KAR Auction Services Inc

NYSE:KAR

Earnings Call Transcript 2020-Q2

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the KAR Auction Services, Inc. Q2 2020 Earnings Call. At this time all participant lines are in a listen-only mode. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Mike Eliason, Treasurer and Vice President of Investor Relations. Thank you. And please go ahead, sir.

[Mike Eliason, Treasurer and Vice President-Investor Relations]

Thanks, Justin. Good morning, and thank you for joining us today for the KAR Global Second Quarter 2020 Earnings Conference Call. Today, we’ll discuss the financial performance of KAR Global for the quarter ended June 30, 2020. After concluding our commentary, we will take questions from participants.

Before Jim 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 last night, 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, Jim Hallett. Jim?

[Jim Hallett, Chairman and Chief Executive Officer]

Thank you, Michael, and good morning, ladies and gentlemen, and welcome to our call. The last time that we spoke, I was concerned about what changes would be needed for us to go forward. Today, I can tell you that I’m genuinely excited to share with you what we have accomplished and how we have used this period of challenge to accelerate the transformation of our business.

My agenda for today includes an update on how COVID-19 is impacting our operations throughout the world. We want to provide you with a review of our performance in the second quarter, including an overview of our monthly cadence within the quarter, provide an update on the performance of TradeRev. I will walk you through the actions that we have taken with our workforce, and I want to close with an update on our progress in the digital transformation of our business and how I see this impacting our financial future performance.

Let me start with the status of our operations throughout the world. In North America, all of our auction locations are open for business. The access to our physical auction sites varies by location. We’re permitted – we are allowing our customers on-site for previewing vehicles and in some cases, bidding from inside the building. However, all of our vehicles are being sold through our digital platforms, OPENLANE, Simulcast, Simulcast Plus and TradeRev.

Over the last few months, we have signed up thousands of dealers on our digital platforms and tens of thousands of dealers have bought cars digitally that have never used our technology previously. This is probably one of our biggest accomplishments during the second quarter. We are not running any vehicles across the block at any of our physical auctions. We are providing ancillary services at all of our physical locations and restrictions on end-of-lease inspections and lot audits are minimal, and our inspection businesses are back to full strength.

The one area that continues to lag is our repo business and that is handled by our PAR [ph] North American division. Our customers are not yet processing repossessions consistently in most areas. We expect the number of repos to begin returning to normal levels as we go into the third quarter. In Europe, our operations are up and running. Our European businesses are all digital auction platforms. I would say the return to normal levels of activity has been a little bit slower in Europe than it has been in North America. And I would expect that our operations in Europe to be back to the prior-year levels sometime in the third quarter.

Our corporate offices continue to be open for essential activities. We are strongly encouraging our corporate employees to work from home as much as possible. I’ve been pleased with our ability to support the field while our corporate office personnel are working remotely. While nobody anticipated that we would need to move many functions to a remote workforce, we were prepared when it was required and have met the needs of the organization without significant disruption at any level.

Now, let me review our second quarter performance. First, and I will say it seems very odd for me to say that a 41% decline in adjusted EBITDA compared to last year was better than I expected. Vehicles sold in the ADESA segment declined 35% and the number of loan transactions at AFC declined 4% in the quarter. We also experienced declines in revenue per unit at physical auctions due to limitations on the services that we were permitted to offer from our physical locations and restrictions on our off-premise activities. Online only revenue per vehicle increased slightly. We also saw declines in loan transaction units and revenue per unit at AFC. This all led to a 42% reduction in our revenue.

With all that said, let me explain why the results were better than I expected. We started the quarter with all of our businesses shut down. We continue to have a small number of transactions [Technical Difficulty] and volume was minimal at the beginning of April. Obviously, we were prepared for the disruption in our markets to continue and expected the recovery to be gradual and perhaps take through the remainder of the year. What actually happened was volumes picked up week over week, consistently beginning in mid-April, and we saw this improve to where June volume was 8% above the prior year. And the values of used vehicles have continued to be strong. In fact, values are generally higher than we expected, and this has supported the sellers using our auction platforms to move vehicles quickly. This is evident in the high conversion rates across all of our digital platforms.

We were cautious in calling employees back from furlough, and we generated higher gross profit per transaction and increased adjusted EBITDA per vehicle sold in May and June. We progressed from losing money in April to seeing our performance in May improve, but still below prior year levels. And then we had a significant increase year-over-year in adjusted EBITDA in June. I’m encouraged by our performance late in the second quarter and heading into the third quarter. While we continue to see positive trends for the wholesale in industry, it is too early to predict with any level of confidence, how things will look a few months from now.

What I can say is we accelerated the digital transformation of our business. We are selling 100% of our vehicles online. We have accelerated the pace of introducing new products, features and functions to support the digital marketplace. And we have made permanent changes to our cost structure that should lead to improved gross profit and adjusted EBITDA margins going forward.

Now, let me speak to TradeRev. Although the TradeRev network was able to operate when our physical auctions were shut down in early April, TradeRev saw volumes decline in April as retail activity was minimal. Like the rest of our business, we adjusted our workforce through furloughs to bring the headcount in line with the sales activity. As the markets began to rebound in late April, in early May, we found TradeRev to meet the needs of the market with fewer people. We maintained a disciplined approach during this recovery.

We adjusted our processes, improved the leverage of our people in completing the imaging and the inspecting of vehicles and focused on assisting our customers with setting realistic pricing expectations. Our total TradeRev volume for the second quarter was down year-over-year, but this was primarily due to the extended shutdown in Canada. The recovery in Canada lagged the U.S. by about a month, and in June, we saw our Canadian volumes grow year-over-year.

The bottom line this TradeRev was able to achieve better than breakeven results for each of May and June, and this includes the allocation of the combined sales team cost to TradeRev. We achieved 60% gross profit on revenue per unit that was approximately $350. Our conversion rate at TradeRev was well above 50%, and our incentive costs were low. Now that we have proven that the TradeRev model can be profitable and it can grow without heavy incentives, I want to focus on winning the digital dealer-to-dealer market.

Before I wrap up my comments, I want to give you a summary of the actions that we’ve taken with our workforce and where our headcount stands right now. As we entered the quarter, we had a little more than 15,000 employees. This includes both full-time and part time. In early April, we furloughed about 11,000 employees worldwide. Every geography we serve was impacted. At the time, most of the business activities were limited by state home orders and restrictions on business activities that were deemed nonessential. As all of us began to adjust to the new reality of a world experiencing at pandemic, we began to reopen our auction locations for limited activities and began recalling furloughed employees as needed.

During the shutdown of our operations, we spent considerable time determining how we could adjust our process to meet the needs of our customers and maintain appropriate social distancing to protect our employees and our customers, and we have made many of these changes permanent in our operations. By the end of the quarter, we called back about 5,000 employees, and we identified 3,000 positions that are permanently eliminated. As of today, we still have about 2,000 employees on furlough. We have notified these employees that while they remain on furlough, if they are not called back to work by October, their positions will be eliminated.

The bottom line is we have adjusted our cost structure to be much more lean. This is both direct cost of services and SG&A. We expect our business should generate higher gross profit margins and higher adjusted EBITDA margins going forward. While COVID-19 provided an unfortunate catalyst to make this change in a very compressed time frame, our changes are consistent with KAR’s strategic objectives that we reviewed with you at the beginning of the year.

Let me conclude my commentary around the digital transformation of the industry. First, this has been a strategic vision for KAR that I have outlined over the past couple of years. Our focus on digital transformation of the wholesale auction industry prepared us to respond to COVID-19 situation aggressively and with a group of offerings that can meet the needs of both buyers and sellers in any market conditions. About two years ago, we migrated from our old technology to Simulcast in order to have a digital platform for selling vehicles from our physical locations. This investment was critical to us being able to move 100% digital in less than a week back in late March.

We’ve been working on Simulcast Plus for over a year, and we had planned to pilot this platform by the end of 2020. We were able to accelerate this timing, and we now have Simulcast Plus in production. And you may have seen our recent announcement for our Hertz sale where we sold vehicles from 22 ADESA and Hertz locations, all within the same sale. With Simulcast Plus, we can have multi-location sales that bring buyers from multiple geographies that have a specific interest in the vehicles that are being offered. This is a completely automated auction that uses a computerized actioner instead of a live auctioneer. We are able to provide additional functionality and flexibility while operating the most efficient platform in the industry and the results speak for themselves.

Our conversion rate is above 60% on Simulcast Plus platform, and we can offer up to 120 cars per hour and the prices have been strong. We now have a digital platform that can serve every segment of the wholesale market. OPENLANE for the off-lease vehicle and other high-value used cars, TradeRev for the dealer-to-dealer transaction, Simulcast for transactions from our physical auction properties and simulcast plus for on-premise or off-premise auctions that can meet the needs of any seller, commercial or dealer. In addition to having the platforms to meet the customer needs, we have also developed a lower cost operating model that has less labor costs. The lower labor cost is realized in reduced sale day costs.

We have also streamlined our field SG&A and have streamlined their field support organization at ADESA, and we have reduced our corporate overhead cost by driving efficiency into our process for the back-office functions that support all of our businesses. COVID-19 caused us to take swift and drastic actions that accelerated the pace that we could drive change through the organization. We have made great progress in permanently eliminating significant people costs from the organization, and we have other opportunities as well. We are looking at further centralization of functions throughout our business to drive even more efficiency. Examples of the areas that we are focusing on are: vehicle inspections, title processing and checkout processes.

We will continue to look for technology to improve everything from customer interfaces to the back office support. I’m excited about the progress that we have made over the past three months, and I’m even more excited about the opportunities I see in the future. Although the second quarter results did not paint a clear picture of where we are today due to the impact of COVID-19 on our business, especially at the beginning of the quarter, the progression of our performance month-to-month through the quarter gives me confidence that the benefits of lower direct labor costs and reduced overhead are expected to be evident in our results immediately, beginning with the third quarter.

Thank you again for your support of KAR through the most challenging period any of us have seen in our professional careers. Our balance sheet is strong, and we are properly positioned to support our growth initiatives going forward. The entire KAR Global team is focused on delivering exceptional results now and beyond in the post COVID period.

And finally, let me say thank you to every employee within the KAR organization that has made personal and financial sacrifices so that KAR could be in a position to be a leader in technology and innovation in the wholesale auction industry.

With that, I will now turn it over to Eric for additional commentary before we take your questions.

[Eric Loughmiller]

Thank you, Jim. As Jim just pointed out in his remarks, the second quarter has been an unusual three-month period. Let me start by confirming that KAR is not providing guidance for 2020 or any future periods at this time.

Retail used car sales have been strong, even above prior year levels recently. There are any number of things that could impact our industry through the remainder of the year. There is uncertainty around how the spread of COVID-19 will impact businesses in the U.S., Canada and Europe. It is clear that opening up for business as usual is not imminent throughout the geographic regions where we operate.

Unemployment continues to be high in the U.S. and many businesses, including the used car retail industry, are somewhat dependent on government support to maintain their current operations. We also believe the government stimulus packages in the United States have helped the consumer and enhanced used car activity. Without continued government stimulus in the United States, it is possible the current level of used car activity would slow significantly.

I will say we are set up well for the third and fourth quarter to be much better than the second quarter. While recovery from COVID-19 shutdowns in Canada and Europe have lagged a recovery in the U.S., we are seeing significant increases in activity in Canada and Europe very recently. Activity in Canada has reached pre-COVID levels in July. Europe is still lagging the recovery in North America but we are seeing results that are approaching 75% of the prior year, early in the third quarter, and there are signs that the recovery will continue in the second half of the year.

We do expect significantly reduced cash taxes as a result in 2020. We also have delayed or canceled a number of capital projects that will result in lower capital expenditures than we expected at the beginning of the year. With that said, the recovery in our business has given us confidence in moving forward on some projects in the second half of the year that we had put on hold in the second quarter. The one thing that is evident from our performance late in the second quarter, we believe we will have higher gross profit margins, operating margins and adjusted EBITDA margins going forward.

And as Jim mentioned, we believe the changes in our cost structure are permanent and will continue in a post COVID-19 business environment. Jim provided you with a summary of changes in our headcount. Let me put some numbers behind those facts. The elimination of 3,000 positions will reduce our total compensation expense on an annual basis by approximately $90 million. This is a combination of direct labor and SG&A. Please keep in mind that the job eliminations include both full and part-time positions. Our total severance for these job eliminations is approximately $6 million.

Now, let me cover a couple of topics that impacted our financial results in the second quarter. First, we recorded the write-off of goodwill and other intangibles totaling $29.8 million. Annually, we review the carrying value of goodwill and other intangible assets throughout all KAR business units. This year, this evaluation coincided with the time period we were reacting to the impact of COVID-19 on our operations. We completed this evaluation and determined that there were no impairments of intangible assets in any of our business units, except for ADESA UK. In ADESA UK., we have seen changes in the UK dealer network that changes the outlook for the UK business in the near term. As a result, we have written off all of the goodwill and a portion of intangible assets in the second quarter for Adesa UK.

Another item of note in our second quarter performance is the level of loan losses at AFC. Our provision for loan losses increased to 4.3% of average managed receivables for the quarter. We have continued to see strong credit performance throughout our portfolio. Our current credit statistics cause me to believe we will lower provisions for credit losses in the second half of 2020. The portfolio is down almost $600 million since year-end. Delinquencies are relatively low and absent an adverse change in the used car retail industry, we expect loan losses could be lower for the remainder of the year.

One major change in our operations since our last earnings call that is worth highlighting is the cash we were able to generate in the business following the negative cash flow in April. For the quarter, we were able to generate positive cash from operating activities. You may recall from our May earnings call that we had used $150 million of available cash in the month of April. We were able to increase our available cash balance by $50 million in the month of May and an additional $150 million in June, excluding the capital raised in the Pipe transaction.

At June 30, our available cash balance was approximately $875 million. We closed July with over $1 billion in available cash. We have strengthened the company’s capital structure, and we believe we are well positioned to get through any future issues we may face. Obviously, our improved capital position is in part due to the $550 million private investment completed in June. Our new investors, Apax Partners and Periphas Capital have closed on the issuance of $550 million of convertible preferred stock. The preferred stock is convertible into common at $17.75 per share. The terms were disclosed in Form 8-K that we filed in May and June and will be included in our Form 10-Q that will be filed today.

At the time we were evaluating private investments in KAR, we were concerned about having adequate capital to navigate the uncertainty created by the COVID-19 pandemic that materially impacted our business. While we have seen improved results since the completion of this transaction, we are in a much better position to accelerate the digital transformation of our business with the balance sheet strength that we have today.

In terms of capital allocation, we have some limitations in the near term, created by the amendment of our revolving credit facility. This amendment puts restrictions on acquisitions, payments of dividends and share repurchases. We plan to use our capital to fuel future growth and create shareholder value. We continue to focus on our current operations and the continued digital transformation of our business. As the outlook for used vehicle, retail and wholesale markets becomes clear over the next few quarters, we will be setting our priorities for capital allocation going forward. At this time, maintaining a strong balance sheet is our priority.

That concludes my commentary. I will turn it back to Justin, so we can take your questions, and thank you for joining us today.

[Operator]

Thank you. [Operator Instructions] And our first question comes from Ryan Brinkman from JPMorgan. Your line is now open.

[Ryan Brinkman, JPMorgan]

Hi, thanks for taking my question, and thanks for the additional disclosure on the intra-quarter trend in volume too which was helpful this quarter. Are you able to comment on the trend subsequent to the quarter in July? Are volumes set to exceed the 8% year-over-year growth in June?

[Jim Hallett, Chairman and Chief Executive Officer]

Yes, Ryan, good morning, and welcome, and thank you for your question. Listen, we’re obviously very, very pleased with the results that we saw in June. I would tell you, as we go through July, prices remained strong, conversion rates remained strong and we expect the business to continue to do well in – as we go into the third quarter.

[Eric Loughmiller]

And as I mentioned, Ryan, we’re starting to see a pickup in Europe, which is also going to add. That volume number in June was a consolidated worldwide number. So, Canada and Europe are really picking up and that will trigger some more growth as well.

[Ryan Brinkman, JPMorgan]

Okay, thanks. And I know you’re not providing guidance, but are you able to discuss some of the puts and takes on volume in the back half, specifically relative to rental car dispositions? And also I think there is some sense of maybe some of the lease returns were deferred and could be coming back and curious to your outlook for repossessions. On the GM and Ford calls, they talked about delinquency as being really very low, almost record lows, which is surprising, but maybe supported by some of the government cash payments, which could be expiring or subsiding. Do you think that there will be an uptick there? How does that all sort of net out to volume in the back half do you think?

[Jim Hallett, Chairman and Chief Executive Officer]

Yes. So, Ryan, I think your assessment there is probably in line with what we would say on repossessions. Repossessions really haven’t started to show up yet. And we think it’s as a result of certain restrictions that were put on financial companies from being able to go and repossess cars especially in this – the climate that we’re dealing with right now. So, I think there’s a good opportunity that the repossessions will start flowing here as we enter into the third quarter and it will certainly have an impact on our volumes throughout the balance of this year.

Rental car is very, very interesting. Rental has always been our smallest segment in terms of the commercial cars we sell. And I mentioned in my commentary, the Hertz situation and that’s been a win for us, especially using our Simulcast Plus product that I talked about as well. We’re seeing a little bit more rental business from some of the other rental car companies. So, I would say, there would be a small uptick there. And we’re seeing very good success. TradeRev continues to grow and cars are being sold at physical auctions, it continue to be positive as well.

So, overall, I would say that as we look at all of our volume in the different segments and where it comes from, I feel good about the balance of the year as we go into the second half here. And I think, barring something unforeseen that Eric spoke about in his comments, we would expect to see a good finish to the year.

[Ryan Brinkman, JPMorgan]

Okay and then just last quick question...

[Eric Loughmiller]

Yes, Ryan, if – if I could, because a lot of investors ask us this. We expect very strong off-lease returns, whether it be through deferrals, but there is also a large number of lease maturities in the second half going back and looking at 2017 lease originations. We expect rental car to be a contributor to our industry. We are doing very well on repossessions. But it will grow because they’ve been lighter. Dealer consignment – while July was very good for us, consolidated dealer consignment was up quite a bit year-over-year. That’s the area – with the retailers being so light on inventory, they’re retailing more trades that could be tight, but we think that it will grow year-over-year for us.

So that – I just wanted to give a summary walking through the different segments. I do think, though, that the next six months have more visibility. It’s still pretty murky looking into 2021 beyond the off-lease area where we know there’s a lot of lease returns. How that will do is highly dependent on unemployment figures in the economy.

[Ryan Brinkman, JPMorgan]

Okay, that’s very helpful. Thank you. If I could just slip in one lastly on liquidity, I mean, it really is quite plentiful now. I wonder if it’s even reasonable to ask if maybe you are overcapitalized, particularly given the better than expected improvement in the end market and in your own execution. Was some of the capital raised maybe motivated by anything other than conservatism such as desire for a strategic acquisition, et cetera? How should we think about that now large cash pile?

[Eric Loughmiller]

Well, Ryan, again, having $1.9 billion of debt and now $1 billion of cash, I would not describe it as overcapitalized. I might describe it as generously capitalized and when we raised the line, we did – to be honest, we did not expect the quick recovery that we had, especially in June. And the good news is, we’re in a period of transformation, where that capital increases our confidence in aggressively pursuing the digital transformation of our industry. Jim, did you want to add anything to that?

[Jim Hallett, Chairman and Chief Executive Officer]

Yes, I would just say, Ryan, as we’ve said many times, none of us saw this coming and we saw 90% of our business disappear overnight. And I referred to it in terms of – this was shock and awe, right? And we were quite concerned about just the financial stability of the company and it was, I guess, as I looked at it, it was like taking an insurance policy to make sure that we had the liquidity and we had this financial strength to get through whatever we were going to have to deal with, not knowing how long this was going to last.

So obviously we went out and we had a very strong interest in the company. And I think you asked a little bit about something to the effect about what else, kind of, what we are thinking about with that. I think we were thinking about, number one, we wanted to get the best economic outcome that we could for our investors. We had put a limit of a maximum of 20% dilution on that. But we were also looking for an investor who understood our strategy and an investor who we felt and believed would support our strategy.

And then, also, we wanted to take a look at who had experience in this digital space, who had taken digital product – who had taken brick-and-mortar products into a digital transformation. And at the end of the day, along with the money, I think we checked all those boxes and we feel very, very good about the investment that we took and the partners that we got.

[Eric Loughmiller]

And I’ll close, Ryan, with one thing. That capital was raised with our long-term future in mind. It was not a short-term band-aid. It did give us confidence, but we never intended for the capital we raised to be used for operations in 2020. It was a long-term view with how we can create shareholder value over a period of time.

[Ryan Brinkman, JPMorgan]

Very helpful, thank you.

[Jim Hallett, Chairman and Chief Executive Officer]

You’re welcome.

[Operator]

Thank you. and our next question comes from John Murphy from Bank of America. Your line is now open.

[Yarden Amsalem, Bank of America]

Good morning, guys. This is Yarden Amsalem on for John.

[Jim Hallett, Chairman and Chief Executive Officer]

Thank you.

[Yarden Amsalem, Bank of America]

I guess a first question on, in terms of your independent dealer buyers, we saw retail demand for used vehicles improve significantly throughout the quarter, but there was still some pressure on credit performance at AFC. So can you discuss the state of your smaller dealer buyers? And to what extent do you think potential losses with AFC can continue?

[Jim Hallett, Chairman and Chief Executive Officer]

That’s a good question. We’re actually seeing very strong performance in the AFC portfolio, which is predominantly independent used car dealers that are smaller in size. And our credit statistics are looking quite good. We did recognize loan losses in the first and second quarter given the pandemic. And I would hope that as the year plays out, you will find that we were conservative in our approach in the first half of the year. But at this point in time, what we’ve done is taken very careful look at the portfolio and potential losses, recognize them early. However, the delinquencies and the performance of the portfolio, I would argue, is stronger than the picture painted by the credit losses recognized in the first half, and we’ll see how that plays out the rest of the year. I am concerned about government stimulus providing the strength to keep these dealers in business. And if that slows or if we reduce the amount of stimulus, I do think you would probably see more pressure on the small independent dealer, and we’re prepared for that.

[Yarden Amsalem, Bank of America]

Okay, thank you. I guess, my second question, can you talk about the trend with online-only revenue per vehicle in the quarter? And your expectations for the rest of the year? I mean do you think ARPU on a consolidated basis can – will likely remain at current levels? Or could it actually trend positively, I guess, through the second half of 2020?

[Eric Loughmiller]

We’re seeing it trend positively month-to-month right now, and it’s primarily because of ancillary services are continuing to grow. Those were – ancillary services were the deepest cut in our business. We couldn’t do anything to a car other than sell it early in the quarter, and that’s coming back. And I think one of the misconceptions I hear from investors is as it goes online, you’re going to reduce the transaction revenue from selling the vehicle. Well, that just isn’t true. Our Simulcast and Simulcast Plus products are able to maintain the same auction revenue per transaction that we’re getting when we had the physical auction. There’s no reductions in the fees. And the mix is right. And the other thing that’s really powerful, the conversion rates we’re getting because of the all-digital platforms is actually driving higher gross profit. That’s what’s doing it. High conversion rates are really good, because we’re getting great leverage off of a fixed cost infrastructure in the technology. Jim, do you have anything you want to add?

[Jim Hallett, Chairman and Chief Executive Officer]

I think you got it, Eric.

[Yarden Amsalem, Bank of America]

I guess, relatedly, if used vehicle prices remain strong through the end of the year, do you expect conversion rates can actually improve in 3Q and 4Q?

[Jim Hallett, Chairman and Chief Executive Officer]

Yes. Conversion rates are well above historic norms. And I would be excited just to maintain those conversion rates as we get through the fourth quarter. Would we take an increase? Indeed, we would, but I’m not sure how much higher the conversion rates can go than where they are right now.

[Eric Loughmiller]

But you are correct. Strong pricing supports the sellers selling the cars quickly. And that’s high conversion rate. They don’t run it twice, because they know they got a great price. And that looks like a trend that is continuing right now.

[Yarden Amsalem, Bank of America]

Thank you so much. That’s it from my end.

[Operator]

Thank you. And our next question comes from Craig Kennison from Baird. Your line is now open.

[Craig Kennison, Baird]

Thanks for taking my questions as well. Jim, you mentioned your 100% digital now in terms of auctions. Is the traditional in-person auction dead? And if so, how does that change your real estate needs?

[Jim Hallett, Chairman and Chief Executive Officer]

Craig, great question and one that has a lot of conversation going around that. I would say that – to answer your question now, right, the traditional brick-and-mortar auction is not dead. It continues. But I would tell you from the KAR standpoint, we are very focused on digital transformation. We’re very focused on all of our platforms and being able to serve all of our customers from a digital standpoint.

As I said in my commentary, we have sold 1.5 million cars in the first half of the year, right? And in the last quarter, I think we sold $600,000 in – quite frankly, in the last quarter, none of those vehicles ran through a physical auction. None of those vehicles went through a lane. And I think we’ve demonstrated to our customers, the real value proposition here. Not only is it efficient and certainly saves time and saves money and expense, it also is getting them more access to more vehicles. There’s a much broader reach with these platforms. As I think I may have mentioned in the Hertz sale, although that sale was kind of from one location, there was 22 locations, and we sold those vehicles into 19 different states. That doesn’t happen at an independent auction or one auction site that you get that kind of reach.

So, from my standpoint, I would hope that we’ve demonstrated to our customers this is the way of the future. This is what we’re seeing in other businesses. This was something that has always been within my vision, something that I always believe would take place at some point in time. And if we can create the outcome that our customers are looking for, I don’t believe there’s any reason for a car to go back to running cars through the lane.

With that, you asked about real estate. I would tell you, real estate is one of the most important assets that we have. Real estate is still important. We still need to inventory these cars. We need to inspect them and image them. We need to get them launched onto our platforms. There’s the ancillary services, that Eric talked about, those still need to be done. I just think that real estate in the traditional brick-and-mortar auction within the KAR organization is going to play a different role.

[Craig Kennison, Baird]

Thanks and second question has to do with TradeRev. You said you are focused on winning in the dealer-to-dealer channel. Now that you’ve proven that TradeRev could be profitable, I’m curious, I guess, does that mean you’re prepared to go back to subsidies to drive market share in TradeRev? Or do you think you can both win market share and forgo any subsidies?

[Jim Hallett, Chairman and Chief Executive Officer]

Yes. So, we have no desire to go back to the incentives that you speak up from past. We’re going to continue to run this business. I think we’ve demonstrated the discipline in running the business and – on sound footing and running the business on the value that you’re delivering to your customer and getting paid for that is critical. We’ve demonstrated that we can make money. I had mentioned we had record months in May and June.

Now that’s not to say that we won’t ramp up our marketing spend over time. But the way we ramp up our marketing spend will not be through incentives. It would be through more sales and marketing and promoting the platform itself and the value of the platform. So we’re feeling very good about our position. I’ll just expand that a little bit, Craig, and say, I think the thing that we need to understand here, if you take all the competitors in this space, it’s probably still selling less than one million cars. We’re in the very, very early innings of this space. We know that we are not the leader in this space. But I can tell you, we also know that we’re now profitable, and we have a collection of assets like nobody else, unmatched in the industry, and I am absolutely certain that we can focus on that leadership position. And with – as we go forward, we will close that gap. My eyes are on the prize.

[Eric Loughmiller]

And Craig, I’ll just add one thing. We aren’t competing for the dealer-to-dealer transaction with TradeRev, we’re competing with KAR. Jim mentioned the collection of assets is unmatched. It’s everything we do; the capabilities from all of our platforms are available to that dealer.

[Craig Kennison, Baird]

Well said, thank you very much.

[Jim Hallett, Chairman and Chief Executive Officer]

You’re welcome.

[Operator]

And our next question comes from Stephanie Benjamin from Truist. Your line is now open.

[Stephanie Benjamin, Truist]

Hi, good morning.

[Jim Hallett, Chairman and Chief Executive Officer]

Good morning, Stephanie.

[Eric Loughmiller]

Good morning, Stephanie.

[Stephanie Benjamin, Truist]

I did want to follow-up on this last question on TradeRev that you mentioned in your prepared remarks about the, I guess, discrepancy and recovery between Canada and the U.S. Could you maybe talk about what you saw as Canada started to improve or maybe break out when TradeRev in the U.S. started really to pick up? Just some more intra-quarter detail would be helpful as we kind of can then use that to look at performance in the back half?

[Eric Loughmiller]

Yes, Stephanie. Canada basically kept a near complete shutdown, almost a month longer than most of the U.S. And so – but I will say the Canadian recovery was much quicker once it started. I mean they really came out of the gate fast. And that’s because TradeRev is the leading dealer-to-dealer platform in Canada without question. And so when the dealers were still light on, call it, in person activity, they were using that platform. So it was great that we had it. And it really picked up late, the last week of May to early June. But the pace of which it recovered was much quicker, where the U.S. started picking up in mid-April and was a more gradual, steady increase in terms of activity, if that describes it. And Europe, Europe was very similar to Canada, but might have even been a couple of weeks behind Canada as well.

[Stephanie Benjamin, Truist]

Thank you. And then just on the ancillary services, could you just kind of walk us through where we stand now in the third quarter of having those services back online or – and similarly, were there any services that you evaluated throughout this process and realized maybe it’s not worth from either a margin or profitability standpoint to continue going forward? Just an update on where we stand on those services would be helpful. Thank you.

[Jim Hallett, Chairman and Chief Executive Officer]

So Stephanie, I’ll start, and I’ll let Eric weigh in here as well. To answer your – the last part of your question, no, all services were deemed necessary and an important part of our offering and that collection of assets I talked about, and we did not stop using any of those services nor did we plan to. When you’re in a hot market, prices are strong, conversion rates are strong, as we’ve talked about. Oftentimes – and we saw this back in the recession in 2009, oftentimes, sellers do not stop and do some of the detailed reconditioning that they would do under normal circumstances.

Now, some of our ancillary services continue to perform. Obviously, we were still doing inspections, we were still financing cars, we were still doing transportation, right? Those services were still intact, and they were still operating and continue to operate and have done quite well. Some of the more on-site ancillary services, the paint and body work, some of the heavy paint body work, some of the reconditioning and mechanical work, some of that work didn’t get done. And as a result, our revenues aren’t back to what we would call near 100%. We’re lagging a little bit there. And Eric, maybe you can speak a little bit more on that.

[Eric Loughmiller]

Yes. And I think the primary issue there is if we are doing the work, it’s taking longer because we have restrictions on how many people in an area, so – and if it takes longer, the seller wants to get the car sold so quickly. They’re saying, okay, I’ll go without that work being done right now in the hot market that Jim mentioned. But we’re able to do all the work, but we are probably taking a little longer to do some of it due to restrictions on proximity people can be to each other, how fast we can process the vehicles. We would expect that to return to normal over time. And again, if prices were to soften at any point in time, sellers would take – would allow more time for us to get the work done, and that number would start to come back up. Even with that said, looking at the second quarter, ARPU from our physical locations was quite strong. I mean, we were down 5% year-over-year. Most of that is related to April because, remember, I’m giving you a quarterly number. It’s not related to the average ticket we saw in May and June. It’s mostly related to the shutdowns in April, because we were still selling vehicles with no services available at all.

[Stephanie Benjamin, Truist]

Thanks, Eric. That’s very helpful. And then lastly, you spoke a little bit specifically when it comes to capital allocation, just some additional digital transformation initiatives you have planned going forward. Could you highlight what some of those additional initiatives might be? Thanks.

[Eric Loughmiller]

Well, as I mentioned in my remarks, we pulled back a little bit on capital expenditures. Our number one capital expenditure is the technology investments we’re making to continue advancing these platforms. You’ll probably see us pick up on that in the second half of the year and especially going into 2021. The other, though, is really nothing specific to talk about, but we are looking with an eye on, are there other businesses that would add to the offerings of KAR over time. And our partners, Apax and Periphas are people that are helping us be focused on what do we need to add to the technologies to be the digital leader in a marketplace, in our case, the wholesale used car marketplace.

[Jim Hallett, Chairman and Chief Executive Officer]

And I think just to recap is, this year, it was strengthening the balance sheet stabilizing the company, making all of the moves that we talked about in our commentary and continuing to drive this digital transformation in 2020. And at some point in time, we’ll be coming to you with some ideas on what our capital allocation plan looks like as we go forward into 2021 and beyond. But other than that, right now, it’s – let’s take care of our – let’s take care of business that is at hand, and let’s continue to focus on this digital transformation for the balance of 2020.

[Stephanie Benjamin, Truist]

Thanks so much.

[Jim Hallett, Chairman and Chief Executive Officer]

You’re welcome.

[Operator]

Thank you. And our next question comes from Bob Labick from CJS Securities. Your line is now open.

[Bob Labick, CJS Securities]

Good morning.

[Jim Hallett, Chairman and Chief Executive Officer]

Good morning, Bob.

[Bob Labick, CJS Securities]

Thanks for the details. I want to follow up – hi, I want to follow up just on the ARPU discussion from a minute ago. I think you said most of the ARPU decline was April. So, was May and June back to normal levels? Is that how we’re trending going forward? I’m just curious as to how ARPU was so strong given the lack of ancillary services?

[Eric Loughmiller]

Yes, Bob. That’s a good question. It’s probably, very close to year-over-year being comparable at physical. The mix is changing. So remember, I’m giving you an ARPU from our physical locations, and that would exclude the online only portion of the business. So the denominator and the numerator are really under the same basis. And we’re seeing it recover, slightly slower, but much closer to normal. And I would tell you, I’m pretty sure that we have the ability going forward for that revenue per unit to continue growing even year-over-year. The high-valued services – probably the biggest pressure item is how quick they’re looking to sell the car because used car pricing is so strong, not the cost of services or the value proposition of the services. Speed is the name of the game for these sellers, especially the commercial sellers right now. And that’s always a good thing, that’s always a good thing for our performance in all ways. High conversion rate will really lead to strong performance.

[Bob Labick, CJS Securities]

All right. And then likewise, you give us the trends throughout the quarter, which were quite dramatic. Was some of the volume recovery in June, perhaps from unsold inventory from April and May? And how is like the overall market trending right now given dealers are holding on a little bit more? And just trying to get a sense of how July looked, if June was kind of a catch-up from the lack of sales from closures earlier in the quarter or where inventory stands now and where, just as I said, like kind of the overall normalized level is not the super low or snap back?

[Jim Hallett, Chairman and Chief Executive Officer]

Yes. So, your point is there was some backup in inventory as we go back to March, April. We had a lot of off-lease cars coming at us that were coming off lease and there were vehicles that were inventory. As a matter of fact, you may have heard us talk about acquiring additional land. We weren’t sure that we had enough capacity to handle the cars that were coming in. And quite frankly, as we started to sell the cars week over week, we created capacity with the high conversion rate. And as a result, we didn’t have to acquire any additional land, and we have no capacity constraints. And then we thought our volume was going to kind of hit record levels. And as we started selling week-over-week, our volume has actually been kind of at the low point.

[Eric Loughmiller]

Yes. The inventory is down, Bob, and we can tell you what segment is causing. It’s repo. We had a lot of repos backed up in March and April, those did work through, and the repo activity has still been delayed in many states, where there’s moratoriums on repossessing vehicles. When that picks up, there is a backlog of repos to be processed, notwithstanding delinquency statistics that we talked about in an earlier question. And when those come in, I think we feel the market is in a good spot, healthy. It is not overstocked like it was in April and early May. I’d say we’re back to more normal levels. And the one area we’re a little light right now would be repo inventory. And that – we think that’s picking up here in the fall, we expect it. And we have insights into that through our RDN platform, which shows us what the backlog of potential repossessions is and what normal activity is. And they’re just – they’re hung up at the finance companies right now waiting for execution.

[Bob Labick, CJS Securities]

Got it, okay. Thank you very much.

[Jim Hallett, Chairman and Chief Executive Officer]

You’re welcome.

[Operator]

Thank you. And our next question comes from Gary Prestopino from Barrington Research. Your line is now open.

[Gary Prestopino, Barrington Research]

Hey, good morning, gentlemen.

[Jim Hallett, Chairman and Chief Executive Officer]

Good morning, Gary.

[Gary Prestopino, Barrington Research]

Kind of couple of questions here. First of all, Eric, you said you got about $90 million of permanent cost reductions from eliminating some positions. But overall, with what you’ve done in the pandemic, can you put a number on what the total cost reductions are across the company?

[Eric Loughmiller]

That’s the number – that’s the tangible number I’m going to give you, because it’s the headcount number. And we’ve done other things, but at this point in time I’m hesitant to quantify because some of it just could be temporary until we reopen, I don’t know what the long-term cost structure – when I say reopen, start offering all of our services. We do – in addition to the $90 million, we probably have had several hundred employees, who were on furlough who took other jobs and are not coming back. So that’s going to be the 2,000 names that remain on furlough. How much would that be? That will be tens of millions of dollars of additional costs. That was not in that number, but I’m not giving you that until we know what the impact is as we get towards October when we decide how many come back and how many positions will ultimately be eliminated based upon the business performance at that time. But that’s another 2,000. The average salary on that compared to the $90 million might be – it might be even more heavily weighted towards part time. So it could be a little lower, but it would be a comparable relationship, in my view. And then the non-labor headcount – all I’ll say is that’s in the numbers in the – if it’s eliminated, it’s in the numbers in the quarter. And our other SG&A was down a little bit in other areas.

[Gary Prestopino, Barrington Research]

Okay. And then two more quick questions here. You said TradeRev, you’re getting a 60% gross profit on the $350 million ticket per car. What – is that – is TradeRev profitable in it of itself when you backed out your sales, marketing expenses? Or is that gross profit include sales and marketing expenses?

[Eric Loughmiller]

Gross profit does not include sales and marketing, but our total performance. We were, as we said, above breakeven. We were just above breakeven in May, and we were well above breakeven in June on an EBITDA basis. So positive EBITDA over that two-month period. And that’s – that by the way is quite an accomplishment. And that was driven by the fact that we were able to get 60% gross profit. Of the $350 million, about $270 million is auction fees, the remainder is transportation revenue. And, as you know, that 60% includes the transportation revenue. That is outstanding performance.

[Jim Hallett, Chairman and Chief Executive Officer]

Gary, as you can imagine, I’ve been waiting a long time to tell you that we’re above breakeven on TradeRev.

[Gary Prestopino, Barrington Research]

Yes, yes. We’ve been waiting too so. And then lastly, just a thought process here, given the fact that new vehicle sales look like they’re going to be down fairly dramatically this year, are we kind of looking at maybe a mini-repeat of what happened in 2009 to 2011, where there was actually, a pretty big impact to the supply of vehicles coming back to auction, just because of that whole phenomenon with new car sales going down?

[Jim Hallett, Chairman and Chief Executive Officer]

Yes, Gary. We maintain the position that we don’t think there is a direct correlation between the SAAR and between used car sales. There’s got to be a significant impact to the SAAR to really have an effect – have a material effect on us. A couple of things that I would mention is, the number that we focused on as we focus on that vehicle churn, as you look at the car park, how many vehicles change hands on an annual basis, and that number has always been somewhere between the high-30 million, 38 million, 39 million to 45 million-ish. It’s kind of been in that – it’s that vehicle turn that we focus on. There is no question that in – with less supply, the dealers may hold on to more trade-ins and they may try to retail cars that they wouldn’t normally try to retail. But if you think about it, I always use the example, if the SAAR dropped by 1 million, right, and 50% of those vehicles have a trade, that takes you down to 500,000, right, and the dealer keeps the cars that he wants to retail and we get 20% of that overall market, it becomes a rather small number. It doesn’t have a material impact on us.

[Eric Loughmiller]

Yes. And Gary, if I could add, there is a big difference between what happened in 2009 and what’s happening in 2020. In 2009, SAAR dropped to about $10 million and of that, retail SAAR dropped to about $7 million and fleet was a big supporter. In 2020, there’s no fleet sales. We’re going to be at a $13 million SAAR with almost all of the consumer purchases.

So, I will tell you, the reduced SAAR in 2020 is much more conducive to the used car marketplace than the reduced SAAR in 2009. So, there is a difference. Lease penetration isn’t down like it – back in 2009. Lease penetration dropped to near 10% of all transactions on a lower number. We’re seeing very high lease penetration. So, I would tell you, this is a little bit healthier situation than the last recession, where SAAR dropped.

[Gary Prestopino, Barrington Research]

Okay, thank you very much.

[Eric Loughmiller]

Thanks.

[Jim Hallett, Chairman and Chief Executive Officer]

Justin, we wanted to let you know, we started a little late, we could probably take one or two more questions if they’re in the queue.

[Operator]

Understood, sir. Our next question comes from Bret Jordan from Jefferies. Your line is now open.

[Bret Jordan, Jefferies]

Hey, good morning, guys.

[Eric Loughmiller]

Good morning, Bret.

[Jim Hallett, Chairman and Chief Executive Officer]

Good morning, Bret.

[Bret Jordan, Jefferies]

When you think about the profile of the auction bidder, obviously, a lot of large public now used car stories out there needing inventory. Do you see the more volume going to the Carvana’s or Vroom’s of the world versus the small independent? And I guess, if there is a market share shift to larger used dealers, where do you see the population of independent used car retail going?

[Jim Hallett, Chairman and Chief Executive Officer]

Yes. So, as you mentioned those companies like Vroom and Carvana and CarMax and the like, listen, these are very good customers, they’re very good buyers. They’re our top buyers, in fact. But they also buy a very, what I would call, high-end vehicles; high-end vehicle with low miles, probably, not much older than five years; and vehicles that can be reconditioned to very, very high standards. Whereas you’ve got the independent dealer, at the other end of the scale, buying the lower-end car in many cases.

In fact, I would tell you that the real sweet spot right now for a lot of people is to buy that $5,000 and $6,000 car. If you think about it, people want private transportation. They don’t want to be on public transportation, especially with this COVID thing going on. And that $5,000 or $6000 car has become a very popular car and that’s kind of the car that the independent focuses on. So, you’re still kind of – each dealer, kind of, has its market and focuses on that market and as we look across our dealer network, they’re all doing well. And I think that they’re all healthy now based on what’s going on in the marketplace.

[Eric Loughmiller]

We’ve seen no reduction in the number of independent dealers’ customers at AFC. In 2009, we saw quite a reduction in the short-term. They came back to the market fairly quickly. But we saw probably as many as 5,000 independent dealers bought a business in a very short period of time. We have not seen that in this cycle, Bret.

[Bret Jordan, Jefferies]

Okay, thanks. And then one quick question. The changes in the dealer network in the UK, that you noted, that drove the charge. What happened over there?

[Jim Hallett, Chairman and Chief Executive Officer]

Well, that was a very small business, Bret that we invested in. And, quite frankly, the dealers weren’t really, I would say, supporting a digital platform. They were more focused on brick-and-mortar auction. And as a result, it’s really an accounting issue that Eric can speak to in terms of what we wrote down there. But from a – from an opportunity standpoint, now, what we’re seeing in the UK is we’re seeing a number of sellers coming back to our people and saying, tell us more about your digital platforms and tell us more about what the opportunities are. So, we think there is an opportunity in the UK and in Central Europe. In Europe, it’s continued to – as Eric said, we’re at 75%, we’ll be back to a 100% and maybe beyond by the end of the year. There is a huge opportunity there, especially with the COVID situation going on. We believe that we’ll continue to sell more and more cars. But in the UK, in a nutshell, I would say, it was just a resistance to technology.

[Eric Loughmiller]

And specifically, Bret, what I’m referring to, there’s been a – the complete shutdown, it’s a right hand drive, so the cars – they don’t have a market broader than the islands. And the number of dealers that are actively in business right now has declined and that was one of the major inputs into our analysis of the intangibles. So again, I don’t think it’s long-term, but we wrote it off based upon the near-term performance we expect in the UK with fewer dealers, fewer transactions in the short-term.

[Bret Jordan, Jefferies]

Great. thank you.

[Operator]

And thank you. And now, I would like to turn the call back over to CEO, Jim Hallett for closing remarks.

[Jim Hallett, Chairman and Chief Executive Officer]

Great. thank you, Justin. And thank you ladies and gentlemen for being on our call today. We appreciate your continued support and your interest in our company. I’ll just close by saying I’ve been in this business for over 40 years and throughout my entire career I’ve dealt with a lot of change and I’ve dealt with crisis throughout that period of time. And I really believe that, that experience over 40 years has really prepared me to deal with this COVID crisis. I can tell you, I think our team – our management team was really well prepared. I was really pleased and really proud of the team, and how quickly we acted and how courageously we acted in making our decisions and making our decisions early and making them quick and staying with them.

I think we’re now in a position, where we’ve really rightsized the company. We’re in a position to really grow the company through this digital transformation. We have adequate liquidity that we’ve talked about. We like the performance we’re seeing on digital and the path forward. And for my last 10, 15 years, our investors have always asked Eric and I, “Do you see a day that some cars will all sell on digital channels or in a digital format?” And I can tell you that we sold a 100% of our vehicles in a digital format in the second quarter of this year. So, someday is today and I believe that we have a value proposition here that will continue to more than satisfy our customers and be the choice going forward, and that’s the position and that’s the focus that I have.

So, as we go forward, we’ll keep you up to date on how we’re doing. But we’re excited about what happened in the second quarter and more excited about what we’re looking forward to here in the second half of the year. We’re feeling pretty good about things. So, thank you for being on. We appreciate it and have a great day.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.