Cars.com Inc. (CARS) Earnings Call Transcript & Summary

Good afternoon. We're pleased to have Alex Vetter, the CEO of Cars.com, with us today. Alex co-founded Cars.com and has served as President and CEO since 2014. Alex took the company public in 2017. It has been transforming and leading its evolution through innovation and acquisitions. We're really pleased that you could join us today, Alex. Thanks again for being a part of this.

Thanks for having me, Brian.

I know, Alex, I know there are folks on the line who are new to the company and the story, and I think it would be great if you could share your perspectives on the business, and then we can jump into some Q&A if that works for you.

Sure, Brian. Well, first of all, good afternoon, everyone. I think when most people hear about my company name, Cars.com, they think we're a singular website. But the reality is the story is much deeper. We're actually powering over 5,000 industry websites across the company and many of the largest dealerships in the nation. And so when you look at our business, Yes, we run the industry's biggest marketplace, Cars.com, which the name stands for itself, but our solution strategy really has expanded the business demonstratively over the last few years and is the fastest-growing part of our business. And if you think about what's been happening in the modern era with COVID, it's actually been a perfect storm. There's increased consumer demand, there's limited supply, having detected the innovation and the inventory platform to bring this all together is what's leading to record growth in the business. So in a weird way, the pandemic has actually accelerated our business quite measurably and accelerated the strategy as well.

That's great, Alex. And I think that's a good segue into the next question that we have here. And I think folks are interested in hearing more about the impact of COVID, which, on the business, certainly seems to have increased car demands really to historical levels. And just wanted to get your perspectives on how the company has adapted the business to support this record buying activity and also how you expect the car shopping process to evolve in this new environment we're in.

Well, sure. I mean, look, I've been through a number of auto cycles, certainly never been through a pandemic, but the company showed its resilience. I mean we ended up stepping up for the auto industry and discounting our fees by 50% at the onset of the pandemic when many dealership showrooms were physically closed, but we were able to cut our operating expenses by a commensurate amount to make sure we maintained our bottom line profitability. I think what we're seeing today, fast forward now several months through the pandemic, car ownership is here to stay. I know when we spun the company public, a lot of people shunned vehicle ownership with the advent of ride sharing services and EV sales, but what we're finding is just the opposite. Consumers are shunning mass transit in favor of vehicle ownership. And what's crazy today, we tend to have about 4 million listings on the Cars.com marketplace at any given time, but the inventory levels are down across the industry, but we're seeing prices rise. So even though new car list prices are up 5%, dealerships reporting they're selling vehicles at or above MSRP, used car sales are booming as well, and those prices on our platform are up 14%. And what this is doing is it's generating incredible dealership profitability, which is where the majority of our revenues come in. And what dealers are doing with this newfound profitability is accelerating what we've been advocating all along, which is to move to a more digital-first showroom, move to a more digital-first technology approach to selling and certainly, with an inventory shortage, using technology to match supply and demand is the only way to market in this environment.

Great point, Alex. And I think that vehicle shortage really seems to be on top of people's minds right now. And I think resulting in kind of this inventory decline, again, really, I think what investors are following in the industry, how long do you expect these trends to continue? And at what point might this challenge, this inventory shortage, challenge your own dealer customer growth?

Well, look, we just surveyed last week 400 of our dealers and across the board, what we're seeing is they're reporting back to us, they see a line of path for inventory improvement on their lots anywhere from 2 to 6 months. I think -- although on our website, new car inventory levels are down over 20%, used car inventory is down over 10% on our actual platform. Now keep in mind, most dealerships, even the biggest digital dealerships may have 40,000 listings on their website, we've got close to 4 million. So we're looking at a much bigger marketplace across the industry. And I think the second order effects that really this inventory shortage is driving is dealership profitability. Every publicly traded dealer group is reporting record profits. They're having to spend less in mass marketing. They're relying more on these more cost-effective technology platforms like Cars, and we're able to mirror supply and demand really well for them and increase their inventory turn. Average dealer supply and inventory typically in our industry normally is around 60 to 65 days, Brian. We're seeing those numbers, they dropped to 39 days in March. In April, they dropped to 33 days. So we're at a pretty amazing level. But what's amazing is how dealerships now are using tech to buy cars. We're putting out some Memorial Day research that dealers are willing to pay top dollar for trade-ins today, and almost half the opportunities that we're bringing dealerships come with trade-ins included. So we'll ask a user, if they're contacting a dealership, "Do you have a trade?" And almost half of the Cars.com shoppers do have a trade. And so for dealerships, it's like a 2 for 1. They want to sell you a car, but they really are desperate to buy one from the private market or the public market. And so we're seeing an acceleration of dealers using our tech to acquire trades right now, which is a phenomenal opportunity.

That's great to hear, Alex. And so maybe shifting to operating performance. Cars has grown its dealer customer base in the last 5 -- I think in the last 5 of the last 6 quarters. What do you attribute to the strengthening retention trends and the dealer growth trajectory in your business?

Well, look, we -- and not only we have grown the dealer base 4 out of the last 6. The only quarter we didn't grow our dealer base was during COVID, the Q2 onset of the pandemic last year. But if you look at all the other publicly available data, nobody has been growing their dealer base faster than Cars. But what's interesting about that, Brian, is we're also selling more technology directly to dealerships. So our average revenue per dealer is still higher, yet we're growing our dealer count faster as well. I attribute this to our differentiated strategy. Number one, we're not just a singular website Cars.com. We just announced a new deal with Ford Motor Company where we can now build websites for all 4 dealers nationally. It was similar to a program that we announced with General Motors last year that led to leading market share gains. And so not only can we continue to add dealers to our marketplace, but we're also adding dealerships aggressively to our website solutions platform. And so that enables us to get double-digit growth in our average revenue per dealer as well, which is exciting. We also haven't talked about these new businesses we've stood up. With the advent of privacy changes and the cookie-less future, about $1 billion in automotive spending that's happening today using modeled audiences is going by the wayside. The automakers and dealerships are now going to have to start finding ways to tap into true first-party data, which -- Cars.com, we generate 75% of our traffic, Brian, that's coming through us organically or directly. So as these privacy changes clamp down on these larger tech platforms, the auto industry is going to have to look for how to access more first-party data. Our FUEL business that we launched last year despite the pandemic grew to $10 million overnight. The platform continues to take market share from traditional broadcast television, and we're on a good care with our solution strategy.

That's great. That's great. Maybe just to shift to Dealer Inspire for a moment. I know you just announced an agreement to become one of the exclusive website service providers for FordDirect. I think it's going to give access to more than 3,000 dealers. How should we think about the rollout of this partnership? And how soon will dealers be able to work with you?

Well, look, in this industry, in order to be an approved vendor for the dealer body, the franchise dealer body where the majority of our revenue is concentrated, you require these OEM endorsements. I think what was significant about the GM deal is it was an exclusive agreement. They had one provider for all 4,000 GM websites. When they opened it up last year and there isn't an exclusive agreement in place, they've always had selection. I got a little bit loss of a signal. Can you hear me okay, Brian?

Yes, we can hear you, Alex. You're good.

Ford is a little bit smaller in terms of the opportunity, but it follows similar fundamentals. We have record interest from Ford dealers nationally. Just the other week when we opened up this announcement, over 104 dealers immediately contacted us about switching the website to Dealer Inspire. And so again, this is part of our differentiated strategy. We're not dependent on any singular piece of tech for our growth. Instead, we're getting growth in our marketplace, we're getting growth in our website platform, we're getting growth in our data business. Each of our business lines continues to scale.

That's great. You mentioned FUEL before. Can you talk a bit more about the recent success of the FUEL product and how it's evolved beyond just being a creative tool for dealers to sell cars in this current environment?

Sure. Well, Brian, I mean it really comes down to narrowcasting the automotive industry's marketing messages just to the population that actually cares. The auto industry spends $30 billion in advertising and marketing, everything from major sponsorships to television broadcast to outdoor advertising. The dirty little secret is only 5% of the population is in the market to buy a car at any given time, and so what that effectively means is that there's 95% waste. Contrast that to Cars.com, if you're on our website, we know you're actively in market and you're going to buy within a 6-month time period. We're seeing record growth in urban markets. Urban buyers are accounting for 30% growth in shopper activity. And we're seeing younger buyers, record numbers of first-time buyers. Again, I think part of this is being accelerated due to COVID. But the FUEL business really says, let's take the proprietary first-party data signal that's coming off of Cars.com. Let's leverage the vast amounts of real estate available through these OTT platforms, whether that's Amazon's platform, YouTube, Facebook, you name it, any of these giant commercial open platforms that have unlimited inventory. When you take the Cars.com first-party data and you marry it with these OTT platforms, we can run high-quality video advertising for the industry at a fraction of the cost of traditional media and deliver it entirely to an end-market car-buying audience. What dealers universally are showing us, post-FUEL, they're all growing in their market position. Every one of the dealers that we've signed on this platform has grown in their standings in market share. And we do sell this on a geographic exclusivity basis. So we think this is a platform that's going to increase in demand over the next few years as the dealership industry becomes more exposed to the power of narrowcasting.

It's really become such a powerful part of the platform. We were chatting about traffic before. It's obviously such an important indicator in your business. And as a metric, you've grown it consistently. Can you discuss how you balance your SEO strength and paid marketing strategy in this environment and how that differentiates your business versus the strategies your competitors are deploying right now?

Yes. I think this is one of the missed stories amongst the investment community that we hope to educate and do a lot more on this year. If you look at our relative sales and marketing costs, which are bundled together with all our competitors, we spend roughly the same in sales and marketing. But actually, we have a larger sales force because of our solution strategy. We're constantly working with the manufacturers and the dealerships to build their websites and stand up their platform. If you look at our marketplace business, we actually spend significantly less in marketing and traffic acquisition because of 2 things. Number one, our tremendous brand strength. Cars.com is a household name. It's been built up over 2 decades in time. But also, the strong growth in our SEO and organic traffic strategy. 75% of our traffic is coming to us in a direct or an organic basis. If you look at our app, highest-rated app, most downloads of any automotive marketplace in both Android and Apple environments. And so the organic strength and our ability to not only grow traffic, but to sustain it, Brian, our traffic was up 4% despite inventory levels being down almost 20% in the first quarter. Some of our competitors went backwards double digits despite spending more in marketing. So we're able to spend less in marketing and get a steady stream of organic value that I think is why we have the industry-leading margins and really strong free cash flow.

And maybe just a follow-up on the traffic point. Do you ever expect that Cars' marketing spend will ever return to those historic levels?

Well, I think we're seeing some really strong organic momentum right now, right? Not only has the pandemic forced more people to seek out virtual options for shopping from home, but I think it also just raised the awareness on how much more people can do their car shopping and have dealers bring the cars directly to them. So we launched home delivery during the pandemic, and we immediately had 8,000 dealers enroll for home delivery. And now dealerships are shipping cars to people's homes all over the country. Things like that are driving more buyers into the market. Now you've got the surge in EVs, Ford launching their EV truck, Porsche's new EV that goes over 450 miles on a single charge, all these new innovations in the auto industry are bringing more and more buyers in. We're seeing strong consumer demand for new tech. And so what was once considered a used car, 5 years old being relatively recent, the advancements in technology are so severe that we're seeing that also accelerated the growth of interest in the market again. And I think consumer interest in these new technologies available in the modern cars are what's going to lead to record new car volume. We're on pace right now for over an 18 million SAAR, the highest retail sales in my lifetime. And I think a lot of it is pandemic related, but credit to the auto industry, the product and innovation that's coming out is incredible.

That's great to hear. Just a follow-up on kind of operating performance. From what we've seen, Cars achieved remarkable success scaling the Dealer Inspire platform and launching other solutions like FUEL. At the same time, we've seen your competitors continue to branch outside of the marketplace genre, if you will. CarGurus acquiring CarOffer, TrueCar acquiring a minority stake in Accu-Trade and Edmunds was recently sold to CarMax. What do you see as the next frontier of opportunity to expand your platform in light of the M&A activity in the online auto category?

Our priority during the pandemic was literally paying down our debt and preserving our cash and really keeping the business focused on its growth agenda, and I'm pleased we did all of that. We paid down $15 million in debt in Q1. We generated record free cash flow. But when I look out ahead, Brian, all the exciting new product innovations that are happening in the category tend to really need 1 of 2 things, either consumer distribution or dealer distribution. We've got both. We will be increasingly using our capital to identify those tuck-in opportunities that we can deploy across our consumer or dealer base, which adds immediate scale and accelerates our growth agenda. So I do think there's exciting opportunities for us to bring more solutions to the auto industry as the industry increases its shift towards digitization.

That's great. And I think as we -- talking about strategy might be a good segue here as we think about -- besides inventory acquisition, what other challenges are kind of top of mind for your customers? And are there any new solutions your team is working on to solve some of those problems?

Well, certainly, the top right now is vehicle acquisition. Dealers are asking us to help them with our technology to source more vehicles. Again, we've changed our lead path so that when consumers contact dealerships, we know if they have a trade-in included with that opportunity. So dealerships can prioritize those first and foremost because it gets them not only a vehicle sale, but also a trade-in acquisition opportunity. I will also tell you that dealerships are wanting to modernize their entire digital experiences. Our website solution sales continue to accelerate as we talk about also the advent of FUEL. Dealers are wanting to use our first-party data now to do a lot more than just list their cars in their marketplace. When I look ahead though, I will tell you a couple of areas that are first and foremost in our mind. Look, the finance opportunity is a huge untapped market for us. We've got 26 million people shopping in our platform each and every month. A vast majority of those are looking for preapproval of financing prior to purchase. We know from our discussions with the bank, there's a significant opportunity for us there. So you can expect us to enter that market hopefully sometime this year. I think the other opportunity is the peer-to-peer market. There are still 11 million cars sold peer-to-peer to year in this country. We know that, that represents an enormous opportunity for us to also build a lot of second order businesses that hang off of that. But those are 2 big opportunities in addition to the vehicle acquisition space which we hope to make a bigger play in this year as well.

That's great. Just a follow-up on strategy. I think on your recent earnings call, you mentioned continued innovation and tech solutions will continue to drive growth in the back half of this year. Can you provide more context around how the product road map is shaping and what we can expect in the future?

Yes. We're right now in the middle of finishing a complete cloud migration, so the new Cars.com and our infrastructure that powers both Dealer Inspire, Cars.com and FUEL and DealerRater will all the cloud-based architecture in the second half of this year. We're seeing some pretty incredible performance gains in overall speed and user results, so we're excited about making that -- finalizing that step to the cloud. That's going to eliminate basically 20 years of technical debt that's been built up over the tenure of the business, right? And so it really is going to increase our ability to innovate. What used to take us about 20 days to make site changes will now take us about 2 hours. So I'm so excited that our team can now restore to innovation and growth and bringing in a lot of the data science investments that we've been making over the past year. Today, we're able to predict how long a car will sit on our marketplace before it's sold. We're releasing some powerful technology that we think is going to help both users and dealerships both buy cars more cost effective -- or more scientifically and know what it's going to take to sell them at what price points. So a lot of the innovation you're going to see from us is really going to be bringing our vast data science and data assets to bear into the front end of the Cars.com marketplace and deployed across 5,000 dealer websites, which is pretty exciting that we can build tech once and deploy it either on our marketplace or on any one of our 5,000 dealers' websites. And that's where the leverage to the business gets exciting because it's much like Shopify is for other sectors. We're building a platform that dealers can use our tech, use our micro services, deploy it on their own websites and get enormous efficiencies and gains.

That's great. I had just a follow-up one on around operating performance. I know Cars.com's business has meaningfully delevered in the last 12 months and I think in the most recent quarter, generated $44 million of free cash flow. What is your approach towards capital allocation in light of the substantial cash flow your business is generating?

Well, look, again, the priorities are still to pay down our debt, but we -- in the last quarter, we got down that number to 3x net leverage. So we're actually right where we need to be. I think with continued momentum in the business, we can not only continue to pay down that debt, but use that capital to afford tuck-in acquisitions that we can then deploy across our sales and dealer networks. So I think we're really well positioned to continue our path to accelerate growth and transformation in the business that we started when we first spun the business out. I'm really excited about our financial strength because consumer traffic is coming to us more organically, which means we're spending less in marketing and traffic acquisition and can invest more in product innovation. And so it's taken us a while to get here, but I feel like we're now coming through in a much healthier place than we were just a few short years ago. And now the industry is accelerating its shift to digital, I think we're just really well positioned to capitalize on all these top line trends.

That's great, Alex, and I really appreciate you running through all of that with us. Just one of the questions kind of coming across the transom here is just, I think people would love to hear your perspectives and kind of what you're hearing from the front line from dealers around -- inflation is obviously the topic du jour. And I'm not sure if you're -- if -- what the effect might be in your business or what you're hearing directly from your dealer customers. Is that something you can comment on?

Yes, sure. I mean only anecdotally, what we hear -- we haven't surveyed on this dimension specifically, but I know that consumer durability and spending has actually been incredible. With the stimulus packages that have come out, consumers are demanding the new tech in cars. Dealerships are not having a hard time selling the cars they have despite raising prices on the vehicles that consumers are hell-bent in on not getting back on mass transit. So dealers have signaled it as a potential worry, but right now, they're not having a hard time getting deals done and consumers are willing to pay more for vehicles. So it's a really healthy market we're in right now.

And the -- you talked about the advances in technology and some of the new things that you've brought on to the platform. Are dealers coming back and kind of commenting on the effectiveness of those? And I assume that's also in turn driving retention rates with them in and above some of your peers. Is that kind of your feeling?

Well, look, I think a few things are going really well for us. Number one, COVID shut down the physical showroom. Dealerships had to cut back on a lot of operating expense. And what do they start to do, they started paying attention to the digital scrubber, and that's where all the action was happening. We -- through our Dealer Inspire platform, we can actually show dealers in Google Analytics all your traffic sources combined and which ones of those sources are converting to vehicle sales. And what we see very clearly, the data, that if a user starts on Cars.com and transitions into the dealer website, they're converting at 2x the rate of all their other traffic sources behind, and so dealerships are realizing that Cars.com is much more than a lead generation tool. It's a demand gen for their entire digital business. That's led to record retention rates. I mean we've had tremendous record retention rates. We're seeing that persist. We are seeing a slight slowdown in new sales, which is normally expected with such inventory shortages. But as that starts to loosen back up and dealerships start to get more inventory, I think we can get that business to continue to grow as it did in Q1. We added over 450 dealers in the first quarter. So the overall trends are extremely positive and dealerships are not going back. They want to do more through the digital showrooms. Brian, imagine this, OEMs have historically forced dealerships to invest so much in the physical showroom. I see a day where OEMs are going to shift their capital allocation to helping dealers invest more in their digital showrooms. And when that happens, you're going to see a ton more capital flow into this market, and we've got the diversified strategy to help the industry really accelerate that shift towards digital-first sales.

That's great, Alex. Another point you mentioned, stimulus, it's obviously -- there's a lot of uncertainty about what that will be, what sectors and industries that will impact, but it's certainly on top of people's minds. Are you hearing anything through your different channels about stimulus and the potential impact it will have or continued stimulus on your business?

Well, look, we're spending a lot of time right now with lawmakers understanding the EV stimulus program. I think certainly, we only see EV search share at sub-5% on our platform in California where there are huge stimulus around EV sales. It got as high as 8%. So if there was a bigger federal stimulus around EV and infrastructure build-out, we think the EV category is going to accelerate growth. I think we're really well positioned right now because most EV sales have gone to one brand. And now that all automakers are coming out with EV models, we think the consumer need for third-party research comparing EV platforms and vehicles is only going to accelerate, and that's going to bode well for Cars.com. I think other forms of stimulus, certainly, we know that consumer research is showing a durable demand for private vehicle ownership. This is not temporary. Record sales in San Francisco and New York, these are cities that used to shun the automobile. We think this is a lasting trend. The average age for driver's license application went back down for the first time in years. Kids are wanting to register for their driver's license sooner than ever. So we think this is a durable shift back towards private vehicle ownership. We think that dealerships now are running far more tech-forward businesses that are generating more profits. We think there's a lot of reasons why this industry is becoming much more efficient, and it's really due to tech.

That's very helpful, Alex. I think on the tech point, one of the other questions someone was -- sent in was just around electric cars and kind of the trend in that direction. How do you feel about the positioning of the business against the transformation that's obviously happening in the consumer demand towards electric cars?

Well, look, there's a lot of discussion right now about manufacturers going direct, the dealer selling EVs differently. Because the majority of our revenue sits really what I would consider in the research phase, regardless of where the sales model evolves, we're going to play a role. More consumers come to Cars.com to compare makes and models prior to purchase than any other platform. And so while the sales models, people can debate, you're not going to bypass the second largest research phase of the second largest transaction in people's lives. Consumers are spending 6 to 7 hours of research online prior to purchase. We're certainly very biased to think that the local dealer model is the winning model. We think the service of vehicles remains a core centerpiece of this industry. And the local dealer network, we believe, is best positioned to capitalize on all that's needed to sell a large transactional item with your car. But regardless of where the industry evolves, it's a distribution model. Our technology platform is relevant for consumers, for sure, and we plan to be a provider for the auto industry for quite some time to come.

Alex, this has been great. I think we hit all the questions I have here in the queue. It's always great to hear your perspectives on where the industry is and where it's going. This has just been a terrific session with you, and we look forward to continuing all the dialogue with you and hopefully having you back next year. Thanks again for your time. We really appreciate it.

Thanks, everyone. Have a great rest of the day.