Greetings, ladies and gentlemen. And welcome to CarGurus, Inc. Third Quarter of 2022 Earnings Results Conference. At this time, all participants are in listen-only mode. Question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It’s now my pleasure to introduce your host, Kirndeep Singh, Vice President, Investor Relations. Please go ahead.

Thank you, Operator. Good afternoon. I am delighted to welcome you to CarGurus third quarter 2022 earnings call. We will be discussing the results announced in our press release issued today after the market closed 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 fourth quarter and full year 2022, 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 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 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 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.

Thank you, Kirndeep, and thanks to everyone joining us today. This year has been a pivotal time in the evolution of our company, as we have been transforming from a Listings business to a transaction-enabled platform at a swift pace, which has enabled us to provide our dealer partners and consumer audience a portfolio of offerings for every stage of the automotive purchasing and selling life cycle. While we are still early in the journey of fully integrating Digital Retail and Digital Wholesale with our core Listings business, I am proud of the progress we have made this year as we put in place the building blocks for long-term success. Regarding our most recent quarter, while there were business areas that exceeded our expectations, our third quarter financial metrics fell short of the low end of our guidance range as we did not adapt our wholesale operations to the rapidly evolving macro market challenges. The shortfall from our guidance is driven exclusively by our Digital Wholesale business, as our marketplace results were either in line or well ahead of our expectations. Our Digital Wholesale business was impacted by unpredicted intra-quarter volatility, which worsened as the third quarter progressed, where we saw a decline in used car retail demand and wholesale volumes, as well as relatively rapid wholesale unit price declines. These market volume and unit price declines resulted in two disappointing trends, compressed wholesale transaction volumes and sell-through rates within our dealer-to-dealer and Instant Max Cash Offer businesses, as well as higher arbitration rates during the third quarter. In addition to these market challenges, we identified operational issues within our CarOffer business, which negatively contributed to an already tough dynamic. Simply put, the processes and operations, which worked well in a rising wholesale price environment were not effective enough in…

Yes, sir. [Operator Instructions] Our first question comes from Chris Pierce of Needham.

Hey, there. I was just curious, you talked about operational procedures you have put in place, what are some things you guys can do to lower the arbitration rate, especially where wholesale prices or used car prices might come in even further? Is it switching third-party services you are using? I am just kind of curious how you can kind of get on top of the arbitration rate a little better?

Chris, I will take...

Sam, do you want to take that?

Yeah. Sorry about that, Jason. Chris, Sam Zales here. Thanks very much. Arbitration rates will always increase in a down market. We know that with prices declining for a seller. They are in that product, that vehicle for a higher price and hoping to get it back up for buyers. It’s a decision of is the bottom of the market there already. So those numbers will go up. But we have those operating challenges and we are being direct about how we are changing that process going forward. It starts with inspections, Chris. We just didn’t have enough discipline in our inspection process for the scrutiny that goes on in a down price market. So what we are doing right now is working with new partners on an inspection basis. One, we are getting scans for frame damage, really important in a market where prices are declining; number two, mechanical inspections; number three, electrical inspections; number four, vehicle history doing more scrutiny on vehicle history. We are doing that in comparison to what was external, more an external look at the vehicle for damage on the outside of a car and needing to have much more rigor on the inside of the vehicle. So we are enrolling new partners to do that from an inspection perspective and it certainly advanced rigor on those vehicles that have much higher mileage or older model vehicles. That’s number one. It starts with the inspection. Number two is our rematch process and the arbitration process. We, again, didn’t have enough operational rigor at CarOffer around that arbitration process. What happened was, if a dealer who was buying said, I don’t like the vehicle, the process of either creating a concession and stopping that arbitration process right at the beginning as opposed to rematching that…

Okay. Thanks for the detail.

Next question comes from Jed Kelly of Oppenheimer.

Hey. Great. Great. Thanks for taking my question. My first question, given the higher arbitration rate and can you talk about sort of the lift that’s going to be to sort of eventually bring dealers back to the platform or can you talk about churn that you have seen? Thanks.

Yeah. Jed, it’s Sam Zales. I don’t -- I wouldn’t say, we actually had churn in the business. In fact, our buyer rate of dealers on the marketplace was up actually quarter-over-quarter. So we are pleased to say dealers still find the platform to be a tremendous capability to acquire and sell vehicles. So more buyers getting on in the quarter, which is terrific. It’s just that in the market when declining prices show up our -- and arbitration is more unnatural as buyers scrutinize the vehicle, they are purchasing, our operating systems weren’t as effective as they could be. And so in that front, we will actually take a tougher stand with some of our buyers and sellers to say, we have our policies. We know if the damage was not above a certain amount. You have got to stick with our policies and make sure we are working together as partners on that front. We were a little too lenient on that front, quite honestly. We try to serve every customer and make them satisfied and that leads to transactions that lose money. And so then more importantly, as we go forward, I think, with this increased level of scrutiny on the inspection by bringing in scans for frame damage, mechanical, electrical, looking at the vehicle history in more detail, we will probably let our fail rates go up, which means we won’t let that transaction go through and we won’t have an arbitration on the back end. So that’s where you will see both of those, but I don’t think we have seen churn on the platform, in fact, we have seen more buyers getting on in the last quarter.

Okay. And then my follow-up, I guess. The Instant Max Cash Offer, it makes a ton of sense. I guess, can you talk about how you are thinking about marketing investments and sort of wanting to introduce this more to consumers? I mean you have to fix some of the operational issues before you kind of feel comfortable marketing this on a more broad basis?

Sorry, Jed. I didn’t hit the unmute button. Sam here, again, good question. We will be more careful about how aggressively we market. Remember that we have had this tremendous consumer experience where consumers are saying it’s the best process I have seen for Instant Max in the market. But we are going to be careful about marketing too much until we fix and make more disciplined our operating process. What we did see in the third quarter is more aged vehicles and a lower price point on the consumer transactions they were trying to sell through the Instant Max capability and because of that, you have to have the disciplined operating processes to manage the inspections at a finer level. So if older vehicles are coming through from consumers, you have got to have those more rigorous inspections. Number two, the arbitration processes I just went through have to be much more disciplined in the way we allow that with our customers and also how effectively we speed that arbitration process to not take losses by rematching to another customer. So you will see a slowdown to speed up again in the future. This whole effort is to say, slow down the marketing. IMCO is still a fantastic consumer experience, but it’s got to be a profitable operation for us. So while we fix those operational issues, we will then ramp up again increase the marketing as we go forward.

Thank you. The next question comes from Nick Jones of JMP Securities.

Great. Thanks for taking my question. If I could sneak in two here. I guess, one, I think, Manheim used value vehicle index came out and the declines in October maybe moderating a little bit. I mean, do you have any sense of kind of the rate of change and what the impact on transaction volume is? Is it potentially improving into 4Q? So that’s the first question. And then the second question is, I guess, back to arbitration. I mean is something kind of structurally different than how the fleets arbitrate versus kind of now indexing away from the fleets, is that potentially underpinning some of the challenges you are feeling today? Thanks.

Nick, we have indexed away from the fleets and that’s important. I think that was my point to Jed that more buyers from a dealer perspective are on the platform. So we are really pleased with that. I don’t think it’s one customer or another. I really put it on ourselves at CarOffer that the operational rigor, the systems, the data we use has to be more rigorous in that process. I will give you an example, we are sending a CarGurus team of data analysts and engineers and project managers to join with the CarOffer team to improve the data processes to allow us to systematically reduce that arbitration as we go forward. The data just wasn’t available to a manager to say, let’s stop that arbitration right at one point as opposed to allowing it to go to a remet situation or move it through with a more economically bad outcome for us. So it really is more on us than the market and I think just in a declining market, and you pointed to the wholesale prices. It’s continued down. The drop in the numbers went through September. October has not looked better. I think the wholesale pricing market is continuing downward. But I hope at a much less aggressive rate as it did through the third quarter. So we think things will stabilize at some point, but more importantly, for us, it’s the operational rigor and execution that we take going forward to ensure that we are ready to eliminate the unprofitable transactions and get back to the full percentage of profitable transactions.

Yeah. And I would just add -- this is Jason here. I would just add, Nick. There was -- as you pointed out and we mentioned in our comments, a very steep decline in used car unit pricing from July to September. And even if it were to moderate in October, if you look at the last couple of years, they are still at very high indexed pricing. And so we are operating on the assumption and we are building the business to plan for some level and it won’t be linear, but some level of ongoing decline until its closer to what I would call normal or expected. I mean I think inflation is real and so it won’t go back to where it was, but I think it still has quite a ways to go, given the sort of 45% increase it had from 2021 to 2022.

Thank you. The next question comes from Brad Erickson of RBC Capital Markets.

Hi. I guess just a couple more on the super fun topic of arbitration. You mentioned you saw the average prices come down on through the quarter. I guess back to an earlier question around potentially being structural. Do you ultimately just have to focus on higher value cars, maybe a bit more to protect the economics? I know you clearly you are doing a lot from an operational efficiency standpoint. But just curious if you have to sort of focus and segment the market a little bit more narrowly to protect the economics there? And then I have a follow-up.

Brad, I would say that, in a price declining market, the entire side of the business goes downwards. So we -- I don’t think we can control it. We are focused and always have been focused. When Jason mentioned in the rising tide market, the model and the operational rigor we had worked fine when the price points were up as high as they have ever been. As those prices decline, it just requires us to have more of that rigor to ensure we reduce that level of arbitration and unprofitable transactions. I think we will always be known as a platform that is a tremendous one for the high priced vehicles. But as the market moves downward and consumers -- part of this is consumer demand is going downward as well and the price points are moving down on the retail side, we are going with the market. And I think once we put in the mechanical, electrical and frame damage inspection partners that are ramping up right now, I think, we will have the capabilities to work with where the market is right now and always our sweet spot in the higher priced vehicles.

Got it. And then just one other one in looking to maybe unpack the EBITDA outlook for Q4. But I think it looks like if you back out the CarOffer drag in Q3, it implies the core is running maybe around 30% or so in terms of EBITDA margins. But obviously, that’s worse in Q4. I understand CarOffer’s clearly going to be a bigger drag. But just curious if in Q4, the EBITDA guidance contemplates margins maybe getting hit on something incrementally or if they are going to continue running in those ranges? Thanks.

Yeah. I can take that one. No. We don’t -- I don’t think there’s incremental hits in the core business at all. We have headcount and marketing are two big expenses, and those can fluctuate. -- marketing can fluctuate, headcount tends to be a steady increase. And we have hired -- we have slowed our hiring, but we are still net adding and that’s to continue to invest in Digital Retail and build innovation in Listings. So I would say no incremental surprises there. And then on the revenue side, no incremental surprises on subscription, where you can see a little more fluctuation would be in advertising and consumer finance, and those do have a little bit of seasonality to them, but it tend to be slower in Q4.

Thank you. The next question comes from Ralph Schackart of William Blair.

Good evening. Thanks for taking my question. Jason, in the prepared remarks, you talked about the focus on increasing operations to sort of work through the near-term challenges with Digital Wholesale, just curious how much can you operate and execute through a declining sort of environment or where the macro is tough. I guess in other words, with the base or with the business continue to run at this profitability level for the foreseeable future until you can get the controls you are trying to put in place or will there be sort of like an immediate or more pronounced operational focus that could hopefully return the business to increase profitability going forward post Q4?

Sure. I will start and then, Sam, if you want to add. And thanks for the question, Ralph. So part of what you are seeing in EBIT in Q3 and Q4 EBITDA is us working out of the operational shortcomings from August and September. And so you can think of that as sort of flushing out of the system, the higher volume of vehicles that we took in, in arbitration and so there’s a piece of Q3 and Q4 that is you can almost think of it as one-time in that nature as we are sort of writing the wrongs that were done a couple of months earlier. I think then when you sort of move to steady-state operations, Sam has already talked about a number of improvements that we have made already. And some of these are simply policy and enforcing that. Some of these are procedures enforcing that in the company. And so you can start to see those changes right away as well. But between flushing through and making those operational changes, neither of those happen overnight. But as Sam mentioned, we have folks here at CarGurus from a variety of functions that are working very closely with the team at CarOffer to make improvements and changes every day. And so even in a even in a price declining environment, and this was my comment earlier, which we are assuming for lack of more crystal ball charity, even if we assume that prices will continue to decline, we are putting in the operations that we will make for the asset-light efficient profitable business that existed 6 months ago. So it’s totally attainable. We have -- we know what we need to do. We just have to work through doing it.

Okay. Thank you.

The next question comes from John Colantuoni of Jefferies.

Hey, guys. Curious to know what you are seeing in terms of used vehicle demand from the rental fleet on CarOffer to a little bit more depth. What is your view kind of on the magnitude of the impact that’s slowly recovering sort of new vehicle supply we will have on the fleet’s appetite for used cars going into Q4 and 2023? And then what is your outlook for the percentage of kind of CarOffer transactions that will end up being comprised by the rental fleets going forward next year? And I have a quick follow-up as well.

Hey, John.

I…

Oh! Sorry, Jason. Go ahead.

I was just going to give you a break from talking to him. So, John, we said in the prepared remarks that rental activity was muted as we expected it to be and that’s what we expect it will be going forward. They are getting more allocations from new and there’s a chance they come back in a sizable way into the wholesale arena. But we are not -- that’s not in our forecast and we are certainly not building a business around that in any way. So the short answer is, while they may come back, we are not forecasting it and nor did we really see it in any meaningful way in this last quarter.

Got it. Thank you. Let me just add, this is Vincent [ph] on for John, by the way. And then I would follow-up by just asking kind of how the departure of the rental players have kind of affected the bid-ask spread that you are seeing on CarOffer, assuming it’s now gone kind of too wide, how -- to what extent has that kind of played out due to the departure of the fleets? Thanks.

I think that largely worked itself out at this point and meaning we had that sort of bid-ask spread hangover from when the fleets were bidding so aggressively, and I think that, that has worked its way through and sort of normalized. Where you see that, I think now in any residual way is that in Instant Max Cash Offer, the offers made to the consumers are not nearly as compelling on a relative basis as they were when the fleets were involved. But from a dealer-to-dealer perspective, I think, the market has come back to a reasonable bid-ask spread. I think what you are seeing, which has led to lower volumes in the wholesale market in general is that you see a lot of dealers that have cars that they are underwater on and they are reluctant to sell those wholesale and take the write-down. They are instead often trying to hold on to those and sell them in retail. And so I think that’s a different form of a bid-ask spread. That’s where you have a seller that is unwilling to accept what is the new market value for that depreciated asset and instead hoping that they can get out from under the underwater dynamic that they are in.

Thank you. The next question comes from Doug Arthur of Huber Research.

Yeah. Thanks. Jason, just to that point, I mean, what are you seeing on the consumer side? I mean, clearly, given your guidance for Instant Cash -- Max Cash in Q4 interest in selling cars at lower prices has dried up pretty dramatically. Is there a real reluctance, because prices are now, I don’t know, 15% lower than they were three months or four months ago and the market just is not adjusting that reality quickly, will eventually, I mean, you are just seeing a lot of reluctance to sell, clearly?

Yeah. I think it’s a few things, Doug. Thanks for the question. So number one, oftentime [Technical Difficulty] had a bunch of static, oftentimes when somebody is selling a car, because they want to buy a car and so all of these things are connected, right? And so we know that retail demand is down. And retail demand is down for a number of reasons, a recession, higher auto loan rates and so fewer people are interested in buying a car, then fewer people need to sell a car. So that’s number one. Number two, prices are down and so if this is somebody who heard from their friends six months ago, oh, I got an amazing offer on my used car or if they checked on a price of their used car six months ago and it’s lower now, that’s just on a relative basis on appealing. So I think that’s sort of the market demand side of it. Then I would say if we look sort of internally at our -- at CarOffer, an Instant Max Cash Offer, as Sam said before, we need to tighten up our operations and make sure we do that before we continue to dial things back up and grow again. And so we are -- we have taken down marketing for Instant Mac specifically. We have done a number of things to consciously slow it down, number one. And number two, while arbitration rates are high in a depreciating asset environment, we need to build in more buffer in addition to making sure that we have arbitration under control. We have to build in a buffer to compensate for what may be higher arbitration rates until we can get them down and so that’s another factor that will lower the offer that we are able to give to a consumer. And that also then in that sort of, I guess, conservative mindset that I am describing, we are also less likely to take a car that has -- that’s significantly older or significantly higher mileage, because that has a higher propensity for arbitration. So a number of factors that are both consumer demand side, as well as our -- the level of aggressiveness that we have in growing that.

Hey, Doug. Does that conclude your question.

Yeah. I am all said. Thank you.

Thank you. The next question comes from Naved Khan of Truist Securities.

Yeah. Hi. Thanks a lot. Two questions from me. One on sales and marketing, can you maybe just provide how much is fixed versus variable related to ad spending here? And how should we think about the ad spending on the Listings business, while you are fixing the other pieces? And the second question I have is around use of cash, so with the increased flexibility that you have on the revolver? What are the goal -- what are the thoughts that the Board has on maybe being more aggressive on share buyback and given the stock has kind of declined pretty significantly in recent months?

Yeah. Hi. Can you repeat the very last thing you said, Naved?

Yeah. Just on share buyback and putting the increased financial visibility to use to buy back share more aggressively?

Sure. So in terms of sales and marketing, fixed versus variable on marketing on our Listings business, or frankly, on any of our sales and marketing for that matter. From a marketing perspective, very little is fixed. If I am interpreting your question correctly, it’s really what is like a locked-in media placement by versus more flexible performance and so a very, very small fraction is locked in contractual media commitments. In terms of use of cash, we -- yeah, so we are happy that we got the line of credit wrapped up. It is -- if you look at our cash position, it’s gravy, so to speak. I mean it’s not something that is needed by any means. Just generically speaking, I mean, as we think about capital uses for our business, it could be to invest more aggressively in operations. But again, we are quite profitable. It could be for M&A, certainly or it could be for a share buyback. We continue to do net share settling. So in any given year, we are buying back $15 million to -- I should say in given year [ph]. In the last several years, we bought back $15 million to $20 million worth of shares through net share settling and that is really one of the three, I guess, CapEx, too. But that’s really one of the three uses that we would think about for the cash.

On the...

Good.

Yeah.

Yeah. Go ahead.

On the sales and marketing, you said it’s mostly ad spend, it seems like. So is it fair to assume that it’s primarily the Listings business where it’s going, because we saw a sequential sort of downtick, but it still is roughly 50% of your marketplace revenue. Is that the right way to think about it in terms of go forward?

I don’t -- I wouldn’t think of it as a steady state. I mean, it’s come down quite a bit over time And well, two things. Number one, I would think of sales and marketing independently and that’s how we think about it. Secondly, even within marketing, we have performance marketing, we have brand marketing. We have a number of different executions and then we also have different messages that we are trying to get to respective audiences. As it relates to Listings and driving activity there, that’s what’s driving value, that’s what’s driving Digital Deal leads, that’s what’s driving leads to dealers, consumer finance leads, et cetera. So we view that as exceptionally low funnel, high ROI value to our dealers. Ad performance marketing is very tunable by the day, advertising or brand advertising and specifically television-based brand advertising is really the only execution that we do of any scale that requires upfront purchasing where you do have some modest level of commitment a few quarters out. We think about all of our marketing on a very ourselves on an ROI basis and so we look at ROAS, return on advertising spend and we have high confidence that ROAS is at a very high ratio.

Thank you. Our final question comes from Tom White of D.A. Davidson.

Hey. This is Tevis Robinson on for Tom. Thanks for taking the question. I am curious whether you guys can comment or quantify the extent to which you may be seeing meaningful growth in the number of vehicle listings from the dealers that show their inventory on your marketplace?

So are you asking -- Tevis, it’s Jason. Are you asking for the volume of dealers who have any inventory in our marketplace?

Yeah.

Yeah. We would probably have to get back to you. I haven’t looked at that. Just for -- maybe for everyone’s benefit, we have paying dealers and then we have freemium dealers whose inventory. We include our freemium model now caps the volume of leads that can go to a free dealer in any given month. But we still think that the inventory there is helpful to the consumer value proposition. Inventory has started to come back. The used inventory was down 20%, 30%, I think, maybe a max of 40%, but that’s come back to near pre-COVID levels. New inventory is where it took the big hit, it was down 70% and that started to come back. That’s most likely more driven by vehicles per dealer and less driven by more dealers coming on to our platform who weren’t done before. But as you know, we have got about 25,000 paying dealers in the U.S. and so the number of dealers that we have in total is greater than that. And I don’t think we actually typically cite that number or that trend, but we can look into it and get back to you.

Got it. Okay. Thank you.

Sure. Thanks.

Thank you. Ladies and gentlemen, we have no further questions on the line. I will now turn the call over to Mr. Trevisan -- Jason Trevisan for closing remarks.

Thank you very much. We’d just like to thank everyone for joining us this evening. And most importantly, I would like to thank our employees and our customers and our partners. And in particular, I’d like to thank all of our veteran colleagues and customers in light of Veterans Day holiday that we are celebrating all this Friday. So, thanks, everyone. I hope you have a good evening.

Thank you. Ladies and gentlemen, this concludes today’s conference. Thank you for your participation. You may now disconnect your lines.

Good-bye.