CarGurus Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 9, 2023

There are 8 speakers on the call.

Operator

Greetings and welcome to CarGurus Q1 2023 Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Kunderdeep Singh, Vice President, Head of Investment.

Operator

Thank you, Pradeep. You may begin.

Speaker 1

Thank you, operator. Good afternoon. I'm delighted to welcome you to CarGurus' Q1 2023 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.

Speaker 1

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 Q2 of 2023 management's expectations for future financial and operational performance our business and growth strategies our expectations for our car offer 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 the market closed today and in our most recent reports on Forms 10 ks 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.

Speaker 1

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 will now turn it over to Jason.

Speaker 2

Thank you, Kuldeep, and thanks to everyone joining us today. Every year, I begin with a theme that aligns to our strategic objectives. 2023 is no exception. In 2021, we focused on the transformation of our business. In 2022, we activated substantial new products across the platform.

Speaker 2

And now in 2023, our North Star is monetization through transaction enablement. During our evolution from a listings business to a transaction enabled platform, we remained acutely focused on providing our dealer partners with the highest ROI, a comprehensive product suite and continued innovation to meet their evolving needs. As we build on the previous year's themes by maturing our end to end offering that better serves our largest consumer audience and dealer partners, we are now beginning to concentrate our efforts on monetizable transaction activities for both dealers and consumers across the platform. Transaction enablement allows dealers to further monetize a retail sale. Instant Max cash offer allows consumers to monetize the transaction through the direct sale of their own vehicle.

Speaker 2

And at CarGurus, we are able to monetize high value digital deal leads. Through innovation in our growth vectors of digital wholesale and digital retail and more robust transaction enablement, we aim to provide increased value to our customers, while striving to achieve a balance between capturing that value and driving greater adoption. We have made tremendous progress in becoming the number one digital destination for consumers and dealers to confidently and conveniently buy and sell any vehicle, anywhere with the best selection and price. Although the macro environment continues to create volatility in inventory and pricing trends, our foundational listings business continues to exhibit resiliency and strong profitability. While we recently faced operational challenges with our car offer business, progress this quarter demonstrates our agility in responding promptly and effectively to navigate the year ahead.

Speaker 2

We are proud that our strong execution allowed us to exceed our forecasted guidance for the quarter, while maintaining a balance among pursuing innovation, Fueling Growth and Ensuring Scalable Profitability. We entered the quarter with expectations that OEM and consumer financing would serve as headwinds and offset our subscription revenue growth. While that was certainly true, during the Q1, we also witnessed reduced dealer inventory levels due to economic projections indicating a potential deceleration or recession. These factors resulted in a further tightening of inventory and marketing dollars as dealers look to preserve healthy profit margins. Despite these compounding factors, I'm pleased to share we exceeded our forecasted marketplace revenue for the quarter.

Speaker 2

One key driver of our marketplace results this quarter was the scaling and over performance of monthly recurring revenue resulting from annual business reviews or ABRs. Through the ABR process, we are renewing a cohort of meaningfully underpriced dealers each quarter, and we have made significant improvements to our renewal process By streamlining our packaging and enhancing the value proposition for our dealers through the addition of new features and benefits to our listings tiers that best support our dealers' needs. Even during a period of historically low inventory, our improved ABR process demonstrated the strength of our platform to effectively scale and recognize more appropriate value delivered, while simultaneously enabling us to be more consultative In introducing cross product adoption opportunities that best support our customers' business needs. In fact, in Q1, the ABR process was 2.5 times more successful converting Area Boost dealers into a new offering known as digital deal with geographic expansion. I'll provide further details about this new offering later in my remarks.

Speaker 2

While ABR has yielded positive revenue As expected, they elevated involuntary dealer attrition as we held firmer on what we're confident is highly attractive pricing and dealer ROI. We ended the quarter with 24,394 paying dealers in the U. S, up 175 dealers from the year ago period, but down 173 dealers from the prior quarter. Excluding ABR related churn, we had positive dealer adds quarter over quarter. Although we observed healthy dealer acquisitions earlier in the quarter, we noticed a rise in voluntary cancellations across all dealer types.

Speaker 2

We believe primarily due to the aforementioned lower inventory levels and margin preservation during a period of economic uncertainty. Despite the quarter over quarter decline, we're pleased with the results of the ABR process and remain confident that we are delivering to our dealers a very compelling value proposition. In Q1, U. S. Quarterly average revenue per subscribing dealer or CarCid was $5,943 growing 4% year over year.

Speaker 2

Performance was primarily due to revenue expansion through listings, upgrades and product adoption, signing on new dealers with higher average monthly recurring revenue and unit price increases. By consistently investing in and enhancing our product offerings, we are capable of innovating quicker and more frequently than any other marketplace, which in turn brings more value to both our dealer partners launched DigitalDeal in May of 2022, a critical step in our ability to create an end to end platform. DigitalDeal provides consumers with the flexibility to customize their car shopping experience by allowing them to do more online. Shoppers can receive trade in estimates, prequalification or hard pull financing, purchase dealer or vehicle specific finance and insurance products And even place a deposit on their preferred vehicle. This offering provides our customers with the flexibility to transact in a way that best suits their needs.

Speaker 2

At the end of the Q1, this new capability has been adopted by 2,251 dealers, adding 663 dealers quarter over quarter. Although there were price increases at the beginning of the year, we were able to boost our sales velocity, which also included the addition of large national players we will be conducting a few more questions. Digital Deal continues to gain dealer share as it attracts high value leads from highly engaged consumers who are ready to purchase, saving dealers time and money. Digital deal leads are over 2 to 3 times more likely to close than standard CarGurus email leads. Moreover, consumers who go farther down the funnel and complete a hard pull are 5 times more likely to close.

Speaker 2

Our most successful dealers utilizing Digital Deal are now seeing an average of 25% of their CarGurus online leads come from Digital Deal. For dealers, this adds tremendous value and ROI as 25% of their shoppers are high value leads making the dealership more efficient in closing a deal and moving on to their next sale faster. A representative at Belk Ford and Oxford Toyota said, digital deal leads that have pre qualified financing are almost guaranteed to convert. They are another indicator they are high quality and are easier to reach with a guaranteed phone number. Our digital retail capabilities do not stop there.

Speaker 2

Coupled with Area Boost, dealers now have the ability to sell vehicles online to consumers We have seen healthy cross product digital retail adoption with 57% of digital deal users also enrolling in Area Boost. Area Boost helps dealers expand their reach by displaying their deliverable listings to shoppers outside their local market. Capitalizing on the synergies between these two offerings, we recently launched a newly bundled offering called Digital Deal with Geographic Expansion. It allows dealers to leverage a high quality lead flow, while attracting a wider audience outside the physical reach of a dealership. This new offering has increased close rates by 2 times when compared to standard Area Boost LEAP.

Speaker 2

Because of the exponentially higher value these two products provide in tandem instead of separately. Area Boost will now be an exclusive feature through digital deal with geographic expansion. Together they provide a dealer with both more volume and higher lead quality. Our early stage digital retail provide these solutions on their own and or want to leverage our largest consumer audience to sell additional inventory through the CarGurus platform to drive greater profitability. As we progress towards our ultimate goal of creating an end to end solution, the power of this vision becomes even more clear, giving our dealer partners a cohesive experience that provides them value, whether it is through an expanded customer base, data driven decision making and or high value lead generation.

Speaker 2

And at the same time, these capabilities provide us an opportunity to not only create a stickier platform, the ability to capture greater market share and dealer wallet share. In our digital wholesale segment, we entered Q1 with plans to intentionally reduce volume sequentially, while we optimize several operational aspects of the business to better handle the market and pricing volatility. Over the last 5 months, we have aggressively addressed these issues to build a stronger, more stable and more predictable business that can thrive in all market conditions. In doing so, we remain committed to building a sustainable business that produces a path to profitability. As we developed our strategy to improve CarOffers operations, it became apparent that a significant number of our challenges were rooted in our need to enhance and transportation inefficiencies were largely the result of our inspection quality.

Speaker 2

For this reason, we intensified our efforts to bolster inspections processes and policies to improve our quality and reduce non revenue generating costs. These efforts have resulted in a 70% reduction in arbitration cases from their peak in the Q4. During the same period, we also witnessed a 55% decrease in rematch rates. A rematch is the act of moving an arbitrated vehicle to the next highest bidder on the platform, potentially causing higher transportation losses and risk of further delayed arbitration from unsatisfactory vehicle quality. By prioritizing positive unit economic transactions and minimizing problematic ones, we also achieved positive transportation margins in the Q1 as well, improving approximately 3,500 basis points quarter over quarter.

Speaker 2

As a reminder, transportation margin is largely pass through. These improved margins stem from a combination of a favorable price environment for dealers as well as a drop in arbitrations, unwinds and rematch rates, which have reduced the occurrence of dead legs, instances where we incur the cost of transportation, but receive no revenue. Our efforts resulted in an approximately 55% reduction quarter over quarter of dead legs. As our KPIs continue to trend in the right direction, we are creating a sustainable path to profitability. This quarter, we meaningfully exceeded our forecasted revenue and EBITDA plans for our digital wholesale segment.

Speaker 2

We generated $64,800,000 in revenue and had an EBITDA loss of $1,700,000 Outperformance this quarter was driven by operational improvements and higher than forecasted dealer to dealer transaction volume as buying conditions improved in February March. While tight dealer inventory and declining wholesale and retail prices to begin the year helped us keep volumes low, we did see greater dealer confidence in the back half of the quarter with seasonally strong consumer demand and rising wholesale prices following a 7 month decline. These factors along with modest reengagement some rental fleet customers, albeit at controlled volumes, caused dealer to dealer transactions to rise quarter over quarter, while we deliberately reduced InstantMax cash offer or Instant Max for short transactions by over 50% from the prior quarter. We ended the quarter with 17,505 transactions, down approximately 5% quarter over quarter. The overall reduction in volumes resulted in gross merchandise sales or GMS of $445,000,000 Although we are pleased with our results, we are aware that external factors have played a meaningful role.

Speaker 2

That is why our decision making continues to prioritize establishing a profitable platform that can thrive in any environment. We are concentrating on operational improvements over volume growth to ensure our platform is In doing so, earlier in Q1, we launched a new option for dealers called 24 hour approval. This capability allows dealers to review vehicle details, photos and vehicle history before making a purchasing decision, which provides dealers additional comfort in a volatile price environment. In the Q1, 24 hour approval facilitated a significant number of transactions, while simultaneously improving dealer confidence and satisfaction. Moreover, as we continue to improve our we remain committed to ensuring that all transactions are executed with the highest level of quality.

Speaker 2

This focus on quality and improvement is showing signs positive traction with our customers as we have seen dealers reengage our platform. By implementing operational enhancements and taking a meticulous approach, we are establishing a stronger foundation for our car offer business as a trusted platform for dealers buying and selling needs. Across the business, we are very pleased with our Q1 results. We made significant strides on the path towards realizing our vision of creating a profitable end to end transaction enabled platform that provides consumers with the trust, transparency and choice they need to confidently shop, finance, buy and sell a vehicle and empower dealers with innovative tools to source, market and sell vehicles. The unique combination of our resilient foundational listings business, differentiated digital wholesale business and innovative digital retail offerings create a unique value proposition as an automotive ecosystem that serves our customers' life cycle needs.

Speaker 2

The year began on a positive note. Our achievements this quarter showcase our resilience in overcoming both internal and external challenges to create a more robust and profitable foundation for the future. We are excited for the opportunities that lie ahead in 2023, we are focused on creating unique value proposition for our consumer and dealer customers and delivering long term value for our shareholders. Now let me walk through our financial results. I'll provide a detailed overview of our Q1 performance followed by our guidance for the Q2.

Speaker 2

Total first quarter revenue was $232,000,000 $17,000,000 above the high end of our most recent guidance range. Total revenue was down 46% from the year ago period. Marketplace revenue was $167,100,000 for the Q1, up 2% from $163,300,000 in the prior year and up 1% from $166,200,000 in the prior quarter. The increase in marketplace revenue compared to the prior year was primarily due to signing on new dealers with higher average monthly recurring revenue an expansion through product upgrades and add ons for existing dealers on our high margin listings business. As anticipated, Growth in subscription revenue was largely offset by a decline in advertising and consumer finance revenues.

Speaker 2

Wholesale revenue was $25,200,000 for the Q1, down 72% from $91,000,000 in the prior year, but up 6% from $23,700,000 in the prior quarter. The year over year decline in wholesale revenue is due to the self imposed slowdown to ensure that the right processes and policies are in place to enable scalable and predictable growth. Quarter over quarter, however, we saw a slight increase in dealer to dealer transactions due to seasonally strong consumer demand, rising wholesale prices and modest rental fleet participation. Lastly, product revenue was $39,700,000 for the Q1, dollars 8,700,000 above the high end of our most recent guidance range. Product revenue was down 78% from $176,300,000 in the prior year and down 59% from $96,800,000 in the prior quarter.

Speaker 2

The year over year and quarter over quarter declines are due to our purposeful slowdown in transaction volumes this quarter for Instantmax cash offer with a greater emphasis on operational rigor. Through higher quality inspections, we saw a meaningful reduction in arbitration rates and consequently arbitration revenue during the Q1 as well. Together, our wholesale and product revenue line items make up our car offer business, otherwise known as the Digital Wholesale segment. Total revenue for Digital Wholesale in the Q1 was $64,800,000 down 76% from the prior year and down 46% from the prior quarter. I will now discuss our expenses and profitability on a non GAAP basis, which backs out our stock based compensation expense, amortization of acquired intangible assets and net income or loss attributable to redeemable non controlling interest.

Speaker 2

1st quarter non GAAP gross margin was 69% compared to 44% in the year ago quarter. The change in non GAAP gross margin year over year is primarily due to the shift in revenue mix to our high margin marketplace business. Total first quarter non GAAP operating expenses were $123,800,000 down 1% year over year. Non GAAP sales and marketing expense was down 13% year over year to $72,500,000 the decrease in marketing expense reflects our decision to limit marketing investment for Instantmax cash offer, partly offset by a slight increase in brand spend related to the launch of our new brand campaign at the beginning of the year. Our first quarter non GAAP product, technology and development expenses grew 25% versus the year ago period to 30,300,000 Similar to previous quarters, the increase is primarily due to an increase in employee related costs as a result of a 6% increase in headcount from the year ago period, coupled with the commencement of our lease in February for our new corporate headquarters in Boston.

Speaker 2

We expect product, technology and development expenses to remain at these levels as we continue to develop and grow our expanded digital retail product offerings to build our end to end transaction enabled platform. We generated non GAAP operating income of $36,600,000 in the Q1, reflecting operating margin of 16%. Consolidated adjusted EBITDA was $40,800,000 in the 1st quarter, dollars 13,800,000 above the high end of our most recent guidance range. This was due to continued strong marketplace subscription performance, prudent and effective expense management, favorable wholesale market dynamics and improved car offer operations. Non GAAP diluted earnings per share attributable to common shareholders was $0.26 for the Q1, dollars 0.07 above the high end of our most recent guidance range.

Speaker 2

On a GAAP basis, we generated 1st quarter gross margin of 67% compared to 42% in the year ago period. The expansion in gross margin versus the prior year period is due to the shift in revenue mix to the higher margin marketplace business. In the Q1, we incurred total operating expenses of $140,900,000 down 9% year over year. As I mentioned earlier, the decrease in operating expenses reflects a strategic reduction in sales and marketing expense in addition to a 46% year over year decrease in stock based compensation expense due to the revaluation of certain liability based stock awards. 1st quarter GAAP operating income decreased 47% year over year to 14,100,000 1st quarter GAAP consolidated net income was $11,900,000 Net income attributable to CarGurus totaled we ended the Q1 with $456,700,000 in cash and cash equivalents, a decrease of $12,800,000 from the end of the 4th quarter, we generated $66,300,000 in cash from operations in the Q1 and $60,500,000 of non GAAP free cash flow, which includes capitalized website development and capital expenditure costs of $5,900,000 Cash provided by operations in the Q1 during the Q1, we repurchased 4,000,000 shares for an aggregate purchase price of $65,200,000 As of March 31st, we had approximately $166,200,000 available for additional share repurchases.

Speaker 2

I'll conclude with the outlook for the Q2. We expect our Q2 revenue to be in the range of $220,000,000 to $240,000,000 we once again expect strong marketplace subscription revenue to be offset by headwinds from consumer financing and OEM advertising. In our digital wholesale segment, we continue to prioritize operational excellence over volumes. In Q2, we are forecasting a softening in we expect 2nd quarter revenue for our product line item to be in the range of $26,000,000 to $36,000,000 we expect our 2nd quarter non GAAP consolidated adjusted EBITDA to be in the range of $34,000,000 to $42,000,000 And non GAAP earnings per share in the range of $0.22 to $0.25 As we continue to make operational improvements that are sustainable for our car opera business, we expect to reach EBITDA breakeven to profitable for our digital wholesale segment during the Q2. Moreover, as it relates to our operating expenses, we expect marketplace EBITDA to be lower quarter over quarter as we will have a full quarter of our lease expense and increased marketing spend related to our brand campaign.

Speaker 2

However, as we previously mentioned, 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. In the Q1, we significantly exceeded our expectations. We are proud of our results and our team's ability to react quickly to overcome challenges. Our achievements and advancements would not have been feasible if it weren't for our incredible employees globally, whose unwavering commitment and hard work

Operator

it may be necessary to pick up your handset before pressing the star key. One moment please while we poll for questions. Thank you. Our first question comes from Marvin Fong with BTIG. Please proceed with your question.

Speaker 3

Good evening. Thanks for taking my questions. I'd just like to start on car I recognize a lot of progress is made there. And I did hear About your commentary for the Q2, but I guess absent just sort of the end market conditions, I mean, how are you feeling In general, about the progress you've made there and about your the timing and willingness you have to really start Leaning back into that business and putting some volume back through the channel, particularly on the Instant Mac side.

Speaker 4

Marvin, I'll take it. It's Sam Zales. Nice to talk to you. Thanks for the question. I think I had said the first as a Straightforward answer, we couldn't be more pleased with the car offer business and its turnaround over the last couple of quarters.

Speaker 4

I think we had said to you that we want to run a profitable business that's predictable and drives Happy path, a great customer experience and more profitable transactions than less, and you can see the progress we've made. It's been remarkable. I'll highlight a couple of reasons why that's been such a success and I want to thank the car offer team in Dallas and really our sets of many business unit teams at CarGurus have traveled to Dallas to do a lot of work over the last couple of quarters to focus on people, processes, Systems and Products to really call what I would say car offer 2.0 for the business. It started with data and getting our access to all of the information on the parts of our transaction process that we're working and need to be improved and needed to be improved. And those results and the data that we accessed allowed us to really attack every part of the transaction flow to improve our performance.

Speaker 4

It started with inspections. And as we talked about creating mechanical, electrical frame damage, every kind of system check that we needed to, we improved our opportunity to understand which transactions or which vehicles should fail and we failed many more of those transactions and it avoided arbitration and turned around Dramatically as you heard in the comments 70% reduction. Our arbitration losses obviously go down because we're working with partners And removed a lot of that inventory that was sitting and depreciating and that's been the success of a very low arbitration rate going forward. Our rematch rate has been phenomenally better. That rematch rate, as you know, is finding the next dealer in the platform to use to try to Create a transaction, we've reduced that process because of the inspection quality that we've done upfront with our partners.

Speaker 4

And finally turning transportation, which was a negative gross margin business into a positive one has been A phenomenal turnaround, all of that driving the path to profitability for this business. As I mentioned a couple of quarters ago, it will take us a few quarters And we're not done with all of that work. It's a remarkable turnaround. It's a tremendous confidence building for our customers on both sides of the buy and sell transaction, but we have more work to do. And so we're not going to take the reins off and run we scaled volume through that to see if it pressure tests our profitability path.

Speaker 4

We feel very strongly we can run a profitable business at lower volumes and we're going to do that. Our priority is to run a profitable business there and then scale up the business with much more volume. And so I think you'll see us continue to push forward on volumes, but we're going to continue on this path to running a profitable business and very proud of the results we have. I hope that answered your question.

Speaker 3

It did and kudos on all the progress you guys have made. If I could do a follow-up question, you've mentioned that the rental agencies have come back. I think you're controlling their participation. And actually, I think it's interesting to hear they came back since I've been hearing that the OEMs have been giving fleets a good allocation in terms of production volume. So just curious, has your thinking evolved on the rental agencies being how much of a part of the mix are going to be on sort of an ongoing basis.

Speaker 3

And as things stand now, are they being More rational in terms of bidding than they were, say, this time last year. Just kind of give us some additional color there would be terrific. Thank you.

Speaker 4

Yes. Thanks, Marvin. It's Sam again. Our process is the same and being This predictable and profitable business that we want to create a car offer, which is to be thoughtful about any one partner Taking on more of the marketplace than any other. I think when you have an instant trade platform that works as well as it does with our technology, But you add to it the incredible improvement in inspections and the quality of the vehicles going through the platform, the players like the rental agencies will say, I am getting more distribution from the OEMs, but if I got to fulfill volume as the market continues to grow and we and I have an opportunity in the summertime to fill up my rental fleets.

Speaker 4

I'm going to do that with the best partners out there. So we controlled their activity coming in. They were watching their impact on the other players in the marketplace and you saw our overall success of having more and more buyers and sellers succeeding on the platform because of our operational work, we're going to bring them in and bring them in at a tamped level where we control the volume and make sure that we are still at marketplace that's creating that confidence build in all of our customers as we go forward. So we'll bring them in, but watch and control how much we let them participate. And we hope that we're fulfilling that need as a secondary source beyond the OEMs and the new car And they're saying you've got quality vehicles that are late model vehicles that I want to put on my rental fleets, then we're going to service those, but do it in a controlled way with this with this tremendous operational improvement that we've created.

Speaker 3

Great. Thank you so much, Sam. Appreciate it.

Operator

Thank you. Our next question comes from John Collettune with Jefferies. Please proceed with your question.

Speaker 5

Hey, thanks for taking my questions. I wanted to start with pricing, it's been up nicely, although U. S. Paying dealers has declined marginally in the past two quarters. How much of that Would you attribute to seasonality and the challenging macro environment versus your efforts to take some pricing?

Speaker 5

And Second question is, it looks like in the Q2, your outlook implies, sort of moderately lower revenue in product and maybe you could just add a little color around that. Thanks.

Speaker 2

Sure. Thanks for the question, John. It's Jason Trevison here. So we as you've heard, we have we've been focused on capturing the value that we're confident we deliver to dealers. We consistently hear through our own survey and research work as well as through 3rd parties that we in most cases are delivering only the highest volume, but also the best ROI as well.

Speaker 2

And so we have focused there as well as on package levels and cross selling other products, so not just on pricing, but pricing is 1. I think we may have said in the prepared remarks that in our annual business reviews, we've held firmer on price. And so by doing so, that certainly more churn than otherwise would have. And if you were to strip out what we call That churn which is involuntary churn then we would have actually seen dealer ads. And we're not quantifying it to an exact number, but I would say that we are making a conscious decision to stand firmer on capturing the value and if that means near term churn, then we're comfortable with that as we focus on MRR really rather than dealer count per se.

Speaker 2

And we also though believe that over time and we need to earn the business back, but that over time dealers will recognize that ROI and return to us. Dealers admittedly are very focused on their own margins. They enjoyed a period of I think probably record setting dealer net income margins and operating margins. And so as they come off of that high that they've experienced in COVID in the back half of COVID here, we certainly are seeing some dealers in some small segments, who are focused on cutting costs in order to try to maintain that margin. I don't To be determined if that's a sustainable strategy or not, but that did contribute a little bit in Q1.

Speaker 2

And I apologize, could you restate the second question?

Speaker 5

Yes. Just Second one, just a quick one about product revenue and your outlook. It looks like you're looking for a sequential moderation in the second quarter. Just curious if you could add a little bit of color around why that's going to happen? Thanks.

Speaker 2

Sure. We are forecasting that and it's partly driven by our marketing spend our expected marketing spend levels. It's also influenced by our forecast on market conditions and consumer sentiment to or appetite to sell. And then also within the quarter, there are dynamics that occur that you know, are not, it's not like flat for each month of Q1 and flat for month of Q2, so there's just some small gyrations in there as well. Perfect.

Speaker 2

Thank you

Speaker 6

so much.

Speaker 2

Much like Sam's comments, we're just focused on making sure that we have a consistent repeatable way to generate profitable transactions and not get surprised with too many negative transactions or bad transactions. We're proud of the gross margin that we experienced in Q1 on C2D.

Operator

Thank you. Our next question comes from Tom White with D. A. Davidson.

Speaker 6

Great. Maybe just following up on the last question there, Jason. I guess, reading through the tea leaves on the product segment guide, it sounds like you guys are maybe anticipating that used vehicle pricing or wholesale pricing kind of declines here or maybe becomes more volatile. Can you just talk a little bit about how the recent volatility that we've seen there is impacting Dealer appetite or how you expect it to impact dealer appetite to do transactions in the second quarter? And then just a follow-up, it sounds like encouraging news on how the ABRs are going.

Speaker 6

And could you maybe just parse out a little bit like when you take these cohorts that were sort of under monetized and you kind of expand revenue for them, Is it mostly from just higher unit pricing for listings or maybe just help us understand like the How much of it is higher unit pricing for listings versus cross sell or upsells? Thanks.

Speaker 2

Sure. Thanks, Tom. I'll take the first one and then maybe Sam can take the ABR the question on ABRs. So dealer appetite for Dealer appetite changes from unit pricing changes in wholesale Has typically been that we've seen if prices are dropping, there's less dealer appetite to transact. And while for every obviously buyer or for every seller there's a buyer, we have seen volumes in the industry, but also on the car offer platform track fairly closely with that.

Speaker 2

And I think that logic is if a dealer sees pricing has dropped in the last week or 2, their expectation largely is that prices may continue to drop for the subsequent week and so they are less inclined to take on an asset that may Lose value before they've even prepared it for sale. I think it's a little different for consumers in the Instant Max model Where their consumers are less tuned into what car prices have done in the last week or 2 and they're more tuned into just the absolute Dollar value they're offered and if dollar values are higher when they versus when they maybe last checked it, Then they're going to be more inclined to transact. So there it's less about the trend and more about the absolute Price levels at that time relative to where they may have been 3 months ago when they happen to check it. So, now that doesn't mean that transactions stop. It just means that dealers take a different lens to it and a lot of what we've done in the last 3 months or 6 months at Carr offer is build the business to be healthy and profitable when prices over that time have really been consistently declining with an exception period in Q1 for a little bit versus what we had been building for the prior call it 2 years when prices had Pretty much increased through that whole time.

Speaker 4

Jason, I'll jump in. Tom, question was on the ABR's annual business reviews and the success of that. We're really, really proud of the results that are going on in that front. You'll recall having known us for years that we moved away for the last couple of years from that old renewal process. First of all, the timing wasn't great with market conditions coming out of COVID, but second of all that we wanted to become much more consultative in this process to actually provide dealers with insights about their merchandising and their success.

Speaker 4

We think we bring the largest we know we bring the largest audience We think we bring the most down funnel shoppers. We bring the highest return on investment for their marketing dollars. So we've been much more with them in providing these insights to help them get the most out of their package. And so what we've done as seen, you asked about the Car SID growth and the pricing growth, it comes in 2 forms. The first is getting dealers to a higher paying package, a premium package or subscribing to a new product.

Speaker 4

The success of Digital Deal has been phenomenal, our fastest growing product out of the gates for the company. And the reason we're doing that is we're bringing tremendous ROI, Those close rates of 2 to 5 times the close rates of our regular email leads, it tells you that you're bringing a product to market that we can continue to increase price on, but package it up for a dealer to say, oh, I've got that plus area boost, I can broaden my share of market that I'm selling to outside of my local market and get those great digital deal and digitally initiated consumers To close with me, I'm going to spend more on that product. We're selling the premium packages that we have or in some cases, as we mentioned, we're going after underpriced dealers. We know they're far below where they should be paying and the ROI they're deriving is not a fair balance with our ROI from the program, so we're going to increase unit price on some of those dealers who can say, I'm staying at the same package, but my price goes up, That's good enough for us as well. So we're very, very pleased with where we are in the ABRs.

Speaker 4

We'll continue to grow those as we go forward.

Speaker 6

That's great. Super quick follow-up on the voluntary churn you highlighted. Am I right to presume that that's mostly like smaller independents and so maybe it impacts Dealer count, but less of an impact on MRR? Thanks.

Speaker 4

Voluntary churn, I think we was sort of across the board. I think following where the market is right now, inventory is down, margin preservation coming out The really positive results Jason just mentioned for the dealer community in 2022. So we saw that across the board. Where we saw The change though in our net dealer adds was pushing the ABRs and saying we're not going to accept a dealer who's underpriced not paying A fair and reasonable price for the program. So involuntary is where we saw that impact our net dealer adds.

Speaker 4

The voluntary hit across the board as it always has in our business

Operator

thank you. Our next question comes from Ron Josey with Citi. Please proceed with your question. Great.

Speaker 2

Thanks for taking the call. Jason, I wanted to take the question. I wanted to ask a little bit more about CarGurus brand ad campaign now that you're seeing demand and newer tools drive greater overall results and just awareness we're seeing The fact that traffic went up, talk to us more about the brand campaign and the efficacy of it as we see top line growing. Thank you. Sure.

Speaker 2

Thanks for the question, Ron. So as a reminder for folks that really kicked off at the beginning of this quarter, so we're or at the beginning of Q1 rather. So we're only a few months in. It is its goal as we've shared is, 1, to really how the fact that we have so much more capability and options on our site for consumers to shop, finance, buy and sell. And so we wanted to share that.

Speaker 2

We also are expecting to grow our unaided brand awareness and broader brand awareness and more of an emotional connection rather than what historically had been oriented toward a very pragmatic Sort of functional approach to branding, and we're doing all of that in an environment where some of the large spenders that existed in our category a year ago or 2 years ago are spending much less. And so we see an opportunity to capture much more share of voice. It's still honestly to be honest early, excuse me, early. We're a few months in. We've certainly started to I do research and read what's happening, and we're excited by it.

Speaker 2

It's still early to See the needle moving extraordinarily on say unaided awareness or even aided awareness. But we absolutely believe that it is laying the groundwork to establish more trust, which is really important as we ask consumers to do a lot more on our website. Historically, we asked them to Enter e mail information or phone number and that was the extent of it. And now we're asking them to consider putting down a deposit. We're getting Hard pull financing with us.

Speaker 2

And so it's an imperative foundation to our strategy. And we are I would say we're excited by the early research, but I would also say it's really pretty early still. In terms of spend expectations for the year, I mean, we've given a lot of guidance around that broadly speaking, But it's also advertising and brand in particular is one of those things where if it's working right and if it's producing the results, then that remains one of the more fungible and variable elements of anybody's P and L. And so if things are going well, we may decide to get more aggressive. And if not, we may decide to get more conservative.

Speaker 2

So we try to give guidance, but we also try to remain nimble as a company. Understood. Thank you, Jason.

Operator

Thank you. There are no further questions at this time. I would like to turn the floor back over to CEO oh, I'm sorry, there was a question. Next question is from Nick Jones with JMP Securities. Please proceed with your question.

Speaker 7

Great. Thanks for fitting me in here. I guess just taking a big step back, what kind of wholesale prices increasing year to date, I think more than people expected. How is kind of industry normalization changing in your minds And how might kind of the rest of the year progress? And do we ever kind of get back to a pre pandemic normal?

Speaker 7

Thanks.

Speaker 2

Sure. I can take that, Nick. Thanks for the question. When talking about wholesale pricing, there's a relative there's a conversation around relative pricing and then there's a conversation around sort of longer term sort of absolute pricing. From a longer term absolute pricing perspective, we're still well above where we were pre COVID.

Speaker 2

And so if we're at 20%, 25%, 30% above where we were pre COVID. Then I think the question remains, if there is a reversion to the pre COVID mean. And I think most people would say, well, simply due to inflation, we're probably not going back Pre COVID because of chip issues, we're not going back to pre COVID. And so then the question becomes, Okay. Do we have 5 points, 10 points more to get to a new post COVID level, normalized level?

Speaker 2

And I think that's the debate that's happening now is, is this the new water level or does it still have a little bit more to drop? I don't think anybody is thinking it drops all the way back to parity with pre COVID. Then you look at the relative lens And on the relative lens, which is what I referenced earlier is what dealers can be very sensitive to if it's dropping for 2 weeks in a row, they may be more reluctant to keep activity levels high in wholesale. And there we saw we had seen a pretty steady decline in the second half of last year. In Q1, we started to see some Increasing of unit pricing and then you also heard us talk about forecasting some softness and we've seen that in a number of other company's reports as well.

Speaker 2

And so expectation for wholesale and retail is to Well, certainly for wholesales to have peaked in Q2 or to peak in Q2 and then perhaps a flattening or steady decline post that. Right now, the market is coming, I think most 3rd party metrics would say that the prices are coming down and sales activity is a little bit lower with lower inventory and declining prices. But you also then need to start to go from sort of microeconomics to macro and say, okay, but at the same time, OEMs are pumping a lot more new cars into the market. When that starts to happen, it's only a matter of time before those become wholesale trade ins as well. So there's no question it's a unit pricing and inventory levels in wholesale have been more volatile in the past 2 years than probably ever.

Speaker 2

But it does seem as though there's more stabilization now than there was last year, But there might still be some price declines in aggregate to occur yet.

Speaker 7

Great. Thank you.

Speaker 3

You bet. There

Speaker 2

are no further

Operator

questions at this time. I would like to turn the floor back over to CEO, Jason Tervison for closing comments.

Speaker 2

I would just like to thank Thank everyone on the call today. Thank you for your thoughtful questions. In particular, I want to thank all of our employees. We just finished talking about volatility and there's certainly a lot of activity around our industry and many industries, but we're really excited about our results from Q1 as you've heard in our remarks today and we're excited about all the activity that we have going on in our business. In May, we will be at the Jefferies and JPMorgan Conferences.

Speaker 2

And so we look forward to seeing investors at those events. Thank you very much.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Earnings Conference Call
CarGurus Q1 2023
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