Good day and thank you for standing by. Welcome to the KAR Auction Services, Inc. Fourth Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Michael Eliason, Treasurer and Vice President of Investor Relations. Please go ahead.

Thanks, Norma. Good morning and thank you for joining us today for the KAR Global fourth quarter 2021 earnings conference call. Today, we'll discuss the financial performance of KAR Global for the quarter ended December 31, 2021. After concluding our commentary, we will take questions from participants. Before Peter kicks off our discussion, I'd like to remind you that this conference call contains forward-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'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's CEO, Peter Kelly. Peter?

Thank you, Mike, and good morning, ladies and gentlemen. I'm delighted to be here this morning with all of you to provide an update on our performance at KAR Global. So on this morning's call, I plan to speak about our fourth quarter results. I will provide an update on volume trends in our industry, particularly volumes from commercial sellers. I'll provide updates on the continued growth of our dealer-to-dealer business and specifically our record quarter in the dealer off-premise volumes sold, a record quarter in dealer off-premise volumes sold in our digital platforms. I will also provide an update on our acquisition of CARWAVE and the solid performance of our finance business, AFC. I will close out with some updates on our cost structure. So I'll start with an update on our fourth quarter performance. While commercial seller volumes remained a challenge in Q4, I was pleased with our performance in the face of that challenge. We achieved the following results in the quarter. For KAR overall, we generated $549 million in revenue. That was an increase of 4% from Q4 of 2020. We generated a total gross profit of $226 million, an increase of 11% from Q4 of the prior year. And this gross profit represented 49.7% of revenue, excluding purchased vehicle net revenue. We generated $97.9 million of adjusted EBITDA. That was an increase of 45% from the same quarter of prior year. Cash generated from operations for the quarter was $61 million. And for the full year, cash generated from operations was $413 million. Within the ADESA segment, we facilitated the sale of 543,000 vehicles, representing over $9 billion in gross auction proceeds. Those volumes were down 20% versus Q4 of the prior year, and this was driven mainly by the continued strain on commercial seller volumes, which were down 44% versus Q4 of the prior year. In our dealer consigned business, however, volumes increased by 34% versus Q4 of the prior year driven by strong double-digit growth in our digital dealer-to-dealer platforms. 53% of our total sales in Q4 were from off-premise locations. We sold 141,000 off-premise dealer vehicles in our digital channels. This is our highest single quarter to date for this metric. In fact, off-premise dealer transactions represented over 50% of our total dealer consignment transactions for the first time ever. And that is an important milestone in our ongoing digital transformation here at KAR. Across the ADESA segment, we generated $297 in gross profit per vehicle sold. This is also our best result with that metric in any quarter to date. This was higher than our gross profit per vehicle generated in the first half of 2021 and nearly 30% greater than the same quarter Q4 of 2020. I continue to be pleased with the performance and continued growth of our AFC business segment. AFC had 342,000 loan transactions in the fourth quarter. That was a 5% increase versus the same quarter prior year, and that was also in line with levels that we had expected. Revenue per loan transaction was 25% higher than Q4 of prior year at $232 for the quarter. Key drivers of this were higher vehicle values and solid management of credit risk. So I'd like to turn and speak to the supply dynamics of used vehicles within our marketplaces, particularly those from commercial sellers. So as with the prior quarter, our volume challenge in Q4 was principally tied to the lack of commercial seller volumes across our various marketplaces. I believe that we're still at the bottom in terms of the disruption, with supply of off-lease vehicles and rental vehicles at physical auctions across our industry at all-time low levels in both categories. Most meaningful to KAR is the disruption in off-lease volumes, which historically have represented approximately 60% of our total commercial seller volumes. Volume of repossessed vehicles also remained below normal but have remained relatively stable at about 60% to 70% of normal levels. Although volumes remain under pressure, our analysis of the quarter's results indicates that we've maintained our market share with commercial sellers. And in fact, we have slightly increased share with some customers. I believe that we're now starting to see the first evidence of the ingredients that are necessary for an improvement in volume in the commercial seller category. To start with, we're beginning to see a modest increase in new vehicle production, with an 11% increase in new vehicle production during Q4 within the NAFTA region versus Q3. I take that as a positive sign. This increased production is being reflected in a modest increase in new vehicle inventory at automotive dealerships. And while it's still well below historical levels, new vehicle inventory of dealerships increased by a little over 22% from the end of September to the end of January according to industry reports. And again, I think that is a positive sign. We believe that this increased supply of new vehicles will ultimately drive a decline in the price of used vehicles, which, as you all know, have been very elevated over the past nine months. We are starting to see some evidence of this happening and the start of 2022 has been characterized by a weaker pricing environment than we've seen in prior years. In fact, per the Black Book report, used vehicle values have weakened for the past seven consecutive weeks. And yesterday's report indicated that the downward trend has accelerated over the past week. And I would just say that this is quite unusual for this time of the year in our industry. Given the high valuation levels of used vehicles right now, I expect values to continue to weaken over time, although I expect it may take some time for those prices to revert to what we would consider to be more normal levels. A declining pricing environment is often characterized by lower conversion rates as buyers refuse to step up and pay the higher prices that sellers have become accustomed to getting. And while lower conversion rates can cause some short-term pressure on gross profit, the long-term gain for KAR in terms of increased volumes sold from commercial sellers within our marketplaces is very significant. From various discussions with our customers in the off-lease, repossession and rental segments, most have signaled that they expect to remarket more vehicles in the second half of 2022 than they did in the second half of 2021. So in summary, we expect that the current commercial seller volume constraints will continue through much of the first half of this year. We expect to see a modest improvement in the second half. We expect to see an acceleration in that volume recovery in 2023 and beyond. And again, as I said on prior calls, this would be very positive for KAR given our higher market share with commercial sellers. And supporting this thesis, I read another report yesterday that stated that automotive loan defaults have now increased for seven consecutive months in a row, which is the longest consecutive streak in more than a decade. If this trend continues, that would also point to an increased supply of repossessed vehicles later this year. So, I'd like to turn now to and provide an update on our progress in the dealer-to-dealer vehicle category. First, if we look at our total dealer consignment volumes of KAR, both on-premise and off-premise combined, we sold 277,000 vehicles in the fourth quarter. That represents an increase of 34% compared to KAR's total dealer volume in Q4 of the prior year. Some of that increase is driven by the acquisition of CARWAVE, but I'm pleased that we were able to deliver a meaningful increase even without the CARWAVE acquisition, particularly in the light of volume constraints across the industry. If we look at the Dealer Off-premise category only, our core volume was 141,000 vehicles sold. That's our highest ever quarter in total. The comparable metric for Q4 of 2020 was 82,000. So we grew our total Dealer Off-premise volume by 72% or 20% organic growth if you include BacklotCars and CARWAVE within both periods. If we look at our total dealer off-premise volumes for the year for 2021 overall, we sold 507,000 vehicles. That was an increase of 110% compared to the 241,000 we sold in the prior year. And again, adjusting for acquisitions, the pro forma annual growth rate was 34%. As I mentioned earlier, more than 50% of our total dealer consignment sales in the quarter were represented by off-premise transactions. We expect this percentage to increase further over time. In Canada, our TradeRev business continues to perform very well, delivering strong volumes in a second consecutive quarter of solid profitability, with EBITDA per vehicle sold in excess of $100 for the quarter on that platform. This gives me increased confidence in the long-term profitability of the digital off-premise model. And finally, while my remarks above have been principally focused on our dealer off-premise category, I would also highlight that our dealer on-premise volumes for Q4 increased by 9% versus the same quarter prior year and increased by 5% for 2021 overall relative to 2020. So, I'd like to spend a few moments on the acquisition of CARWAVE. We closed on our acquisition in early October. We've made good progress with the integration. Our initial focus has been on harmonizing our buyer and center policies and that will be completed within this quarter. We've also been focusing on developing a new enhanced vehicle condition report that combines the best of the CARWAVE and Backlot inspection reports into one unified format. Once those are complete, we will then move forward with the platform integration that will leverage the features and functionality from both offerings to provide our sellers and buyers with the best experience possible. Our teams are currently working on this. It's a high priority initiative for KAR, and we expect to have it complete by the end of the third quarter. I'd like to spend a few moments on AFC. As I mentioned earlier, AFC performed well in Q4 and in 2021 overall. AFC has been able to grow its business in a disciplined way and also reengineer business processes to have a more efficient service delivery for its customers. This has also helped to improve margins and profitability. AFC continues to experience lower than normal levels of risk driven by current market conditions, combined with strong operations. I expect to see continued strong and steady performance from AFC given the current environment. Eric will provide further updates on AFC in his remarks. I'd now like to spend a few moments talking about our cost structure. On recent earnings calls and again at our Analyst Day event, we have discussed our strategic focus on reducing our cost structure to reflect our transition to a more digital marketplace business. We continue to make meaningful progress on that front. In Q4, we completed our assessment of cost and revenue opportunities relating to four distinct aspects of our business. First, accelerating our sales and our go-to-market opportunities; second, evolving our service operations; third, focusing our technology investments; and finally, fourth, managing our SG&A. So our analysis indicates an opportunity in excess of $200 million in annualized benefit, which is a mix of revenue and monetization, which we believe represents approximately 40% of that total and cost side opportunities representing the remaining 60% of that total. Over $100 million of this opportunity would be incremental to the analysis that we presented at our Analyst Day. We have started that implementation process. And in Q4 alone, we addressed cost and revenue opportunities that we believe will represent an annualized improvement of approximately $30 million. We have many additional initiatives in planning and early execution phases. And we expect to substantially execute these initiatives in 2022 and 2023. I would say that these initiatives represent a key priority for our business, and I will continue to report on our progress in future earnings calls. I also want to highlight some of the operational progress we made during the quarter that will continue to contribute to our future performance. We continue to focus our technology roadmap on the platforms that are the most strategic to our customers and also represents our highest opportunity for long-term growth. And we're taking active steps to better integrate and increase the attached rates of our supporting services like financing and transportation with every vehicle transaction. From discussions with various customers, we also know that some more customers are looking to create more continuity between the retail and wholesale operations. We are well placed to support our customers in this, and we view these as opportunities to expand and grow our business over time. My last point this morning is to speak about 2022 and beyond. As discussed on our last call, it is difficult to predict the supply of vehicles in the wholesale market at this time. We withdrew our guidance in September, and I believe that we should not provide further guidance until our visibility into those volumes improves. I'm very encouraged by our performance in Q4. I believe that our Q4 results demonstrated that our business was able to deliver a significantly improved operating performance despite the historic low volumes. At the same time, I have to acknowledge that we and our industry are both starting 2022 with lower commercial volume supply than we started 2021. So those volume headwinds that we saw in Q4 didn't end on December 31. I want to assure our shareholders that we're not just waiting for volumes to return. We are highly focused on controlling what we can control and delivering strong performance across our business, focusing on maintaining and growing our market share, accelerating our higher growth segments and transforming our cost structure for a digital future. The goal is to transform this business in this time of lower volume so that as volumes increase, they will flow through a more digital and more efficient model, and I believe we're making good progress in that. While we're not providing annual guidance on today's call, I believe that the framework for growth, as we presented on our Analyst Day in September remains intact. And to repeat some of the key components of what that model represented. We believe that this business can deliver the following compound annual growth rates viewed over the period 2020 to 2025: 7% growth in net revenue, 15% growth in adjusted EBITDA and over 20% growth in operating adjusted net income per share. In addition, we believe that this business can deliver consolidated gross margins of more than 50% on a percentage of net revenue basis. And finally, we expect that this business will continue to deliver strong cash flows, something that has always been a strength of the business. So, I believe that our Analyst Day framework for 2025 remains intact and is achievable, and it is supported by the following factors. Firstly, I believe that we're on track to see a recovery in commercial seller volumes between now and 2025, consistent with how we presented. Secondly, our volume expectation in the dealer off-premise category is to achieve 1.2 million vehicles sold by 2025. That is approximately double our Q4 volume on an annualized basis. This part of our business is a strong forward momentum and growth rate, and I believe that doubling that business over the next four years is achievable. Third, our gross profit per vehicle sold, which was $297 in the fourth quarter, was materially higher than the $272 that we modeled into our 2025 and Analyst Day framework. So it may be possible that we could have some long-term upside on this important metric that will drive performance. And finally, as I mentioned on this call, our opportunity for cost and efficiency improvements exceeds the amount that we have modeled into our Analyst Day models. So to summarize my key messages for today, I was pleased with our Q4 results, which were delivered in the face of an unprecedented challenge with commercial seller volumes. We delivered our best ever quarterly performance in terms of gross profit per vehicle sold. We increased our adjusted EBITDA by 45% versus Q4 of the prior year despite 20% lower volume. We had our best quarter yet in dealer off-premise transactions. And for the year, we sold over 0.5 million dealer consigned vehicles in our dealer off-premise channels. Our AFC business continued to perform at a very high level. Our assessment of the cost opportunities exceeds that which we previously communicated. We have started to take action on those opportunities, and there is more to come. And finally, we are one quarter closer to the volume recovery that we know will come, and we're starting to see the first evidence of the ingredients that are necessary for that volume recovery, such as increases in new vehicle production, increases in dealer inventory and declines in used vehicle pricing. When those volumes do return, we will be better positioned than we have ever been to support our customers and deliver a strong operating and financial performance at KAR Global. With that, Eric will now provide a more detailed review of the financial results for the quarter and 2021 overall. Eric?

Thank you, Peter. As Peter has already commented on many of our financial metrics and performance in the fourth quarter, I have only a couple of additional areas to review. Let me start by recapping our full year performance for 2021. As we have discussed all year, supply constraints have limited volumes for us and all others in the wholesale remarketing industry. For KAR, we sold 2.6 million vehicles in our various marketplaces. Off-premise transactions represented 53% of all transactions executed by KAR through its ADESA entities. Strong used car pricing led to a 10% increase in average transaction value for the year. Increased vehicle values combined with targeted fee increases during the year led to a 17% increase in average auction fees per transaction. This increase in auction fees per transaction is net of a decline in this metric for the commercial off-premise segment of our business. While increased used car values contribute to higher auction fees on a majority of our platforms, the one exception is the private label transactions for our commercial sellers where the fees are generally fixed and used car values do not impact these schedules. Because of the volume challenges, our 2021 performance was also challenging. Total revenue, excluding 2021 acquired businesses, was down 3.5%. Control of expenses did allow us to generate improved gross profit, increasing our gross profit as a percent of net revenue to 50.8% on a consolidated basis. This drove an increase in our adjusted EBITDA for 2021 to $434 million, up from $375 million in the prior year. To be clear, adjusted EBITDA for 2021 includes $32 million of realized gains on the sale of our stock held as part of strategic relationships with certain customers. As a reminder, we have invested in a small number of private auto-related enterprises. When these enterprises go public, it is our practice to monetize our investments. In summary, 2021 was an interesting year. Early in 2021, we provided an outlook for the year that contemplated the beginning of a recovery of the wholesale marketplaces in the second half of the year. What actually happened is the conditions in the wholesale marketplace worsened in the second half of the year. We identified this change in expectations in the third quarter and withdrew guidance in September. Given the hand we were dealt, I am pleased with our performance. We increased gross profit per vehicle sold to $277 from $233 in the prior year. We decreased SG&A 11% year-over-year, excluding the $77 million of SG&A added from acquired businesses. And our company generated $413 million of cash from operations in 2021, an increase of 7.5% from the prior year. In terms of capital allocation activities in 2021, let me summarize the significant items. We allocated $522 million to business acquisitions. This includes CARWAVE and Auction Frontier. We also repurchased $181 million in common stock during the first half of the year. Our capital expenditures aggregated $109 million for the year. And in working capital, we used $194 million of cash generated from operations to invest in the growth of the AFC portfolio. This is the increase in equity in our floorplan loans. Our senior secured leverage ratio is at 1.76x and our total net leverage ratio is 3.96x adjusted EBITDA. Our leverage target continues to be total net leverage of 3x or less. Our leverage increased when we used available cash to complete the acquisition of CARWAVE in the fourth quarter. We have a $325 million revolving line of credit available for any short-term cash needs that arise during the year. Before I finish, I want to comment further on AFC performance. We are clearly benefiting from strong retail used car demand, strong used car pricing and a low-risk credit environment. AFC's performance exceeded our expectations for the year. We had net bad debt expense of $3.5 million for the year. This was $16 million in provision for losses, offset by $12.5 million of recoveries of previously written-off receivables. As a reminder, we obtained personal guarantees from substantially all of our borrowers at AFC. When a loss is incurred and the full loan balance is not repaid, we enter judgments against the principals of the dealership to document our rights to personal assets. In many cases, we recover all or a portion of these judgments at a later date. These recoveries are routine for this business, even though they are unpredictable. As I look forward to our recovery in volumes in future years, I believe AFC will contribute a lower percent of KAR's total adjusted EBITDA than it did in 2021. I expect used car values to gradually decline, interest rates to increase. And as a result of the current operating environment, we will have fewer bad debts to recover in the future. This could contribute to lower growth in adjusted EBITDA at AFC when compared to the growth rate we expect at ADESA. In conclusion, our cost structure has improved over the last two years, and we are well positioned for the future. I must admit I am looking forward to the recovery of the used car marketplace to begin. I continue to be confident we can achieve the goals we have set for 2025. While we would prefer to see some signs of recovery earlier than it's happening, nothing has changed in our outlook at this time. I have one housekeeping item before we go to Q&A. I expect to file our 10-K early next week; because Monday is a holiday, I wanted to give you a heads up so you don't think there was some unexpected delay. So that concludes my remarks, and I'll turn it back to our operator, Norma, to begin Q&A. Thank you.

Thank you. Our first question comes from John Murphy with Bank of America. Your line is now open.

I just wanted to touch on the cost and execution in the quarter as well as sort of juxtapose that versus the dealer and commercial mix. I'm just curious, as you think about what happened here, there was a very significant shift in mix with dealer up 34% and commercial down 44%. I mean how much of that impact margins and your ability to go after cost and how much of your cost cutting was net of that? I mean it's just kind of all intertwined there. So I'm just trying to understand what mix meant to the business because there's pretty significant shift along with the cost cutting.

Yes. Thank you, John. I'll take a first attempt of that. You're right. There was a lot of different moving pieces. I would say the cost was generally independent of that phenomenon that you described. Again, if I just think about our business and a commercial seller vehicle, particularly an on-premise commercial vehicle, will tend to have a higher attach rate of services and ultimately a higher gross profit per vehicle sold relative to a dealer car that in the physical channel, the on-premise channel doesn't tend to have those services attached to anything like the same rate. So I'd say the relative decline in commercial seller volume relative to dealer would have put downward pressure on that metric. But obviously, the metric was still strong in spite of that. So I think our cost actions were generally independent of that. There was a little bit of—we did adjust some fees in the fourth quarter. So, there was some monetization as well reflected in the higher number of $297. But Eric, I don't know if you want to add to that, I'm not...

No, there was an offset to the decline in commercial volumes, and that is the retail reconditioning did grow in the fourth quarter and it is contributing gross profit, but not as much as we would have had in a normal wholesale environment doing reconditioning for the seller. It's still a growing part of our business. And then the other element, John, is the SG&A. Again, most of the direct costs movement we made began in 2020 with the workforce reductions, the fact that we weren't running vehicles through the length. What we did most recently is really focused more on the SG&A. There was very little cost action, though, supporting the dealer-to-dealer that we maintained our cost structure and any changes we anticipate in the future are yet to be realized in our numbers.

Okay. That's helpful. I mean, I guess, just to follow up, I mean my understanding is, I mean, commercial, you get higher dollars in gross but lower percent margins. And then on the dealer side, you get lower grosses, but higher because it's mostly buy/sell fees, you get higher margin. So that's why it's a little bit confusing because it's I mean, you certainly argue that the mix shift should have helped your percentage margin but hurt your total dollar margin. So, it's just — that's kind of why — that's kind of why I was asking. And it seems like you probably outperformed that pretty significantly. I'm just trying to get — it seems like the underlying operations did even better than what you're talking about just based on this mix. And I was just trying to figure that out. We can maybe follow up on that dig into it a little bit deeper later. On the used...

And John, let me clarify one thing. If you look at the numbers, and you can get this in the supplement, the decline in services revenue in the ADESA segment is far less than the impact of commercial volume would normally indicate. That's where—and that is the lower margin services revenue, and what drove that in part was increases in retail reconditioning.

That would add incremental dollars, but that would be at a lower margin than the 49%–50% that we have in the business overall, okay?

Okay. Got you. And then just second on the pricing dynamics. I mean what is your gauge on used to new pricing right now? Because it just seems like that's — I mean, Peter as kind of you alluded to, I mean, that's really a lot — I mean, there's a lot of — there's a desert of actual supply, but then also this jam-up of used to new pricing is creating problems in somewhat in the retail market. I mean what's your relative gauge of used to new pricing at the moment?

Yes. Well, that is a good — we do look at that index, what percent of a typical new vehicle to used vehicle prices represent. And frankly, in the latter part of last year, that percentage was at its all-time high level of, I think, close to 70%. And that is an unsustainable level of used vehicle pricing relative to new. I think a more typical situation is something closer to 60 and sometimes it's below 60%. And again, Tom Kontos runs that analysis for us. But listen, there are different opinions out there on what the trend line on used vehicle pricing is. I think most analysts are expecting used vehicle values to decline as new vehicles are produced in greater numbers. There's probably different opinions on the rate of decline, some predicting a more steady decline. And I guess I lean a little more towards perhaps a more rapid decline. And I think we're actually starting to see certainly a noticeably weaker pricing environment, as I mentioned in my remarks, this year relative to a typical sort of spring market with declining used vehicle values and lower conversion rates generally in various marketplaces. Not just us, but in the industry. And honestly, I think that's a good thing for our business. I think that's something we want to happen. We want these prices to normalize. Getting there, the quicker we can get there, the better in my opinion. But obviously, I don't have a perfect view of the future, so different people have different opinions on the pace of that change.

Okay. And then just one last one. You mentioned service evolution as part of the second point in your fourth quarter review. I'm just curious exactly what you meant by that because we're coming across is a lot of smaller AV and even non-AV fleet managers that are not so sophisticated that really could use some help on the service and maybe local logistics that you guys are very good at it. I'm just curious if that's part of the equation or what you really mean by that service evolution and development.

Well, Eric, do you want to take that?

Yes. I mean, John, you are right. But when you're talking about actually the bigger players in the industry also have a shortage of service capacity, given the used car marketplace today. So I would tell you that this has been a plus for ADESA and that we have a lot of demand for us to provide services that have always been available, but we're providing it to call it the buyer of the wholesale transaction or the retailer as opposed to the seller who was the consignor. And I would agree with you, although, again, our capacity seems to be consumed by the larger used car retailers versus the smaller ones right now.

Thank you. Our next question comes from Ryan Brinkman with JPMorgan. Your line is open.

I realize you're not guiding to '22 given the industry uncertainty, but still wanted to check in on some of the big picture puts and takes with regard to the current year, including, if possible, what maybe a range of outcomes might be reasonable to assume from a unit volume perspective? And what factors could cause volumes to maybe be higher or lower, for example, is it really the level of used car prices and new car sales, that will be the driver, how you're thinking about how those metrics could track? Or if there may be some other metrics worth monitoring independent of volume on the top line, such as, I don't know, conversion of — the conversion rate of EBITDA and the free cash flow, et cetera. And then what are the factors that you would need to see? For example, stabilization in one sales channel or another, like off-lease or repo or the healing of the automotive supply chain, providing better visibility into new car sales or pricing? What factors would you need to see in order to feel comfortable reinstating guidance?

Thanks, Ryan. I appreciate that, and I was expecting we'd get questions on guidance. I guess there's one principal factor that causes me to be cautious about providing guidance. And it's volume, specifically volume in the commercial seller channel. And I think there are two principal inputs to that. One is, what is the timing on new vehicle production and how quickly can we see more new vehicles showing up at franchise dealers' lots. And I think we're seeing different sort of statements from different OEMs. But I think generally, most are predicting that their production will increase this year and more vehicles will be delivered to dealers. So that's one factor. And then the second factor related to that is, what does this do to used vehicle pricing? Because if I look at the volume constraints in particularly our off-lease segment, which is our biggest commercial segment, it really is tied to used vehicle values and the equity that a lessee has at the end of their lease right now. Again, lessees right now have, we believe, average equity value of over $10,000 at the end of every lease. So the simple fact is they're not returning those leases. They're rather keeping it or if they do happen to return it to the dealer to whom it is returned by us, it doesn't enter the pool around simply because there's $10,000 to be gained by just purchasing at a residual. And as that market price adjusts, that's what's going to open up the supply dynamic, particularly in our largest commercial segment. And then related to sort of new vehicle production, rental companies, if they get more vehicles allocated from the manufacturers, which they're expecting to get based on my discussions, recognize they've got leases that are older and higher miles than they typically would like to have, so that will induce them to remarket more cars. And then on the repossession segment, it's tied to things like automotive defaults, but also is in part tied to used vehicle value. So I think, Ryan, those are the two factors: production of new vehicles and used vehicle values. And I think we've all got a good understanding of directionally which way those trends are going. They're going in a way that's favorable for our business. What remains to be debated is the speed of that and the extent of that. And the conclusion that we came to is that if we were to provide guidance right now, the range would be too wide to be meaningful. But we hope to be able to reinstate guidance once we've got better visibility or as soon as we've got better visibility into those dynamics that I just talked about.

Okay. That's very helpful. And then just lastly for me. I saw in the press release that you are talking about maintaining or maybe even gaining market share with commercial consignors. It would be great if you could maybe comment on the competitive dynamics there? And also whether you see the potential for digital dealer-to-dealer peers to penetrate the commercial market or what the barriers to entry there might be?

Yes. Again, if I could look at our Analyst Day framework, the thesis on the commercial seller side was one of maintaining our current share. And I believe we're doing that. I would say that generally, both in the on-premise and off-premise categories, commercial seller market shares were very stable in 2021 overall. But we did have some modest share gains with a small number of customers, so we felt good about that. To the second part of your question, hard for me to comment on that, I think obviously, we've got a strong market share in commercial off-premise with OPENLANE. I think that's a very strong sort of differentiated offering that's hard to duplicate. And obviously, in our physical on-premise volume channels, there's a relatively limited number of competitors that have those assets and have that market share. And again, those market shares have tended to be pretty stable over time.

Thank you. Our next question comes from Gary Prestopino with Barrington Research. Your line is open.

Peter, I'd like you to, if possible, maybe comment on some of the new entrants into this dealer-to-dealer space, particularly CarBravo with GM and then another one of my coverage company, CDK is putting out a system where to do dealer to dealer trades. So as you see it, what are your competitive advantages there versus some of these newer platforms that are coming out? How do you keep gaining share? It's just becoming a very crowded field.

Yes. Well, thank you, Gary. I appreciate the question. Let me take it in two parts. First, I'll talk about just competition and then I'll talk a little bit about CarBravo, which I don't actually see as competition, but I will explain myself there. So I guess I'd say on competition. First of all, I think our industry has always been competitive and continues to be competitive. And I think our customers have always had choice and options as to where to send their vehicles and where to buy their vehicles. And frankly, the strong cash flow characteristics of our business also attracts competitors as they see opportunity to go in and compete there. I guess as I view it, at the end of the day, our customers want access to marketplaces that can sell vehicles quickly, for full value and at reasonable cost. And fundamentally, we're focused on delivering that. And I think we've got a lot of advantages in terms of expertise, scale, customer relationships, technology platforms and so forth, that enabled us to do that very, very well. I also, I'd say, believe our digital strategy enables us to improve our ability to deliver on those outcomes. And I believe that will be increasingly evident over time as we move forward. So I guess, I kind of focus on our business and what we are doing and how we're taking care of our customers. And I believe that if we continue to do that, we can execute well and we can deal with any competition that exists. I don't really want to comment on any one individual brand or customer; I recognize some new entrants. I will say, generally, my opinion is this industry tends to be a lot more complex than people often think of at initial glance. So I'm — I don't want to be dismissive of any competitor, but I also think some of those entities will find it a struggle to really achieve their objectives there. If I go to CarBravo, I actually see the CarBravo program and programs like that as potential opportunities for KAR. If I think of the customer there, they're an important customer of ours. We are deeply integrated into their off-lease process. It's a very positive and strong relationship in our business. There is insurance in that program, the possibility of selling some off-lease vehicles, for example, or company vehicles direct-to-consumer. But to do that, those vehicles have to be brought in fully retail-ready condition, and that's an opportunity for us at our facilities. So that's a revenue and profit opportunity for us. The cars are still facilitated through dealers, okay? So the dealer has to ultimately still buy the vehicle, and there's a transaction fee there for us. And then there's other opportunities to integrate our digital platforms into that experience to create other wins for both CarBravo and for the retail customer and the dealer. So there's a whole host of opportunities there. And again, I see that as — I see it as a change, but I don't see it as a threat. I see it as an opportunity for our business.

Thank you. Our next question comes from Stephanie Moore with Truist. Your line is open.

I wanted to take a step back and maybe ask a bigger picture, longer-term oriented question. A lot of work has, obviously, been done over the last couple of years from the digital transformation, obviously cost cutting, but a lot of actions behind the investments between dealer to dealer. So as you look to the years ahead, let's assume the recovery or some recovery in volumes occur. How should we think about the integration of all of the KAR platforms because in this instance, it's a very large inventory car kind of has under its umbrella? So maybe just talk through about the seamlessness that if you kind of can envision how each platform works together is integrated together seamlessly. So you're not really jumping back and forth. I'd love to get a big picture thought of how just the really the umbrella of cars offering looks like.

Stephanie, thank you. That's a good question. And I think you're hitting on an important point in our business and one that's on my mind. Listen, our business, as I've said before, one of the things we want to do is simplify it, both from our customer standpoint and also an investor standpoint. When I'm principally focused on the customer. And part of that is trying to get to fewer brands, fewer platforms and greater sort of consolidation. And frankly, I think that is a whole host of benefits for us in the long run. It's obviously got cost benefits of focusing our investments in a fewer number of platforms and brands. So there are benefits there on the cost side of our business. But I also think it's got customer benefits through scale, network effects, liquidity and simplicity and things like that. So we are working on that. Obviously, in 2021, we integrated CARWAVE and BacklotCars and TradeRev into marketplace in the U.S. We accomplished that quickly.

BacklotCars.

Sorry, BacklotCars and TradeRev, I should say. And in the current year, we're integrating CARWAVE and Backlot into one marketplace. But we're actually going beyond that, and I wasn't necessarily planning to talk about it, but we have an initiative underway looking how we integrate into one marketplace format in Canada. And subject to that being successful, how we might do that in the U.S. after we complete Canada. Ultimately, I do want to get to one — the quicker we can get to one venue for all our vehicles and where all our sellers and all our buyers can participate, I think that's going to be a benefit for them and also for our business. But obviously, there's a complexity there, Stephanie, and it will take some time, but it's something we're actively working.

Absolutely. And just a follow-up. What has to be done from a reconditioning or—I'm sorry, from an inspection report standpoint to have, call it, a full integration across the platforms. Is it a lot of work? Or is there a best practice for the one? So how should we think about just the work going forward? What's behind the inspection report?

Yes. And I mentioned that in context of BacklotCars and CARWAVE. I wouldn't characterize it as a lot of work, Stephanie, if I look at that particular solution. The simple fact is, both companies had a smartphone app-based inspection format that an inspector would use, a guided format to inspect a vehicle. They were quite similar, but they also were different because they've been developed by different groups. So what we have done in that case is try to pick the best of both, add some new features and deliver that. So it's one unified inspection platform for all our inspections in that channel in the U.S. So now expanding that to ADESA and, more broadly, obviously, that takes more work. But the integration I spoke to in the context of BacklotCars and CARWAVE is relatively simple and will be done, I believe, within the next 90 days.

Thank you. Our next question comes from Bob Labick with CJS Securities. Your line is open.

You outlined—or you discussed some very attractive cost savings initiatives of $120 million or so. I wanted to kind of ask if you could dig into that a little bit. And with the context of how much of the cost of service and of the SG&A lines right now are fixed versus variable. What are the primary fixed costs? And is that where the $120 million is coming out of?

Yes. Good question, Bob. You're right. Based on the math, I said, approximately 60% of that is cost and SG&A is a significant component of that. I guess one view I have is that in the long run, no cost is entirely fixed, but in the short term, obviously, costs are fixed. And we have elements of fixed costs in our business, which tend to be, I'd say, deeper on the on-premise side of our business with facilities and leases and the management structure that you would need to operate a facility; those tend to be fixed at least in the short and medium term. And a lot of the cost tied to the operation of the shops and the back office and stuff like that tend to be a little bit more variable, I would say, given the low volumes in the fourth quarter. The low commercial seller volumes started to bump up against some of that fixed cost element of our business, but still managed to deliver, I think, a good strong gross profit per car sold performance on that. In terms of the sort of things we're looking at that make up some of the cost initiatives we're talking about, let me just explain some of the things we're looking at. I'm looking at spans and layers of the Company. I'm trying to have fewer layers between myself and the frontline workers in this company and trying to have appropriate sort of spans at all levels of management in this company. So addressing that to Stephanie's question, as we address technology platforms, if we can start to consolidate our focus and our investments on fewer platforms, that creates cost savings opportunities as well, and that's an inherent part of our modeling. And then I'd say doing things differently, trying to automate certain processes, trying to centralize certain processes, more digitization and less paper. Those are sort of savings that, obviously, take time to execute, but can change the way you do business and reduce your costs over the longer term. So those are the things that comprise the types of initiatives we're going after.

And Bob, on the SG&A front, I did a little quick math here. About 15% of SG&A is incentive pay commissions for salespeople—what I call truly variable. It doesn't mean you can't reduce the workforce if volumes go down. But I'm saying at the current workforce, it's about 15% of SG&A that is actually tied to performance and 85% is more of a structural SG&A.

Thank you. Our next question comes from Bret Jordan with Jefferies. Your line is open.

Some overlapping calls this morning, so I don't want to ask about stuff you've already discussed. But could you talk a bit about the fee environment, whether or not with more competitive players in the space? I know a few years ago with dealer-to-dealer shipping costs were getting promotional. But can you talk about the ability to either take fees up in the current scenario where supply is short or anything that might be changing around that?

What I'd say is I think the competitive dynamic seems to be, I would say, fairly rational. We're not doing, and we're not seeing those types of incentives that you referenced, which were featured in the business maybe two-plus years ago. We've seen some competitors raise some prices. I think that creates room for us to look at that as an opportunity as well. We did a small level of fee adjustments in the fourth quarter. Principally, those related more to our on-premise than off-premise channels, but we expect to see benefits from that over time and I referenced that as part of the initiatives we had executed on—$30 million of initiatives will include some level of fee increases as part of that. So I guess, I see some opportunity, and I see the competitors behaving in a rational way and focused on—obviously everybody wants to grow, but we're also focused on being profitable and delivering profitable growth. So I think that's a healthy dynamic for our business.

Thank you. Our next question comes from Daniel Imbro with Stephens. Your line is open.

I don't want to belabor a point, but just to clarify, Peter. So if we look at the GPU, I think you said about 30% at ADESA. Are you able to parse out on that metric? How much would be driven just by the favorable increase in year-over-year revenue per unit or used vehicle prices versus how much of that 30% was specific cost removal that we can underwrite into next year, if prices roll over because you've talked about prices moderating being a tailwind to volume, trying to understand if there's going to be an offsetting headwind to GPU at ADESA?

Daniel, that's a good question. Well, I don't have a precise number to give you, but I'll answer directionally and then Eric can weigh in as well with his point of view. I would say higher used vehicle values do create a support to that number because if vehicles are up in value, maybe we move into the next tier of fees, maybe the buy fee is $25 higher than it would have been if the car was sold for $1,000 less or something like that. So there is an element of that, but it's not sort of proportional to the value. If the vehicle value was up 20%, our fees do not go up 20%. And frankly, those fees are only the buy fees; the sell fees don't tend to reflect that. And as Eric mentioned, the sell fees and our commercial off-premise channel don't reflect that either. So there is a component of that. I would say it's relatively small. It's certainly, I would say, less than half of the increase, for sure. And then the other thing that runs the other way is just the volume. In any business, when you have less volume, your gross profit margin and your gross profit in absolute terms is under pressure. So because every business has some element of fixed costs and our business for sure has. So I actually think when I sort of weigh a declining used vehicle value equation versus increased supply. I think the increased supply will be more positive to that metric than the declining used value will be negative. Now that would be my view, but I will let Eric comment on that.

Yes. And Daniel, this is really good. On gross profit dollars per transaction, the one thing that won't be linear is the off-premise or the services related to not the car sold. So when my volume goes up, the denominator increases, probably greater than my gross profit dollars in total, unless I can grow some of my off-premise services like the repossession activity, like our inspection business, like our transportation business. So in the Analyst Day, we even commented that we were targeting something that would be more in, I would call it, the $260 to $275 range long term, but that's because the denominator gets better on dividing that gross profit by what we believe will be a growing volume of transactions. Keep in mind, about one-third of our transactions are off-premise with no ancillary services. If that grows on the commercial side, that would probably put pressure on the absolute number. But my gross profit would actually increase in total.

Okay. And then I wanted to ask one on the dealer business; you guys have spent, call it, $1 billion over the last couple of years to fuel growth. With the balance sheet, I think total net debt is around 4x levered. Are there other M&A opportunities? Or could you do other M&A opportunities given the leverage right here? And then that's kind of a lot of capital you've spent to fuel this growth on the digital side. I know it's maybe not CapEx heavy, but it's a pretty high growth cost. How capital-intensive should this business be longer term as you look at the next few years or longer term around the dealer-to-dealer business?

Yes. Thanks, Daniel. Obviously, we have done some significant acquisitions. That is correct. I'm pleased with those acquisitions. I think to get us, as I mentioned, we're at 0.5 million vehicles sold in that dealer off-premise channel and growing — and seeing profitability evidence in TradeRev, strong profitability, I would say. So I feel good about that business. There are no other acquisitions currently contemplated. I think we have a good position in the market, and we're pleased with the assets we have. I'm focused more on integrating those platforms and continuing to deliver that organic growth. And your comments on leverage, obviously, I'm aware of that as well. My current focus is on growing the Company, increasing our earnings and ultimately reducing that net leverage number. And I believe that is absolutely possible. I believe our business will deliver on that, and we'll get that back closer to our target of three.

Thank you. Next question comes from Ali Faghri with Guggenheim. Your line is open.

I just have a question, I guess, on your outlook for wholesale volume recovery starting in the second half and then into 2023. While I recognize it's a tough environment to predict, your primary physical auction competitors are predicting industry wholesale volumes up 2% in 2022 and then actually declining in 2023, back to 2021 levels again, primarily due to a reduction in overall vehicles coming off lease in 2023 as a result of lower new car sales and lease penetration rates during the pandemic. And then on top of that, isn't that dynamic of off-lease vehicles being in the money, so to speak, likely to continue through at least the end of next year since I think even the most bearish used car pricing forecast expect values to remain above pre-pandemic levels over the next few years. So that would suggest that it will continue to be advantageous for dealers and consumers to keep their off-lease cars for the foreseeable future. So, I'm wondering at a high level, what gives you confidence in a volume acceleration into 2023? Because it seems like there could be a scenario where commercial volumes and off-lease, in particular, remain cyclically depressed through the end of next year.

Yes. Ali, I appreciate the question. Let me attempt to answer. So first of all, within the commercial category, let me just comment on rental. We're expecting to see volume increases. Repos, we're expecting to see volume increases for the reasons I talked about. But let's spend some time on off-lease as well. I think the big question is not the total number of leases written or the total number of leases reaching maturity. It's really that equity value question. I know that was inherent in the question you asked. It's really what is the economic equation that the lessee or dealer has when that lease is ending, okay? And just to kind of give you context on that right now, the situation we have right now is because of this sort of $10,000 equity situation, essentially almost no off-lease vehicles are reaching the physical channel. I don't think that needs to go back to zero for a substantial number of leased vehicles to start to reach the physical channel. Because we saw earlier last year that when those numbers were more in the $3,000, $4,000 or $5,000 level of equity, there still was not the normal volume reaching the physical channel, but a substantial number. So I don't think it needs to revert the whole way. And I guess just from conversations with customers, just asking them about their portfolio and what they expect, I would say my expectations very much reflect the feedback I'm getting from customers as well. That their expectation in terms of their risk management and their residual management and their assessment of marketing volumes, what they're telling me is they don't believe that new vehicle production needs to be all the way back to normal or that used vehicle values need to be back to pre-pandemic levels for there to be a significant increase in off-lease volume relative to the current level. And I'm not predicting that they get back to 2019 anytime soon. That's not a part of the model or a part of the plan. But we are predicting that we will increase versus the current levels. And again, the current levels are very close to zero. So I guess time will tell. We will have to see how this plays out, but my expectation is consistent with what I said: I expect to see an increase in these volumes in the second half of this year and accelerating in 2023.

And Norma, we are out of time. So we'd like to go to Peter's closing remarks.

All right. Back over to Mr. Peter.

Thank you, Norma, and thank you, ladies and gentlemen, for your time this morning and for your questions. I recognize on today's call, we closed out our reporting on 2021 and the year overall. And clearly, it was a year that brought some challenges, but I'm pleased with the way that our team here at KAR rallied to meet that challenge and deliver the results that we did. So I don't want to leave today's call without saying a sincere thank you to all of our employees across the Company to help make that a reality. We appreciate it. Thank you so much for those great efforts in 2021. So I'd like to close out my remarks today by reinforcing what I and the team are most focused on in 2022. While we expect to see some relief in the commercial seller volumes in the second half of this year, we are focused on getting through the current supply challenges and controlling what we can control. And I think our Q4 results demonstrate that we are able to do that in this business. We continue to use this as an opportunity to reengineer our business, lowering our cost of service. Our goal is that as the volumes return, we can support those increased volumes with a lower cost delivery model than we've had in the past and be more profitable at lower volumes than we've been in the past, and I believe we will be able to do that. In dealer-to-dealer, we are focused on continuing to grow our digital off-premise volumes towards our goal of 1.2 million vehicles sold by 2025. This, in turn, will drive a significant increase in our overall profitability. To help drive this, we are focused on increasing our marketplace participation by sellers and buyers in the U.S. and Canada as well as ensuring a successful integration of CARWAVE and BacklotCars. And finally and most importantly, we remain very focused on our customers. As I said on prior calls, our purpose is to make wholesale easy so our customers can be more successful. And I believe that if we do that well, our customers will award us with more of their business, and our company will have a bright future. So with that, we'll end today's call. I look forward to when we connect in three months to give you an update on the current quarter. Thank you all very much.

Ladies and gentlemen, thank you for your participation in today's conference. You may now disconnect. Everyone have a wonderful day.