CARG - NASDAQ

Greetings. Welcome to the CarGurus' Third Quarter 2023 Conference Results [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to Kirndeep Singh, Vice President, Investor Relations. Thank you. You may begin.

Thank you, operator. Good afternoon. I'm delighted to welcome you to CarGurus' third quarter 2023 earnings call. With me on the call today are Jason Trevisan, Chief Executive Officer; and Sam

Thank you, Kirndeep and thank you to all those joining us today. Before I begin, I would like to share the exciting news that we have accelerated the purchase of the remaining minority equity interest in car offer. Our decision to expedite the purchase was driven by our strong desire to accelerate new product opportunities that allow us to build an end-to-end transaction-enabled platform even sooner. Further, this decision aims to help us continue the momentum of our operational improvements to build a stronger platform for our dealer partners. We believe that by accelerating our purchase, we will realize synergies of our integrated platform sooner and create an even better consumer and dealer experience. I would like to thank Bruce Thompson, CEO of CarOffer for his partnership for nearly three years. Upon Bruce's resignation in connection with the expected closing of the acquisition in December,

Thank you. [Operator Instructions] Our first question is from Rajat Gupta with JPMorgan. Please proceed.

Great. Thanks for taking the question. I just had a couple. Firstly, on the fourth quarter guidance, it implies a flattish sequential EBITDA, maybe like $1 million higher, but if I hear your comments around the Marketplace business, it would suggest that increase as you confirmed that in the prepared remarks as well, but it kind of implies the cargo for EBITDA, kind of, flattish sequentially. So is that just seasonality? Or because I would have expected with the operational focus we continue the improvement. So maybe if you can just clarify that, and then I have a follow-up.

Sure. Thanks, Rajat. So yeah, I think in our remarks, we talked about given the growth in Marketplace and the comments on OpEx that sequential EBITDA there should be higher. But I think it's also fair you're in the ballpark to say that car offer is expected to be flat.

Understood. Got it. And just on the car offer purchase decision, obviously, a little surprising that you decided to buy the remaining stake a little earlier. You mentioned some of like the product integration efforts that led to that decision. But I'm curious, was there any increasing visibility around the business turning to profitability in the near-term or anything around broader market condition that also lead you to act sooner on the purchase? Thanks.

Sure. I wouldn't say that the broader market led us to act sooner. In terms of visibility, I think we have, as we all know, it's a transaction business, and so it's much harder to forecast that in our subscription business, but we have gotten better at predicting it and forecasting it because of the operational challenges that we've made. And we've talked about -- but I would say the four reasons that we accelerated this are: one, it's been accelerated for product innovation between our two platforms. Two, it allows us to have full ownership to have more ball control on the operational improvement. Three, we're excited about

Understood. Thanks for the clarification I’ll jump back in queue.

Sure. Thank you.

You want to jump in…

Thanks, sure. Thanks Tom, thanks. It's Sam

Thanks.

Our next question is from Naved Khan with B. Riley. Please proceed.

Yes. Hi. Thank you. A couple of questions from me. Jason, you had mentioned that you'll be done with the ABR for this year, but we'll continue to look at opportunities into next year. Can you give us some sense of the scope of that, what percentage of dates might be still paying significantly below when the rate card is? And then I had a follow-up question. If I look at the wholesale gross margin, it was down sequentially. Is it just because of the scale being down sequentially? Or did anything change in terms of arbitration rate going on or anything else been on in that line? Thank you.

Sure. I can handle the first question and then Sam, if you want to speak to the second question or go ahead, Sam, why don't you take the first one, on ABRs.

Okay, happy to take that one and jump in later if you like. Naved, thanks for asking. I want to keep reminding that our Carfit [ph] number, which has grown so successfully year-over-year and quarter-over-quarter at 9% year-over-year. We're thrilled with, but it doesn't just come from the ABRs. I'll take your question because it's a good one. I just want to remind that Carfit is growing because we're bringing on new customers at a higher price point. We're up-selling customers to higher packages, premium packages. We're cross-selling new products and programs like this New: Sell My Car - Top Dealer Offer, it's a tremendous opportunity to keep growing our subscription revenue. On ABR specifically, we've said that we're going to renew about 20% of our base this year. So that last quarter is happening right now. Those were the largest price point customers away from the market rate, if you will. They were the lowest priced customers, as you can tell, each quarter, we've gone after the next set of price point customers slightly below the market rate for us. We're still seeing that success, as Jason just said, renewing them agreeing to the price point and if they say no for a short period of time coming back on again. Our thought is that there will always be ABR components to our Carfit growth. By next year, as our lead volume continues to grow, we can keep producing an ROI for our customers. There will be more customers that we will be able to renew on an annual basis. So we can't tell you what percentage that will be. We'll continue to go after that ABR component as part of our Carfit growth. The beauty is, though, that's only one portion of that Carfitgrowth. We know we're going to keep acquiring customers as the question just came up, we're winning more new business and acquiring that at higher rates. We're going to keep adding to our premium packages. So customers move up to a higher platform, digital deal now in our featured premium package. That's going to be a tremendous lift to Carfit as we go forward. And then obviously, as we sell additional products like this New: Sell My Car - Top Dealer Offer, is an additional way to keep growing Carfit. So ABR, we're very excited about continuing it, but it's just one of those many levers that grow Carfit for our business. I hope that answers the question on that.

Just the quick follow-up there Sam, on the Sell My Car or The Top Dealer Offer, what's the subscription pricing on that? Have you determined that? Or is that still something that you're testing?

Yeah. I don't think we've announced that publicly, Naved. It's a great question, and it would be looked upon as a product at similar price points to the others that are out there in the marketplace. What's been great about that product, we're still what we call it in a pilot mode. We're out at 18 regions of the country and we're not fully out to market yet. But the -- we launched this in the fourth quarter from a pricing perspective. It's had great take rates. I think what you want to think about the Sell My Car - Top Dealer Offer program, is, number one, it allows the consumers something very different in the marketplace. They can choose the white glove experience and say, "I like what IMCO is, pick the vehicle up from my home, let me get a digital payment and you can drive it away from me. But consumers are now getting a second offer, which is a choice, would you like to drop that off at your local dealership and get a higher price point there, while there isn't the same convenience factor, you get a higher price point. Dealers requested us to build this product. Our largest dealer said, "Could you build something like this. We're not satisfied with the tool sets that are out there in the marketplace. You heard about the NPS score, we're getting from our customers on it thus far. They're getting a great return on that subscription investment. And it's adding significantly to Carfit and will be a long-term growth lever for our business as we scale it. We're only in 18 markets right now. And then on your second question around wholesale and arbitration. So wholesale unit prices are – have been trending down this year. They're the lowest, I think, this past month than they have been since the spring of 2021. So it has been a steady decline since then. And – and we expect it to probably continue to decline in aggregate over the next -- through the balance -- till the end of next year. Conversion rate as a result is down. So the number of transactions that actually occur in wholesale versus those that were attempted is also down. And it's up a little bit recently because the UAW strike, but tends to be tends to be down. And -- but our -- and those two factors would point to, all else being equal, arbitration increases. But as you've heard us talk about, our operational and product-related improvements that we've made at CarOffer are really limiting in a nice way arbitration. And those are things like inspection, integrity, ability to see cars to different product machinations that we've built off the matrix, ability to have a more discrete matrix, faster delivery times, textile registration processing. I mean all the things that go into transparency of a transaction and customer satisfaction have – have helped keep our arbitration levels really low, really nicely about.

Got it. Thank you, guys.

Thanks.

Our next question is from Kunal Madhukar with UBS. Please proceed.

Hi, thank you for taking the questions. A couple, if I could. One on the semi car top dealer offer, how does that work technically in the sense? I thought that dealers would enter the prices in the matrix, and that is what would be shown to the consumer. So where does the second offer come in into play? How long does that take? Is that also instant -- and if it is, how does that work? And then on this one, is the delta between the two offers, really, the cost of picking up the car? Or is it something else? And then the second one would be on the Car Shed. As we look at next year, how should we think of the evolvement of -- or the growth of Car Shed into 2024? Thank you.

Kunal, thanks. it's Sam

I'd wait for -- sorry, the second part of the question was, Jason, do you want to take that one?

Yes, I can take it. It's related to cars next year, so it's a different topic. So we have not given guidance for Carson next year. The -- but I'll just quickly run through what are the drivers of carsid [ph] and carside is but one factor in dealer growth is the other factor. So new and customers that we're bringing on for the first time that we're rewinning at market rates is a significant driver versus those who were legacy customers on at lower rates. -- upgrading to new packages is a key driver. We talk about ABRs, and I think they probably get overplayed a bit because they're one manifestation of us renewing customers. And there are many ways that we renew customers, and ABRs have -- are sort of the most extreme of those that are underpriced. But we are renewing and resigning customers all the time. Other products. So we are adding in and building a broader portfolio of other products like highlight, new car highlight, geographic geo expansion, digital deal. Now you've heard us talk about popular offer. So there's a number of other products. And then we also -- you heard us talk about dealer data insights. And so these are features that we don't charge a la carte for, but there are features that we are confident at value to what our dealers are getting from us. And if we do that successfully and in meaningful enough ways, then we think we'll have even more success helping dealers realize the value that we're driving them.

Thank you so much

Our next question is from Doug Arthur with Huber Research Partners. Please proceed.

Yes, thanks. Jason, I guess, looking at the product side of the business, I mean, what set of circumstances, if you're predicting price in the wholesale market is likely to decline through the balance of next year, which I think is pretty rational. What set of circumstances is going to jump start this business? And then just sort of a follow-up on this, sell my car cannibalization issue. Are you beginning to look at ways to pivot away from the original IMCO proposition?

Sure. Thanks, Doug. So yes, if the wholesale prices continue to decline, which there's -- I would say that's the general consensus view. We think -- I mean, digital penetration in wholesale is still quite small. And so we know that we have an opportunity for digital to take much more share than it is. The ranges of what digital represents today range from maybe low double digits to 30%-ish. I mean, so there's still the majority of the market that is offline that we think we can go after. Number two is we do think we're making these operational and product changes already, which are opening up new customer segments who are historically not going to be an early adopter to buying sight unseen, and they're now willing to try a product that's more like a matrix rather than an auction. The third is as we now are one unified company, 100% together, we are excited about the acceleration of product innovation. And our long-term vision is that we can have full visibility on data and give this to dealers from wholesale all the way to retail and the easiest example of that is we are seeing the retail trends. We can tell a dealer what types of cars they should be sourcing and then we can help them source those exact cars. So -- that's one example from a product and data perspective. Another one is tighter integration on our sales and account management and go-to-market. And so it's early days in digital adoption. It's still early days had car offer from a total life of company perspective, it's still a young business. And now with

Okay. Thank you very much.

You bet.

Our next question is from Ralph Schackart with William Blair. Please proceed.

Thanks for taking my question. On car offer, Jason, you noted some operational improvements in a prior question. Just curious if you sort of expand on that a little bit and talk or more broadly where you are in that process in terms of making operational improvements? And then now that you'll own all of car offer, does that significantly increase your ability should you need to make operational improvements or further ones going forward? Does that increase your ability to do that at a much faster rate? Thank you.

Ralph, I'll take it. I'm close to that business day to day. So thanks for asking Sam here. The operational improvements we talked about the last few quarters have been tremendous. We've talked about mechanical inspections. We've talked about the ability to look inside a vehicle for frame damage. We've done electrical. We've done much more in the upfront process of understanding customer vehicle quality and that's led to arbitration dropping dramatically. We needed to do that to have a trusted process for buyers and sellers, and that's been tremendous. Our transportation efficiency has been phenomenal. We've got much more margin out of how we've led that business. So, all of the efforts on operations have been terrific. But I think you're speaking to the exact point here. Number one, by being able to manage the business directly day-to-day, which has been sort of a third party relationship and advisory. It gives you the opportunity to do the same thing we've done at CarGurus is run a predictable efficient, highly profitable business. And we'd like to take control and the opportunity came to us to be able to do that earlier than later. And as Jason said,

I'll just add one thing to complement what Sam said. Any time there's an earn-out structure, which effectively step two and step three were, there's -- it's just tough to perfectly align incentives if nothing else, the set remeasurement was on EBITDA or a line on EBITDA, but you're not aligned on time horizon, for instance. And you're also limited in how closely you can integrate, because you want to let that business perform to its highest potential. And so 100% ownership there allows total alignment of incentives of time horizon of integration and an efficiency of operations, if you can do things at a greater scale rather than it's two different entities.

Great. That’s helpful. Thanks Jason, Thanks Sam.

Our next question is from Marvin Fong with BTIG. Please proceed.

Hi. Great. Good evening. Thanks for sneaking me -- question on the new cellular car products. So from CarGurus' a standpoint, do you guys have like a different margin profile between the INCO mantra driven way, which I think is kind of a transaction fee basis versus what sounds like a subscription model for the -- for sort of like the in-store drop-off. So do you guys have a preference? And sort of a second part of that question. So is there no arbitration risk if it's dropped off at the dealer? Is it dealer responsible for inspection and all that letting?

Sure. Thanks, Marvin for the question. Yes, they're very different. So the cell my car, top dealer offer is a subscription product. It is oriented around the leads that are driven to that dealer. And so it's extremely high margin similar to our listings business. The Instant Max cash offer, as you know, is a gross revenue rev rec dynamic and it's more a transaction fee based. I wouldn't say, I wouldn't think of it as whether we have a preference. The preference is to give the consumer selection and convenience, and so we think we're doing that. And especially by giving them the two highest offers, the white glove highest offer and the local dealer highest offer, we're sort of doing most right by the consumer and giving the most control to dealers by allowing them to bid whatever they feel is appropriate to bid. So we are very early days in Sell My Car, really excited by it. And -- but it's -- I wouldn't try to compare the two because there's such different treatments, and it's really about giving the consumer and the dealer frankly more options.

Understood, thanks. And maybe a follow-up question, I guess, to tackle a different topic. I mean, it's great to hear that both the UK is not profitable, but I think Canada as well. You guys obviously narrowed your focus a couple of years ago. I mean, would you entertain expanding internationally again, or do you feel like you have enough on your fleet?

That's not on the short list of our priorities right now. We think there's so much opportunity in our expansion to move into supporting all the transaction types that you're hearing us roll out now, that's where our focus is. And by the way, doing that in Canada and the UK as well, where we're bringing modified versions there of the things that we're doing here. And that's a small reason that those companies or those countries rather are achieving the success that they are. But it's certainly a contributing factor. There's just a lot of runway in those countries, even with our existing model. And as we get more scale, then that gives us more, a little more pricing power, but also more brand recognition and more dealer customer satisfaction.

Got it. Thanks so much, Jason.

Thanks, Marvin.

Our next question is from John Colantuoni with Jefferies. Please proceed.

Hey, guys. Thanks for taking my questions. This is Vincent Kardos on for John and Jefferies. May first question talked about digital D a little bit. You talked a lot about the 2X conversion on leads and then 5X conversion on leads that you'll see a bit further down the funnel. Can you talk a little bit about the features that make that product such a great tool for converting leads and then whether 2X is kind of about where you'd expect the conversion to stick around at long term? Or if there are product enhancements or new features or ways to channel in more down-front leads that could push that multiple higher over time? Thanks.

Sure, Thanks for the question. I think Vincent, what's your name? You cut out there for your name. So yes, we've given a 2X to 5X times higher conversion rate data point on digital deal. And that range reflects that a user can do different aspects in the digital deal funnel. So for example, if they do simply a prequalification, financing prequalification, then that may only increase their close rate at the lower end of that. But as they start to do some or all of things like getting a trade and appraisal, or setting up an appointment or if they do a hard pull on financing to get actual penny perfect deals or if they put down a deposit -- with each of those items, you're getting just so much further and further down the funnel and ready to purchase that those conversion rates get to the higher end, and in some cases with some combinations at some of the best run dealers, they're getting just phenomenal close rates. And so what we're pushing for as a company and within the digital deal product, is giving the consumer and the dealer as much choice as they can. I mean, we talk about it as consumer who's sort of going down this path to buying a car, they can decide to pull on any of these levers that they'd like and then they can decide to get off the highway and go into the dealer at any point that they'd like and give them that selection. So they don't feel as if they're boxed in to doing all of it online or if they're boxed in and not doing any of it online. So summarize its different elements in different combinations and given the skill set of the dealership that will drive the close rate improvement.

And our next question is from Jed Kelly with Oppenheimer. Please proceed.

Jed, I'll jump in on the second one, which is a good question about Sell My Car as a subscription business versus anything like a pay-per-lead business. We went to market after customers asked us to build this product and built it in pilot phase and then came to market through testing and trial and obviously now in 18 regions. This explicit feedback from dealers is I've got a budget. I want to set a budget. I want to look at my budget and manage it over time. And if it were on a pay-per-lead basis that wouldn't be too variable for me, I can't control when it goes up or down over time. Instead, what they're doing with us is paying a subscription for a block of those opportunities. So being able to say, I'm going to buy a block of 100 of those leads that gives me an opportunity to manage my budget. Fortunately, right now, we're in such a mode where consumers are buying into this Sell My Car top dealer offer and more -- we have more demand from a consumer side than we expected to have. So now we can go out to dealers and say, buy a second block, by a third block. But they're able to manage that in a budgeted way as opposed to as a variable on a per lead basis. So they preferred that. And for us, it's terrific because it's a predictable subscription with monthly recurring revenue, which runs at a margin and more like our core listings business. We're also selling to the same customer, which is wonderful. We're going out to be marketing leader who's saying or the General Manager of a store saying, I want leads for buyers, I'd love leads for sellers, from consumers, so I get more inventory. I can sell that at retail, and I own the budget for marketing to go acquire those customers. So it's a perfect win-win for our business. We're really proud of this new product we launched recently.

Thank you.

We have reached the end of our question-and-answer session. I would like to turn the call back over to Jason for closing remarks.

Thank you. So I just want to thank everyone and thank our employees, certainly, as we did, thank our customers and our shareholders. Thanks for your -- we appreciate your interest, and we hope you share our enthusiasm for our momentum in our core business and innovation on all these new products. Have a great evening, everyone.