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

Great. Thank you. Thanks, everyone, for being here today. I'm Nick Jones, an Internet analyst here at Citi. If you need my disclosures, you can find them. If you e-mail me, I can send them to you or our corporate office things can send. We're really excited to have Cars.com here today, and Alex Vetter, the CEO, to run through some questions. If anyone has questions, there's a box in the window you are looking at. Please submit -- you can submit questions through there, and I'll be happy to ask them on your behalf. But Alex, thanks for being here.

Thanks for having.

Yes, absolutely. And I think the best way to kick things off, would be to just kind of talk about what current trends you see. The last 18 months have been pretty interesting, to say the least. There was an unprecedented shutdown in the economy last year, dealer shutdown, followed by demand bouncing back rapidly. There's some supply constraints today. So what are you seeing in terms of changes in behaviors at dealers and by car shoppers?

Well, Nick, thanks again for having me here. Listen, I think if there's one thing that's happened over the past year, it's the durability of marketplaces and the durability of the local dealer model has shined through. The last 18 months have been pretty interesting, to say the least. But the auto industry, our strategy really is about arming the rebels. And when I say arming the rebels, it's giving dealerships technology and tools to allow them to move their business into a digital-first format. And the COVID pandemic and the stay-at-home shutdowns really forced dealers' hands to actually have to engage and drive the strategy more proactively. And that's why you're seeing robust trends in my business where not only has our marketplace growth surged, but the growth in our technology solutions, which is enabling dealerships to compete, has also experienced double-digit growth. And so this environment, as difficult as it's been, has really served as a boon for the business and the industry.

So as you think about some of the behavior, I think consumers to some degree have kind of been evangelized and are more comfortable transacting online. How do you think about these trends? Do you see these as being sticky kind of from here? Or do things kind of revert over time as kind of the COVID impact wanes?

Nick, when I talk to investors, a lot of them, because of our brand strength and even our stock ticker being CARS, they think about my company as being a singular website, Cars.com. Well, our marketplace is a core ingredient to our success, but we also are powering over 5,000 dealership websites across the U.S. We just launched our first Ford website last week. We won a deal to help build out 4 websites. There's over 3,000 in the country, and we just launched the first one last week. So I look at data across not just our marketplace, which reliably has over 25 million people coming to it every month, but I'm also to look directly into the consumer behavior on over 5,000 dealer websites. And I think what we see is a very similar trend, which is that consumers are wanting to do more and more of the process online, are willing to complete more upfront work to save time in the dealership. And conversely, dealers are willing to meet consumers where they are. We've had record numbers of dealers adopting our digital tools that allow them to communicate directly with customers while they're actively shopping. And increasingly, the dealer body is willing to expand the footprint of their dealership and deliver cars directly to people's homes. And so I'm seeing really positive behavior on both consumers and how the industry is responding to advance their digital offerings.

Great. So from here, as we look kind of through the back half of the year and maybe beyond, how are you thinking about COVID variants? Do you think dealers are kind of prepared and we won't see kind of the shutdowns we saw last year? Or is that just still a risk to the ecosystem as the Delta variant, and now there's I think a new variant, begins to spread?

Well, look, it's hard to predict exactly what will happen. I think local dealerships are one of the last groups of entrepreneurs in this country, right? They employ more than any other small business category in this country, and they are hyper resilient and very agile. And you saw this vividly through the pandemic. When their physical showrooms were shut, they just pivoted and focused exclusively on their digital showrooms. And so don't back these guys into a corner. They know how to compete. They know how to operate their business locally. And they were the first to step up with home delivery. We had over 8,000 dealers opt in for home vehicle delivery right in the midst of the pandemic. When most people were frozen and unsure of what to do, these guys were promoting their ability to bring the cars directly to you. So I think the dealer body has evolved a tremendous amount. I think we have a long way to go. We only have 19,000 dealers in a realistic universe for us of about 40,000. So we have a long way to go to digitize the long tail of retailers in this industry. But I think the consumer durability of vehicle ownership is here to stay, Nick. We're seeing record numbers of first-time buyers. We're seeing the average age of driver's license drop for the first time in decades, meaning young teens are wanting to get their license sooner. And I think this is a more broader trend, which is people shunning for mass transit, large format environments in favor of private, safe, secure transportation on their own.

Great. Maybe this is a good segue into the supply constraints we're seeing in the ecosystem today, kind of for both new and used cars, new as the chip shortage, used cars is in high demand. This has been a big topic of conversation for investors. How does this dynamic impact your relationship with dealers today? If they maybe don't have the inventory they wish they had to sell, does that impact how much they're kind of willing to spend to drive conversion?

I think it's strengthening our relationship with dealers. One of our key messages to dealers is they need to spend less on advertising because while their cars don't need advertising because there's strong demand, those cars do need to be found. And that's the beauty of our platform. They only list the cars they actually own. And therefore, they're only marketing their available inventory, not cars that they can't get a hold of. So our platform is matching supply and demand. It's hyper efficient. It costs pennies on the dollar compared to traditional advertising. So dealers can set us, forget us and only worry about people contacting them about their actual cars they have online. If there's been a headwind for us, it's been actually on the OEM side. The OEM business is about 15% of our business. Certainly, car companies aren't promoting and drawing attention to their limited inventories. But I also know the inventory shortage is affecting all OEMs differently. Some are saying they're going to have supply back before the end of the year. Some are saying it's middle of next year. We see that the top 15 vehicles accounted for almost 75% of the decline, right? So if you look at like Ram trucks, Ford F-Series, there just isn't any supply. So we're seeing consumer behavior on our marketplace. Consumers are now searching nationally for cars or trucks that they normally could find locally. So I will say the August trends are solid. Even though inventory levels are down, consumer demand is persistent, and we're seeing robust trends of dealer growth and consumer strength. And therefore, we think the business is going to finish the year on a real high note.

Great. So how should we be thinking about the supply constraint easing overall and that ending up being a net benefit to the marketplace business?

Well, I think that the industry has certainly -- there are certain elements of this environment that the industry has enjoyed. I mean dealerships are enjoying record profitability because used car prices are up, in some cases, almost 30%. And so gross profit per sale is at an all-time high. I think on the manufacturer side, they haven't had to spend their incentive budgets. OEMs were spending close to $4 billion in vehicle incentives, and OEM incentives have dried up virtually in this environment. And so that's adding profitability for every vehicle sale. I think there's going to be a growing trend to align supply and demand. In fact, I think this is one of the growth areas for my business is that most of our users are 90 days from purchase. We sit in the pretail category, Nick, I know a lot of people in the industry are obsessed about investing in digital retail solutions. If you look at the market, pretail or where consumers go prior to purchase, is a much larger TAM. There's over $30 billion being spent in automotive advertising amongst dealers and OEMs, and we're aggregating all that demand on a singular platform and helping convert that traffic directly into dealerships environment. So I think we're in a really good spot because we're seeing, despite the inventory constraints, our solutions fit the mold. If OEM advertising comes back in a big way, you'll see much faster growth on top line and bottom line for the business.

Great, great. So maybe we could switch gears a little bit and talk about how you view the total addressable market. You talked about the 40,000 dealers addressing a long tail. But you also have products like Dealer Inspire and FUEL which have seen strong early traction. So how does this change your view of really what the Cars.com opportunity is, particularly with these new solutions?

Nick, I think our opportunity is much bigger, and I don't think the company is being recognized for its differentiated strategies, which is why I appreciate you give me the platform here today. Again, I think most people see us as a singular website, Cars.com. But look at any of the top dealer groups in the country, and we're powering their auto tech. Over 5,000 dealer websites are currently subscribing to our technologies. We have very SaaS-like revenues, highly sticky because dealers aren't going to turn off their own website. And yet we have the operating margins of some of the strongest leading digital marketplaces globally. And so we have SaaS-like revenues, strong free cash flow, strong operating margins north of 30% last quarter. So the U.S. auto advertising industry is $30 billion. We're capturing less than 2% of that spend. But if you pan back just a little bit, the opportunity for automotive tech is close to a $90 billion TAM, right? And we're scratching the surface. Our solution strategy has been going at double-digit rates. We bought Dealer Inspire just a few short years ago and have rapidly grown that business. We stood up a new business, FUEL, in-house purely through innovation. That's going directly after the $10 billion being spent on traditional TV. And the whole strategy consistently is about giving the auto industry technology and tools for them to run a digital-first business. And so the TAM is significantly more massive than I think the market realizes today.

Great. As we -- since your relationships with dealers kind of underpin the growth in Q2, we saw a slight increase in dealer count. Can you give us a sense of what the growth outlook on retention for dealers looks like given the current backdrop? Is that something you're expecting to see improvement in kind of through the back half and into next year? Or is it still kind of a touch and go environment today?

Yes. Look, I think, first of all, we've grown our dealer base in 5 of the last 6 quarters. The only quarter where we saw a pause in growth was during Q2 of last year, the COVID quarter, when I think everybody was hit with a degree of shock. So the business has been growing, again, dealer growth in 5 of the last 6 quarters. Importantly, this is a time when you're seeing other marketplaces and other platforms to go backwards in volume. So clearly, our value delivery, our brand strength and our tech-forward approach is being rewarded through the data and dealers are seeing the value. I think you're also seeing this reflected in our growth in pricing. We've had 10% ARPD growth and crazy high retention rates. I think this is part of our differentiated solution strategy where the marketplace and the dealer website are working in tandem to drive operating efficiencies for the dealer body. So we expect growth in Q3 to be similar to Q2 levels. And ultimately, again, we're not assuming any return to growth in the OEM business. But I'd be remiss to say that, that business did eke out growth in the last quarter and OEMs aren't going to sit on the sidelines forever. It's just a matter of when do you think they'll be coming back in a big way.

Got it. Got it. I think this is a good segment. We have a question that came in and kind of take a look what could be kind of the competitive dynamic today. So how should we and how do you think about competition within the vertical for the marketplace business? Could you maybe touch on the competitive market dynamics, market share evolution and pricing trends? You just touched on ARPD growth. So any additional color there?

Yes. Look, I'll put competition in a couple of buckets. Let's talk about the similarly situated players. Most of the other marketplaces run gimmicks that really create a race to the bottom for the auto industry. They incentivize dealers to lower the price of their car and then they bid up search results and charge more for the privilege. So your cost base is rising while you're reducing the price to your goods to compete with your peers. Same thing on the new car side and the used car side. I think Cars.com, we've run a level playing field. We let the car be the star and the dealers to hero up in our model. And I think the difference in that is that, look, we've had competition for almost 25 years. What doesn't change is the consumers' reliability of not knowing who to trust when they enter the car market. So every year, we've got 25 people every month coming to Cars.com reliably, with the bulk of that traffic coming to us organically. Most of our peers have got to bid crazy amounts of money, particularly in arbitrage marketing, to sustain their value delivery. We've got 75% of our traffic coming to us directly, and that's a direct reflection of the strength of the brand. I don't think there's ever going to be the day where people aren't going to do research prior to purchase, and knowing that our brand sits in the pretail category versus retail, I think we're really well positioned to have a seat at the table. I think the second big bucket of competition certainly are all the places that dealers and OEMs waste money today. The amount of money being spent on the Google auction or even in the Facebook Marketplace is astronomical. But unfortunately, a lot of those efforts charge significantly high dollars for cost per click or cost per like or cost per engagement. The only thing you can source on Cars.com are actual vehicle sales. We're driving traffic of people that are actually going to buy. 70% of our audience is undecided on make or model and 90% of our audience is undecided on dealer. So I don't care how much money you're spending to promote your own service, you're plugging into our ecosystem because this is a rich reservoir of source of sales and incremental volume. I think dealers are waking up to the fact that spending all your money to compete for clicks in the auction may be driving a lot of phone calls for your service department, but they're truly not driving your variable fixed ops budget. And so the business is highly sticky. It's got clear ROI for the dealers that participate and we're going to continue to take share. And that doesn't even begin to touch what we can do with like things like broadcast television, again, a $10 billion category where dealers are spending very little in video online, and we're going to help lead that transformation from television and broadcast directly to online.

I want to touch on FUEL in a moment, but maybe just to expand a little bit. You had mentioned a lot of bank, of course, goes towards Google and Facebook. I mean how do you think about Google or Facebook maybe entering the category more seriously? I think there was some evidence that Google is testing kind of a dealer-focused or kind of search results page down in Texas. Do you see them being able to kind of viably enter the category and kind of compete with the marketplace model?

I think everybody is asking that question for over 2 decades. And I think we've done fine just navigating the storm. Look at other categories. I mean for commodity goods, I get it, right, plane tickets, hotel rooms, things you're going to buy multiple times in a year and you're not living with it. Buying a car is the second largest transaction in people's lifetimes, and a platform, a freemium model like ours, you're not finding consumers bypassing the research phase. And so this is never going to be a category that's going to be one search and done. Consumers are going to do several hours of digital research prior to purchase. So I think dealer websites have a place in the future. I know marketplaces always do. I mean just look at other categories, Nick. I mean if [ Chewy ] can build a site around dog food, I'm pretty certain there's room for a vertical market for cars.

That's fair. That's fair. Maybe then let's talk about FUEL a little bit. Can you walk us through how integrating video into your platform has been beneficial for capitalizing in kind of in-market audience? And what other results the offering has provided dealers so far?

Yes. Look, FUEL was the creation of both Cars.com and Dealer Inspire coming together. Dealer Inspire had a programmatic bidding platform that it had used to run campaigns for dealers. And Cars.com spends close to $200 million a year building its high-quality first-party audience. One of the things that's going to happen in the future, as everybody is aware, Nick, is the cookie is crumbling and the ability for the auto industry to use modeled audiences to chase auto intenders is going to -- that's a well that's going to run dry. I sleep really well at night because we generate all our own first-party data of high-quality end-market shoppers. So our audience is pure. And what FUEL really enables dealerships to do is take the power of all the OTT platforms and digital streaming services and social media tools that are out there, and marry that with our high-quality first-party data and narrowcast their advertising and marketing campaigns just to those people that are actively in the market to buy a car. FUEL doesn't come cheap because it's a precious commodity. There's only 5 million people buying a car every month, and you think about how much of the auto industry is wasting money advertising to the general population across the U.S. And FUEL, what we see consistently is when the dealer subscribes to FUEL, they're narrowcasting their messages just to the Cars.com and high-intention audience in a set geographic area. And in many cases, despite them spending 5 to 10x less, they're seeing 4 to 5x lift in performance because of that narrowcast just to those people and percentage of the population that's in market. So FUEL is in the early innings. We just launched this during the heart of the pandemic. It's accounting for almost half of our ARPD growth. And then the subscription rates here are almost 5x what our core subscription rate is for our marketplace. So lots of headroom to go with FUEL. We're just getting started.

Great. Maybe switching to Dealer Inspire, another solution that's seen some solid growth since the acquisition. Can you comment a little bit on the opportunity with GM and Ford? And how should we think about other OEMs engaging with Dealer Inspire over time?

Well, first of all, on GM, they went to a semi-exclusive model from an exclusive model and only awarded GM dealers the right to use, work with 3 other vendors, of which we're 1 of the leaders there. In fact, no provider has grown more share of GM websites than our Dealer Inspire business. We've got about 800 of the websites that have launched, which is about 85% of the sites that are already contracted switched to us. There's still room to grow there. GM has got over 4,000 dealer websites. And dealers are increasing their investment to modernize their digital experience, and we've got room to grow there. The Ford deal was more recently announced. Again, I mentioned before, we launched our first Ford website just about 8, 9 days ago, and Ford's got over 3,000 dealers in its network that we can now go out and convert to our website solutions. So the pipeline here is growing. Again, we've got 8,000. So there's tons of opportunity just to go on new customer acquisition. But importantly, we're outfitting these dealers with digital tech. We've got digital retail solutions. We've got online chat solutions, trade-in solutions, things that we're plugging into the dealer's website. And importantly, once they work with us on our tech, we can now plug those technologies into our marketplace and help generate incremental demand for the dealerships. So again, lots of room to grow on our solution strategy.

Great. Great. Maybe let's touch on traffic. To think of that, it's something that a lot of investors focus on because it's something, I guess, most people can get access to. When we compare it to kind of the broader landscape and some of the competition, how should we be viewing traffic? How do we size kind of the quality of the leads that Cars.com has been able to achieve with this traffic versus maybe other competitors? And is traffic kind of the right metric to be looking at?

Well, I do think traffic is a general strength and a sign of health of a marketplace because the more participants in the marketplace, the more network effects you can generate. And I'm proud to report that no marketplace has been growing faster than Cars.com over the last few years. So what's exciting about that growth is it's really through the strength of our brand. We're not having to buy our traffic nearly to degrees that others are to sustain value delivery. Part of that's because of the strength of the brand. The other part is because we produce high-quality editorial content. We are critically reviewing best third row SUVs. We're talking about new makes and models, so consumers can use the vast amounts of research and reviews on our platform to get smart prior to purchase. Again, we sit in the pretail part of the industry rather than focus purely on the retail. I think the part that's missing is that even though we've got 25 million people every month using Cars.com, again, Nick, we've got 45 million car shoppers every month across our network of dealer sites. And when you think about the exciting next legs for growth for the business, think about all the secondary market and growth opportunities in the financing space, in the vehicle trade-in space. Any of these technologies that we plug into our network, we're not only plugging that into the strength of the Cars.com platform, which gets 25 million people a month, we can plug it into the 45 million people shopping on dealer sites every month and help enable our dealerships to grow their business through those technologies and tools as well. So traffic is important. I think most people look at our traffic mix as only our marketplace. The frequency and reach that we have on a day in and day out business is 4x greater than what most people think about my firm.

Got it. And you noted on the 2Q call and previously as well that the majority of your traffic is organic. Paid search is less efficient for engagement and conversion to sales. So what have been the major drivers of organic growth? And then I guess what has that done to ROI trends for dealers on the Cars.com platform, given how much organic traffic you're able to win?

Yes. I mean, look, I think the strength of our app, if you look at both Android and iOS environments, Cars.com is consistently rated not only one of the most downloaded apps but the highest rated. And so our app has been a real strong source of growth over the years. Again, just the sheer volume of people that type cars directly into a search engine, and we benefit every time someone thinks about this category. So we have a high concentration of natural organic value that we generate each and every month, which is also another reason why the industry needs to subscribe. It's not like this is traffic you can buy elsewhere. These are users that are coming to Cars.com for our research, our reviews. And our SEO has been growing faster than any other property in the category. We just completed a fairly significant overhaul in migrating our platform to the cloud. So our site speeds are significantly faster and our ability to innovate has radically improved. And so you'll expect to see a much faster rate of innovation in the business and parity in terms of our experience and growing our traffic footprint.

Great. I think we have time for one more question. Maybe you could talk about kind of, I guess, M&A or consolidation within the segment. There's a handful of competitors. How do you see this category evolving over time? Does this maybe look like some of the European markets where one really kind of dominates? Or is this a category where there's going to be a handful of players for a while, and then maybe over time, as ROIs and things like that show up and additional solutions are provided, to begin to kind of consolidate around fewer platforms.

Yes. I mean, look, there are many fundamentals to our model with other European counterparts, whether that's our strong free cash flow yield or our industry-leading EBITDA margins. I think when it comes to this market versus European markets, probably the biggest difference, Nick, is the volume and dealer density that exists in this country. And I think in other environments, the manufacturers did a much more modest rollout of franchise points across their geographic footprint. In the U.S., in Chicago alone, you've got 8 Toyota dealerships within a 30-mile radius. So I don't think you're going to see consolidation to a singular player. Those consumers are using multiple sources to collect information prior to purchase. And in many cases, they're shopping 2 to 3 destinations prior to online engagement. I think dealers are resistant to have a singular winner. They like to have a level playing field to support them because of the heavy amount of dealer density in the country. So look, we've spent 20 years building our brand. It's a brand that consumers trust and rely on each and every time they go into the car market. And I think the dealer body growing 5 of the last 6 quarters has recognized that we're an enabler for their success. And most other marketplaces, I think, play more of a predatory role. And I think that's one of the reasons why the industry has started to swing favor our way is that we're doing a lot more for them than sending them leads.

Great. Well, Alex, thank you so much for the time. This was great. This will conclude our call.

Nick, thanks a lot for having me, and have a great rest of the week, everyone.

Okay. Take care, everybody.