CarGurus Inc

NASDAQ:CARG

Earnings Call Transcript 2022-Q4

[Operator]

Good day, and welcome to the CarGurus Fourth Quarter and Full Year 2022 Earnings Conference Call. Please note, this event is being recorded.

I would now like to turn the conference over to Kirndeep Singh, Vice President and Head of Investor Relations. Please go ahead.

[Kirndeep Singh, VP and Head, IR]

Thank you, operator. Good afternoon. I'm delighted to welcome you to CarGurus’ fourth quarter and full year 2022 earnings call.

We will be discussing the results announced in our press release issued today after the market close and posted on our Investor Relations website. With me on the call today are Jason Trevisan, Chief Executive Officer; and Sam Zales, President and Chief Operating Officer.

During the call, we will make statements regarding our business that may be considered forward-looking within applicable securities laws, including statements concerning our outlook for the first quarter of 2023; management's expectations for our future financial and operational performance; our business and growth strategies; our expectations for our CarOffer business and acquisition synergies; the value proposition of our current product offerings and other product opportunities; the impact of the semiconductor chip shortage and other macro-level industry issues; and other statements regarding our plans, prospects and expectations. These statements are not promises or guarantees and are subject to risks and uncertainties which could cause them to differ materially from actual results. Information concerning those risks and uncertainties is available in our earnings press release distributed after market close today and in our most recent reports on Forms 10-K and 10-Q, which, along with our other SEC filings, can be found on the SEC's website and in the Investor Relations section of our website.

We undertake no obligation to update or revise forward-looking statements, except as required by law. Further, during the course of our call today, we will refer to certain non-GAAP financial measures. A reconciliation of GAAP to comparable non-GAAP measures is included in our press release issued today as well as in our updated investor presentation, which can also be found on the Investor Relations section of our website.

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

[Jason Trevisan, CEO]

Thank you, Kirndeep, and thanks to everyone joining us today.

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

Despite these short-term difficulties, we're well down the path of delivering on the vision of being the number one digital destination for both consumer and dealer customers to confidently buy and sell their vehicles with the best selection, price, convenience and trust.

Our vision has remained steadfast, despite an evolving and volatile automotive market landscape. Throughout the past year, the automotive market still encountered challenges arising from the semiconductor chip shortage. However, in 2022, a reversal of two key factors brought us to an inflection point. New inventory increased, albeit below pre-pandemic levels and interest rates rose quickly, driving automotive lending rates to levels not seen since 2010, which curbed consumer demand and drove up days on lots.

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

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

Fourth quarter cancellations were driven by concerns of rising interest rates, softening consumer demand and continued uncertainty toward acquiring inventory with declining prices. However, at the same time, some dealers were supercharging their advertising to increase turn rates and continue to drive shoppers to the dealerships in times where consumer interest is waning.

As for our annual business reviews, after several years of pausing broad-based renewals, we have taken strides to update our renewal process by simplifying our packaging and increasing the value our dealers receive by adding features to our listing tiers. These steps have resulted in dealers moving up our listings ladder and greater monthly recurring revenue or MRR. As we grow MRR through renewals, there will be a trade-off between dealer adds and revenue growth. But we remain confident in the ROI we provide and our ability to grow paying dealers and Quarterly Average Revenue per Subscribing Dealer or QARSD over the long term.

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

We're pleased with the growth of our highly profitable Listings business. It is through continued product innovation and partnering with our customers that we're able to drive sustained growth and value that sets us apart from the competition. A key component to the to the success of our Listings business is continued innovation with new product offerings and capabilities.

Digital retail capabilities continue to remain a competitive focus for dealers as market share for online transactions continues to grow. While only a small percentage of transactions are now being done fully online, over 70% of buyers say they prefer to do more from the convenience of their home for their next purchase. As consumers look for added flexibility to complete more elements of their vehicle shopping journey online and dealers operate with smaller sales forces compared to pre-pandemic levels, we are enhancing our toolkit to arm dealers with the capabilities to meet evolving consumer needs while focusing on higher quality leads.

In May of 2022, we launched Digital Deal an offering which allows consumers to build a near penny perfect deal with either dealer or vehicle-specific finance and insurance products and then place a deposit on their vehicle of choice with a seamless online to in-store experience. As of the fourth quarter, there are now 1,588 dealers utilizing this newly deployed capability to better serve their customers.

With more digitally enabled listings available in than other online retailer, we're providing consumers with a convenient, self-selective purchasing journey, all while providing trust, transparency and the best pricing from the largest selection of inventory among major online automotive marketplaces in the U.S.

Digital Deal continues to deliver growth opportunities for our foundational Listings business by enabling dealers to reach even more high-intent shoppers utilized at cargurus.com. Our marketplace, coupled with Digital Deal frontloads the majority of consumer buying research and selection effort through our online experience, allowing them to schedule their appointment through CarGurus to complete the remaining steps in store.

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

The seamless user experience has resulted in a remarkably high Net Promoter Scores for both consumers and dealers. And so, as of the beginning of this year, we have increased the price of our Digital Deal offering to better align with the value we are providing our dealer partners.

Our digital retail capabilities increase optionality and convenience for both dealers and consumers by providing consumers flexibility to complete a sale or purchase in a manner that best works for them and offering dealers more choice to tailor their product suite that best serves their individual business needs.

The future of digital retail will level the playing field for our dealer partners who are unable to provide these solutions to consumers on their own and/or wish to utilize our largest consumer audience to sell additional inventory through the CarGurus platform to drive greater profitability.

While we've seen success with the Marketplace and Digital Retail businesses, our Digital Wholesale business was more greatly impacted by difficulties in the second half of 2022. As we mentioned on our last earnings call, CarOffer encountered operational challenges that were optimized for a rising wholesale market that were insufficient in a declining price environment, negatively contributing to an already tough macro dynamic of declining wholesale prices and lower conversion rates. These challenges were identified in October, and we worked quickly to optimize reporting, systems and processes to counteract this decline.

While we're confident that our fast action short-term remediation efforts have addressed immediate concerns, we remain vigilant in monitoring the business continuously to ensure the newly defined processes and policies are resilient and produce a path to profitability.

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

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

Another step we've taken towards maturing CarOffer operations relates to stricter adherence to arbitration and rematching policies. Historically, in an effort to create goodwill amongst dealers, there was leniency with regard to the arbitration claims window, placing the burden of vehicle depreciation on us. We, therefore, instituted stricter policies such that if a dealer has an issue with a vehicle, they must make a claim within days. This helps ensure that a dealer complies with our arbitration policies and allows CarOffer to handle claims more quickly and effectively.

Through arbitration claims, we also witnessed a high number of vehicles get rematched, the act of moving an arbitrated vehicle to the next highest bidder on the platform. To limit the number of rematches, which cause higher transportation losses and risk of further delayed arbitration, we enforced strict locations. Fewer rematches coupled with a shorter arbitration window has allowed us to reduce unnecessary transportation expenses and liquidate vehicles faster to support shorter market exposure, which is critical in a declining price environment.

Through more rigorous inspections, better management of the arbitration process and stricter enforcement of our policies, we slowed down the Digital Wholesale business with levers that were in our control. This allowed us to focus on the implementation of the changes without the overhead of managing volume. While this was a conscious decision, our self-imposed slowdown was compounded by a general slowdown in the wholesale space. As a result, fourth quarter revenue from our Digital Wholesale segment, which includes our dealer-to-dealer business and Instant Max, was approximately $120.5 million, down 33% year-over-year. Similarly, both gross merchandise sales, or GMS, and transactions were down year-over-year. GMS for the quarter was $455 million, and we conducted 18,405 transactions. Transactions is a new key business metric that is comprised of dealer-to-dealer transactions and Instant Max Cash Offer transactions and is discussed further in our press release issued today.

Instant Max Cash Offer is powered by the CarOffer matrix. Challenges which impacted the dealer-to-dealer business, similarly affected our consumer-facing product offering as well. With Instant Max, we also have the ability to quickly toggle up or down our marketing spend to grow or shrink the traffic coming to our site to trade in the vehicle. In an environment where wholesale prices were declining, and we were working quickly to improve our operations, we felt it was in our best interest to reduce marketing spend to limit the number of transactions flowing through our system.

Additionally, we had less competitive offers, which further reduced conversion rates on our platform. While this set us back from a market share and volume perspective, we believe it was the right decision to ensure we did not exacerbate our challenges while we work to fix them. In the fourth quarter, Instant Max Cash Offer generated $73.7 million in revenue, in line with our fourth quarter guidance.

Our number one objective is to ensure the right processes, policies and team members are in place at CarOffer, so we can build a sustainable business that scales predictably over time. We're focusing on benchmarks and KPIs that as we progress towards our goals, will signify increased stability of the business. As that stability increases, we intend to shift back to prioritizing reengagement with dealers and capturing dealer wallet share with the goal of growing transactions and market share on the platform.

CarOffer’s matrix technology allows dealers to transact automatically and at any time, using rules-based strategies to create a buying and selling experience that is unlike anything offered in the market today. And we believe that as we work through these operational issues, we are setting up CarOffer for success.

Despite headwinds and self-imposed slowdowns, 2022 was a year of growth for CarGurus and I'm immensely proud of the team's progress towards fulfilling our vision of building the only end-to-end automotive transaction-enabled platform.

At CarGurus, we give people the power to reach their destination. For consumers, this means empowering them with the tools and information necessary to confidently shop, finance, buy and sell in the largest network of dealers and their inventory in the U.S. For dealers, it means continuing to provide innovative forward-looking solutions by giving them the resources and capabilities they need to grow their businesses efficiently and profitably. It is through our consumer and dealer solutions and the combination of our innovative Digital Retail offerings, resilient foundational Listings business and differentiated Digital Wholesale business that we're able to create a unique value proposition as an automotive ecosystem.

As I mentioned earlier, we're mindful of striking a balance between innovation, growth and profitability to maintain a healthy business that is prime for scale and competitive strength. In a market of broader economic uncertainty, a technology sector that is largely pulling back and an auto subsector that is experiencing unprecedented pricing demand and supply chain volatility, it's important we remain disciplined in growing our financial and strategic position in the market.

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

Now, let me walk through our financial results. I'll provide a detailed overview of our fourth quarter and full year performance, followed by our guidance for the first quarter of 2023.

Beginning with our 10-K, we have evolved our external reporting to better align with the transformation we have undergone as an end-to-end transaction-enabled platform. We now have two reportable segments: our U.S. Marketplace business and Digital Wholesale business, otherwise known as CarOffer. This new reporting structure allows stakeholders to better understand key components of our business and its corresponding performance. In our filings, you will find our financials updated prospectively to incorporate this new two-segment view.

Total fourth quarter revenue was $286.7 million, down 16% year-over-year but nearly $2 million ahead of the midpoint of our guidance range. Revenue for the full year was $1.655 billion, up 74% over the prior year. This was heavily influenced by our wholesale and product revenues, which I will discuss shortly.

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

Wholesale revenue was $23.7 million for the fourth quarter and $237.6 million for the full year 2022. Wholesale revenue declined by 71% compared to the same period in the prior year and declined by 50% from the third quarter. The decline was predominantly due to the continued market softening which began earlier in the year, resulting in decreased transaction volumes for our dealer-to-dealer business. As expected, decreased volumes resulted in reduced transaction fees and transportation revenue for the quarter.

Lastly, product revenue was $96.8 million for the fourth quarter and $758.6 million for the full year 2022. Product revenue grew by 1% year-over-year and declined by 55% from the third quarter. The decrease in product revenue was due to reduced transaction volumes and continued declining average selling prices associated with Instant Max Cash Offer.

As I mentioned earlier, this quarter, we materially decreased marketing investments in Instant Max to reduce the top of funnel traffic and focused our efforts on improving CarOffer operations. Fourth quarter Instant Max Cash Offer revenue was $73.7 million, which was in line with our most recent guidance range. Together, our wholesale and product revenue line items make up our CarOffer business, otherwise known as the Digital Wholesale segment. Total revenue for Digital Wholesale in the fourth quarter was $120.5 million and for the full year was $996.3 million.

I'll now discuss our expenses and profitability on a non-GAAP basis, which backs out our stock-based compensation expense, amortization of acquired intangible assets, acquisition-related expenses and net income or loss attributable to redeemable non-controlling interest.

Fourth quarter non-GAAP gross profit margin was 50% compared to 59% in the year-ago quarter. The change in non-GAAP gross profit margin is primarily due to a lower gross margin profile in wholesale and product. Non-GAAP gross profit margin increased from 37% in the third quarter to 50% in the fourth quarter, primarily due to the shift in revenue mix.

Our Marketplace business continued to drive significant gross profit margins in the fourth quarter. This was even more pronounced in our gross profit margin percentage with the Digital Wholesale business representing a smaller percentage of our revenue. However, even though our Marketplace business continued to generate increase in gross profit in the fourth quarter, the lower volumes in the Digital Wholesale business, coupled with increased arbitrations and the liquidation of inventory that built up at the end of the third quarter resulted in a decline in the Digital Wholesale margin in the quarter. It should be noted that the increase in arbitration losses occurred, primarily in October and November as we liquidated the inventory that built up in September as prices were declining.

Improved operational rigor resulted in significant inventory control and a reduced inventory balance of $5.3 million at the end of December. In the fourth quarter, as we liquidated CarOffer inventory from our books, we estimate this flush inclusive of vehicle depreciation to have had a gross profit impact in the mid-single-digit millions.

Total fourth quarter non-GAAP operating expenses were $118.8 million, down 4% year-over-year. Non-GAAP sales and marketing expense decreased 18% year-over-year to $70.6 million. Non-GAAP sales and marketing expense represented 25% of revenue, flat to the same period last year. The decrease in marketing expense year-over-year speaks to our strategic alignment of expenses to top line growth. We remain thoughtful with our investments as we continue to grow the business and develop our brand campaign without material incremental marketing investments in Q4.

Our fourth quarter non-GAAP product, technology and development expenses grew 25% versus the year-ago period to $28 million. The increase is primarily due to an increase in employee-related costs as a result of a 16% increase in headcount from earlier in the year, and continued investment in our technology teams to grow our new areas in Digital Wholesale and Digital Retail in the coming year. We expect this expense to continue to increase as we continue to develop and grow our expanded product offerings to build our end-to-end transaction-enabled platform.

We generated non-GAAP operating income of $23.6 million, representing an operating margin of 8%. We generated $27.8 million of consolidated adjusted EBITDA for the quarter, almost $14 million ahead of the high end of our guidance range due to continued strong subscription business performance, prudent and effective expense management and improved CarOffer operations, albeit at lower volumes, resulting in lower arbitrations, reduced vehicle rematches and improved transportation losses.

Non-GAAP diluted net income per share attributable to common shareholders was $0.22 for the fourth quarter, $0.06 above the high end of our guidance range.

On a GAAP basis, we generated fourth quarter gross margin of 48% compared to 53% in the year-ago period. The contraction in GAAP gross margin is primarily due to the lower margin profile of our Digital Wholesale business.

In the fourth quarter, we incurred total operating expenses of $107.4 million, down roughly 21% year-over-year.

Fourth quarter GAAP operating income decreased 33% year-over-year to $29.6 million. Fourth quarter GAAP consolidated net income was $23.2 million Net income attributable to CarGurus totaled $24.8 million and fourth quarter GAAP net income attributable to common shareholders of $159.2 million. We ended the fourth quarter with $469.5 million in cash and investments, an increase of $65.1 million from the end of the third quarter.

We generated $95.3 million in cash from operations in the fourth quarter and $90.5 million of non-GAAP free cash flow, which includes capitalized website development and capital expenditure costs of $4.8 million. Cash provided by operations in the fourth quarter was primarily driven by our results as well as an increase of $32 million, driven by working capital movements.

In December, we initiated a share repurchase program in the amount of $250 million. During the fourth quarter, we repurchased 1.4 million shares for an aggregate purchase price of $18.7 million. As of December 31st, we had approximately $231.3 million available for additional share repurchases.

I'll conclude with the outlook for the first quarter. We expect our first quarter revenue to be in the range of $195 million to $215 million. We expect to see healthy growth in 2023 for our Marketplace business. However, in the first quarter, we expect modest headwinds related to OEM advertising to offset quarter-over-quarter subscription revenue growth.

For our Digital Wholesale business, we plan to further limit our marketing investment for Instant Max Cash Offer.

With our substantial reduction in marketing, coupled with materially lower transaction volumes, driven in part by macro factors and our purposeful slowdown, we expect first quarter revenue for our product line item to be in the range of $21 million to $31 million. Please note that we now we’ll be guiding to product revenue, which aligns with our GAAP financial statements line item. As we have previously mentioned, product revenue includes Instant Max Cash Offer revenue, but excludes inspection and transportation revenue and includes arbitration revenue related to our dealer-to-dealer business.

We expect our first quarter non-GAAP consolidated adjusted EBITDA to be in the range of $19 million to $27 million and non-GAAP earnings per share in the range of $0.17 to $0.19.

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

Additionally, beginning in the first quarter, we expect our expense base to increase as our lease officially commences for our new corporate headquarters in Boston, and we expect to see the full year grow over impact of people and people-related costs.

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

With that, I'll open up the call for Q&A.

[Operator]

[Operator Instructions] Our first question comes from the line of John Colantuoni with Jefferies.

[John Colantuoni, Jefferies]

I have two high-level questions. First, given your -- you've now had the opportunity to assess the Digital Wholesale performance in a favorable and unfavorable industry backdrop. What are the key areas where you sort of plan to pivot the long-term strategy to better optimize the product offering? I know you mentioned a lot of inspection network and revamping arbitration. Is there anything else that you'd point out? And second, turning back to the margin targets for each business that you provided at the Analyst Day. Can you just talk to whether those targets are still relevant? And if so, can you give us a framework for what needs to happen for those targets to materialize? Thanks.

[Jason Trevisan, CEO]

Thanks, John. This is Jason Trevisan. I'll have Sam Zales to talk about the first one on digital wholesale, and then I can speak to your margin target question.

[Sam Zales, President and COO]

Thanks, Jason. And John, hi. Sam Zales here. Thanks for the question. I don't think there's a long-term change having seen CarOffer through the highs of the market and the incredible lows of the macro environment that we would change the product offering itself. We think there is a competitive advantage to the instant trade platform that allows dealers the most efficient way to get the best buying and selling opportunity in the market. What we're really focused on is operating the business much more efficiently and effectively. You've heard us go through the inspection process, which has been remarkably changed in advance to include now mechanical engine, frame damage, electrical -- inspections that we used to just do cosmetic, that wasn't good enough in a downturn of a market. We've improved our processes in arbitration, our re-matching process that added to extra costs, transportation legs that weren't paid for by customers. It's all about the operations that will improve this business and get it back to profitability and expand what we're doing.

A couple of areas I'd point to when you speak to product features and how can we make ourselves continue to advance and innovate as we have with this platform. One is one that we're testing right now, which is called a with-a-look [ph] capability. It is early stage, just starting. But with a process that a dealer is buying sight unseen in a price declining market, we're giving dealers an opportunity to take more look at the features of the vehicle, the inspection report with photos, allowing them to see a little bit more of the purchase before they want to make and commit to that purchase. That's an important element of this process, we've improved in inspections to allow dealers to be sure they're right. So we've reduced that arbitration as we have over the last several months. But we think the biggest opportunity here with this innovative and differentiated platform is to put CarOffer and CarGurus together to create dealer opportunity to source, market and sell their vehicles in the best and most efficient way possible.

We've talked about in their listings package, being able to see, I can sell a vehicle wholesale at the same price I might have tried for on a retail level, that's just unheard of in our marketplace to allow them to do that. And we think that putting the two platforms together creates that expanded capability that no other partner in the market can do.

[Jason Trevisan, CEO]

Thanks, Sam. And then, John, on your second question on margin targets, and there might have been a second part to the second question. And if so, just remind me what that was when I'm done here. But yes, we still think that the long-term targets from our IR Day, hold. I think the ones to focus on our marketplace product and wholesale. And you can see from that slide that marketplace was already achieving the gross margin targets that we think are long term. They were at the high end of it. Product was close. Now granted, that was as you pointed out, when prices were rising, and it was a better environment. But given all of the operational improvements that you've heard us talk about, we still believe that those are the right long-term targets and same with wholesale as well. And what this doesn't contemplate is actually echo of what Sam just said, if and as we bring these pieces of the platform together, better over time and we think there are continued marketing synergies and other opportunities as well. But on a standalone sort of independent business line perspective, we think these margin targets are still our long-term goals.

[Operator]

Our next question comes from the line of Jed Kelly with Oppenheimer.

[Jed Kelly, Oppenheimer]

Just circling back to the Marketplace segment. I guess could you just assess the visibility in Marketplace going into '23 and just how we should think about the margins in that segment being back, I guess, to those ‘21 levels that you highlighted? And then, I guess for Sam, can you talk about how dealer engagement is progressing with CarOffer? I mean, is there any KPIs you can just share around more dealers using the product? Thank you.

[Jason Trevisan, CEO]

Sure. Thanks, Jed. It's Jason. So on Marketplace for '23, we talked about, I think, in the script, that we continue to see growth into Q4 and into Q1 and from the subscription basis. There are some short-term headwinds on some of the revenue elements like OEM advertising is a good example. But we -- but the marketplace business will grow in '23. From an expense basis, we do have -- we've highlighted a couple of times that we have the rent of our new headquarters that is being built out, and that's not insignificant. So, that's low double-digit millions of additional rent, and we have grow over expenses from some of the hiring that we did in last year. But we have really strong visibility into our Marketplace business given the nature of it and the EBITDA -- and strong visibility into EBITDA as well. And the investments that we're making outside of rent, I would say, of the new building, the investments we're making are for new innovation around Digital Retail, Digital Deal and things that we're confident are going to drive revenue.

[Sam Zales, President and COO]

Jed, I'll jump in. It's Sam Zales here on CarOffer. Thanks for asking the questions. I think you've got to cloud your overall question on cohorts or engagement of dealers with the macro environment. All dealer wholesale transaction volume has been reduced over this period of time as prices declined dramatically in the wholesale arena, just transactions are low overall. So, I don't dissect that from the operational issues we've got, but I think that's going to put a cloud overall on transaction volume per dealer as we look at the whole market moving in that direction.

What I'll say though is, we're making the explicit path right now to say, reduced volumes of transactions at CarOffer to create a higher and higher percentage of profitable good transactions. We're in a mode right now of saying fix the operations, make it profitable again, and then you can scale as fast as you want. That's our path right now. So, it's a little bit of a deliberate strategy there. When we use inspections to increase our fail rate, we're going to have fewer transactions going through, and that's okay because we're not going to let those arbitrated transactions go through. When we get tougher on dealers around the arbitration process and say that you can't take advantage of it in that process, they're going to do less transactions on the platform. On the consumer end and C2D, our Instant Max Cash Offer business, consumers aren't selling their vehicles as much as they were previously. Every player in the market is finding that. And so when they're not transacting as much, we're certainly going to stop them if they've got a vehicle that's not going to be healthy for a dealer to transact with, and we're going to lower those transactions as well.

So, I think it's a combination of both the macro market and us explicitly and deliberately slowing down transactions, getting them to be profitable and a higher percentage of profitable transactions to then scale up again as we get through a couple of quarters of rebuild here.

[Operator]

Our next question comes from the line of Chris Pierce with Needham & Company.

[Chris Pierce, Needham & Company]

I was just curious, you talked about 4Q dealer trends in the U.S. How responsive is that to changes in trend? Because 4, 6 months ago, dealers were sitting on overpriced inventory, but January and February retail sales came in, I think, better than expectations. So, I was just curious. And then you've got Digital Deal. And I'm just kind of curious how responsive that is to changes in trend in the overall market and the new products you're introducing?

[Jason Trevisan, CEO]

Thanks, Chris. I don't think Sam or I caught the crux of the question, how responsive you said the other trends are to macro factors, like inventory levels, is that what you asked?

[Chris Pierce, Needham & Company]

Not sure inventory levels, but I know that the second half of last year was a difficult time for a lot of dealers, specifically used dealers and you guys lost dealers quarter-over-quarter, but then January and February have been better from a retail sales perspective. So I'm just curious how real time are these decisions for dealers in terms of like dealer growth in '23, what that might look like if the market continues to be stronger?

[Jason Trevisan, CEO]

Got it. Understood. The answer is it's mixed. You will see a couple of different and even conflicting reactions from dealers. So, when it's harder for -- well, if you go back a ways, when it's easier for dealers to sell cars, then some dealers will turn off different marketing partners in order to sort of “save money” and drop more to the bottom line because the cars are selling themselves, so to speak. Then in -- but then when cars are harder to sell, you will sometimes see some dealers say cars are harder to sell. I'm not sure if I'm going to sell that many, I better cut on expenses just to be safe. You have other dealers that say, I would argue the more long-term focused dealers who say, well, if cars going to be harder to sell, I better invest in marketing in order to keep my inventory turns at a pretty consistent pace over time.

So, the dealers who -- maybe not surprisingly, who tend to be more reactive in the immediate moment in the real time, tend to be the smaller dealers that are operating more like entrepreneurs and less like bigger businesses who are running on budgets and forecasts. And so, you see that mix with us. What makes us have confidence is that with our ROI value proposition, that plays well in any environment. And I think increasingly, dealers are seeing that they believe and we have -- we believe, we're confident that we've always had a really strong ROI. But now as we are really improving the quality of our leads through things like Digital Deal, they're starting to also realize that quality is very important because many dealers remember, don't have the same size sales forces that they used to have. And so, they need to try to handle or manage or service a certain volume of leads with fewer people. And so, the higher the quality of the lead, the higher the conversion rate, the more they can handle with a smaller sales force.

[Operator]

Our next question comes from the line of Marvin Fong with BTIG.

[Marvin Fong, BTIG]

Just thought I'd follow up a bit on IMCO. I appreciate that you guys have dialed back the marketing there and improving the operations. I'm just curious about the bidding prices between the sellers and buyers, I think you guys said in prior quarters, but that also kind of needed a readjustment for sellers to kind of realize that car prices have come down, that sort of thing. And of course, the rental agencies are no longer those aggressive bidders. So just curious if you could kind of shed some light on how -- are the prices getting narrower between sellers and buyers? And then, I have a follow-up.

[Sam Zales, President and COO]

Hey Marvin, it's Sam Zales. Thanks very much. I think they're -- yes, they're getting narrower in the definition you're using. I think the real situation right now is that consumers for the first six months of 2022 had incredible market opportunity to sell their vehicles at the highest prices they've ever been from a wholesale perspective. And I think any time in that environment, we had aggressive buyers in there, and we had a significant transaction volume because dealers were willing to pay anything in a rising tide environment to do so.

I think the macro environment is just telling you consumers may be thinking they could go back to what their vehicle was worth six months ago, and it's not worth that today. The consumer demand for purchasing vehicles is down. So dealers are depressed in their bid prices right now on the program. So, I don't think we're any less competitive. We're really just following the market trends right now, consumers hanging on to their vehicles and not selling as much and the bids lower because there isn't as much demand for buying vehicles at the retail area right now with interest rates and other things, and it's leaving us with less volume. I think you'll also see that we're being smart in saying with all these changes we've made operationally. The reduction in marketing expense when we know we're failing more vehicles with our inspections, we're being tighter on our processes and our data. We're just going to be careful about how aggressive we're going into that market. So, we're starting to see pricing sort of lift a little bit in the new year, but I think it's too early to tell whether we're on another upswing again. And if we are, I think you'll see more of that balance in the buy-sell price and consumers will get more aggressive, and we'll have more bids that will work on that front as we go forward.

[Marvin Fong, BTIG]

Okay, great. And then a question just about the dealer adds for the quarter and maybe what you're thinking about for this coming quarter. So, was the decline concentrated perhaps in independent to smaller dealers, or was it just kind of across the board? I think someone else in your space has suggested that independents are under particular pressure this quarter. But -- and then secondly, what are your -- what's embedded in your guidance, or how are you thinking about the dealer count in terms of your guidance for the first quarter? Thanks.

[Sam Zales, President and COO]

Thanks, Marvin. I think what you saw in fourth quarter, a small decline was really based on a couple of factors. One is seasonality. Every year that I've been in the business for eight years November, December is that time, Jason just talked about that the more -- we didn't see anything in a differentiation but by one segment or another. But any dealer is going to get more cautious on their budgets as they come into the new year and finish up the year to maximize their profitability. So, that's the typical time in any market scenario that we have seen a churn hit in that time period.

We also reinitiated our annual business review. So you'll know by following the Company over the last number of years, coming out of 2020 into 2021 and even through most of 2022, we were very deliberate and careful about reinitiating an annual business review, which says to a dealer you're receiving X in quantity of leads and an ROI that we expect should be Y therefore your price point should move to Z or you can move to one of these new packages that's most valuable to you. And as we got more aggressive then you'll see us continue to move going forward with this strategy of saying we have to take our fair value out of the ROI equation with our partners is we involuntarily said if some dealers can't accept that price increase, we're going to move forward and turn that lead volume over to another dealer who will and will pay for that performance. So, I think both of those factors are really a process that will sort of define the fourth quarter. And I don't think we're sharing any details on first quarter, but we have confidence in where we're going from here.

[Jason Trevisan, CEO]

And I would just add that especially because of the annual business review process that has sort of reignited a bit here, while we look at dealer count and we look at QARSD and those are helpful ways to model the business, we really focus on net new MRR. And dealer count often falls out of that. It's not always linear, but it tends to track. But in an ABR environment where we are holding a little firmer on price than we have sometimes in the past, you may very well find that we can end up with better net new MRR, better revenue growth and not as strong a dealer count, and we're okay with them, that the trade-off will take.

[Marvin Fong, BTIG]

Yes, that makes total sense. I appreciate the color, both of you.

[Operator]

Our next question comes from the line of Brad Erickson with RBC Capital Markets.

[Unidentified Analyst]

Just a quick question. It sounded like arbitration got a little bit better in the quarter. Is that some potential TAM unlock for you guys as per unit arbitration costs come down, you can start to access potentially…

[Jason Trevisan, CEO]

Sorry to interrupt. We've not been able to hear your question so far. Can you repeat it? Thanks.

[Unidentified Analyst]

Sorry. Can you hear me?

[Jason Trevisan, CEO]

That seems a little better.

[Unidentified Analyst]

Okay. Sorry. As I was saying, it sounds like per car arbitration has gotten a little bit better in the quarter and you guys are making some improvements there. Do you guys view that as a potential TAM unlock of being able to deal in different types of cars or potentially lower ASP cars that you guys typically deal with? Is there any sort of TAM unlock from lower arbitration costs? And then I have another follow-up.

[Sam Zales, President and COO]

It's Sam Zales. I appreciate the question. I think we'll be careful in that direction. We've seen the incredible uptick of the CarOffer business. And with the macro environment hitting us knowing we needed to double down, triple down, quadruple down on the operating effort, yes. We're seeing arbitration rates move in the right direction. We're very pleased with that. We have more work to be done. As we said, this is a multi-quarter activity for us to really improve upon. That will make us more confident that we will have more and more profitable transactions in this business and get ourselves back to profitability. But we're going to stay in the realm where we have in the past of the hopefully, a larger percentage of later model year, lower mileage vehicles. Obviously, with the market going down, our average selling price was down to about $25,000 on the D2D business, 72,000 or so on the C2D business.

We're not purposely going to go down to the low end of the market. But I do appreciate your question, which is with these inspections at a much more fine level and you talk about mechanical and engine and frame damage and electrical, you have the ability to look at vehicles and be certain that you're sending the right ones through with that lower arbitration rate. So, we could go and expand the TAM. I think our effort will not be deliberately to look down market right off the bat and say, let's head down that direction. We prefer to focus where we are on improving and beating our projections to where we have much more efficient and profitable operation.

[Unidentified Analyst]

Got you. That's super helpful. And then just one quick one on Marketplace. Kind of your -- I know you talked about the CarOffer marketing spend. But what's your philosophy on marketing expense in the Marketplace business in the event of a higher growth scenario than what you're currently baking in?

[Jason Trevisan, CEO]

In the event of a higher growth scenario you said, how should we think about -- how would we think about marketing?

[Unidentified Analyst]

Yes, exactly. Like would you reinvest those dollars into marketing to capture the growth upside, or would you let this fall to the bottom?

[Jason Trevisan, CEO]

Yes, I think that -- so there's no rigid formula. And I think we need to -- in a case where our growth is exceeding our expectations, considering to invest in marketing more is certainly a possibility. It's always a consideration as we think about capital allocation. What we have been challenged with, in the past, and I'm now going back several years is if -- when we have reinvested in marketing and that has generated more lead growth and more value growth to dealers, we've not always been able to monetize that as quickly. And so, we're very cognizant of that. This year, there is also an added dimension, which is our new brand campaign that we're very excited about. Our brand campaign we believe can really open up awareness and top of funnel for sort of overall audience growth in ways that we maybe haven't been able to in the past. And so, we're watching -- we're very excited about it. We're watching it closely. That's not as immediate a read as performance marketing. But as we see how that performs this year, we will decide if we should increase that as well.

So the short answer is, yes, it's definitely consideration, but that it also is a trade-off with not just dropping it to the bottom line, but also investing in other things like product and Digital Retail and other areas of innovation for us.

[Operator]

Our next question comes from the line of Doug Arthur with Huber Research.

[Doug Arthur, Huber Research]

Yes. Just a quick one. Jason, the reference you made, obviously two transactions being down 75%, and that's going to become a more important metric. What is the exact definition of transactions? If you could just refine that a little bit.

[Jason Trevisan, CEO]

Sure. It's what we call net cars moved, which is when there is a -- when a car is -- has been sold and the sale is complete, and it's based at the VIN level. And so, we look at it once the vehicle has been -- think of it as fully sold at the unique in VIN basis.

[Doug Arthur, Huber Research]

And does that crossover between IMCO and CarOffer, is that strictly IMCO?

[Jason Trevisan, CEO]

No, it's IMCO -- it's both. It's what we think of as wholesale, which is both dealer-to-dealer wholesale as well as Instant Cash Offer. But it's not related to listings in any way or means.

[Operator]

Our next question comes from the line of Nick Jones with JMP Securities.

[Nick Jones, JMP Securities]

I guess the first one, on engagement metrics, I know you're focused on getting kind of higher-quality leads. How should we think about where these engagement metrics will trend kind of over time and maybe where they kind of bottom out and stabilize and maybe return to growth as you refine your focus on leads? And then I have a follow-up on the arbitration.

[Jason Trevisan, CEO]

There's not really a moment or a quality threshold that once we've hit it, we're then going to go back to volume. I mean, the way -- and it's always going to be a mix. So, you probably heard these numbers or these data points. But just to put it in perspective, if we're sending a dealer 1,000 leads a month and they sign up for Digital Deal and all of a sudden, 150 of those leads converted multiples and another 100 of those converted to even higher multiples, that dealer is going to be thrilled. And what we look at is total cars sold estimated. We look at various forms of attribution to determine. And so, we have a proxy for all of our dealers about the number of cars we help them sell in a given month, and we watch that closely, and we're trying to grow that. And so the formula or the recipe for how we get to that is a combination of some growth, some quality improvement. But ultimately, it's distilling down to gross profit maximization at the dealership.

Now, there's going to be a point at which -- sorry, just to close it out. There's a point at which we will never be -- we're never going to get 100% of our users through Digital Deal in the next year. And so, at some point, we have to acknowledge that there's sort of some natural self selection among users. And in which case, if we feel that we're reaching that local maximum, then we would resort back to growth within the different segments.

[Nick Jones, JMP Securities]

Got it. And then actually, I'm going to follow up on that then, and I can ask the arbitration one offline. I mean, so I guess what's the balance of kind of having this rich upper funnel content at CarGurus and making sure people kind of keep coming to research cars, maybe aren't as high quality leads, but they still like to engage with the brand from a content perspective. So, it seems like there's kind of two problems to solve. There’s one being kind of a top of mind brand that people can utilize and you can get that traffic cheaply and then kind of making sure you're only kind of paying for the high-quality leads. Does that question make sense?

[Jason Trevisan, CEO]

Yes, I think so. And it's a multipronged approach that is from a marketing perspective, that's precisely the balance of brand and performance marketing. The brand is to create the awareness and the interest and the intent. And the performance marketing is to capture them when they're much closer to ready to buy from the marketing side. And then there's the product side. And the on-site merchandising side, which is giving that user a better experience when they're on our site that is more germane to more personalized to what they're looking to do, but also gives them the awareness and the opportunities to go into these other channels or click pads that turn them into much higher converting users. So, it's marketing plus product. And we have we think an extraordinarily long way -- long and exciting way to go. Because if you look at the percent of users on our site today, for instance, who are going through Digital Deal and who are 2 or 3 times more likely to convert, it's very small. I mean it's gone from zero to what it is. So we're excited about the growth, but the runway is just significant.

[Operator]

Our next question comes from the line of Tom White with D.A. Davidson.

[Unidentified Analyst]

This is Wyatt Swanson on for Tom. Thanks for taking our questions. My first question, I'm just kind of trying to dig deeper into marketplace subscription renewals here. Curious what approach you guys are kind of taking to renewals and volume-based pricing adjustments for your listings product this year. It seems like you paused a lot of that over the past couple of years. What's your appetite for trying to reset your pricing with dealers this year? And what's contemplated in your 2023 outlook on that front?

[Sam Zales, President and COO]

Thanks, Wyatt. It's Sam Zales here. We are deliberately restarting a process, but it's a different kind of process, one in which we do an annual business review with our partners. And so, it's less of a sort of a very transactional old way of doing things, which was we call you and say that your lead growth was up 20%. Your price point went up ex Take it or leave it at the end of the month. We're actually in a cycle of conversations about programs and consultation and what's working well, unique and proprietary data that that dealer could use and helping them see the value of our programs.

And what we're doing in that regard is offering them a set of packages, all of which will impact our QARSD, obviously, I think that's the right way to do things. But to give them the opportunity to buy their way into higher-value programs. And if not, put them into a program where they may see less volume or less activity and then give that opportunity for next dealer to take their slot at a higher value program. So, we've developed these new packages and it allows us to get that flexibility to grow QARSD and help our dealers see the value and if they're willing to pay for performance go there. We're doing this in our early stage in December and have added capabilities. We've got a product called Lead AI, we call. It's one that allows dealers to focus on the most engaged shoppers on their platform and hit those first, so helping dealers convert more of their consumers coming in to close sales.

And so by doing so, we're finding more and more features and capabilities to drive the dealers into upper level and higher paying premium packages. We've always had great success with our featured sponsored listings. And so that's an opportunity, again, for dealers to take advantage of getting to the top slots and paying more. So, we're doing this more deliberately. We'll be more aggressive as we head into 2023. And we're also selling new customers at a higher price point. Now that's something that's been important to our overall effort in the marketplace business. If we know, as Jason said, we have the highest ROI program in the market, and now we're adding Digital Deal to that. We have the opportunity to raise Digital Deal pricing, which we've done in 2023. And so, these are opportunities where we are going to be more aggressive, to your question on strategy, going forward.

[Operator]

Our next question comes from the line of Ron Josey with Citi.

[Ron Josey, Citi]

Maybe two quick ones. And Sam, this is more of a follow-up on what you were just asked and talking about with Digital Deals. Now that we're pricing, call it, more in line with greater conversion rates, are you -- talk about just the go-to-market strategy on Digital Deals. In other words, are these included in those packages for renewals or Digital Deals front and center? How are you thinking about marketing them specifically now that we do have firm conversion rates and more insights on pricing would be helpful. And then Jason, just on process here, any update on CFO progress would be helpful. Thanks, guys.

[Sam Zales, President and COO]

Thanks, Ron. You're asking a great go-to-market question Digital Deal. We're really proud of those results. We mentioned in the opening remarks of 2 times and 3 times and even more close rates and for our dealers that we're seeing the results within using IHS data to get us there. That will compel us to be more aggressive. We're selling it on a standalone basis in some respects. So you go to a dealer and you say, you have an opportunity as Jason just said, to get X percent of your leads now closing at a much higher rate or already at a market high. Here's the price point. So we've raised that price point from what was and $250 and $200 depending on the market segment and inventory size to $500, $400, $300, a much higher price point on their way in. We're more aggressive and more committed to that as we go forward. We are packaging the Digital Deal program with Area Boost, which is now a product that you know helps dealers market their inventory outside of their local market.

So, think of it as a value proposition that says to the dealer, you have an ability not only to find that consumer is willing to travel and look for a vehicle or have it delivered. If they prefer it that way, we're now adding Digital Deal there, so we're going to have that consumer further through the funnel, doing their financing, maybe putting a deposit down and knowing what their F&I products they want are into that mix. It just brings a much further down funnel shopper who you can sell, as Jason said, with fewer sales resources in the Company. So that package becomes more premium rich package. And then going forward, you will hear more from us in 2023 on packaging it, Digital Deal and even our highest premium packages to maximize our overall revenue and QARSD in the business. So you're right on the Digital Deal product proving itself in the market and then we have to take advantage of it on a commercialization basis.

[Jason Trevisan, CEO]

And then, yes, thanks. On the CFO search, Ron, so we have been in the market with the search firm for about five months. When you're bringing in exec from the outside, these things take time, and we're maintaining a very high bar, as you would expect and want us to do. And so, we're seeing good candidate flow. We have candidates that are in multiple rounds at this point. And I'm -- it's one of my highest priorities at the moment. And so, I'm confident that between certainly myself, but also the exact team and to a lesser extent, the Board is giving it to do attention, and we're certainly excited with some of the candidates that we have in the background.

[Operator]

Thank you. This concludes our question-and-answer session. I'd like to turn the call back to management for closing remarks.

[Jason Trevisan, CEO]

Thank you. So this is Jason. Thank you very much, everyone, for your interest. As you can tell from our remarks and hopefully, our Q&A, we're very excited about the strength of our core business, about the lead quality that's driving value to our dealers and helping them grow the value of their dealerships. Our new brand is launched, which is helping to grow the awareness among consumers and help them understand all that we're now able to offer them that much of which is relatively new. We're encouraged by the progress we're making at CarOffer, and we're really excited about the innovation in Digital Deal and Digital Retail more broadly. So there's a lot happening, and the market is -- the auto market is seeming to stabilize a bit, which is encouraging. So, we're very excited for 2023 and very proud of 2022. So, thank you, everyone. We appreciate your interest.

[Operator]

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation, and have a great night.