back in February, remains intact. Together with our customers, we are driving a channel shift from physical to digital marketplaces. The transaction will allow us to more rapidly develop and deploy the digital solutions that our customers need and value the most. In doing so, this transaction will advance our vision to build the world's greatest digital marketplaces for used vehicles. The used vehicle market in North America represents a 40 million vehicle per year market at the retail level and over 20 million vehicles per year at the wholesale level. We believe that our leading digital brands, platforms, and technologies will help us advance digital transformation of our industry and fuel our future growth. And with approximately 350,000 vehicles sold on our platforms in the first quarter, we have plenty of opportunity to grow. This transaction will also simplify our business. It will enable us to focus our strategy, energy, and investments on expanding our capabilities, growing our volumes, and increasing our market share. We believe this focus will help us generate the greatest benefits for our customers and deliver the greatest value to our stockholders. And as we outlined in our February announcement, the transaction enhances our financial profile. It helps us streamline our operating structure, becoming a more asset-like company. We believe it will enable us to increase our gross profit margins and our EBITDA margins and drive a faster long-term growth rate at CAR. The transaction enables us to pay down debt, creating more flexibility in terms of future capital allocation. And CAR will continue to generate strong cash flows going forward. We look forward to sharing more with you about our strategy at an Analyst Day update call that we will likely schedule for June, and I'll provide more details around that later on this call. So with the remainder of our time, I'd like to discuss our first quarter results and our outlook for the rest of this year. Consistent with our earnings release last night, the results that Eric and I discussed today exclude the divested Adessa US physical auction business, which is treated as a discontinued operation in the financial reports. Also, in my remarks today, I'm going to speak about our business in two segments, a marketplace segment, which we formally call the Adessa segment, and the AFC segment. So, the first quarter was challenging. Our volumes continued to be negatively impacted by the vehicle supply and used vehicle pricing issues that are affecting the broader industry. This is certainly the case with commercial vehicles, particularly off-lease vehicles, but it's also the case, to a lesser extent, with dealer-consigned vehicles as well. Notwithstanding all of that, we made important gains across many aspects of our business. For car overall, and again, this does not include the Odessa U.S. physical auction business, The performance highlights in the first quarter include we generated $369 million in revenue. That was flat with the same quarter of the prior year, and we also increased our auction fee per vehicle sold. We generated total gross profit of $159 million. That was a decrease of 4% from Q1 of 2021. This gross profit represented 49.1% of revenue, excluding purchased vehicles. We generated $49 million of adjusted EBITDA, a decrease of 36% from same quarter last year. However, it's important to note that our Q1 2021 results included a $17 million realized gain on the sale of marketable securities. Within the marketplace segment, we facilitated the sale of 351,000 vehicles. This represented over $6.5 billion in gross auction proceeds. Those volumes are down 23% versus Q1 of the prior year. driven by the continued strain on commercial seller volumes, where volumes declined by 46%, or 146,000 units. I'll provide more detail on that in a few moments. In our dealer consignment business, volumes increased by 39,000 units, representing 28% growth over the prior year. This positive growth was driven mainly by organic growth of backlot cars and trade route, and by our acquisition of CarWave. We generated $285 million in revenue, a decline of 6% versus Q1 of 2021, And we generated $255 in gross profit per vehicle sold in the marketplace segment. That was an increase of $7 per unit versus Q1 of last year. In our AFC segment, we experienced another solid quarter performance with revenue of $84 million in the quarter, an increase of 28% over Q1 of last year. So as I mentioned a few moments ago, our first quarter performance was negatively impacted by the ongoing supply chain challenges, semiconductor shortages, and the lagging new vehicle production and new vehicle sales. This principally impacted us in terms of off-lease transactions. With used vehicle prices at all-time highs, consumers have significant equity in their off-lease vehicles, and this means they are more likely to retain those vehicles than to return them when the lease ends. This led to a 61% reduction in the number of off-lease vehicles returned to our open-lane platform compared to Q1 of 2021. This reduction in supply at the top of the funnel materially impacted the performance of that business. I want to be very clear. This is not a loss of share or of customers. And also, conversion rates within the channel remain very strong. In fact, they were stronger than one year ago. We believe that these factors ultimately are temporary. And while neither we nor our commercial customers can accurately predict when these factors will recede, I'm confident that our continued investments in OpenLane and in our off-lease solutions in general Positioned as well to retain and grow share when the new vehicle production increases and when off-lease vehicle volumes return to more normal levels. Vehicle production shortages and reduced new car sales were also a headwind to growth in our dealer-to-dealer category. Fewer new vehicle sales by franchise dealers result in fewer trade-ins, and that flows through to our business. So while we grew our seller count on backlog cars, car wave, and trade rev, we saw fewer vehicles posted per seller versus the same quarter prior year. That said, we're pleased with the performance of our dealer-to-dealer business in the quarter, where in addition to growing our volume by 28%, we increased our revenue per vehicle sold by over 25% versus the same quarter last year. While significant uncertainties still exist across our industry, we are now four months into 2022, and we're able to provide guidance that we expect to deliver $265 million in adjusted EBITDA for 2022. This would represent approximately 11% growth in adjusted EBITDA year on year had we applied the same discontinued operations accounting to our 2021 results and had we excluded the realized gains from the sale of marketable securities during 2021. I believe that delivering this growth in face of the uniquely challenging set of circumstances is encouraging as we continue to focus on the factors that are within our control and the opportunities that do exist. The key drivers in delivering this result in 2022 are the following. As I noted earlier, AFC performed well in Q1. Given our current visibility into this business, I expect to see continued strong performance from AFC throughout the balance of this year. Although we do not report separately on Adesa Canada, we expect it to contribute meaningfully to our 2022 results through strong market share, its digital operating model, and strong unit economics. We also expect our digital dealer to dealer business to be a growing contributor in 2022. We also believe that our diligence and consistent efforts to manage our cost structure will contribute meaningfully to our success in 2022 and to our improved financial performance beyond 2022. We believe that once the ADESA U.S. physical auction business transaction closes, we will have an additional opportunity to streamline our organization and make meaningful progress towards a cost structure reflective of a fully digital business. We are targeting a material reduction in SG&A. By the end of 2022, I expect our cost reductions at an annual run rate to be at least $30 million per year. One important area of our business that we expect to underperform prior years will be the open lane business, as well as some of the related services businesses businesses that service the off-lease vehicle in particular, businesses such as CarsArrive and AutoBin. The fact is, it is impossible for these businesses to deliver their historical level of earnings contributions, given top-of-funnel off-lease supply is down by approximately 60% versus normal levels. However, OpenLane remains a very important and very valuable asset. It represents an essential and deeply integrated capability and is key to some of our largest customer relationships. I am confident that Open Lane will be an important driver of our future profits. As I look past 2022, I'm encouraged by our prospects for growth, and I believe that our growth will be driven by a number of important factors. Firstly, by a secular shift towards digital marketplaces across our entire industry, which is driving increased volume in both the dealer and commercial parts of the business. Secondly, by a recovery in commercial volumes. Given the continued supply chain issues with new vehicles, this will likely take place over a longer timeframe than I would have hoped for six months ago. But I'm confident that ultimately it will recover towards historical levels. So I see it as a question of when, not if. Third, the continued strong performance by businesses like AFC and Adesa Canada, where we have differentiated offerings and a strong market position, will support our performance going forward. And finally, our continuous focus on cost, efficiency, and being an asset-like company. I'd like to make a few remarks as regards future capital allocation. As I mentioned earlier, the completion of our divestiture will allow us greater flexibility in terms of capital allocation. We expect to pay down a substantial amount of our outstanding debt. We will continue to invest in the technology and platforms that create the most value for our customers and position us to capture the opportunities ahead and expand our addressable markets. Following this transaction, CAR's capital structure will allow it to be more nimble and more strategic in deploying capital to drive growth. And if our stock continues to be undervalued, as I believe it currently is, we have the ability and capacity to repurchase shares. Eric will speak to that in a few moments. As we committed to you when we announced the Adessa U.S. physical auction transaction, we intend to update our previous investor and analyst day materials to reflect our new company and an updated set of assumptions. We're currently targeting June for this update, and we will send a save the date after the deal closes. During this meeting in June, we will go more deeply into car strategy and our expectations for growth and our future performance. I'm looking forward to that discussion, and we will publish details as soon as the date is set. So in closing my remarks here this morning, I'd like to summarize some of my key messages for today. Our ADESA US physical auction transactions are expected to close within the next week. The transaction will be transformative for CAR and for our customers, and I remain very optimistic for our future. With a smaller, nimbler, and more asset-like company, we intend to execute a focused digital strategy to capture what we believe to be considerable opportunities for growth, both in and beyond our current market. This includes meaningful growth across both our commercial and dealer solutions, both in terms of increased market share and an expanded portfolio of services to support our customers. For 2022, we expect to deliver 265 million in adjusted EBITDA, representing 11% growth on a like-for-like basis, in spite of a uniquely challenging set of circumstances facing our industry. And as we look to the future, we're excited and energized by the opportunity ahead. We believe we have a significant opportunity for growth, exceeding the 15% adjusted EBITDA CAGR that we spoke to in our analyst day last September. We have differentiated platforms, a diverse and expanding customer base, and a large addressable market space in which to innovate and invest. Ultimately, we believe that the combination of our assets and the opportunities ahead will drive strong revenue growth and margin improvements. And we look forward to discussing these opportunities and our strategy to capture them on our call with you next month. So with that, I'll hand it over to Eric, who will provide a more detailed review of the financial results for the quarter.

Eric? Thank you, Peter. I would like to start by explaining the basis for the presentation of the Odessa U.S. physical auction business in various filings. First, we are required by GAAP to treat Odessa U.S. physical auction businesses as a discontinued operation. This results in removing all activity from the Odessa U.S. physical auction business from the financial statements for our continuing operations. For clarity, I will refer to our continuing operations as CAR Remain Co. throughout this discussion. The first impact of discontinued operations is we remove all detailed activity for the discontinued ops from our income statement, balance sheet, and statement of cash flows. As you can see in our financial statements in the press release, the financial information for discontinued operations is presented in aggregate in each of the various statements. We do not present line item detail, for example, revenue, cost of services, SG&A, and so on in the income statement. It is presented in a single net line item, income from discontinued operations, net of income taxes. In each category of the balance sheet, we present the aggregate activity in a single line item, asset or liability held for sale. And in the statement of cash flows, we present the cash flow activity for each category of cash flows as a net cash provided or used by discontinued operations. In all financial statement presentations, we restate prior year financial statements in this manner to reflect the ADESA U.S. physical auction business as a discontinued operation. We have completed this restatement for the first quarter financial statements. We will be determining the impact of discontinued operations of each quarter of 2021 after we complete the transaction. We do not have that information to share with you today, but we'll provide it as soon as it is available so you have comparisons for each quarter going forward. We have other financial information that has been provided or discussed as part of the ADESA U.S. physical auction transaction. Carve-out financial statements for the business was provided to and was published in an 8K by Carvana. You will likely notice that the basis of presentation for the carve-out financials is substantially different than the presentation of discontinued operations. The carve-out financials include allocation of costs from CAR to the U.S. physical auction business that are not part of our transaction with Carvana. GAAP requires the statements to reflect the operations of the business from the perspective of CAR, not Carvana. Accordingly, the carve-out statements include $42.6 million in allocated corporate costs in the financial statements. The allocation of these costs was primarily based on revenue and headcount for the Odessa U.S. physical business in relation to Car Remain Co. Some of these costs will be retained by Car Remain Co. for the duration of the transition services agreement with Carvana. Some of these costs relate to contractual relationships with third-party technology providers, and the costs will be retained until the termination of existing contracts. As Peter mentioned, reducing costs at Car Remain Co. is a priority in 2022 following the closing of the sale of the Odessa U.S. physical auction business. I also want to comment on our outlook for $265 million of adjusted EBITDA for 2022. This represents our estimate of reported results for continuing operations of car remain goal for the full year. This expectation does not include any pro forma adjustments. For example, We have a commercial agreement with Carvana as part of this transaction. Our expectations include expected revenue from the commercial agreement actually billed and collected from the date of the close of transaction to the end of 2022. To the extent Car Remain Co. incurs any non-recurring expenses like severance or contract termination payments, these will be included in our reconciliation of net income to adjusted EBITDA consistent with our treatment historically. we will not be including pro forma activity as if the transaction closed on January 1, 2022. Given the expectation that our transaction will close in the near future, let me summarize this transaction for you. The total proceeds from the sale of the Odessa US physical auction business will be $2.2 billion. Up to $49 million of this purchase price will be held back until consents to assign leases are received from certain landlords. We expect to receive these consents on all of the properties before or shortly after the closing of the transaction. This transaction will result in a substantial gain. We expect the net gain to be taxed at a rate of approximately 26.5%, including applicable state taxes. We estimate that the gain net of taxes, fees and expenses will be approximately $1.65 billion. We expect this gain will be realized in the second quarter of 2022 upon closing of the transaction. As we have previously disclosed, we will utilize the proceeds to repay existing debt. Upon closing of the transaction, our credit agreements require the repayment of term loan B6 within three days of closing. After repaying our senior debt, the remaining net proceeds will be used to redeem or repay senior unsecured notes. We expect within 365 days of closing to apply remaining net proceeds to redeem or repay the senior unsecured notes. We will not be redeeming the senior unsecured notes prior to June 1, 2022, as the redemption premium on the notes steps down on June 1st. In our balance sheet as of March 31, 2022, we have classified our term loan B6 borrowings as current, given the expected timing of the closing of the transaction and the requirement to repay this debt within three days. The senior unsecured notes are classified as non-current as of March 31, 2022, because there is no requirement to repay this debt within one year from the balance sheet date. We expect a portion of the senior notes to be reclassified as current obligations as of June 30, 2022, in accordance with our expectations and the terms of the senior notes indenture. As mentioned in our release last night, the Board of Directors has increased our share repurchase authorization by $200 million and extended this authorization through December 31, 2023. Following the closing of the Carvana transaction, we expect to have attractive cash generating businesses with an expectation for profitable growth over the next several years. We anticipate purchasing car shares in the open market opportunistically. We believe the repositioning of our company as a digital marketplace business combined with the growth we expect over the next several years as we increase volumes in our digital dealer-to-dealer business and experience the recovery of commercial volumes is not yet reflected in our stock price. We have the flexibility to repurchase car shares if the market does not properly value car in the near future. A few quick comments on our performance in the first quarter. First, our cash from operations for the quarter was negative, both continuing operations and discontinued operations. This is due to the timing of quarter end. As you can see in the balance sheet, the net impact of trade receivables and payables was the use of cash. This is not a change in cash patterns for our transactions, but a reflection of the quarter ending on a Thursday. The cash use reversed over the next several days following quarter end. This was not impacted by the Odessa U.S. physical auction transaction or any changes in terms with our customers. Car Remainco's marketplace businesses Open Lane, Backlot Cars, CarWave, Odessa Canada, TradeRev, and Odessa Europe all experienced low supply of wholesale vehicles, especially in January and February. We saw some recovery in March, although supply still remains constrained. In our volume disclosed in the earnings release supplement and what will be disclosed in our 10Q, only the volume of CarRemainCo is reflected. Our auction fees per vehicle sold increased 29% in the first quarter. A major contributor to this increase was fee increases implemented at Backlot Cars in early March. This contributed to an increase in gross profit per vehicle sold to $255 from $248 in the prior year. Overall performance in our marketplace businesses was challenged by the supply situation. However, we saw March results that were significantly better than January and February. To put it in perspective, our March performance represents approximately 45% of the adjusted EBITDA for the quarter. The improved March performance was driven by the growth in digital dealer-to-dealer volume combined with fee increases and improved gross profit per vehicle sold. The AFC business continued a strong performance in the first quarter. Although the number of loan transactions was flat year over year, this was against the backdrop of decreased volumes in all channels of wholesale transactions. The strong performance was driven by strong revenue per loan transaction including the impact of low credit losses and increasing interest rates. The low levels of dealer inventories across all segments of the retail market drives positive performance at AFC. We continue to see elevated used car prices that drives higher average loan values per car floor. Low inventory levels for dealers drives improved payoffs as cars are sold. The challenges in the wholesale supply of vehicles is a positive for our AFC operations. So that concludes my remarks. I am sure you have plenty of questions today. So I will ask Amanda, our operator, to begin the Q&A portion of our call. Thank you.

Thank you. And as a reminder, to ask a question, you will need to press star and 1 on your telephone keypad. To withdraw your question, please press the pound key. Our first question is from the line of Ryan Brinkman with JPMorgan. Your line is now open.

Great. Thanks for taking the question. This is Rajat Gupta on Forion. Just had a first question on the EBITDA guidance for the year. Did it give us a sense of the trajectory from 1Q to the full year in terms of what's driving the sequential movement? How much of it is volume versus GPU or SG&A improvements? And if you could also give us a sense of How much of the commercial service agreement is embedded in that guidance as well? That was the first question. Have a follow-up.

Thank you, Raghav. Let me take that question. Yeah, so in terms of sort of a bridge from our Q1 performance to a 265 for the full year, I guess what I'd say, there's a number of factors that are additive to our Q1 performance. So let me outline what those are. And I would say that, you know, the factors inherent in our Q1 performance, I expect to continue. So I kind of see the Q1 performance as a base with these additive to it. We expect an improving EBITDA contribution in the digital D2D businesses. Eric spoke about some of the changes on the monetization side that we made in March. So those weren't really fully reflected, certainly not fully reflected in Q1, but they'll be reflected every month going forward. So that's an important aspect. We expect to see some improvement in the open lane performance and corresponding services businesses. We have a number of new programs going live with certain customers. And we expect these to have a positive impact starting as soon as May and some of them going live in June and July. And I'd also say these programs don't require incremental top-of-the-funnel volume. So we expect incremental positive movement there at Openlanes, which will be positive for us as well. There will be a contribution from the Carvana Commercial Services Agreement. I'd say it's relatively modest, but it is incremental and helpful. And then, as you mentioned, SG&A reductions do play a role, although those will tend to ramp up over the course of the second half of the year, but they will be incremental to the Q1 story as well. So, essentially, that provides the bridge, Rajat, from the Q1 to the 265.

And, Rajat, if I could add something on the commercial agreement. There is a contract minimum volume in the commercial agreement. Our guidance assumes only the minimum is achieved, so there is no risk to the number we've assumed in there because of a contractual minimum. We will not disclose the specific terms of the transactions, but I wanted everyone to know, while it is a volume-oriented number, there is a minimum, and we have used the minimum in our expectations.

Understood. That's helpful. So maybe just following up on that, you know, we've obviously heard of many dealer customers, you know, deciding to look at alternatives to the physical platform. And you also see a lot of public announcements from the OEM partners, so moving away from Odessa with the physical business. Could you give us a sense of how much, of how this is maybe impacting OpenLane or BackRot? You know, have you... have the customer conversations then, you know, maybe from the OEM side for OpenLane and then just dealers who are already using Adessa. I mean, are you seeing more of a shift to the digital because of that? Or are you seeing some kind of a backlash maybe because, you know, a competitor is acquiring the platform? Maybe just if you can give us an update on that. Thanks.

Thanks, Rajat. Obviously, my focus is on, as Eric described, the domain code and the platforms that are Stay with car post-transaction, so I'll confine remarks to that. And no, we haven't seen backlash in that regard. I think our customers understand the strategy. And I'd say uniformly, pretty much, our customers see a future where there are more digital transactions, not fewer, and understand the strategy and are very interested to see what we can do for them and the solutions we can bring to them in that regard. But let me provide a little bit more context on that. For sure, the announcement of the transaction was a big event in our industry. It did take, you know, a little bit of time to digest, and there was some, I'd say, confusion in the very initial stages as to, you know, exactly what has been acquired or divested and all that sort of stuff. Given all of that, you know, it was important for us, certainly in those early days and weeks of initial week post-announcement, to spend a lot of time with our customers, which we did, and frankly, which I did personally. And I guess I'd characterize the response as regards RemainCo as follows. Our customers understand the strategy. They understand the rationale, and I think they're enthusiastic about working with the new car. They, again, as I said, whether it's commercial or dealer, whether it's seller or buyer, most customers see more digital transactions in the future than in the past. And it's possible this transaction might accelerate that to some extent. I'm not saying it would, but it's probably another step along that road. And I think our customers are very interested to see how this transaction enables us to focus our investments on the digital solutions and what are the types of offerings we can bring to them. And we've had some initial discussions of those, and I think there'll be exciting product development opportunities in that direction, which I'm excited to start to bring to market. So I guess one other comment I'd say, if I look at our commercial sellers in particular, I talked about how conversion rates have increased through COVID and to the present, even though the top of funnel supply is very low, the conversion rates are stronger than they were pre-pandemic. I would say our customers are keen to sustain those strong conversion rates into the future. So they're looking for opportunities. How do we ensure that as volume returns at the top, we can still keep high conversion through that channel. So listen, I think there's a lot of opportunity and I think there's a good alignment between our strategy and what our customers are looking for going forward.

Understood. Thanks a lot for the details. I'll get back into you.

Thank you, Richard.

Our next question is from John Murphy with Bank of America. Your line is now open. Good morning, everyone. This is Aileen Smith on for John.

So I wanted to ask another question around the $265 million outlook. Just to make sure I understood it correctly in the context of some of the prior comments you've made. I think you last commented when the sale of the adjusted physical auctions was announced that the transaction was going to reduce 2022 adjusted EBITDA by 100 million, which I'm assuming is all else equal outside of any changes in the market or the business more broadly. So within that new $265 million outlook, is it fair to assume the $100 million reduction from the adjusted physical sale holds and the remaining incremental negative, particularly on a year-over-year basis? you know, versus pro forma results is just due to persistent industry headwinds in the secondary market.

Yes, I think that's a reasonable assumption. I think that indication on the $100 million, I think, is still valid. And I would say, you know, candidly, the new vehicle supply issue and, again, the challenges that our OEM customers are facing in addressing that and getting their production back to normal levels, let's say, I think that's just proven more challenging than perhaps we would have expected six months ago. So I think the way you've summarized it there is accurate.

Okay, great. And then I wanted to follow up on Raj's second question, and specifically whether dealers continue to send vehicles to an auction house that's owned by a competitor. And I wanted to ask instead of whether you are or are not seeing change in traffic or shift to other alternatives, which you commented on, but rather, how do you actively change the discussion with some of those dealer customers of moving to the online marketplace offered by Odessa or offered by Carr? Is there an extensive education process that you need to go through? I think you mentioned your customers are interested and they understand the industry shift is happening. but is there any incremental cost of time or resources that you need to make to catalyze customers to shift from physical to digital, or is it happening relatively quickly?

Let me... I'll attempt to answer that here in a second. Let me just go back to your prior question just for a moment, just to kind of give you a little bit more context. You know, I talked about some of the challenges facing open lane and the services businesses. You know, those are significant. I would say... My assessment is that that off-lease decline represents a headwind of something like $100 million in terms of current performance versus normal performance. So I see that as an opportunity to grow back, but that is maybe indicative of how does this headwind show up in our business? And I'm talking about at Romainco in that regard. So to go to your other question on... you know does this require additional education or effort on our part i guess i would say no because we have been with our customers we you know i think part of our company culture is to stay in very close communication and close partnership with our customers uh so we've been in communication with them for many years around digital transformation i think our customers understand that we're a company that has helped drive the digital transformation of the industry both at the commercial and on the dealer side and on the sell and buy sides of the business so That's something we're obviously very experienced in. And I think our customers like our digital solutions. They find them very effective, powerful. I think in the case of many of our customers, our digital solutions represent their highest performing channels. So I would see it as a redoubling of that effort. But I would say the advantage to us is being exclusively focused on that enables us to sort of be fully committed and not to be ambiguous in terms of, you know, well, you could do this or you could do that. We're going to have a very focused message of, hey, these are the solutions we bring to market. We think these are the best. What can we do that would make these solutions better? And how would we deliver that for you? So that's kind of the discussion we want to have with our customers.

Okay, got it. That's very helpful commentary. And then one bigger question, if I may, on AFC, since I'm sure you're going to get a lot around Adessa. But does the sale of the Adessa physical auctions have any near or longer-term implications to AFC that we should be thinking about? Obviously, the customer set is, in many cases, dealers that are using Adessa auction services and then getting financing from AFC. And I'm not even sure if that financing capability is something Carvana can offer as they – acquire the physical auctions. So as you digest the physical sites, is there any risk to AFC going forward that we should be thinking about from a modeling perspective?

You know, I don't believe that there is a risk or that AFC will be hurt by the sale of the U.S. physical auction business. And to provide some context on that, you know, as you mentioned, AFC serves independent used car dealers who are purchasing cars in the wholesale market. including at cars marketplaces, at Adessa, but also at our competitors' marketplaces, whether digital or physical. So when AFC establishes a relationship with a dealer, it's very important that they support that dealer's vehicle purchasing, irrespective of where the dealer acquires the inventory. So that very much has always been part of their strategy. And as a result of that, only a relatively small percentage of AFC's total loans were purchased from cars marketplaces or from Odessa, okay? So, you know, I think AFC really has a sort of a channel agnostic point of view. As long as the dealer wants to buy a car, AFC will finance the vehicle. So we don't see any risk. We haven't seen any risk show up in the numbers. We haven't seen any erosion of the customer base whatsoever in the past 60 days since announcing this transaction. So I don't think there's any knock-on effects there.

And, Aileen, let me add, as part of our commercial agreement with Carvana, the AFC personnel that are on-site at Odessa U.S. physical auction locations will remain on-site through the duration of that contract at no rent cost to Car Remain Co. So that's an attractive logistics arrangement for us relative to having the AFC resources still available to the customers at those locations.

Okay, fantastic. Thanks for taking the questions, guys.

Thank you very much.

Our next question is from Gary Presapino with Barrington Research. Your line is now open.

Hey, good morning, everyone. Hey, Peter, Eric, when you talk about, you know, over time reducing your SG&A as a percentage of sales, what do you feel would be the optimal percentage number there? I mean, it was running at 32% versus 29%. year over year, but what would be an optimal number for you?

You know, I guess what I'd say is we have two businesses, you know, as I described the segments, the segments in the AFC segment, and they have sort of somewhat different characteristics when it comes to sort of SG&A as a percentage of revenue and, you know, you know, margin structure, so on and so forth. So to some extent, you know, what the total number for car is ultimately how those two blend together and, you know, it might make more sense to look at them separately in terms of that analysis. But I guess what I'd say is we do see a significant opportunity. I would say some reduction of SG&A in absolute terms relative to what it is today, and then as our revenue and volumes grow, which we fully expect they will, that SG&A will grow at a much lower rate. So I do have some targets that, honestly, I'd rather speak to in our analyst day with the broader group, but I look forward to going into it in more detail. But for sure, SG&A as a percent of revenue declining is part of our expectation and part of our modeling, and we'll go into more detail on that in June.

Okay, and then just a second question. You mentioned in your commentary and some of the growth that you're anticipating some new programs with OpenLane. My understanding is you had most of the OEM programs there, so could you maybe elaborate where these new programs are coming from?

I would characterize these, Gary, as new programs with existing customers. So, you know, we've had, frankly, and I'd rather not go into the specifics. We don't talk about specific customer contracts. But, you know, our customers... the reality that they're experiencing today in terms of their office portfolio is, is markedly different to what it was, you know, certainly two and a half years ago. Okay. And I'd say these programs would be more reflective of, okay, how are the vehicles selling today? I talked about conversion rates being higher, but also this sort of where the vehicles are selling within the channel, within the funnel is a little different. So we've had some programs that, that address some of those aspects and working with customers in that regard. Okay. Thank you. You're welcome, Gary. Thank you.

Our next question is from the line of Brett Jordan with Jefferies. Your line is now open.

Hey, good morning, guys. Good morning, Brett. Could you talk a little bit about the integration of CarWave? Just give us an update as to where that is and maybe how you're seeing it merging into the backlot business.

Thank you. Yes, good question. So that is on track. From an integration perspective, we broke it into, we called it two waves, wave one and wave two. Wave one is now complete. And wave one, in essence, had a number of key attributes. First one was the deployment of a new and improved common inspection format for both backlot and car wave, so that the sort of intake point of the vehicle into either channel would be the same and consistent across both. So that's new inspection platform was deployed within the first quarter we're pleased with how that has gone and that that's an improved inspection capability relative to what backlog cars had before so it's a it's an improvement and a consistent sort of experience okay uh the second aspect was really addressing a lot of the alcohol the policy and the pricing aspects of the programs so as eric talked about the improvement in monetization of backlog cars really what that was was the deployment of a common sort of policy and revenue framework that sort of can apply to both platforms. So that has been done and that has a number of impacts. One, in terms of customer benefit, it provides both the seller and the buyer increased protection in terms of the transaction. There are, you know, guaranteed type products or increased protections the buyer has or the seller has that the That if the vehicle is not what was expected, there is protection, but then we monetize that protection. Okay, so it has the impact of doing both of those things. So wave one is complete. We're pleased with how that's gone. It's going to be purely positive for our performance past Q1. Wave two, we are currently tracking towards Q3, and that's the deployment of the more integrated technology solution. And so more to come on that. Our team is working hard on that and looking to get that done by the end of Q3.

Okay, great. And then I guess you commented that AFC obviously continues to do well regardless of the ADESA relationship. But just could you give us an idea maybe what percentage of loan originations at AFC came at physical ADESA sites or was most of this, you know, digital or, you know, it didn't really depend upon that ADESA salesperson?

Just in general terms, Brett, it's about 30% of their floor planning is from Odessa sites. I do not have a breakdown. That would include Canada, which will still be part of car remain code. So 30% from Odessa. And I don't measure, again, in that portfolio Canada versus U.S., although U.S. would be a substantial amount of it.

Actually, Eric, can I – yeah, I actually think – Maybe we need to clarify this. I think it's 30% car. I'm sorry, you're right. 30% car across all platforms. Adessi US is in the low teens.

12%, 13% generally speaking, Adessi US. That would be right. Thank you for correcting me, Peter.

So to clarify, it's about 12% Adessi US, 30% of car properties.

And car would include back lot cars, car wave, trade rev. Very little on open lane. It's more than just Odessa, Canada.

Okay, great. Thank you.

You're welcome, Brett.

Thank you.

Our next question is from Bob Labic from CJ Securities. Your line is now open.

Great. Good morning. Thanks for taking my questions. Morning, Bob. I wanted to just take a kind of big picture step back in terms of the free cash flow profile of the business now with this transformation. Can you discuss a little bit the kind of conversion from EBITDA to free cash flow? What's the, you know, CapEx profile going forward? And what's the targeted leverage? So what's the kind of interest expense we should expect going forward, you know, a couple of years out?

Now, I'm going to let Eric speak to a little more specifics. Let me offer just a couple of perspectives, Bob. Appreciate the question. First of all, I think the strong cash flow generation of the business, those characteristics will continue. the business will continue to be a strong cash flow generator. So that is a positive story for CAR. If I also then look at areas where we have reduced cash expenses or cash outlays, there is a reduced need for capital investment given that we have a reduced physical auction footprint, which was um you know a meaningful amount of our annual annual capex so that that is diminished and i'd say also obviously cash to to service debt uh those expenses are reduced as well um i'll allow eric or i'll ask eric to uh provide a little more color on some of that yeah bob we have not set a leverage target with our board yet although it's all understood we've had the discussion it's substantially less than the three times leverage

target that we've had for many, many years. So it'll be significantly less than that. It will take us a little while to get there because of some of the mechanics of repaying the senior unsecured notes that I described in my discussion. But also, we've disclosed, and you'll see it in the 10-Q file today, that our expectations for CapEx will be $75 to $80 million for RemainCo for 2022. That would be down from $115 million, which was the expectation for Carr Global prior to announcing this transaction. And that number had been previously disclosed. The reduction in cash interest expense is likely to be $70 to $80 million a year once the bonds are redeemed. And I don't know the timing of that. There's several factors that will influence the timing of that redemption. So as we look at it, the free cash flow conversion actually will be slightly improved over what it was at CAR once we get past the transaction. One qualifier on that, I am excluding from cash taxes a substantial tax payment that will be due on the gain from the sale of the Odessa US physical auction business. I'm not including that in my ongoing cash tax and that That tax payment in 2022 will likely be in excess of $400 million. So I'm excluding that.

Certainly fair enough, and thank you for the details there. And then two kind of dealer-dealer, digital dealer-dealer questions. I'm not sure how much you will say now. Maybe we have to wait, but hopefully you can give us a little insight. In terms of what is the brand strategy going forward, what are the advantages and disadvantages to having multiple U.S. dealer-to-dealer brands in Backlot and CarWave, and is that going to continue indefinitely, or might you consolidate brands, or how should we think about that going forward?

Bob, I would expect with Wave 2 of the integration, we consolidate brands. Now, we may see the CarWave format live on as a format within the Backlot Cars model, but I think ultimately we have a digital marketplace business. We're dealing with network effect both on the seller and buyer side of those marketplaces, so fragmenting that marketplace doesn't make sense. Okay, great. Absolutely. By the way, Bob, sorry to interrupt. I would say the strategy goes further than that, candidly. Again, we can speak to this more, but we have dealer-to-dealer vehicles. We have off-lease vehicles that also flow into an upstream open marketplace. And we have the potential to get other types of commercial vehicles. As I mentioned, our RDN platform is used by the vast majority of companies repossessing vehicles across the United States. So as vehicles of any type flow into an upstream digital marketplace, it makes sense to get them into one single marketplace, right? So I think you're going to see that's going to be an important part of our strategy going forward. And we'll provide more details on that, you know, in our call in June as well.

Okay, yeah, that's super, and I appreciate that as well. And then maybe last one, and maybe kind of, again, trying to take a little bit from June here, but in terms of the trajectory, I think the goal for the digital dealer was maybe 1.2 million units by 2025, and maybe $100 per unit in EBITDA. Are those still the general parameters of how you're thinking about the opportunity set? And if so... what's the path to profitability in terms of getting to that, you know, 120? Is it linear? Is there an investment phase now for market share with the profits turning on at the end? Or how should we think about the trajectory of growth for the digital dealer to dealer?

I guess what I'd say, Bob, good question. I think as a target, and again, we will provide a more specific update in June, but I would say that target, I think we're still looking at that as being sort of you know, in the zone of the target we think is appropriate. Okay? So I think we're still looking at a target very much from a volume perspective in that regard. I think the EBITDA per vehicle target is also reasonable. I will say that we saw EBITDA per vehicle in our TradeRev marketplace that exceeded that in Q1. So that gives me confidence that that level of EBITDA per vehicle is possible in this marketplace and may be even possible to exceed that in this marketplace. But again, we'll provide more specifics, I hope. So I think as a set of targets, that's generally the right area. And I think it's plausible and that's what we're aiming for. In terms of how we get there, I think we're... Listen, we've got to continue to invest in these businesses in terms of product development and so on and so forth. But the businesses now are also generating substantial revenues and gross profits. So I think we're out of the phase of having losses and there being a cash drain. So I think my expectation is we're going to see more of a linear progression in terms of the profitability. Maybe it's not perfectly linear. Probably not. it probably sort of ramps up a little bit over time. But frankly, this year, certainly at the business unit level, if we exclude sort of a bucket of corporate costs, these businesses will be profitable this year, okay? And I think their contribution in absolute terms will increase from here.

Okay, super. Thank you very much.

You're welcome, Bob. Thank you.

Our next question is from Daniel Inverall with Stevens. Your line is now open.

Yeah, hey, good morning, guys. Thanks for taking our questions. I wanted to talk about the core gross margin first, maybe excluding purchase vehicles. I think it was down pretty materially year over year despite the fee increase. Can you talk about just the drivers of that? And if it was just driven by lower volume, is this really the high 30s, the right way we should think about core gross margin until we see volume more materially pick back up?

Well, Daniel, one of the things I'll point out is there's a substantial impact from purchased vehicles. When you look at net of purchased vehicles, it was down to, again, I'll do this, about 49% from 52% net gross profit on a consolidated basis. But it does look in the ADESA segment, it's much more substantial than that. So as I look at it, all I'll say is there's a a lack of scale in the first quarter, especially January and February. The gross profit in March was much stronger, much more consistent with what we've been experiencing. So I don't think there's been a change in the business model. We just suffered from extremely light volumes in the first two months of the quarter. So as I look at it, I don't think anything's broken. I think you have a bit of a mix issue in Q1, mix of revenue. You have a high impact of purchased vehicles. which was a little bit unusual given the platforms and it did not include purchase vehicles from the Odessa U.S. physical auction business, which was taken out. So all in all, you know, I'm looking at it and thinking you'll start to see what you were experiencing last year as the year moves on and volumes normalize. I won't say they'll get back to normal, but normalize from where we were in January and February.

If I could add maybe one more comment, I'd also say, you know, the mixed shift relative to OpenLane. OpenLane is probably our highest gross profit generator, you know, across the portfolio. And with, you know, with that business volumes being down at the top of the funnel 60%, you know, that showed up in the aggregate numbers as well.

Got it. Got it. And then a bit more of a conceptual question, Eric. I know... Over the last year, most transactions have been fully digital. But how much of that's a function of just the environment with a lack of inventory? Just trying to think that as prices decline, if I think over the last few cycles, you guys have said how the use of reconditioning and physical assets picks up when prices decline. So why wouldn't commercial sellers need reconditioning similar to past cycles? Or how do you plan to meet those needs for your customers given the pending sale of the Odessa U.S. physical locations?

I guess what I'd say there is there is some continued need for those services. That is true. But I would also say that the fundamental trend, the secular trend, is towards more and more digital selling. And I think that's consistent across all types of sellers and all types of buyers. Um, so is there a space for that? Yes. But is that going to diminish over time? Yes. That's how I see it. And when I look at, you know, the types of vehicles we sell across our portfolio, we sell everything from, you know, high end premium off lease vehicles with very little damage at high prices all the way down to sub $1,000 vehicles that are quite heavily damaged. And they sell, you know, uh, in a purely digital format, right? So there is an element of sort of customer choice there, right? So I'm not saying there's no need for that, but I do think that need has been diminishing over time. I think ultimately it continues to diminish over time, but I don't think it goes away forever or goes to zero, I guess I should say.

And Daniel, let me add, out of necessity, we had to look at our capabilities and capacity We started selling reconditioning services to the buyer. We call it retail-ready recon. It would not surprise me if the seller continues to believe that the buyer can handle some of the responsibility for reconditioning the car. They've learned they can get full value for the vehicle, even if it needs reconditioning. And our marketplace, as evidenced by the transaction we're doing, the buyers are more willing to do reconditioning of the vehicle after they purchase it, and I think that will continue.

Got it. So that's not just a function of the inventory shortages right now. That's helpful. And then just to follow up, clarify on the guidance quickly. Peter, I think you mentioned in the remarks the 265 of EBITDA this year would be 11% growth if we excluded the equity gains from last year. Does the 265 exclude the equity gains this year, or would that include the $17 million in 1Q and then

any equity gains going forward oh no it does not include any there are there are no equity gains in this year's uh expectations so the 265 excludes that and on a like-for-like basis had we excluded that in last year's performance then that would then comparing those two numbers is the 11 percent got it so 265 doesn't include the one q17 got it thanks absolutely not you're very welcome thank you amanda we're out of time

I believe there may be one more question. If we could make it one quick question, I think we'll try to fit it in.

Absolutely. Our final question comes from Ali Farhiri from Guggenheimer. Your line is now open.

Awesome. Good morning. Thanks for squeezing me in. So just a more specific question on the implication on OpenLane from the sale of the U.S. physical business to Carvana. So over the years, car management has talked about the moat around OpenLane being the company's physical assets and the ability to offer OEMs vehicle reconditioning and storage. So with the sale of the U.S. physical auction business to Carvana, how do you see that impacting your value proposition to the OEMs and competitive differentiation? versus digital-only competitors who are increasingly focused on the commercial segment?

Thanks, Ali. I appreciate the question. I guess as a founder of Open Lane, I'll comment. I don't recall making the argument that the defense of Open Lane was physical assets. Frankly, what I would say, if I look at the vehicles that actually sell on Open Lane or sold on Open Lane last year, close to 0% of them sold from our physical property or some other auctions physical property. So I don't know the exact percentage, 98, 99% plus of them sold from dealership lots. So I don't think the physical assets are a necessity there. And frankly, when we looked at, you know, when we looked at cars that don't sell on open lane, where do they go to? they get distributed to a wide range of auctions. We never had the ability to say, well, let's direct all those to Odessa auctions. The customer makes that choice, as they should. So I don't think that the physical assets are a necessity or a moat on OpenLane. I think the moat on OpenLane is build great digital products that work for the seller and work for the dealer and provide a very effective digital marketplace that transact a high percentage of their cars quickly and at low cost. And I think that's what OpenLane has focused on for 20 years. I think our customers are very pleased with the service we offer. And I think this acquisition enables us to redouble our focus and frankly, I hope, bring a whole lot more innovation to that channel than perhaps we have done in the past just by being more focused on it. So I don't see the dependency and I see a lot of opportunity with OpenLane. I think it's an area where we're clearly differentiated vis-a-vis all our competitors. and where we've got an unrivaled set of customers and a compelling and strong value proposition.

Thanks, Pierre.

You're welcome, Ali. So, hey, I appreciate that. I know we're a little over. I'm just going to conclude with a few closing remarks. Again, you know, the Adessa transaction is expected to close within the next week. I believe the transaction will be transformative for CAR and for our customers and for our stockholders, and I remain very optimistic for the future of our company. With a smaller, nimbler, and more asset-like company, we intend to accelerate a more focused digital strategy to capture what we believe to be the considerable opportunities for growth both in and beyond our current market. The first quarter was challenging. There's no question about that. When we were facing a 61% decline in off-lease supply relative to the same quarter last year, that's a significant headwind. That said, I believe we made meaningful progress in many areas of our business, particularly in our dealer-to-dealer business and at AFC. We have guidance to deliver $265 million in adjusted EBITDA this year. That represents 11% growth on a like-for-like basis, and that will be accomplished in spite of what I would characterize as a very adverse environment that affects our industry and our business. So I don't love the number, but I'm pleased with the performance in the face of the headwinds we have. As I look past this year, I'm very excited, and I think the team is very excited about the opportunities that lie ahead for our business. We intend to capitalize on what is a secular shift towards digital marketplaces by both commercial and dealer customers and both on the seller and buyer side of our industry. And in addition, we expect to see a recovery in commercial seller volumes that will play out in the years to come. So I believe we have a significant opportunity for growth. We have differentiated platforms, a strong customer base, and a large market space in which to innovate and invest. So I'm looking forward to providing more details on that and on our future plans in an analyst day update. We intend to send out a save the date after we close the transaction and we're targeting sometime in June. And with that, we'll end today's call. I look forward to reconnecting on our next conversation. And thank you all for attending and thank you all for your questions this morning.

This concludes today's conference call. Thank you for participating. You may now disconnect.