CarGurus, Inc. (NASDAQ:CARG) Q4 2022 Earnings Call Transcript

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CarGurus, Inc. (NASDAQ:CARG) Q4 2022 Earnings Call Transcript February 28, 2023

Operator: Good day, and welcome to the CarGurus Fourth Quarter and Full Year 2022 Earnings Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Kirndeep Singh, Vice President and Head of Investor Relations. Please go ahead.

Kirndeep Singh: Thank you, operator. Good afternoon. I'm delighted to welcome you to CarGurus' fourth quarter and full year 2022 earnings call. We will be discussing the results announced in our press release issued today after the market close and posted on our Investor Relations website. With me on the call today are Jason Trevisan, Chief Executive Officer; and Sam Zales, President and Chief Operating Officer. During the call, we will make statements regarding our business that may be considered forward-looking within applicable securities laws, including statements concerning our outlook for the first quarter of 2023; management's expectations for our future financial and operational performance; our business and growth strategies; our expectations for our CarOffer business and acquisition synergies; the value proposition of our current product offerings and other product opportunities; the impact of the semiconductor chip shortage and other macro-level industry issues; and other statements regarding our plans, prospects and expectations.

These statements are not promises or guarantees and are subject to risks and uncertainties which could cause them to differ materially from actual results. Information concerning those risks and uncertainties is available in our earnings press release distributed after market close today and in our most recent reports on Forms 10-K and 10-Q, which, along with our other SEC filings, can be found on the SEC's website and in the Investor Relations section of our website. We undertake no obligation to update or revise forward-looking statements, except as required by law. Further, during the course of our call today, we will refer to certain non-GAAP financial measures. A reconciliation of GAAP to comparable non-GAAP measures is included in our press release issued today as well as in our updated investor presentation, which can also be found on the Investor Relations section of our website.

With that, I'll now turn it over to Jason.

Jason Trevisan: Thank you, Kirndeep, and thanks to everyone joining us today. As I shared at the beginning of the year, following a transformative 2021, 2022 was a year of activation across our platform. With the theme of activation guiding our 2022 road map, we were able to bring more dealers on the foundational Listings business, launch and grow the dealer base utilizing Digital Deal and expand into new geographies with Instant Max Cash Offer. While we're extremely proud of these activations, dynamic changes in automotive market conditions caused us to experience challenges in the second half of the year that required us to recalibrate our goals and address CarOffer's operational difficulties. Though we're pleased with the results of our efforts in tackling these challenges and are seeing some encouraging early signs of improvement, we still have work to do to ensure that our operations and products are built with scale and profitability in mind.

Despite these short-term difficulties, we're well down the path of delivering on the vision of being the number one digital destination for both consumer and dealer customers to confidently buy and sell their vehicles with the best selection, price, convenience and trust. Our vision has remained steadfast, despite an evolving and volatile automotive market landscape. Throughout the past year, the automotive market still encountered challenges arising from the semiconductor chip shortage. However, in 2022, a reversal of two key factors brought us to an inflection point. New inventory increased, albeit below pre-pandemic levels and interest rates rose quickly, driving automotive lending rates to levels not seen since 2010, which curbed consumer demand and drove up days on lots.

The concurrent impact of these factors contributed to a decline in used retail and wholesale car prices as well as a reduction in wholesale activity. Though it is encouraging to see prices trend down, outside of typical seasonality, it creates a transitory environment that makes buying and selling difficult for both consumers and dealers alike. While we continue to monitor the impact of these factors closely and remain agile in this transient environment, we're still marching towards fulfilling our vision of creating the only platform where dealers can source, market and sell, and consumers can shop, finance, buy and sell. We remain excited about the long-term trajectory of our end-to-end transaction-enabled platform, while remaining thoughtful in balancing innovation, growth and profitability.

As we continue to balance internal and external factors, I'm pleased to share that we met and/or exceeded our forecasted guidance for the quarter. Although 2022 was filled with unpredictability, there's one thing that has remained constant and predictable, our foundational Listings business, which marked another year of record marketplace revenue and gross profit. To combat several challenging years in the automotive landscape, our strategy was to focus on reducing dealer attrition and growing dealer adoption. As a result of these efforts, in the U.S., we ended the year with 24,567 paying dealers, up 707 compared to the prior year. In 2022, we saw steady dealer adds, except in the fourth quarter from expected seasonality resulting from dealer year-end budget adjustments and the commencement of our annual business reviews.

Fourth quarter cancellations were driven by concerns of rising interest rates, softening consumer demand and continued uncertainty toward acquiring inventory with declining prices. However, at the same time, some dealers were supercharging their advertising to increase turn rates and continue to drive shoppers to the dealerships in times where consumer interest is waning. As for our annual business reviews, after several years of pausing broad-based renewals, we have taken strides to update our renewal process by simplifying our packaging and increasing the value our dealers receive by adding features to our listing tiers. These steps have resulted in dealers moving up our listings ladder and greater monthly recurring revenue or MRR. As we grow MRR through renewals, there will be a trade-off between dealer adds and revenue growth.

But we remain confident in the ROI we provide and our ability to grow paying dealers and Quarterly Average Revenue per Subscribing Dealer or QARSD over the long term. U.S. QARSD grew approximately $209 year-over-year to $5,842. Fourth quarter performance was driven by signing on new dealers with higher average monthly recurring revenue, unit price increases and revenue expansion through listing upgrades and product adoption. In fact, multiproduct attach rate for three or more products increased by 90% this year as dealers look to find additional ways to attract high intent, ready-to-purchase shoppers to their inventory. As we continue to innovate our product offerings and target high-intent ready-to-transact shoppers, we are able to provide an exceptional ROI for our paying dealers.

We're pleased with the growth of our highly profitable Listings business. It is through continued product innovation and partnering with our customers that we're able to drive sustained growth and value that sets us apart from the competition. A key component to the to the success of our Listings business is continued innovation with new product offerings and capabilities. Digital retail capabilities continue to remain a competitive focus for dealers as market share for online transactions continues to grow. While only a small percentage of transactions are now being done fully online, over 70% of buyers say they prefer to do more from the convenience of their home for their next purchase. As consumers look for added flexibility to complete more elements of their vehicle shopping journey online and dealers operate with smaller sales forces compared to pre-pandemic levels, we are enhancing our toolkit to arm dealers with the capabilities to meet evolving consumer needs while focusing on higher quality leads.

In May of 2022, we launched Digital Deal an offering which allows consumers to build a near penny perfect deal with either dealer or vehicle-specific finance and insurance products and then place a deposit on their vehicle of choice with a seamless online to in-store experience. As of the fourth quarter, there are now 1,588 dealers utilizing this newly deployed capability to better serve their customers. With more digitally enabled listings available in than other online retailer, we're providing consumers with a convenient, self-selective purchasing journey, all while providing trust, transparency and the best pricing from the largest selection of inventory among major online automotive marketplaces in the U.S. Digital Deal continues to deliver growth opportunities for our foundational Listings business by enabling dealers to reach even more high-intent shoppers utilized at

Our marketplace, coupled with Digital Deal frontloads the majority of consumer buying research and selection effort through our online experience, allowing them to schedule their appointment through CarGurus to complete the remaining steps in store. The less work the dealer has to do to move inventory, the higher their ROI. And with consumers doing the legwork directly through CarGurus, dealers are able to better understand the attribution of a lead. In fact, an analysis based on latest IHS data reveals that Digital Deal leads are over 2 times more likely to close than regular CarGurus email leads, and leads including prequalification are 3 times is likely to close. Our high-value leads are a testament to our ability to attract highly engaged consumers lower in the funnel who are ready to purchase saving dealers time and money, allowing them to move on to their next sale faster.

The seamless user experience has resulted in a remarkably high Net Promoter Scores for both consumers and dealers. And so, as of the beginning of this year, we have increased the price of our Digital Deal offering to better align with the value we are providing our dealer partners. Our digital retail capabilities increase optionality and convenience for both dealers and consumers by providing consumers flexibility to complete a sale or purchase in a manner that best works for them and offering dealers more choice to tailor their product suite that best serves their individual business needs. The future of digital retail will level the playing field for our dealer partners who are unable to provide these solutions to consumers on their own and/or wish to utilize our largest consumer audience to sell additional inventory through the CarGurus platform to drive greater profitability.

While we've seen success with the Marketplace and Digital Retail businesses, our Digital Wholesale business was more greatly impacted by difficulties in the second half of 2022. As we mentioned on our last earnings call, CarOffer encountered operational challenges that were optimized for a rising wholesale market that were insufficient in a declining price environment, negatively contributing to an already tough macro dynamic of declining wholesale prices and lower conversion rates. These challenges were identified in October, and we worked quickly to optimize reporting, systems and processes to counteract this decline. While we're confident that our fast action short-term remediation efforts have addressed immediate concerns, we remain vigilant in monitoring the business continuously to ensure the newly defined processes and policies are resilient and produce a path to profitability.

In the short period since our solutions have been in place, we've seen positive trends that lead us to believe that our efforts are working. Take, for example, the inspection process. As we did a deep dive into operations for areas of improvement, we determined that the overall inspection process was lacking rigor in consistently identifying vehicle quality. To combat this and promote scalability, we broadened our partner network to perform more complete mechanical, engine and frame damage checks. In doing so, we've seen our inspection fail rates rise this quarter, which we believe confirms less problematic vehicles are making their way through our platform, allowing us to unwind the transaction before it is sent to the buying dealer. Since the addition of our new inspection partners, more than half of vehicles undergo a more thorough mechanical check.

As it relates to Instant Max Cash Offer or Instant Max, for short, we have evolved our intake process to now include a self-inspection pilot allowing consumers to submit videos and photos of their vehicle, while they wait for CarOffer to review their documents. CarOffer can use the completed self-inspection to validate that the vehicle meets the transaction criteria. If the car's condition does not meet the requirements, CarOffer can adjust or terminate the offer before deploying additional resources to inspect and transport the vehicle. With more thorough inspections, we expect these improvements to reduce arbitration claims, which spiked in the second half of the year. Another step we've taken towards maturing CarOffer operations relates to stricter adherence to arbitration and rematching policies.

Historically, in an effort to create goodwill amongst dealers, there was leniency with regard to the arbitration claims window, placing the burden of vehicle depreciation on us. We, therefore, instituted stricter policies such that if a dealer has an issue with a vehicle, they must make a claim within days. This helps ensure that a dealer complies with our arbitration policies and allows CarOffer to handle claims more quickly and effectively. Through arbitration claims, we also witnessed a high number of vehicles get rematched, the act of moving an arbitrated vehicle to the next highest bidder on the platform. To limit the number of rematches, which cause higher transportation losses and risk of further delayed arbitration, we enforced strict locations.

Fewer rematches coupled with a shorter arbitration window has allowed us to reduce unnecessary transportation expenses and liquidate vehicles faster to support shorter market exposure, which is critical in a declining price environment. Through more rigorous inspections, better management of the arbitration process and stricter enforcement of our policies, we slowed down the Digital Wholesale business with levers that were in our control. This allowed us to focus on the implementation of the changes without the overhead of managing volume. While this was a conscious decision, our self-imposed slowdown was compounded by a general slowdown in the wholesale space. As a result, fourth quarter revenue from our Digital Wholesale segment, which includes our dealer-to-dealer business and Instant Max, was approximately $120.5 million, down 33% year-over-year.

Car, Tehnology, Industry
Car, Tehnology, Industry

Photo by Joey Banks on Unsplash

Similarly, both gross merchandise sales, or GMS, and transactions were down year-over-year. GMS for the quarter was $455 million, and we conducted 18,405 transactions. Transactions is a new key business metric that is comprised of dealer-to-dealer transactions and Instant Max Cash Offer transactions and is discussed further in our press release issued today. Instant Max Cash Offer is powered by the CarOffer matrix. Challenges which impacted the dealer-to-dealer business, similarly affected our consumer-facing product offering as well. With Instant Max, we also have the ability to quickly toggle up or down our marketing spend to grow or shrink the traffic coming to our site to trade in the vehicle. In an environment where wholesale prices were declining, and we were working quickly to improve our operations, we felt it was in our best interest to reduce marketing spend to limit the number of transactions flowing through our system.

Additionally, we had less competitive offers, which further reduced conversion rates on our platform. While this set us back from a market share and volume perspective, we believe it was the right decision to ensure we did not exacerbate our challenges while we work to fix them. In the fourth quarter, Instant Max Cash Offer generated $73.7 million in revenue, in line with our fourth quarter guidance. Our number one objective is to ensure the right processes, policies and team members are in place at CarOffer, so we can build a sustainable business that scales predictably over time. We're focusing on benchmarks and KPIs that as we progress towards our goals, will signify increased stability of the business. As that stability increases, we intend to shift back to prioritizing reengagement with dealers and capturing dealer wallet share with the goal of growing transactions and market share on the platform.

CarOffer's matrix technology allows dealers to transact automatically and at any time, using rules-based strategies to create a buying and selling experience that is unlike anything offered in the market today. And we believe that as we work through these operational issues, we are setting up CarOffer for success. Despite headwinds and self-imposed slowdowns, 2022 was a year of growth for CarGurus and I'm immensely proud of the team's progress towards fulfilling our vision of building the only end-to-end automotive transaction-enabled platform. At CarGurus, we give people the power to reach their destination. For consumers, this means empowering them with the tools and information necessary to confidently shop, finance, buy and sell in the largest network of dealers and their inventory in the U.S. For dealers, it means continuing to provide innovative forward-looking solutions by giving them the resources and capabilities they need to grow their businesses efficiently and profitably.

It is through our consumer and dealer solutions and the combination of our innovative Digital Retail offerings, resilient foundational Listings business and differentiated Digital Wholesale business that we're able to create a unique value proposition as an automotive ecosystem. As I mentioned earlier, we're mindful of striking a balance between innovation, growth and profitability to maintain a healthy business that is prime for scale and competitive strength. In a market of broader economic uncertainty, a technology sector that is largely pulling back and an auto subsector that is experiencing unprecedented pricing demand and supply chain volatility, it's important we remain disciplined in growing our financial and strategic position in the market.

In 2022, we demonstrated our thoughtful and judicious decision-making approach through milestone-based investment growth in Digital Retail, securing a $400 million line of credit, authorizing a share repurchase program and foregoing acquiring additional equity and CarOffer. We also continue to demonstrate remarkable discipline in our operating expense as we remain nimble in managing marketing spend, and we're thoughtful with hiring. Through it all, our focus on customer centricity remains a critical driver of our innovation and success, fueling product developments, operational improvements and strengthening our relationships with both dealers and consumers as a trusted partner. As we continue to persevere through these transitory challenges, I firmly believe the decisions we have made to address these difficulties have strengthened our resiliency for the long term, enhancing the benefits for both our customers and our shareholders.

Now, let me walk through our financial results. I'll provide a detailed overview of our fourth quarter and full year performance, followed by our guidance for the first quarter of 2023. Beginning with our 10-K, we have evolved our external reporting to better align with the transformation we have undergone as an end-to-end transaction-enabled platform. We now have two reportable segments: our U.S. Marketplace business and Digital Wholesale business, otherwise known as CarOffer. This new reporting structure allows stakeholders to better understand key components of our business and its corresponding performance. In our filings, you will find our financials updated prospectively to incorporate this new two-segment view. Total fourth quarter revenue was $286.7 million, down 16% year-over-year but nearly $2 million ahead of the midpoint of our guidance range.

Revenue for the full year was $1.655 billion, up 74% over the prior year. This was heavily influenced by our wholesale and product revenues, which I will discuss shortly. Looking at the components of our revenue. Marketplace revenue was $166.2 million for the fourth quarter and $658.8 million for the full year. Fourth quarter Marketplace revenue was up approximately 3% from the year-ago period and 1% from the third quarter. The increase in Marketplace revenue was attributable to new dealers with higher average monthly recurring revenue and expansion through product upgrades and add-ons for existing dealers on our high-margin Listings business. This growth in subscription revenue was partly offset by a decline in advertising and consumer finance revenues as well as foreign exchange headwinds in our UK business.

Wholesale revenue was $23.7 million for the fourth quarter and $237.6 million for the full year 2022. Wholesale revenue declined by 71% compared to the same period in the prior year and declined by 50% from the third quarter. The decline was predominantly due to the continued market softening which began earlier in the year, resulting in decreased transaction volumes for our dealer-to-dealer business. As expected, decreased volumes resulted in reduced transaction fees and transportation revenue for the quarter. Lastly, product revenue was $96.8 million for the fourth quarter and $758.6 million for the full year 2022. Product revenue grew by 1% year-over-year and declined by 55% from the third quarter. The decrease in product revenue was due to reduced transaction volumes and continued declining average selling prices associated with Instant Max Cash Offer.

As I mentioned earlier, this quarter, we materially decreased marketing investments in Instant Max to reduce the top of funnel traffic and focused our efforts on improving CarOffer operations. Fourth quarter Instant Max Cash Offer revenue was $73.7 million, which was in line with our most recent guidance range. Together, our wholesale and product revenue line items make up our CarOffer business, otherwise known as the Digital Wholesale segment. Total revenue for Digital Wholesale in the fourth quarter was $120.5 million and for the full year was $996.3 million. I'll now discuss our expenses and profitability on a non-GAAP basis, which backs out our stock-based compensation expense, amortization of acquired intangible assets, acquisition-related expenses and net income or loss attributable to redeemable non-controlling interest.

Fourth quarter non-GAAP gross profit margin was 50% compared to 59% in the year-ago quarter. The change in non-GAAP gross profit margin is primarily due to a lower gross margin profile in wholesale and product. Non-GAAP gross profit margin increased from 37% in the third quarter to 50% in the fourth quarter, primarily due to the shift in revenue mix. Our Marketplace business continued to drive significant gross profit margins in the fourth quarter. This was even more pronounced in our gross profit margin percentage with the Digital Wholesale business representing a smaller percentage of our revenue. However, even though our Marketplace business continued to generate increase in gross profit in the fourth quarter, the lower volumes in the Digital Wholesale business, coupled with increased arbitrations and the liquidation of inventory that built up at the end of the third quarter resulted in a decline in the Digital Wholesale margin in the quarter.

It should be noted that the increase in arbitration losses occurred, primarily in October and November as we liquidated the inventory that built up in September as prices were declining. Improved operational rigor resulted in significant inventory control and a reduced inventory balance of $5.3 million at the end of December. In the fourth quarter, as we liquidated CarOffer inventory from our books, we estimate this flush inclusive of vehicle depreciation to have had a gross profit impact in the mid-single-digit millions. Total fourth quarter non-GAAP operating expenses were $118.8 million, down 4% year-over-year. Non-GAAP sales and marketing expense decreased 18% year-over-year to $70.6 million. Non-GAAP sales and marketing expense represented 25% of revenue, flat to the same period last year.

The decrease in marketing expense year-over-year speaks to our strategic alignment of expenses to top line growth. We remain thoughtful with our investments as we continue to grow the business and develop our brand campaign without material incremental marketing investments in Q4. Our fourth quarter non-GAAP product, technology and development expenses grew 25% versus the year-ago period to $28 million. The increase is primarily due to an increase in employee-related costs as a result of a 16% increase in headcount from earlier in the year, and continued investment in our technology teams to grow our new areas in Digital Wholesale and Digital Retail in the coming year. We expect this expense to continue to increase as we continue to develop and grow our expanded product offerings to build our end-to-end transaction-enabled platform.

We generated non-GAAP operating income of $23.6 million, representing an operating margin of 8%. We generated $27.8 million of consolidated adjusted EBITDA for the quarter, almost $14 million ahead of the high end of our guidance range due to continued strong subscription business performance, prudent and effective expense management and improved CarOffer operations, albeit at lower volumes, resulting in lower arbitrations, reduced vehicle rematches and improved transportation losses. Non-GAAP diluted net income per share attributable to common shareholders was $0.22 for the fourth quarter, $0.06 above the high end of our guidance range. On a GAAP basis, we generated fourth quarter gross margin of 48% compared to 53% in the year-ago period.

The contraction in GAAP gross margin is primarily due to the lower margin profile of our Digital Wholesale business. In the fourth quarter, we incurred total operating expenses of $107.4 million, down roughly 21% year-over-year. Fourth quarter GAAP operating income decreased 33% year-over-year to $29.6 million. Fourth quarter GAAP consolidated net income was $23.2 million Net income attributable to CarGurus totaled $24.8 million and fourth quarter GAAP net income attributable to common shareholders of $159.2 million. We ended the fourth quarter with $469.5 million in cash and investments, an increase of $65.1 million from the end of the third quarter. We generated $95.3 million in cash from operations in the fourth quarter and $90.5 million of non-GAAP free cash flow, which includes capitalized website development and capital expenditure costs of $4.8 million.

Cash provided by operations in the fourth quarter was primarily driven by our results as well as an increase of $32 million, driven by working capital movements. In December, we initiated a share repurchase program in the amount of $250 million. During the fourth quarter, we repurchased 1.4 million shares for an aggregate purchase price of $18.7 million. As of December 31st, we had approximately $231.3 million available for additional share repurchases. I'll conclude with the outlook for the first quarter. We expect our first quarter revenue to be in the range of $195 million to $215 million. We expect to see healthy growth in 2023 for our Marketplace business. However, in the first quarter, we expect modest headwinds related to OEM advertising to offset quarter-over-quarter subscription revenue growth.

For our Digital Wholesale business, we plan to further limit our marketing investment for Instant Max Cash Offer. With our substantial reduction in marketing, coupled with materially lower transaction volumes, driven in part by macro factors and our purposeful slowdown, we expect first quarter revenue for our product line item to be in the range of $21 million to $31 million. Please note that we now we'll be guiding to product revenue, which aligns with our GAAP financial statements line item. As we have previously mentioned, product revenue includes Instant Max Cash Offer revenue, but excludes inspection and transportation revenue and includes arbitration revenue related to our dealer-to-dealer business. We expect our first quarter non-GAAP consolidated adjusted EBITDA to be in the range of $19 million to $27 million and non-GAAP earnings per share in the range of $0.17 to $0.19.

As we continue to make operational improvements for our Digital Wholesale business, we expect to see a further reduction in transactions, resulting in continued compressed profitability. Moreover, as it relates to our operating expenses, earlier this month, we launched our long-anticipated brand campaign, Get it with Gurus. We're thrilled to embark on this journey of increasing our brand awareness. However, in doing so, we expect to see a slight increase in our brand spend in the first quarter. However, we remain prudent in our marketing spend for the full year and expect it to be modestly below 2022 spend due to our reduction in Instant Max Cash Offer marketing. Additionally, beginning in the first quarter, we expect our expense base to increase as our lease officially commences for our new corporate headquarters in Boston, and we expect to see the full year grow over impact of people and people-related costs.

In 2022, we achieved many significant milestones as we activated across the business. And in 2023, we're continuing to bring our vision to life as the only end-to-end automotive transaction-enabled platform. None of our progress or results would have been possible without the incredible employees globally whose hard work and unwavering dedication has been instrumental in making our vision a reality. With that, I'll open up the call for Q&A.

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