CarGurus Inc

NASDAQ:CARG

Earnings Call Transcript 2018-Q4

[Operator]

Ladies and gentlemen, greetings and welcome to the CarGurus’ Fourth Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this program is being recorded.

It is now my pleasure to introduce your host, Rodney Nelson, Head of Investor Relations. Thank you. You may begin.

[Rodney Nelson, Director, Investor Relations]

Thank you, operator. Good afternoon, and welcome to CarGurus’ fourth quarter 2018 earnings call. We’ll 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 is Langley Steinert, CarGurus’ Founder and Chief Executive Officer, Jason Trevisan, Chief Financial Officer; and Sam Zales, President and Chief Operating Officer.

During the call, we will make statements related to our business that may be considered forward-looking, including statements concerning our financial guidance for the first quarter and full-year 2019; management’s expectations for our future financial and operational performance; our business and growth strategy and our plans to execute on our growth strategy, including our ability to expand our global audience; our ability to realize benefits from our acquisition of PistonHeads and successfully implement related integration strategies; the impact from our adoption of ASC 606; our brand awareness efforts; our investments in and ability to drive adoption of new and existing products and their benefits; the value proposition of our products, including the ability of new products to drive AARSD growth; the growth levers we expect to drive our business; our ability to maintain existing and acquire new customers; our expansion into international markets and our international growth strategy; the impact of changes in leadership; our expected expenses, our ability to successfully grow our product and engineering organization; and other statements regarding our plans, prospects and expectations.

Forward-looking statements may include words and phrases such as we expect, we believe, we intend, we anticipate, we plan, may, likely, upcoming and similar terms. These statements reflect our views only as of today and should not be considered our views as of any subsequent date. We undertake no obligation to update or revise these forward-looking statements, except as required by law.

Forward-looking statements are not promises or guarantees of future performance and are subject to a variety of risks and uncertainties that could cause the actual results to differ materially from our expectations. For a discussion of material risks and other important factors that could affect our actual results, please refer to those contained under the heading Risk Factors in our Annual Report on Form 10-K filed after today’s market close as may be updated by our other SEC filings.

Further, during the course of today’s call, we will refer to certain non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our press release issued after market close today. The press release and our SEC filings can be found in the Investor Relations section of our website at investors.cargurus.com and the SEC’s website at sec.gov.

Finally, I’m happy to announce that CarGurus will be hosting its first-ever Investor Day on June 11, 2019 in Boston. We will be sharing more details surrounding the event closer to June, but space will be limited. If you have interest in attending, please contact me directly or email [e-mail].

With that, I’ll turn it over to Langley.

[Langley Steinert, Founder and Chief Executive Officer]

Thanks, Rodney, and thanks to everyone for joining us today. I’m pleased to share, we had a strong fourth quarter that was marked by several key developments. In our U.S. business, we generated robust audience growth, launched audience retargeting, our latest digital marketing product and capped off a successful year of brand building.

In our International segment, our unique visitors grew more than 100% year-over-year in the fourth quarter. For the full-year, we were the fastest-growing listing site in both Canada and the UK, as measured by Comscore, and we delivered 80% segment revenue growth.

On a consolidated basis, we exceeded our revenue operating profit and earnings per share guidance for the fourth quarter and fiscal year. We closed 2018 with another quarter of strong U.S. audience growth. Our site averaged 33 million unique monthly visitors in the fourth quarter, up 29% year-over-year. Further, we averaged more than 34 million unique monthly visitors over the course of 2018, an increase of 40% compared to 2017.

Our U.S. audience averaged 89 million unique monthly sessions in the fourth quarter, up 29% year-over-year and we averaged 92 million unique monthly sessions for the full-year, up 42% from 2017.

And during 2018, we recognized that building the CarGurus brand would be an important initiative for raising awareness among consumers and growing our audience, an effort that we believe will help ensure the long-term durability of our business.

We are working tirelessly to build the world’s most trusted and transparent automotive marketplace, and we are eager to communicate that message to car shoppers, so they recognize the unique benefits of our consumer-centric platform.

In the fourth quarter, we launched the next iteration of our detective TV advertising campaign in the U.S., with ads that highlighted these benefits, including that we give every car a deal rating from great to overpriced, provide more information on cars and dealers and automatically sort the best deals first.

We believe building a loyal audience at scale requires a combination of brand investment and increasing efficiency and algorithmic traffic acquisition. Together, these efforts have allowed us to build the largest U.S. automotive marketplace, as measured by Comscore unique visitors. And our leadership position is growing, as our audience spends more time on our platform than all of the major competitor sites combined.

According to Comscore, we achieved 61% minutes share among major U.S. automotive listing platforms in the fourth quarter, our largest share to date. In fact, time spent on CarGurus was three times that of our nearest closest competitor in the fourth quarter, a testament to both the size and engagement of our car shopping audience. Overall, we are pleased with the audience growth in 2018, and we still see significant opportunity to increase our brand awareness and expand our U.S. audience in 2019.

We believe that the size and quality of our audience creates a value proposition for dealers that is unmatched in our industry. Our audience is engaging with our dealers more than ever, as evidenced by the 62 million connections we delivered to dealers in 2018, up 22% from 2017.

We are educating dealers on the quality of our audience and the strong ROI premise, which we believe will attract more paying dealers in the U.S. To that end, we added 406 U.S. paying dealers in the fourth quarter, compared to 257 in the third quarter.

While we still view U.S. dealer acquisition as a growth lever, we recognize that our growth moving forward will be more dependent on the factors that drive average annual revenue per subscribing dealer, or AARSD, including growing connection volume, new product sales and pricing and packaging.

Historically, we have grown U.S. AARSD principally by increasing connection volume from our own audience. And while we believe that will continue to be the primary growth driver for the near-term, we do expect new products to drive a greater share of AARSD growth in 2019 and beyond.

Our audience gives us the opportunity to unlock unique, data-driven insights into the automotive shopping market, and we are focused on delivering to dealers compelling new products that leverage these insights.

In the fourth quarter, we officially launched audience retargeting in the U.S. Audience retargeting is a digital marketing product that allows dealers to target and attract car shoppers once they travel beyond the CarGurus marketplace to other downstream websites.

With this product, we can identify in-market shoppers and show highly relevant ads, featuring actual cars from the dealer’s lot to consumers that have searched on CarGurus for similar vehicles near their dealership. In this regard, dealers can leverage the CarGurus audience to attract the most relevant consumers to visit their dealer website.

Audience retargeting is made possible because of our industry-leading audience scale, deep data and technology foundation and highly sophisticated consumer acquisition platform that drives our own audience acquisition.

Our product suite is growing. With our enhanced and featured listing products, dealer display and delivery, we’re positioned well to capture our growing share of $3 billion U.S. listings market. With SEM Plus and audience retargeting, we’re beginning to tap into the $10 billion that U.S. dealers spent annually on other digital marketing products.

Our growing product suite is resonating with dealers. We ended 2018 with a multi-product attach rate of 26%, up from 19% at the end of 2017. Taken together, growth in connection volume and new product sales drove accelerated U.S. AARSD growth throughout 2018, culminating in 23% year-over-year U.S. AARSD growth in the fourth quarter.

Dealers like Acton Chrysler Jeep Ram in Massachusetts are finding value in our broadening product portfolio and focusing their digital marketing efforts on the CarGurus platform. Colman Hoyt, President of Acton notes, our overall marketing strategy has been to go 100% digital, and CarGurus fits in as our only listing provider, only SEM provider and only one of two retargeting providers, Hoyt continued.

Within a year, CarGurus has become our number one generator of inquiries on used cars, and in the new car side, it’s also powerful. While our new products represent a small portion of total revenue today, we believe dealers like Acton showcase the power of our growing digital marketing suite.

Moving beyond the U.S., we made strong progress in our International segment in 2018, including the launch of two new countries, the roll out of our first international brand campaign and accelerated audience growth in the second-half of the year. In the fourth quarter, international unique monthly visitors more than doubled year-over-year, with the bulk of the growth coming from our UK platform.

Most importantly, international user engagement is on the rise as well, as international monthly average sessions grew faster than unique visitors, rising 112% year-over-year to $13 million in the fourth quarter. We view audience growth as the best predictor of long-term success in our International segment.

As we believe, dealers will invest, where the consumer is. Our audience growth throughout 2018 has improved our value proposition to the 55,000 dealers in our international markets, and we generated strong paying dealer growth in the period.

We brought on 473 new international paying dealers in the fourth quarter, our highest total of the year. Dealers like Fords Of Winsford in the UK are recognizing the quality of our audience. Nathan Quayle, Group Marketing Manager of Fords notes that their dealership gets very low bounce rates from CarGurus trafficking and we get very high conversion rates from the traffic. We believe experiences like this underscore the quality of our audience and the benefits dealers receive from our transparent platform.

Looking ahead, we’re committed to growing our international business, and we’re making strategic investments to increase our scale.

First, our U.S. audience growth has been successfully bolstered by our brand building initiatives. We believe the same opportunity exists in our other countries, so we are investing in our brand in certain international markets. These efforts started in Canada earlier in 2018, and we recently launched our first brand campaign in the UK. We believe these investments will help us grow our audience faster by highlighting the consumer-centric benefits that are unique to the CarGurus platform.

Second, we announced in December that we had reached an agreement to acquire UK-based automotive website, PistonHeads, a deal we closed in January. PistonHeads is a revered brand among dealers and consumers alike in the UK and has a large dedicated audience, that in 2018 totaled over 5 million average unique monthly visitors, as measured by Google Analytics.

The acquisition increases our audience scale in the UK and will ultimately provide dealers with a unique opportunity to market their inventory on a high-growth platform in CarGurus and a widely recognized brand in PistonHeads, all through one touch point.

As we integrate PistonHeads, we will maintain the independent brand and invest in the platform’s technology to maximize performance in the consumer experience. I’d like to welcome the PistonHeads team to our CarGurus family and express how excited we are to have them on board. As we integrate the business, we’ll keep you appraised of major developments.

Before I turn the call over to Jason, I want to highlight two important promotions within our leadership team that we announced earlier this month. First, our COO, Sam Zales has been named President of the company. Sam is an extraordinary leader with a strong track record of results at CarGurus, and he’s been an invaluable partner to me in shaping our global operations. The Board and I are confident Sam’s expanded leadership will be invaluable as we seek to continue to grow our global business.

I’m also thrilled to announce Kyle Lomeli’s promotion to Chief Technology Officer. Kyle has been a critical force in our engineering team since our early days, helping to build CarGurus core technology and develop our world-class engineering team. The technology behind CarGurus is what sets us apart in our space. And with Kyle’s engineering leadership, we intend to continue to deliver innovative new software solutions for consumers and dealers around the world.

I also want to recognize the enormous contributions of our outgoing CTO, Oliver Chrzan, and thank him for his strategic partnership over these past 11 years. Oliver was an integral part of the foundation and vision of this company, and I’m deeply grateful to have had the opportunity to work with him. All of us at CarGurus wish him well in his new adventures.

Finally, I want to thank each and every CarGurus employee for their fantastic work in 2018, and we’re looking forward to tackling new challenges in 2019, as we work to grow our global business.

With that, let me hand it over to Jason, who’ll walk through our financial performance and outlook.

[Jason Trevisan, Chief Financial Officer]

Thanks, Langley. I’ll provide a detailed overview of our fourth quarter performance, followed by our guidance for the first quarter and full-year 2019. I will elaborate on the impact of ASC 606 on individual line items in our 2018 results, as well as our guidance.

Additionally, our 10-K includes a pro forma reconciliation of our full-year 2018 financial statements that reflects our transition from ASC 605 to 606. Please note that all 2017 financial metrics I reference are reflective of the ASC 605. On future calls, we will only discuss our financial results on an ASC 606 basis.

Total fourth quarter revenue was $126.1 million, up 39% year-over-year and roughly $4 million ahead of the high-end of our guidance range. For the full-year, our revenue rose 43% year-over-year to $454.1 million, which includes only a minor $126,000 benefit from the adoption of 606.

Our marketplace subscription revenue drove the outperformance in the quarter, as total marketplace subscription revenue grew 40% year-over-year to $113 million. Advertising and other revenue grew 34% versus the year ago period to $13.1 million. As I’ve often stated, we expect advertising and other revenue to be less predictable than our subscription revenue, as OEMs and other auto partners can vary campaign timing and promotional activity.

Looking at our performance by geography. The U.S. continues to serve as our principal revenue driver, representing 96% of revenue for the full-year 2018. In the fourth quarter, U.S. revenue rose 38% year-over-year to $121.1 million.

Our International segment revenue grew 63% versus the year ago quarter to $5 million. As a reminder, we’re prioritizing inventory and audience building over commercialization at this stage in our newest international markets that we are encouraged by the progress we’re making monetizing our longer-tenured international markets.

Turning to our paying dealer count. We surpassed 31,000 total global paying dealers in the fourth quarter. We ended Q4 with 31,472 paying dealers, representing an increase of 879 from the end of the third quarter.

In the U.S., we finished the quarter with 27,534 paying dealers, up 10% year-over-year and an increase of 406 paying dealers from the end of the third quarter. This compares to 257 U.S. net dealer additions in the third quarter.

While we are pleased with the improvement in net dealer additions in the fourth quarter, we continue to expect variability in our quarter-to-quarter U.S. net dealer ads. We expect net dealer ads in the U.S. to decline over time as our paid dealer market penetration increases.

In our International segment, we have a large dealer acquisition opportunity before us, as we address over 55,000 dealerships across Canada, the UK, Germany, Italy and Spain. In the fourth quarter, we enjoyed our strongest quarter of the year in terms of international net dealer additions with 473. International paying dealer count grew 55% year-over-year for the second straight quarter, and we ended the fourth quarter with 3,938 international paying dealers.

The strength we realized in connection volume in 2018 led to accelerating AARSD growth rates throughout the year in the U.S. U.S. AARSD grew 23% year-over-year in the fourth quarter to $14,819.

As I noted on our third quarter call, we anticipate that the combination of our growing connection volume and our rolling renewals process will continue to drive AARSD in the near-term. We expect connection volume will remain a primary driver of U.S. AARSD growth in 2019, but we do believe new products will drive a greater portion of AARSD growth over time.

International AARSD was $4,778 in the fourth quarter, a decline of 3% year-over-year. We expect AARSD to be lumpy on a quarter-to-quarter basis, as we experienced high percentage growth and paying dealer count in our International segment. We view audience growth and paying dealer count as the best indicators of long-term success for our international business, and we’re pleased with the strong progress we made on each of these fronts in 2018.

I’ll discuss our expenses and profitability on a non-GAAP basis, which backs out our stock-based compensation expense. In the fourth quarter, non-GAAP gross margin was 94.6% consistent with previous quarters. Total fourth quarter non-GAAP operating expenses were $106.6 million, up 32% year-over-year. Non-GAAP sales and marketing expense represented 67% of our sales in the fourth quarter, down from 73% in the year ago quarter.

Full-year 2018 non-GAAP sales and marketing expense totaled $310.8 million and represented 68% of revenue. For the full-year, we realized a $9.3 million benefit to non-GAAP sales and marketing expense from the adoption of 606, as we capitalized and deferred a portion of our sales commissions, all of which would have been expensed under ASC 605.

Under 605, full-year 2018 non-GAAP sales and marketing expense would have totaled $320.1 million, or 71% of revenue, down from 74% of revenue in 2017, illustrating our commitment to gaining operating leverage in this significant expense item. We expect the bulk of our operating leverage will continue to come from sales and marketing, as our business scales over the long-term that we intend to invest aggressively, but thoughtfully in expanding our audience and pursuing growth for the foreseeable future.

Our non-GAAP product technology and development expenses grew 66% year-over-year to $11.2 million, and represented 8.9% of revenue in the fourth quarter. For the full-year, non-GAAP product technology and development expense grew 82% year-over-year to $38 million and represented 8.4% of revenue.

Growing our product in engineering organization remains a focal point for us, and we expect to increase product technology and development spend as a percentage of sales over the long-term. We achieved non-GAAP operating income of $12.7 million in the fourth quarter, which includes a $2.1 million benefit from the adoption of 606. Under 605, fourth quarter non-GAAP operating income would have totaled $10.6 million, $1.6 million ahead of the high-end of our prior guidance range.

For the full-year 2018, we generated non-GAAP operating income of $44 million, representing 9.7% of sales. Under 605, our full-year 2018 non-GAAP operating income would have been roughly $34.6 million, or 7.6% of revenue. This compares with full-year 2017 operating income of $20.3 million, or 6.4% of revenue.

Non-GAAP diluted earnings per share were $0.11 for the quarter, which includes a $0.01 benefit stemming from the adoption of 606. Under 605, fourth quarter non-GAAP EPS would have been $0.10, $0.03 ahead of the high-end of our guidance.

For the full-year 2018, non-GAAP diluted earnings per share were $0.36, which includes a $0.06 benefit stemming from the adoption of 606. Under 605, full-year 2018 non-GAAP EPS would have been $0.30, $0.03 ahead of the high-end of our guidance. This compares with full-year 2017 non-GAAP EPS of $0.15.

On a GAAP basis, we delivered fourth quarter gross margin of 94.6% and total operating expenses of $112.3 million. Operating income increased to $6.9 million versus approximately break-even in the year ago period. The increase in operating income is primarily the result of a relatively slower growth in sales and marketing expense, as we lap periods that included brand investments and a $2.1 million benefit from the adoption of 606.

Fourth quarter GAAP net income attributable to common shareholders totaled $12.5 million. Similar to prior quarters, we recognize the tax benefit, which in the fourth quarter totaled $4.8 million, stemming from stock deductions from the taxable benefits of equity-based compensation, as well as federal and state research and development tax credits. GAAP diluted earnings per share totaled $0.11 in the quarter.

Geographically, our fourth quarter GAAP operating income was $18 million in the U.S. and we had a GAAP operating loss of $11.1 million in our International segment. We ended the fourth quarter with $157.7 million in cash and short-term investments, an increase of $10.1 million from the end of the third quarter.

We generated $17.1 million in cash from operations in the fourth quarter and $12.5 million in non-GAAP free cash flow, which includes capital expenditures and capitalized website development costs of roughly $4.6 million. The increase in CapEx in the fourth quarter stems primarily from fitting out additional office space near Cambridge headquarters. The adoption of 606 does not impact cash from operations or non-GAAP free cash flow.

During the fourth quarter, we withheld and remitted $4 million in withholding payments from the RSU – from RSU share settlements, stemming from our equity compensation plan. This compares with $4.4 million in withholding tax payments in the third quarter.

As we stated last quarter, we continue to evaluate this practice may explore other avenues for managing tax withholding related to equity compensation going forward, though no change is imminent. Overall, our business continues to demonstrate its strong underlying cash generation profile.

I’ll close my prepared remarks with some commentary on our expectations for 2019, before offering our first quarter and full-year guidance. In the U.S., we remain focused on growing our audience through brand building and efficient algorithmic traffic acquisition. We made strong progress on both fronts in 2018, but we still see ample room to grow aided and unaided brand awareness and we continue to improve our algorithmic traffic acquisition execution at ever-increasing scale.

We also recognized an opportunity to educate dealers on our scale and audience leadership position. We believe the brand building helps dealers recognize our market-leading position and we’re promoting our strong ROI premise with dealers.

We expect these efforts will help fuel further net dealer ads. But as Langley mentioned, we expect that U.S. dealer acquisition will remain gradual and that U.S. net dealer acquisition will become a less material revenue growth driver moving forward. As a result, we anticipate that U.S. revenue growth will become more reliant on the levers that drive AARSD.

Our audience generated 62 million connections in 2018, which feel the vast majority of U.S. AARSD growth during the year. We expect connection volume to remain the primary driver of U.S. AARSD growth in 2019. But as we lap periods with more difficult audience growth comparisons, we believe new products will become a more meaningful driver of AARSD. These products remain a small portion of our revenue base today that we are encouraged by the progress we made in 2018.

We expect our U.S. business will demonstrate increased operating leverage in 2019 via sales and marketing, though we will continue to grow our product and engineering headcount and use our cash generative U.S. business to fund our international expansion.

We made several important strides in our International segment in 2018, and we expect the addition of PistonHeads to accelerate our UK businesses scale in 2019. We are investing in our brand in both Canada and the UK and are encouraged by the international traffic acceleration we witnessed in 2018.

We believe our growing international audience will unlock larger revenue opportunities with new and existing dealers in our International segment in 2019 and beyond. In our newer markets, we’re investing in both sides of the marketplace through audience and inventory acquisition.

Further, we continue to evaluate new international markets for opportunities to launch our marketplace. As a segment, we believe our international business will show accelerating organic revenue growth in the back-half of 2019, compared to the first-half of the year.

With respect to 2019 expenses, we will incur a disproportionate share of our expenses in the first-half of the year, as we maximize our consumer marketing spend efficiency. Similar to years past, we plan to invest more consumer marketing dollars in the first-half of the year in response to consumer car shopping seasonality, and we will likely taper that spend in the back-half of the year. As a result, we expect quarterly operating margins to ramp over the course of the year.

We’re also investing resources in product innovation and pursuing long-term bigger bets. We will continue to develop our digital marketing suite, while also driving innovation in our peer-to-peer marketplace with new features, such as consumer financing and an improving value proposition to consumers. We believe each of these endeavors will unlock long-term growth opportunities for our business.

Finally, the adoption of 606 provided a $9.3 million benefit to operating income, stemming from capitalized sales commissions in 2018. We expect this benefit to shrink by roughly $2.5 million in 2019, as we begin to amortize previously deferred sales commissions. We’ll also incur both integration costs and operating costs associated with PistonHeads for the first time, and we expect that PistonHeads will be a $2 million headwind to operating income in 2019.

Under 605, we expect that we would have generated full-year 2019 non-GAAP operating margin roughly in line with 2018, inclusive of PistonHeads cost. Under 606, we expect consolidated non-GAAP operating margin percentage to contract roughly 80 basis points at the midpoint of our guidance range, which reflects the diminished expense benefit from our initial transition to 606 and cost associated with PistonHeads.

We expect to resume consolidated margin expansion in 2020, once the impact of our transition normalizes. With these factors in mind, we’re issuing full-year 2019 revenue guidance of $554 million to $566 million, non-GAAP operating income of $46 million to $54 million and non-GAAP earnings per share of $0.35 million to $0.40.

For the first quarter, we expect revenue in the range of $127 million to $130 million, non-GAAP operating income of $7.5 million to $9.5 million and non-GAAP EPS of $0.06 to $0.07.

In summary, we’re proud of what we accomplished in 2018, and we’re optimistic about 2019, as we look to add more than $100 million in incremental revenue to the top line. We’re delivering more value to our dealers than ever before, and we’re striving for another year of audience growth and increased contributions from our new products.

Our business is driving a unique combination of profitable U.S. growth with an accelerating International segment and we’re aiming to deliver strong results in the coming year.

With that, we’ll open up the call for Q&A.

[Operator]

Thank you. Ladies and gentlemen, we will now be conducting a Q&A session. [Operator Instructions] Our first question comes from the line of Tom White with D.A. Davidson. You’re now live.

[Tom White, D.A. Davidson]

Great. Thanks for taking my questions. A couple on AARSD, if I can. So you talked again a little bit about new products being more important driver of AARSD this year. Can you give us maybe a rough sense of kind of the average monthly spend levels for dealers in these products or general pricing? And maybe even some sense of what kind of attach rate for some of these is reflected in the outlook?

And then as a follow-up, I think the 23% growth in connections, obviously, traffic growth and audience growth is a big driver of that. But curious if you guys feel like there’s any sort of meaningful opportunity to boost kind of on-site conversion as a way to kind of squeeze more connections out of the audience growth that you get this year?

[Sam Zales, President and Chief Operating Officer]

Sure. Hey, Tom, it’s Sam Zales here. Thanks for the question. I’ll take the first one on new products and we’ll turn it over to Langley on consumer. You asked about rough AOS or the price points for products like this, we’ve always talked about sort of a dealer thinking about $1,000 worth of monthly spend on a listings product.

When you add the display product, the first product that was out the door is our second attach rate product, it’s about $300 a month and spend there for that branding opportunity around the dealers vehicle detail page. A search engine marketing plus spend and we think about that as a management fee to the spend that the dealer is spending on search engine marketing overall our fee typically about $1,000 a month on that product.

And then the newest audience retargeting products surprising us that with our large audience and the ability retarget, we’re earning again another $800 or so a month in spend on that subscription product. So you see an average dealer spend growing dramatically the opportunity if you can attach that across a broad segment of your dealers, it’s a big amount of spend. And again, we’re looking at that large multibillion dollar spend in digital marketing that we’re seeking and the new products are beginning to create great success out in the market to achieve that.

From an attach rate perspective, I think, we mentioned we’ve gone from 19% to 26% year-over-year, obviously, the newest products SEM Plus and audience retargeting are newer. So those create a much smaller impact on that increase in attach rate. Really most of it is from the products have been out there for the longer period of time and that would be the first display product we offer.

I’ll turn to Jason.

[Jason Trevisan, Chief Financial Officer]

Just one thing to add to that, Tom, is that these attached products that we have, they often tend to skew toward larger more sophisticated dealers, which is another way of saying oftentimes franchise dealers more often in MD [ph]. And so there are two implications to that.

One is that, each of these products is not relevant or germane to every dealer that we serve. And the second is that the dealer who may be paying us $1,000 a month for a management fee for SEM Plus is typically a dealer that’s paying us more than $1,000 a month in listing. So, we don’t want to give the impression that we can take every average dealer of $,1000 and double up them with SEM, because that’s – that would be overstating it.

[Langley Steinert, Founder and Chief Executive Officer]

Hey, Tom, it’s Langley. So the second question you had was around traffic conversion. We [indiscernible] test our our site constantly and probably on a daily basis with every new release of the site. I would say, if you think about our traffic sources as being, well, I guess, three, organic, brand and algorithmic traffic, there is quite a bit of work that we’ve been doing, specifically in algorithmic traffic acquisition to cut the data different ways to try to generate even more efficiency through that spend. And that’s been a big focus of ours last – this last year and this year probably even more going forward. So that’s certainly one of our focus is, I assure you

[Tom White, D.A. Davidson]

Great. Thanks so much for the color and Sam congrats on the expansion of the role.

[Sam Zales, President and Chief Operating Officer]

Thank you, Tom.

[Operator]

Thank you. Our next question comes from the line of Ralph Schackart from William Blair. You’re now live.

[Ralph Schackart, William Blair & Company]

Good afternoon. Thanks for taking the question. Just on the international front, traffic accelerated pretty strong in the quarter. I think you talked about most of it from the UK platform. Just curious if that was from the acquisition, or if you’re just seeing broader acceleration across UK in general?

And then you talked about expanding the brand building internationally in 2019, and then also I think you talked about talking about 2019 since second-half for reacceleration. Is that from the brand building internationally, or is that combination of some other factors as well? Thank you.

[Sam Zales, President and Chief Operating Officer]

Ralph. Hi, Sam Zales again. Thanks for the question. There is no PistonHeads impact to those results on traffic growth internationally, that’s all organic. And so you can think about that as a bunch of markets there. But obviously, the biggest ones are the ones we’ve been in longest, which is the UK and Canada.

The brand building impact in 2019 is predicated on great success of our U.S. market. We’ve seen terrific results from not only the growth of awareness of our brand and both aided and unaided awareness and also the traffic that it’s driving for our business very efficiently in the U.S. We’re modeling that same success then to launch Canada and the UK. And our expectation is that, we’ll continue to drive traffic growth and do it efficiently for us, which is our premise we’re using to replicate in those international markets.

[Ralph Schackart, William Blair & Company]

Great. Thanks, Sam.

[Operator]

Thank you. Our next question comes from the line of Heath Terry from Goldman Sachs. You’re now live.

[Daniel Powell, Goldman Sachs]

Hi, thanks. This is Daniel Powell on for Heath. One question and a follow-up. And I know this is probably a bit muddied by the 606 transition, but it looks like you saw pretty meaningful leverage on marketing spend, while you also saw a bit of a deceleration in your traffic growth in the U.S. Just curious if you guys saw an opportunity to potentially spend more and see faster traffic growth in the fourth quarter, as you go into 2019, where it sounds like connection volume is still going to be a meaningful driver of AARSD if there’s any additional color around traffic growth in 4Q? And I have a follow-up.

[Jason Trevisan, Chief Financial Officer]

Hey, Daniel, it’s Jason. No. I – the – so yes, we saw – yes, sales and marketing is muddied by 606, but even in a 605 steady state environment, we saw sales and marketing leverage and we broke that out in the script. So hopefully, you can see that apples-to-apples in both scenarios.

The reason that Q4 has traffic deceleration is, because – well, it’s always the slowest quarter from a car purchasing standpoint, but that was the same in 2017 as it was in 2018. But instead, I would say that we’ve gotten – every year, we get a little bit smarter on where to spend our marketing dollars from a – on a seasonable basis – seasonal basis. And that’s because we look at efficiency of customer acquisition and where it’s going to have the biggest impact for them to purchase cars in their car shopping life cycle.

So we had also just started brand spend second-half of last year and we were experimenting with some bigger dollars that were less efficient than we’ve gotten this year. And so it was not a conscious decision to try and grab leverage, it was instead a decision to try and make the most out of our marketing dollars over the course of the year.

[Daniel Powell, Goldman Sachs]

Got it. Thanks. And then just curious if you guys can give any details around your expectations for revenue contribution from PistonHeads over the course of the year. I believe you quoted the headwinds on op income, but just curious if there’s any color around revenue? Thanks.

[Jason Trevisan, Chief Financial Officer]

Sure. Jason again, yes. We said that there would be about a $2 million headwind to operating margin. And while we’re not giving exact detail, you should think of PistonHeads as a mid single-digit $1 million revenue business. It’s one that was part of a much bigger media company and was one of many titles that they had and was not receiving a ton of investment. And we think there’s a lot of potential there, especially with the skill set that we bring. And so we see ample opportunity for growth, but it will require some investment.

They also have, I would just mention and said this in some of the comments. But they sort of have an outsized audience and an outsized brand reputation among consumers and dealers that we think sort of overweight vis-à-vis the revenue contribution that they have.

[Daniel Powell, Goldman Sachs]

Got it. That’s helpful. Thank you.

[Operator]

Thank you. Our next question comes from the line of Dan Kurnos from The Benchmark Company. You’re now live.

[Daniel Kurnos, The Benchmark Company LLC]

Great, thanks. First question, just on the dealer count, just curious how much of the upside, I think, because you guys obviously talked about that slowing, but still a growth lever still pretty strong in the quarter? How much of that do you guys think came from maybe incremental competitor churn versus other means?

And then separately on, I want to go back to some comment you guys made about sort of the balance between product add-on and connection driving AARSD? And I’m just curious how you guys sort of balance the ability to extract more from the dealer budget in a pretty tight environment here understanding that you guys have really high ROI prop, but you guys are still “leaving money on the table” with a lot of your connection negotiations. So asking them to pay $1,000, $1,500 a month more with some of the other products could be a little bit daunting, just love to hear a little bit more color on that? Thanks.

[Sam Zales, President and Chief Operating Officer]

Yes, Dan, Sam Zales, I’ll take the first one. The dealer count, I think, we’ve said is going to slowdown over time that dealer growth will slowdown over time. It’s choppy by quarter. We had a good quarter in the fourth quarter. I’d attribute that to many things.

One is, I think, our message that we’re the largest audience, the most engaged audience that we’re filling in both our general marketing in the marketplace and our brand that touches both consumers and dealers continues to convince dealers to move from our free program to our paid program, the return on investment that dealers are getting, the message, I think, is out there in the marketplace that we’re driving a tremendous return on investment for customer acquisition for dealers.

I don’t know that I credited to competitor churn. I think a dealer continuously looks at where they’re getting the best return on their marketing dollars. As you know, many still spend on offline channels, and we’re continuing to reap the benefit of converting those dollars to digital and making those successful for customer acquisition. And I do think that when our audience is growing as fast as it is and is as large it is – as it is comparative to the direct competitors in the marketplace. It’s easier for a dealer to say, I will put more of my spend to the CarGurus audience, because it’s driving a bigger return for my customer acquisition dollars.

[Jason Trevisan, Chief Financial Officer]

Yes. and on the second – on the second part of your question, we’ve said a number of times audience and audience growth, connection growth, lead growth is the dominant driver of AARSD expansion still, and we anticipate that to be the case in 2019. New products, which are early, but growing nicely will be a growing contributor to that.

As far as how dealers spend their marketing dollars, they have a lot of different marketing executions if they do in a number of different channels that are offline and online. They want to diversify those marketing executions, because some are more lead-oriented, performance-oriented, some are more brand-oriented and awareness.

And they also know that consumers when shopping for a car go through a pretty long life cycle. And there are many, sometimes dozens of touch points that a consumer will have in identifying the car and the dealer wants to be there for many of them, not just in listings.

And so they’re doing these – this variety of marketing. And we believe that given the audience scale that we have and the insights we derive from that audience, that we’re as well positioned as anybody on a number of these digital executions to serve them well for both performance and brand.

So it’s – if – in a lot of cases, we’re not necessarily growing their marketing budget, as they adopt a new product of ours. They may be taking it from offline and maybe coming from radio and newspaper, or it may be coming from other online providers that don’t bring the level of insight that we do.

[Daniel Kurnos, The Benchmark Company LLC]

Got it. Thanks for all the color and congrats, Sam.

[Operator]

Thank you. Our next question comes from the line of Mark Mahaney from RBC Capital Markets. You’re now live.

[Mark Mahaney, RBC Capital Markets]

Okay, great. I think most of my questions – or all questions have been asked. But I want to ask about the audience retargeting product. So any more color on that? And I think that it’s a pretty recent launch, but the way to think about the adoption curve on that versus some of the other products that you’ve rolled out? Thank you.

[Langley Steinert, Founder and Chief Executive Officer]

I mean, I think a lot of it – we talked a little bit about there being kind of sweet and that’s the way we like to try to market is, we go to a dealer and say, listen, you’re already using hopefully our dealer display, hopefully you’ll soon be using our search engine marketing product and retargeting.

I mean, I think retargeting is nice, because it opens up quite a bit larger market opportunity, because it’s essentially any website that a consumer will have visited post CarGurus becomes a potential opportunity to market a dealer’s product.

I think, as Sam had mentioned, just the sheer size of our dataset represents a pretty unique asset that dealers are increasingly wanting to get in front of. I think, some of the recent moves by Facebook to exit the market retargeting and data analytics has created a real vacuum for dealers.

And they’re clamoring for data sets that can segment tightly down to make models, ZIP code and trim. And we have the biggest dataset and probably the deepest understanding of all those different dimensions. So we think it’s a really exciting opportunity. And I think Sam can attest or I think he talked earlier about some of the recent uptick from our dealers has been very well received.

[Mark Mahaney, RBC Capital Markets]

Could I ask the question this way, if we think about an average dealers AARSD versus one, who also adopts the whole suite display SEM and retargeting. What that kind of difference in AARSD could be? And I understand that, that could be a very tiny use case for a substantial period of time. But just hypothetically, what that delta in AARSD could be?

[Sam Zales, President and Chief Operating Officer]

Yes, Mark, it’s Sam Zales, and I’m just going to let Langley comment, what Langley had said. A great descriptor of sort of why this has been successful for us. Langley has always said, if you bring the largest audience and the most down funnel engage shopper, dealers will say if they have to us. I bought your listings product. I’m spending as much as I can. How can I get in front of a broader audience that you have? And that’s why these digital marketing suite products fit into that value proposition so well.

I think, I described earlier that the average price point, it’s really hard to work off averages, because you are talking about a base of very large franchise or national dealerships in our base, all the way down to the very small independents. I think, that’s the CarGurus value to consumers. They’re going to have the opportunity to see vehicles across that very broad spectrum, the broadest and largest inventory spectrum in the marketplace. And so averages are really hard to use.

But I guess, you’d say, if the dealer, as Jason said before, the more sophisticated, the larger dealer is spending maybe it’s $2,000 to $3,000 a month on the listings package, another $1,000 on SEM. And again, if you could attach every product, we’re not saying we’re going to do that tomorrow, $1,000 on SEM, $1,000 between all the display products, that’s a customer that might be spending – that would be $50,000 a year on that program.

Again, that’s a larger dealer that spending more and buying those extra products. The smaller dealer might be spending only $500 a month on the listings package. So I don’t want to get into too much detail. The averages move very quickly when you talk about a different segment of the marketplace, but that gives you some color, I hope that’s helpful.

[Mark Mahaney, RBC Capital Markets]

Thanks, Jason and Sam. Thank you.

[Operator]

Thank you. Our next question comes from the line of Aaron Kessler from Raymond James. You’re now live.

[Aaron Kessler, Raymond James & Associates, Inc.]

Great. Thanks. A couple of questions. First, if I may provide an update on, I think, the last couple of quarters you talked about enabling dealers for more direct sales, an update there?

And second, just how are you thinking of the financing opportunity for consumers longer-term, I think, we talked about that historically as an opportunity as well? Thank you.

[Jason Trevisan, Chief Financial Officer]

Aaron, can you just clarify your question on direct sales?

[Aaron Kessler, Raymond James & Associates, Inc.]

Yes. Basically, online sales are enabling dealers to basically sell directly on the CarGurus site and then delivering the vehicle?

[Sam Zales, President and Chief Operating Officer]

Sure, happy to talk about delivery, Aaron. It’s Sam, and then we take the consumer finance one separately. The delivery product that we launched fairly recently has had great success, because we saw that some consumers were having a very small set of search results in a local market that might be a remote geographic location.

What we’ve done is, we’ve enabled dealers to participate in that delivery program by saying to the consumer, if there are only 20 search results in that market and the dealer is willing to drive 100, 200, 500 miles to deliver that vehicle, we’ll be very upfront with the consumer in stating that this is a delivered vehicle driven to your doorstep. There might be a delivery fee for that product as well and we’ll enable the IMV or Instant Market Value to account for that delivery fee.

We must make every dealer abide by our seven-day no questions asked return policies or making it a very consumer-focused offering. And then providing that IMV to the consumers that are looking at the price point of that vehicle in their local market comparative to a dealer that sits with physical inventory right there located next to them.

So the consumer is seeing a very clear choice of the dealers in their local market and the vehicle – and what’s available to them, plus delivered vehicles from our other dealers around the country. It’s a win-win for consumers and dealers. It grows our revenue. It’s another product to attach to our dealer base and they’re finding great success in broadening the reach of their vehicles to a broader section of the country. The consumer gets the benefit of very transparent experience, but instead of getting 20 search results, they might have 40 now, including the delivery vehicles. So it’s a win-win, we think for consumers and dealers

[Jason Trevisan, Chief Financial Officer]

And then on the finance. So today you can think about the way in which we’re operating in finance in two areas really. One is with dealers. So we have relationship with Capital One, and that is increasingly integrated between our two companies, where we are trying to provide the consumers shopping for a car think they know which car they want to get an experience online that allows them to be pre-approved for financing through the dealer with Capital One.

And it’s important that I emphasize through the dealer, because we want to work with the dealer in this financing. It improves the consumer experience quite a bit. The average time a person spends in a dealership buying a car is over three hours. And so to enable them to take the financing piece largely out of it, they can spend less time in the dealer. They and the dealer can focus on other things other than financing paperwork.

We want to over time give consumers the same level of transparency and choice in financing that we give them with cars. And so it’s an important piece for us in providing the most trusted and transparent car shopping experience online.

The second piece of financing for us is in peer-to-peer. And there, we are providing direct lending or offering direct lending to buyers of cars through a partner. Today’s, it’s estimated that 50% to 55% of used cars are financed. And so it’s a meaningful piece of a peer-to-peer transaction and it’s a fairly painful piece of a consumer-to-consumer transaction. And so we’re offering that on our site today as well.

[Aaron Kessler, Raymond James & Associates, Inc.]

Great. Thank you.

[Operator]

Thank you. Our next question comes from the line of Marvin Fong from BTIG. You’re now live.

[Marvin Fong, BTIG, LLC]

Hi. Thanks for taking my question. Just one on – so the guidance about relatively flat operating margin. Could you help us think about how that will breakdown between the United States and international? Should we think about international being a larger loss next year given the brand new marketing efforts, or will both geographies be kind of flat on an operating margin basis?

[Jason Trevisan, Chief Financial Officer]

Yes. We’re not giving – hey, Marvin, it’s Jason. We’re not giving segment specific guidance for 2019.

[Marvin Fong, BTIG, LLC]

Okay.

[Jason Trevisan, Chief Financial Officer]

But I would – there’s no – there’s – I don’t – there are no major plans that would we think seriously surprise anybody.

[Marvin Fong, BTIG, LLC]

Okay. Thank you. And a follow-up, if I may. Just on the advertising business, it seems like you guys are doing well relative to some of your peers. Any commentary on why you believe that’s the case? And for next year, how do you think about navigating some of the OEM cutbacks should we consider that is impacting your – the growth trajectory in that business? Thank you.

[Sam Zales, President and Chief Operating Officer]

Hi, Marvin, it’s Sam Zales. I think we’re always wary of the headwinds or any impacts macro level to the manufacturer industry. I think, we’ve been cautious about that. I think, you see us spending much more of our investment and time on the subscription business, which is a very different business and advertising which can be lumpy.

That said, I think, we’re very proud of where we are right now. We’ve not seen the headwinds that others may have with our partnerships in the marketplace, and the advertising business looks to continue to be strong. But we’re always wary that major changes are happening with the manufacturer market and that may cause some pullback at some point down the road. Therefore, we’re going to continue to push our subscription business as hard as we can, and continue to try to weather any headwinds in the advertising arena with the success we’ve had so far.

[Marvin Fong, BTIG, LLC]

Okay, great. Thanks guys very much.

[Sam Zales, President and Chief Operating Officer]

Should just add Marvin. I think the – you said what’s the takeaway. The takeaway is, as Langley said it before, the largest audience, the most engaged audience, it’s hard for a manufacturer not to see where we stand in the marketplace. And that’s what’s led to the biggest strength for the advertising results.

[Marvin Fong, BTIG, LLC]

Okay.

[Operator]

Thank you. Our next question comes from the line of Naved Khan from SunTrust. You’re now live.

[Naved Khan, SunTrust Robinson Humphrey Inc]

Hi, thanks a lot. I just got a couple. In terms of the SEM Plus adoption, can you give some commentary or color on how many dealers you [indiscernible]? And then on the growth in the international markets, I think if understood it correctly, I think, Jason, you talked about growth sort of accelerating in the back-half of the international markets. What’s – if that is correct, what’s the driver of that acceleration in the back-half?

[Sam Zales, President and Chief Operating Officer]

Naved, I’ll take it. At the beginning – it’s Sam Zales. The SEM Plus results, we don’t breakout at a product level, where each of our product stands today. I think, you should think about the SEM Plus business a little differently than our listings or display business only, because in that regard a dealer has to make an explicit decision to rip out a current provider that they’re working with and maybe making it a little dramatic. It’s – make a choice of working with a new vendor, when they are making the change of an SEM provider, search engine marketing provider.

Therefore, those – the flow and the sales cycle is typically longer. When you say to a dealer, you can get into a display product immediately and get in front of our audience. It’s a very quick and rapid acquisition opportunity. The others take a little – this SEM Plus product takes a longer time to convince a dealer that because of our data, because of our technology, because of the ATA prowess we’ve had over the years, we will – we should be the player that they work with.

We’re having success doing that, but it’s a slightly different sales cycle, obviously, a different price point, because it’s a bigger investment and we’ve done well with it. But it works very differently than some of those other products that are quicker to attach, because the dealer is just saying, I’ve already got money spent in brand advertising. I’m going to just add this to it. Hope that provide some clarity about how it’s different, though we’re not reporting at a product by product level. Do you have any?

[Naved Khan, SunTrust Robinson Humphrey Inc]

That’s helpful. Thanks.

[Jason Trevisan, Chief Financial Officer]

And then, Naved, just want to confirm – this is Jason. Just want to confirm your question on acceleration international, that’s in reference to 2019 or in 2018.

[Naved Khan, SunTrust Robinson Humphrey Inc]

Correct. I understood it in context of 2019, but correct me, if I’m wrong?

[Jason Trevisan, Chief Financial Officer]

Yep. No, that’s fair. So first thing I would say is, this is barring geopolitical issues that could arise. Brexit is clearly affecting the UK and the UK is one of our two most mature markets in international. But barring that, we expect that our lead – everything starts with leads and connections.

And so in order for us to forecast an acceleration, we believe that our leads and connections will grow meaningfully. That is fueled in 2019 by more brands than we had in 2018 certainly, as well as ever-increasing efficiency and algorithmic traffic acquisition.

That begets more sellable dealers, because we have more dealers who are receiving a sufficient volume of leads that they would – we would be able to pique their interest. And that leads to us having the confidence to hire more salespeople, when we believe that they’ll be as productive as our model sees fit.

A very small piece of it is that we have launched other countries that we’ve told you guys about. And over time, as more of those come online in the monetization stage, that’s going to add layers, albeit very small early on. But given how few countries we’re in, if – it can – a new country or monetizing can have an effect.

[Langley Steinert, Founder and Chief Executive Officer]

Yes. Naved, this is Langley. Just to highlight something that Jason just talked about, if you think about how we progressed in a market, Jason talked about traffic drives dealers to join our platform, because that’s where the consumers are and that drives revenue. I would argue, it might even start a little farther upstream than that, and why we believe we have succeeded in the U.S. and why we believe we will succeed in Canada and the UK, Germany, Italy, Spain, because we have a unique product.

I know that sounds like a platitude. But we’re the only platform out there, which will coordinate the search results to show the best deals at the top of the search results. It’s much like how Google does search and how Yahoo!, in our opinion, got it wrong. All our other partners, excuse me, all our competitors, while they may be nibbling around the corners around maybe showing some good deal monikers here and there, they won’t change their search results, because if they change their search results, they blow up their income statement in their entire business model.

So, when we think about Canada and UK and some of these other foreign markets we feel certainly it’s going to take time, because we have great respect for our competitors and they’ve build big brands. But we believe strongly that the product that we offer in those markets is unique, and then it will be – it’s going to be extremely difficult, not just technically, but from a business model standpoint for our competitors to react to us, because if they do so, they need to change their entire revenue model, which is essentially a paid inclusion, paid to get to the highest place in the search results.

So it really begins with product. And that’s why 12 years ago, when people asked me if I was out of my mind coming into the United States market and trying to go up against Cox’s, it’s a big company called Autotrader, I was okay with that, because we had a different take on the product. And even if you look at today, why we have the share of minutes that we have here in the U.S. is because our product is unique and different. And it’s – the same thing is going to play out in these other markets.

And we’re really excited about the international markets, because it really speaks to the biggest factor of growth in addition to new products, it’s the number of dealers, can we acquire more dealers. And you look at – you add up Canada, England, Germany, Italy, Spain, I think we mentioned it in the earnings transcript. There’s like 55,000 more dealers to go after.

So, when some people ask me about, are you worried about your slowing acquisition of dealer acquisition numbers? My answer is no, because we think about the market globally. We don’t think just think about in the United States. And so we’re really excited about the opportunities, not just for new products, but for these new markets as well.

[Naved Khan, SunTrust Robinson Humphrey Inc]

Thanks. Super helpful. Thanks, guys.

[Operator]

Thank you. Ladies and gentlemen, we have reached the end of our Q&A session. I’d like to turn the floor back over to management for closing.

[Langley Steinert, Founder and Chief Executive Officer]

Hi, it’s Langley. I just want to thank, everyone, for joining the call, and we look forward to speaking with you again soon. And as Rodney talked about, we would urge everyone that wants to join our first investor conference to register and come join us here in Boston and learn more about, not just the financials, but meet some of the management team and learn more about our product directions. So anyway, thanks for everyone and have a good evening.

[Operator]

Thank you. Ladies and gentlemen, this does conclude a teleconference for today. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.