OPENLANE, Inc. Q4 FY2020 Earnings Call

Good morning, ladies and gentlemen, and welcome to the KAR Auction Services, Incorporated Fourth Quarter and Fiscal Year 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. Operator provided instructions. I would now like to turn the conference over to your host Mr. Mike Eliason, Vice President, Investor Relations and Treasurer. Please go ahead.

Thanks, Jerome. Good morning and thank you for joining us. Today we will discuss the financial performance of KAR Global for the quarter ended December 31, 2020. Before Jim 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 KAR Global’s business, prospects and results of operations and such risks are fully detailed in our SEC filings. In providing forward-looking statements, the company expressly disclaims any obligation to update these statements. Let me also mention that throughout this conference call, we will be referencing both GAAP and non-GAAP financial measures. Reconciliations of the non-GAAP financial measures to the applicable GAAP financial measure can be found in the press release that we issued yesterday, which is also available in the Investor Relations section of our website. Now I’d like to turn this call over to KAR Global CEO, Jim Hallett. Jim?

Thank you, Michael, and good morning, ladies and gentlemen. Welcome to our call. Today I plan to cover three topics. I want to review 2020; provide you with an update on the integration of TradeRev and BacklotCars; and review our guidance for 2021. Let me start with acknowledging the challenges that we faced in the most unusual year. Obviously, COVID-19 impacted all businesses in 2020, including KAR. We remain committed to providing the safest possible working environment for our employees and our customers. With the challenges COVID-19 created in our workforce, we also saw challenges that directly impacted our marketplaces for our wholesale used cars. We continue to operate our auctions on our digital platforms, Simulcast, Simulcast+, OPENLANE, TradeRev and DealerBlock. But demand was very low in April, as uncertainty was prevalent throughout the automotive ecosystem. We continued to offer vehicles only through our digital marketplaces from mid-March through the remainder of 2020. The key challenge that we faced in the second quarter was the need to accelerate the development of our digital marketplaces. This increased level of online bidding began literally over a two-week period, and our technology teams had to make sure our systems were always available and there were no service disruptions caused by the increased use of our networks. I'm extremely proud of the collective effort of all KAR employees to make this happen. In the past, many investors have asked me what keeps me awake at night. Technology and digital disruption have always been at the top of the list. While the challenges of 2020 took technology and digital disruption to a new level, we responded quickly and today we have the best collection of digital assets in the entire industry. We were able to accelerate the transition of our legacy physical auction business to a digital operating model in a matter of weeks, instead of the three to five years that we anticipated at the beginning of 2020. Another challenge that we faced in 2020 was handling our workforce. In late March, we closed all of our auctions and sent our employees home with pay to evaluate the impact COVID-19 was having on the safety of our employees and our customers. We furloughed 11,000 of our 15,000 employees globally. In April, our weekly revenue had fallen to as low as 10% of prior year revenue, the low point for KAR Global performance. By May, we began to see some recovery in demand. Our supply at the time was strong as inventory had been building up at our sites; it became obvious that our business process had changed and many of these changes were going to be permanent. We leaned heavily into technology for auctions and supporting our back office functions. Changes in the business operations and especially all of our support functions led us to permanently eliminate 5,000 positions, reducing our annual payroll costs by over $150 million. By fall, we had our headcount and cost structure aligned with the business and our digital auction process. We saw the impact of the permanent changes in our cost structure in our third quarter results and expect this to contribute to an improved financial performance going forward. And then we saw a resurgence of COVID-19 with impacts that went beyond what we had experienced in the spring. We saw the supply of used vehicles tighten and our inventory levels continue to decline as retail demand remained strong, resulting in strong conversion rates and high wholesale prices. Lower transaction volumes led to reduced performance in the fourth quarter despite all of the reductions that we've made to our cost structure. In any organization people are the most valuable asset. In this environment, the strain and the uncertainty our people are feeling is the most challenging aspect of running the business today. It looks like it will be a while longer before we see relief from the strain of COVID-19. Now let me share some of our accomplishments in 2020. First, we have successfully migrated all of our auction platforms to digital marketplaces. This has been a strategic direction for KAR for over two years, and we were able to accelerate the pace of change during 2020. We are committed to operating a digital marketplace business supported by services and logistics capabilities that make the wholesale process easy and efficient. Our collection of digital assets that we have strategically focused on building and acquiring over the last five years put us in a unique position to move forward with a digital business model. It is true that many of our competitors are running cars through the lane despite the increased COVID numbers over the past several months. But we have not returned to the old way of doing business and don't believe there is any evidence that running cars across the block improves the financial outcomes for our customers. We are committed to providing our auction services digitally going forward. In 2020, we introduced Simulcast+ to the marketplace. Simulcast+ is a fully automated auction that can easily sell cars from multiple locations using technology instead of people to manage and run the auction event. Simulcast+ has proven to expand the geography represented by buyers and this improves liquidity for the sellers. We are also not tied to a sale day event when using Simulcast+. We can operate Simulcast+ any day of the week from one or multiple locations. These can be ADESA or customer locations. The Simulcast+ platform gives us additional digital capabilities that allow our sellers to manage the auction event in real time without leaving their office. We have provided a number of demos to investors this year. If you've seen one of those virtual tours, you saw that we have a significant amount of information available to both buyers and sellers that leads to strong pricing and conversion on the Simulcast+ platforms. We see a number of benefits for both buyers and sellers. We've seen increased liquidity, we're able to reach a greater number of buyers that are interested in the car being offered, we've seen lower costs to execute the transactions for all involved and it is easier to integrate data and analytics in the process that is available to all parties. Better information leads to better price attainment on the vehicle and realistic expectations by the sellers as to what the current value of the vehicle is. Another success in 2020 was the improved growth and profitability for our TradeRev platform. Our combination of dealer consignment sales teams of ADESA and TradeRev has been a success. We reduced the use of incentives and focused on service levels. We simplified our auction process in order to provide a better experience for our customers. We generated positive earnings for several months in 2020 and have proven this business model can be profitable growth going forward. We acquired BacklotCars in order to accelerate our growth in the dealer-to-dealer segment in the U.S. market. And finally, let me talk about the permanent reductions in our cost structure. First, the changes we made in moving to a digital business model allowed us to make permanent reductions in our labor costs both direct labor and SG&A. Our SG&A was down year-over-year in Q4 by $25 million. This decrease was achieved despite adding $5 million of SG&A in the fourth quarter related to BacklotCars. Even though we were able to reduce our costs, our fourth quarter performance fell below our expectations as we saw the supply of wholesale vehicles decline throughout the entire industry. Our volumes in Q4 reflect the slowing of the economy in response to the increased COVID cases. I do not believe the lower volumes reflect the seasonal impacts or the permanent disruption of our marketplaces. I believe the factors that negatively impacted our supply in Q4 are transitory. Now, let me give you a real time update on TradeRev and BacklotCars. First, we are migrating all U.S. dealer-to-dealer transactions that previously took place on TradeRev to the BacklotCars platform. We ran a pilot migration in three U.S. markets in January to refine our migration playbook. We were pleased with the results of the migration and the acceptance of the BacklotCars platform by our TradeRev customers in these markets. Beginning February 1, we initiated the migration of all U.S. TradeRev customers to the BacklotCars platform. We expect the migration activities to be completed in March. By moving our U.S. customers from the TradeRev application to BacklotCars, we will be moving from a timed auction format to a 24/7 bid-ask marketplace. Our analysis of the performance on the two platforms supported this move. We believe running a single dealer-to-dealer digital marketplace will maximize liquidity. Utilizing the inspection process developed by BacklotCars should lower our inspection cost per vehicle and provide greater consistency in the inspection reports for cars sold on the BacklotCars platform. Most important, we believe the price realization on the BacklotCars platform in the U.S. outperforms the competition in the U.S. market. The early results on the migration activities have been very positive. Initially, there was a small reduction in volumes as former TradeRev customers began using the BacklotCars platform. The learning curve for our customers seems to be about five to seven days and in the second week we began seeing our combined volumes increase in the markets that were in the first wave of migrations. We believe BacklotCars is the fastest growing dealer-to-dealer platform in the U.S. market. Our goal is simple. We want BacklotCars to be the number one digital dealer-to-dealer marketplace in the U.S. Just to be clear, we will continue to operate TradeRev in Canada. To sum it all up, after 90 days of owning BacklotCars, we are pleased with the performance and the fit with KAR. We have a focused and energetic team leading our efforts to be the leader in the digital dealer-to-dealer transactions in the U.S. Our customers have been receptive to change in the early days of integration activities and bringing the strength of the KAR organization to the outstanding team at BacklotCars is a winning combination that should accelerate the already fantastic pace of growth in the digital dealer-to-dealer space. The last item on my agenda and an important topic for today is an update on our outlook for 2021. We are reinstating annual guidance for 2021. While we continue to be in the middle of the COVID crisis in all of our markets, we believe we are better-positioned to analyze the impacts on our business and assess the likely outcomes across various scenarios. As you saw in our press release, we are providing guidance. Adjusted EBITDA will be at least $475 million and operating adjusted net income per share will be at least $0.87 for 2021. We are not providing a range, but we are providing the minimum level of performance we expect this year. We still have significant uncertainty around the economy, employment, levels of new car production, the timing of repossession activities and many other factors that are still a ways from returning to normal. Obviously, our guidance indicates we expect to continue to be below pre-COVID levels of transactions, and this is representative of our industry outlook. I would like to provide some insight, without specific numbers, into how we see 2021 coming together. First, we expect lower supply of wholesale used vehicles to persist through the first half of the year. As a result, our outlook for the first and second quarter is conservative. We do believe the second half of 2021 will improve upon the first half of 2021 and the second half of 2020. We have seen good progress in providing vaccinations in the first months of 2021 and expect continued progress on this front in all the geographic markets we serve. We also see stimulus in the U.S., Canada, and Europe as a positive for our customers in the used car retail market, if passed by legislators. We also believe that our financial performance may exceed 2019 levels before we achieve 2019 volume levels given the improvements that we've made in our cost structure. Let me speak to the parts of the market that we believe will drive a return to normal. First, our digital dealer-to-dealer platforms, BacklotCars in the U.S. and TradeRev in Canada are expected to grow substantially over 2020 levels. We expect to continue gaining market share in this channel throughout the year. We are committed to expanding the use of Simulcast+ in 2021. We are targeting an increased number of events using this technology platform. There is tremendous value to using the Simulcast+ platform for multi-location sales events, targeted marketing for similar vehicles that allow us to create events that have high buyer interest and expand the geographic reach of the typical physical auction. Our growth internationally, especially at ADESA Europe, formerly CarsOnTheWeb, is very strong and we expect this to continue throughout 2021. We have not given a range of guidance. It is difficult to set an upper end of the range with the uncertainty on when operations will return to normal levels. We still have more questions than answers on what our markets will look like, especially in the first half of the year. But we have an opportunity to outperform above the adjusted EBITDA and operating adjusted net income per share provided in our guidance once volumes start improving. As a team, we will focus on controlling our costs and increasing our market share. We expect our market share to be driven primarily by digital dealer-to-dealer platforms, BacklotCars and TradeRev, and we will be disciplined around capital deployment. We think our balance sheet is an asset in the current economic environment. As we look to deploy capital, we expect uses of capital to have a strong connection to our strategic priorities around the digital transformation of the wholesale used car industry. As I finish, let me summarize my key messages on this call. We are a digital marketplace business that utilizes data and analytics and value added services through a network of locations throughout North America. We are leading the digital transformation of our industry. We have reduced our cost structure permanently, and we expect increased profitability going forward. We have combined two leading digital dealer-to-dealer wholesale auction platforms and have the goal of being the leading provider in this segment of the market in the United States and Canada. Finally, we believe our balance sheet is well-positioned to support the growth of our business. We will deploy capital going forward on the initiatives that support our strategy. So with that, thank you for your time today. I will now turn it over to Eric for more details on our financial performance. Eric?

Thank you, Jim. And before I get into my remarks, I'd like to correct a statement Jim made during the call. He said that we do not believe the second half of 2021 will improve upon the first half. He misspoke; we do believe the second half of 2021 will improve upon the first half of 2021 and the second half of 2020. So now I'll get into my remarks. Let me start with an overview of our financial performance in 2020. To say the least, it was a challenging year and our results quarter-to-quarter were like riding a roller coaster. We experienced both ups and downs in performance this year. In review, we started the first quarter strong and performed very well until the middle of March. Uncertainties created by COVID-19 caused us to shut down our operations for the last two weeks of March. We lost approximately $35 million in those two weeks as revenue was minimal, and all employees were paid for two weeks despite all locations being closed. We lost money in the month of April. We had negative adjusted EBITDA of approximately $25 million for the month. We then saw a relatively fast rebound during May as weekly volumes rebounded to over 90% of the prior year, followed by June where volumes and our financial performance exceeded the prior year. Volumes and financial performance remained strong in July as we saw strong used car demand, low new car inventories, used car values increasing and we were selling inventory that had been on our properties through the pandemic. While volume started to decline in August, we finished the third quarter with volumes over 90% of 2019 levels for the quarter and adjusted EBITDA that was 8% above 2019 levels. We had gross profit of over 50% of net revenue and adjusted EBITDA margin that was 23.5% of total revenue. We feel this performance demonstrates the performance characteristics of our business model going forward when volumes are at or near 2019 levels. Unfortunately, the fourth quarter saw volumes drop to 75% of the prior year, excluding acquisitions, and our financial performance deteriorated due to the low revenue levels. Gross profit declined to 46% of net revenue. Even though we have improved our cost structure and reduced direct labor, there is a fixed component to our direct cost and the volume levels experienced in the fourth quarter did not generate sufficient revenue to maintain our gross margins. In terms of SG&A, we're able to control costs and hold SG&A below the prior year by $25 million. This was accomplished despite recording approximately $16 million in incentive pay in the fourth quarter, compared to $7 million in the prior year. This increase in incentive pay reflects the proposal by management to adjust the threshold for payment to 50% from approximately 95% of target by 2020. We felt the sacrifices and contributions of our employees should be recognized with the opportunity for a performance-based incentive payout. The threshold set at the beginning of the year did not reflect the challenges we faced in 2020. The compensation committee of the Board of Directors approved the adjustment of the threshold. The total payout for employees with annual incentive programs was approximately 70% of target for the year. We also recorded an adjustment to contingent purchase price related to the acquisitions of CarsOnTheWeb and Dent-ology that was a net increase in expense of $4.7 million. This represents an increase in the expected contingent purchase consideration for CarsOnTheWeb as performance has exceeded the expectations set at the time of the transaction, offset by a reduction in contingent purchase consideration related to Dent-ology where payments are expected to be less than estimated at the time of the acquisition. Our effective tax rates for the fourth quarter and full year were unusual in 2020. The contingent purchase consideration and the write-off of goodwill totaling $25.5 million for our U.K. operations that we recorded earlier in the year are not tax deductible and increased our effective tax rate. As we look forward, we expect our effective tax rate to be approximately 30% unless the U.S. federal income tax rate is increased from current levels. I know the big question in everyone's mind is what does KAR's performance look like post-pandemic? We believe our performance in June and through the third quarter gave us insight on what we can do going forward. We believe when volumes get back to 90% or more of 2019 levels, our business can generate gross profit of approximately 50% of net revenue with adjusted EBITDA margins in the mid-20% range. Our focus on operating a digital marketplace business and maintaining processes that leverage technology for a more efficient cost structure will allow us to perform at this level. Now we need the markets to get back to what we would call normal so we can prove to you the changes we have made will generate these results. Now let me speak to changes in the presentation of our financial statements and segment reporting. As you can see in the financial statements included in our press release, we are providing four revenue line items now. We are providing auction fees, service revenue, purchase vehicle revenue, and finance-related revenue. This will give a clear picture of the major components of revenue in our businesses. In terms of key metrics provided in MD&A, we are now disclosing volumes for on-premise and off-premise vehicles sold. We're reporting auction fee per vehicle sold as a key performance metric. We will no longer be utilizing physical revenue per vehicle sold as a key metric. While the number is easy to calculate, a significant portion of services revenue is generated from off-premise activity and not related to the on-premise vehicle sold. We're also computing the gross profit dollars per vehicle sold, and including that in MD&A. This is a key indicator of performance and trends in this metric will be important going forward as volumes increase. This metric will capture both the impact of option revenue and services revenue on our performance. We have also simplified our segment reporting to be consistent with the simplification of the KAR businesses post-spin of Insurance Auto Auctions. All holding company costs are reflected in the ADESA business segment other than cost specifically related to AFC. This simplified segment reporting better reflects the KAR organization structure and how the businesses are being managed. We want to maintain a cost structure that reflects the revenue and performance of the business. Aligning our costs directly with the reportable segments simplifies our reporting and matches the cost structure of KAR with the revenue produced by our businesses. Let me close with some comments on guidance. I will not go through all the numbers as they are included in a table in our earnings release. However, one item that creates confusion is the computation of weighted average diluted shares. Generally Accepted Accounting Principles require us to compute per share numbers using either the two-class method or the if-converted method when determining the impact of the Series A convertible preferred stock. For clarity, we use both calculations and for GAAP are required to use the number that produces the lower earnings per share. For GAAP purposes, we reduced net income by the preferred dividend and exclude the preferred shares from the calculation of fully diluted shares outstanding when we use the two-class method. In computing operating adjusted net income per share, we're utilizing the if-converted method. In this method, we do not adjust for the preferred dividend, but do include the conversion of the preferred shares into common shares in the calculation. To the extent preferred dividends are paid in kind, we include the accrued dividends in the conversion calculation. We have provided the share count in both calculations in the guidance table in the press release. In summary, the only difference between the two weighted average diluted shares numbers is the conversion of the convertible preferred stock into common shares using the conversion price of $17.75 per share. We did buy back $10.2 million of common stock in the fourth quarter at an average price of $17.50 per share. We acquired the shares in the open market within the parameters we established during our open window during the quarter. One last item that I will provide on the call because it will be included in the 10-K that will be filed later today or tomorrow is our expectation for capital expenditures for 2021. We expect capital expenditures to be approximately $125 million, an increase from actual capital expenditures of $101 million in 2020. The increase in capital expenditures expected in 2021 reflects continued investment in technology to support our strategy around digital transformation, as well as a return to normal capital spending to support our physical locations. Our 2020 capital expenditures were reduced from our expected levels for 2020 to conserve capital as our business was adversely impacted by the pandemic. Thank you again for joining the call today. I will now turn it back to the operator and take your questions.

Operator provided instructions. Your first question comes from the line of Ryan Brinkman with JPMorgan. You may now ask your question.

Hi. Thanks for taking my questions. The first of which is about margin. So in both 2Q and 3Q, your vehicles sold and revenue were materially lower year-over-year, but still you managed to eke out increases in both gross and EBITDA margin given a lot of cost out actions. I get the volume deleverage, of course in 4Q, but it does seem like the revenue headwinds were maybe less than in 2Q. And so I'm trying to understand why the margin performance was materially softer. Maybe you can comment on the trend in ADESA SG&A, which seems to increase materially from 3Q to 4Q even as volume and revenue sequentially declined. So, maybe just talk about the layering back in of the expenses, if that went as planned? Or maybe there's just some seasonal costs in 4Q that cannot be avoided, such as compensation, I'm not sure. And then just how much should we consider? Or what should we consider about these trends in margin? Should we place more emphasis on 4Q as opposed to 2Q or 3Q, etc., when it comes to forecasting the trend in 2021?

Thanks, Ryan. First, let me just speak to fourth quarter. In fourth quarter, we do have the annual issue of the revenue mix tending to be more heavily weighted towards services, and that's every year. That impacted us and gives us higher revenue per transaction, but some of that revenue is much lower margin. Second, and we highlighted this relative to overall performance, we did have some expenses in the fourth quarter. There are annual incentive payments that do hit direct labor that would impact margins in the fourth quarter. We made the decision to use discretion to change the threshold for the year so that we could compensate our people based upon the performance and the hard work. We recorded most of that expense in Q4 because we had not been accruing it against the previous threshold that we had in the first three quarters. There was some bonus accrual in the third quarter, but most of it was in the fourth quarter. So that changed the expense structure a little bit and we've called that out. It was really just that the number of transactions was so low in the fourth quarter. You actually get decremental margins on the work we're doing and that's the impact. So we don't see any changes in the overall cost structure. We don't see changes in the pricing of individual transactions, and falling to 75% of 2019 for the full quarter consistently through the quarter was a headwind we couldn't overcome.

I see. Thanks. Then, I'll just finish by asking on volume. Presumably the off-lease volumes are weighing quite a bit, given the strong residuals that are out there in the marketplace. Are you able to quantify the impact of lower off-lease volume in 4Q, or maybe what your expectations are for 2021? And there's a lot going on also with regard to the repossession volumes. Maybe you can just talk about what you're seeing there, what you're expecting and how much do you think stems from lower repossession volume from a genuinely better economy relative to maybe any sort of ongoing forbearance on the part of lenders? Do you have any insight into when those forbearance activities might start to subside?

So I'm going to talk about some specific numbers. Then Jim is going to talk more about the latter topics, Ryan. We did see some declines on the off-lease volumes. But the biggest impact is the fact that they're getting purchased upstream by grounding dealers. If we don't get the transaction, you are correct, it's a lower revenue per transaction if it's executed at the grounding dealer level. So while it wasn't as large a decline as you might expect, there was a very significant decline downstream, which would have impacted both ADESA and all our competitors that process from physical locations. Very few off-lease cars are getting into the physical auction network. Relative to repossession volumes, repossession volumes are off at least 40% for the year and continue to be off. I'll let Jim take over talking about what we see, how that's going to continue maybe longer than we expect and how stimulus actually might be a negative for repossessions.

Good morning, Ryan, and thanks for your question. As Eric mentioned, off-lease volumes are affected by strong pricing. With strong pricing it will be more difficult to get those vehicles to our platforms and through the funnel down to the physical auctions. There's no question that we expect for the first half of the year those volumes will continue to be tight. We've been talking about repossessions and waiting on repossessions since the middle of 2020. We thought repossessions were starting to return to a more normal level in the second half of 2020. In fact, now I would tell you that with the uncertainty in the marketplace, and all that's going on with COVID and unemployment, and the public attention on repossessions during a crisis, there are laws and protections that can affect repossession activity. Through the first half of the year, I would say that we're not expecting to see a huge return or a huge increase in repossessions. But we do think if the market can get better, and all the things we talked about related to COVID and vaccinations and unemployment improve, we should see an increase in repossessions in the second half of the year. I'm not sure they get back to 100% of what they were in 2019, but we think that there will be an increase in the second half of the year.

Okay, very helpful. Thank you.

Your next question comes from the line of John Murphy with Bank of America. You may now ask your question.

Good morning, guys.

Good morning.

To follow up on Ryan's question, and maybe think about sort of all the channels of vehicles flowing into the auction, and maybe just thinking about dealer, commercial and then sort of the major buckets in 2021. I think the thing we're struggling with is you hear from dealers—CarMax, Carvana, the business is actually going fairly well, volumes are okay, a little bit hampered by supply, but not nearly as much as what you're seeing down 23%. So it seems like at the retail level, the industry is functioning fairly well. But at the wholesale level, obviously, there's this pressure. So just trying to understand really what you think is going on between the retail and the wholesale side, but then also the channels and the flow in 2021 beyond just the repo, which is an important question. Really what you think is going to happen here on the dealer side? I'm trying to understand the near-term flow going into 2021.

John, it's a good question. I see a lot of similarities to what we saw in 2010 and 2011. While retail used car sales remained strong, dealers have the opportunity to source inventory elsewhere. As values are increasing, they are acquiring inventory at relatively low values, whether that would be by buying vehicles from consumers or taking trades, and retailing because cars are being sold at strong retail prices. All the public retailers are having reasonably strong retail used car results right now, but they've all acknowledged supply is tight. The truth is, at this point, you don't see them running through the wholesale network and that applies to every channel. We continue to see very strong performance in our digital dealer-to-dealer space. In fact, we sold 316,000 cars if you take BacklotCars and TradeRev platforms together, which is an outstanding performance and we think that's a source of significant growth in 2021 for us. Off-lease will likely be slightly below previous levels because dealers are buying out leases early and pulling those vehicles upstream. With a lack of new car production, dealers may be extending leases until they have new car inventory for consumers to turn in their cars. When repossessions come back, those are big users of our networks; that has been a low-volume performer recently. Captive finance companies and lenders have emphasized forbearance and other measures, and it's not the right time to repossess vehicles from a publicity perspective. Over time, those things should free up. Jim, do you want to comment on the dealer consignment portion of our business?

Yes, I can add. We do expect that our dealer consignment business can offset some potential losses on the commercial side, especially with off-lease and repossessions. As I said earlier, we are very excited about the acquisition of BacklotCars and now taking TradeRev and transferring it to a single platform. The receptivity by the dealers has been very good. In fact, every dealer that we've gone to so far has migrated over to the Backlot platform. When we were evaluating TradeRev, we were excited about the leadership and the product, but we learned a lot. Backlot has a bid-ask marketplace and strong inspection processes in the U.S., and we believe combining sales teams with ADESA will accelerate adoption. We think we can take the leadership position in dealer-to-dealer digital in the U.S. and we're focused on becoming number one in that space in the short term.

Okay. And then, Jim, just a strategic question. You have Simulcast, Simulcast+, DealerBlock, OPENLANE, TradeRev, BacklotCars—it's a lot. Is there a move to simplify this so your sales force can go into a dealer and present a single, simple go-to-market message? It feels like there are a lot of moving parts and it might be easier to sell if it was a simpler, single-branded message.

John, that's a great question and it's one we're focused on. We have combined sales forces and sales teams—Backlot and ADESA now work together to walk dealers through how the platforms operate and how to get on the platform and use it. In many cases, we stay with them until they've transacted a certain number of vehicles, either on the buy or sell side. We have a commercial sales team focused on articulating how these platforms work and how they add value. For 100 years we've been totally focused on never telling a dealer which channel they should use. We want to provide all those channels and platforms, but our job is to make sure that we support customers and help them use the platforms effectively. Over the last year we've signed up over 20,000 new buyers that had never bought a car online or on the platform. A very high percentage of those dealers have now transacted on the platform. Getting them to the platform is one step; getting them to use it is the next, and that's what we're focused on now—getting them familiar with the platform and supporting them.

John, to add, one of our strategic initiatives is to make it seamless to move a car offered on BacklotCars to a Simulcast or Simulcast+ auction if you don't get the price you want, so you can try a different market. We're working to make that a seamless experience and offer a more end-to-end solution to the seller than any of our competitors because we have all the solutions.

We have quietly done a pilot in Canada where we've been taking cars that haven't sold on TradeRev and shipping them seamlessly to the physical auction. With no marketing dollars behind it, and doing it quietly, we've been encouraged by the results. We think we can continue on that path and bring that into the U.S. market. There's a huge opportunity there.

Okay. One last quick one: with the stock where it is at $14, can change. When do you consider going private?

We run the business and we feel we have a strategy that has a lot of value. The current stock price does not reflect the long-term value that we see in the KAR opportunity, and that's all I can really say today. We won't worry about who owns us; we'll just run the business for our owners.

I appreciate the feedback. That's helpful. Thank you.

Your next question comes from the line of Craig Kennison with Robert W. Baird. You may now ask your question.

Hey, good morning. Thanks for taking my question. Jim, I know you were excited after you acquired TradeRev. What really were the lessons from that integration that you take to the Backlot integration? What's going differently this time around?

Craig, fair question. I think it was execution and go-to-market strategy. We missed on the go-to-market strategy with TradeRev in the U.S. Dealers in the U.S. behaved differently than in Canada. We learned that we couldn't just drop the Canadian product into the U.S. market. Backlot figured out what was important to U.S. dealers: the bid-ask marketplace that gives dealers up to three days to sell the car and the inspection process where mechanics go out to do inspections. That adds credibility and confidence in the condition report. We recognized that in Canada dealers could do their own inspections, but in the U.S. dealers wanted us to do inspections. We learned that dealer behavior is different and the go-to-market needs to be tailored. We did get to break even and were profitable in some months with TradeRev, so we stumbled but also learned a lot. That led us to acquire Backlot and now I'm very bullish on our leadership opportunity in dealer-to-dealer.

Craig, I’d like to add that TradeRev still has a lot of value, and the Backlot team is excited about having our sales force represented because that accelerates their entry into new markets. Our operations support has gone over to the Backlot platform, giving them greater support and better customer service as a result. The combination creates value—it's not just one taking over the other.

The leadership team at Backlot grew up in the retail car business, know dealers, and built the product around what dealers wanted. Aside from execution and go-to-market, their knowledge of the industry has really shown up in BacklotCars' performance.

Thanks to both of you. You have a big goal to expand volumes significantly. When you think about that, what are the barriers or bottlenecks that you are concerned about? Is it adding dealers? Is it hard to add enough mechanics to provide that type of feedback to buyers? What are the KPIs you use to run that business and feel good that you're on track?

Craig, the most important metric in our business is one word: volume. We need more volume, and we're focused on volume. In 2021 there is more focus on volume than on profitability, although we want to operate the business at breakeven or better. It's really about getting existing dealers to do more volume, getting more dealers signed up, and driving the volume metrics.

Very specifically, it's often easier to sign up a dealer than to get him to use the platform on the first day. First you sign them up, then get them using the platform and having success, then increase the volume they put through and get them to a super-user status where they're selling high numbers per week. The market is well-defined; it's getting dealers to use the platform.

Thank you.

Your next question comes from the line of Stephanie Benjamin with Truist. You may now ask your question.

Hi, good morning.

Hi, good morning.

Could you maybe talk how TradeRev and BacklotCars performed in the fourth quarter versus your expectations without breaking out individual volumes? Directionally how did the dealer-to-dealer segment perform compared to the overall industry in the fourth quarter?

The very strong growth at BacklotCars and TradeRev on a combined basis is a strength of our business. When you look at quarterly performance of dealer-to-dealer off-premise, it is doing very well and is where our growth will come from, Stephanie. On a combined basis, digital dealer-to-dealer was up year-over-year in Q4 by about 60%. We were pleased with that combined performance in a period following our closing of the Backlot acquisition on November 12. That combined growth rate reflects the two platforms as if combined in the prior year as well.

Got it. That means the other component to this business would be primarily OPENLANE, which must have been down pretty materially in the fourth quarter. Is that because dealers grounded vehicles or kept them? Anything beyond that or is it going to roll off in early 2021? What happened with OPENLANE between 3Q and 4Q?

OPENLANE had fewer listings. The bottom line is fewer cars came onto the network. Conversion rates remained reasonably strong and pricing was very strong, but there were fewer listings. That's a function of dealer behavior—buying out leases and buying at grounding dealers. Not all grounding dealer transactions come through us, so that can impact our numbers. We somewhat expected that given the strong pricing environment.

With the strength of price in the market, many cars are returning off-lease 'in the money.' Cars are being bought below residuals or below the wholesale value being realized in the marketplace. In many cases dealers are taking them, and in other cases consumers are buying the car knowing they're getting a value relative to market. That's been a takeaway from OPENLANE.

To give a specific example, a recent third-party report shows current residuals on three-year-old vehicles running at about 54% of MSRP three years ago, up from 48% at the beginning of this year. That's a specific number from third parties that track residuals.

And a follow-up to Ryan's question: you called out some annual incentive payments that you didn't accrue for the majority of the year but paid in Q4. Can you give a rough breakout of what was between SG&A and cost of sales? You gave total incentive dollars but a rough breakout either dollar or percentage wise?

It's roughly about 80% SG&A and 20% direct costs. That's a back-of-the-envelope breakout but that's approximately correct.

Got it. Lastly, strategically, how would you look at appetite for additional acquisitions in 2021 and 2022? And off the prior question, if presented with a takeout opportunity to go private, is there anything from a tax consequence perspective that could keep you from engaging in those discussions?

On acquisitions, we're very focused on our strategy. Our priority is continuing to build a digital company and transform the industry to fully digital. That's the future and where we're investing. You should expect us to continue to invest in areas that support our digital initiatives and platforms. I'm not suggesting we would not do an acquisition, but it's not a priority and there's nothing on the board I can speak of today. If you see us spending money, you should see it supporting our strategy.

Relative to your tax question, referring to the tax-free spin in June 2019, I see no tax issues that would be a limitation on opportunities for the company. I don't see anything that would have an impact on the tax-free treatment that would prevent discussions.

Got it. Thanks so much, guys.

Probably—Jerome, we probably have time for just one more question.

Okay, sure. Your next question will be from the line of Daniel Imbro with Stephens, Incorporated. Your line is open.

Yes, thanks. I wanted to ask a broader question on competition. During 4Q, Jim you mentioned some of your traditional competitors brought physical auctions back online. You said there's no difference in the returns, in your opinion. But do your customers share that view? Did you see any share shift during the quarter? Additionally, you have some online-only competitors. Salvage auctions are talking more about whole car channels. Do you think that poses any challenge to your volume? Any incremental thoughts on competition would be great.

Daniel, anytime anybody takes a car away from us they're a competitor. There's no question our competitors are running cars. Our commitment to going digital may have caused us to lose some vehicles from people who haven't made the transition to digital, but we don't expect that to be a long-term issue. It's our job to provide evidence through data and analytics that digital delivery provides equal or better economic outcomes. We continue to gather and share that information with customers. We aren't interested in returning to the old way of doing business; we're committed to the digital strategy. Salvage companies selling low-end cars have always been part of the marketplace and may continue to sell some low-end cars. We have a major competitor on the dealer-to-dealer digital side and we think we're closing the gap and can take a leadership position. There's always competition; our job is to stay in front of it and our strategy is guiding us.

Got it. If I could ask a quick follow-up: you added a sentence in the supplemental that vehicles on-site use services at a higher rate, and the shift to offsite is hurting that. If the business continues to shift to more off-premise sales, how do you think about utilizing your physical assets, given the scale you've built over time?

I'll let Jim talk about the land, but the shift is at least partly temporary because of high values. During previous cycles when cars sold quickly, it was easier not to use on-premise services. That applies to the whole industry, since you can't run large groups in auctions right now, and that reduces cars showing up on site.

I've always maintained that our brick-and-mortar, our land and real estate is one of our critical assets and a differentiator that few have. Especially in urban areas, when dealers decide to wholesale a car they need space, they need the car off their property right away. We need to get the car to auction, get it imaged, reconditioned if necessary, and auctions continue to provide these services. It's important to have the right land in the right location and the right size. That's not to say we would never divest some land; we have exited small auctions in the past. We would often prefer to own the land and lease it. You'll see us continue to differentiate ourselves with land because few can provide these assets. When you think about digital platforms you need more than a platform and a buyer base; you need inspections, transport and logistics, finance and reconditioning. We're unmatched in those assets and that's why we're positioned to win.

Got it. Thanks. Best of luck.

Thank you. That's the end of the Q&A session of today's call. I'll now turn the call back to our Chairman and CEO, Jim Hallett, for any closing remarks.

Okay. Thank you, Jerome and ladies and gentlemen, thank you for being on our call today. Obviously, fourth quarter was a tough quarter and not easy to report. But I want to reiterate what we've said: we are a digital marketplace business that utilizes data and analytics and value-added services. We are committed to this direction. We are not interested in reverting to running cars across blocks; we are interested in moving this industry forward. This transformation is happening now and we believe we are leading it. We have taken some short-term pain, but we will take the leadership position as we go forward. We have now right-sized the company—5,000 jobs were permanently removed from the organization—and we believe we've aligned costs. We can add volume without adding proportional costs. That is sustainable and we can continue to take it forward. The combination of BacklotCars and TradeRev truly strengthens our position and makes us the leader in dealer-to-dealer in the U.S. and in Canada with TradeRev. We expect huge gains in the dealer-to-dealer segment. We also have a strong balance sheet to support our strategy and to take advantage of opportunities that align with our digital transformation goals. We're looking forward to coming back next quarter and will have more information to share on these transitions. Thank you for your interest and for being on our call today.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.