CarGurus, Inc. (CARG) Q1 2023 Earnings Call Transcript

CarGurus, Inc. (NASDAQ:CARG) Q1 2023 Earnings Conference Call May 9, 2023 5:00 PM ET

Company Participants

Kirndeep Singh – VP & Head, IR

Jason Trevisan – CEO, Treasurer & Director

Samuel Zales – COO & President

Conference Call Participants

Marvin Fong – BTIG

John Colantuoni – Jefferies

Tom White – D.A. Davidson & Co.

Ronald Josey – Citigroup

Nicholas Jones – JMP Securities

Operator

Greetings, and welcome to CarGurus Q1 2023 Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Kirndeep Singh, Vice President, Head of Investment. Thank you, Kirndeep . You may begin.

Kirndeep Singh

Thank you, operator. Good afternoon. I’m delighted to welcome you to CarGurus First Quarter 2023 Earnings Call. We will be discussing the results announced in our press release issued today after the market closed and posted on our Investor Relations website. With me on the call today are Jason Trevisan, Chief Executive Officer; and Sam Zales, President and Chief Operating Officer.

During the call, we will make statements regarding our business that may be considered forward-looking within applicable securities laws, including statements concerning our outlook for the second quarter of 2023, management’s expectations for future financial and operational performance; our business and growth strategies; our expectations for our CarOffer business and acquisition synergies and 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 the market closed today and in our most recent reports 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 will now turn it over to Jason.

Jason Trevisan

Thank you, Kirndeep, and thanks to everyone joining us today. Every year, I begin with a theme that aligns to our strategic objectives and 2023 is no exception. In 2021, we focused on the transformation of our business. In 2022, we activated substantial new products across the platform. And now in 2023, our North Star is monetization through transaction enablement.

During our evolution from a listings business to a transaction-enabled platform, we remained acutely focused on providing our dealer partners with the highest ROI, a comprehensive product suite and continued innovation to meet their evolving needs. As we build on the previous year’s themes by maturing our end-to-end offering that better serves our largest consumer audience and dealer partners, we are now beginning to concentrate our efforts on monetizable transaction activities for both dealers and consumers across the platform.

Transaction enablement allows dealers to further monetize retail sales. Instant Max Cash Offer allows consumers to monetize the transaction through the direct sale of their own vehicle. And at CarGurus, we are able to monetize high-value Digital Deal leads. Through innovation in our growth vectors of Digital Wholesale and Digital Retail and more robust transaction enablement, we aim to provide increased value to our customers while striving to achieve a balance between capturing that value and driving greater adoption.

We have made tremendous progress in becoming the #1 digital destination for consumers and dealers to confidently and conveniently buy and sell any vehicle, anywhere with the best selection in price. Although the macro environment continues to create volatility in inventory and pricing trends, our foundational listings business continues to exhibit resiliency and strong profitability.

While we recently faced operational challenges with our CarOffer business, progress this quarter demonstrates our agility in responding promptly and effectively to navigate the year ahead. We are proud that our strong execution allowed us to exceed our forecasted guidance for the quarter while maintaining a balance among pursuing innovation, fueling growth and ensuring scalable profitability.

We entered the quarter with expectations that OEM advertising and consumer financing would serve as headwinds and offset our subscription revenue growth. While that was certainly true, during the first quarter, we also witnessed reduced dealer inventory levels due to economic projection indicating a potential deceleration or recession. These factors resulted in a further tightening of inventory and marketing dollars as dealers look to preserve healthy profit margins.

Despite these compounding factors, I’m pleased to share we exceeded our forecasted Marketplace revenue for the quarter. One key driver of our Marketplace results this quarter was the scaling and overperformance of monthly recurring revenue, resulting from annual business reviews or ABRs.

Through the ABR process, we are renewing a cohort of meaningfully underpriced dealers each quarter, and we have made significant improvements to our renewal process by streamlining our packaging and enhancing the value proposition for our dealers through the addition of new features and benefits to our listings tiers that best support our dealers’ needs.

Even during a period of historically low inventory, our improved ABR process demonstrated the strength of our platform to effectively scale and recognize more appropriate value delivered while simultaneously enabling us to be more consultative in introducing cross-product adoption opportunities that best support our customers’ business needs. In fact, in Q1, the ABR process was 2.5x more successful in converting Area Boost dealers into a new offering known as Digital Deal with geographic expansion. I’ll provide further details about this new offering later in my remarks.

While ABR has yielded positive revenue expansion as expected, they elevated involuntary dealer attrition as we held firmer on what we’re confident is highly attractive pricing and dealer ROI. We ended the quarter with 24,394 paying dealers in the U.S., up 175 dealers from the year ago period, but down 173 dealers from the prior quarter. Excluding ABR related churn, we had positive dealer adds quarter-over-quarter.

Although we observed healthy dealer acquisitions earlier in the quarter, we noticed a rise in voluntary cancellations across all dealer types, we believe, primarily due to the aforementioned lower inventory levels and margin preservation during a period of economic uncertainty. Despite the quarter-over-quarter decline, we’re pleased with the results of the ABR process and remain confident that we are delivering to our dealers a very compelling value proposition.

In Q1, U.S. quarterly average revenue per subscribing dealer or QARSD was $5,943, growing 4% year-over-year. Performance was primarily due to revenue expansion through listings, upgrades and product adoption, signing on new dealers with higher average monthly recurring revenue and unit price increases. By consistently investing in and enhancing our product offerings, we are capable of innovating quicker and more frequently than y other marketplace which in turn brings more value to both our dealer partners and largest consumer audience while driving long-term QARSD growth.

As a part of our continued product development, we launched Digital Deal in May of 2022, a critical step in our ability to create an end-to-end platform. Digital Deal provides consumers with the flexibility to customize their car shopping experience by allowing them to do more online. Shoppers can receive trade-in estimates, prequalification or hard-pull financing, purchase dealer- or vehicle-specific finance and insurance products and even place a deposit on their preferred vehicle.

This offering provides our customers with the flexibility to transact in a way that best suits their needs. At the end of the first quarter, this new capability has been adopted by 2,251 dealers, adding 663 dealers quarter-over-quarter. Although there were price increases at the beginning of the year, we were able to boost our sales velocity, which also included the addition of large national players with 100 to 200 rooftops.

Digital deal continues to gain dealer share as it attracts high-value leads from highly engaged consumers who are ready to purchase, saving dealers time and money. Digital Deal leads are over 2 to 3 times more likely to close than standard CarGurus’ e-mail leads. Moreover, consumers who go farther down the funnel and complete a hard pull are 5 times more likely to close.

Our most successful dealers utilizing Digital Deal are now seeing an average of 25% of their CarGurus online leads come from Digital Deal. For dealers, this adds tremendous value and ROI is 25% of their shoppers are high-value leads, making the dealership more efficient in closing a deal and moving on to their next sale faster. A representative at Belk Ford and Oxford, Toyota said, “Digital Deal leads that have prequalified financing are almost guaranteed to convert. They’re another indicator they are high quality and are easier to reach with a guaranteed phone number.”

Our Digital Retail capabilities do not stop there. Coupled with Area Boost, dealers now have the ability to sell vehicles online to consumers outside of their immediate geographic reach. We have seen healthy cross-product Digital Retail adoption with 57% of Digital Deal users also enrolling in Area Boost. Area Boost helps dealers expand their reach by displaying their deliverable listings to shoppers outside their local market.

Capitalizing on the synergies between these 2 offerings, we recently launched a newly bundled offering called Digital Deal with geographic expansion. It allows dealers to leverage a high-quality lead flow while attracting a wider audience outside the physical reach of a dealership. This new offering has increased close rates by 2 times when compared to standard Area Boost lead.

Because of the exponentially higher value these 2 products provide in tandem instead of separately, Area Boost will now be an exclusive feature through Digital Deal with geographic expansion. Together, they provide a dealer with both more volume and higher lead quality.

Our early-stage Digital Retail capabilities provide flexibility and convenience for both our dealers and consumer customers. We are leveling the playing field for our dealer partners who are unable to provide these solutions on their own and/or want to leverage our largest consumer audience to sell additional inventory through the CarGurus platform to drive greater profitability.

As we progress towards our ultimate goal of creating an end-to-end solution, the power of this vision becomes even more clear, giving our dealer partners a cohesive experience that provides them value, whether it is through an expanded customer base data-driven decision-making and/or high-value lead generation. And at the same time, these capabilities provide us an opportunity to, not only create a stickier platform, but the ability to capture greater market share and dealer wallet share.

In our Digital Wholesale segment, we entered Q1 with plan to intentionally reduce volumes sequentially, while we optimize several operational aspects of the business to better handle the market and pricing volatility. Over the last 5 months, we have aggressively addressed these issues to build a stronger, more stable and more predictable business that can thrive in all market conditions. In doing so, we remain committed to building a sustainable business that produces a path to profitability.

As we developed our strategy to improve CarOffer operations, it became apparent that a significant number of our challenges were rooted in our need to enhance and upgrade our inspection capabilities and our corresponding policies and procedures. Increased arbitrations, rematches and transportation inefficiencies were largely the result of our inspection quality. For this reason, we intensified our efforts to bolster inspections, processes and policies to improve our quality and reduce nonrevenue-generating costs. These efforts have resulted in a 70% reduction in arbitration cases from their peak in the fourth quarter.

During the same period, we also witnessed a 55% decrease in rematch rates. A rematch is the active moving and arbitrated vehicle to the next highest bidder on the platform, potentially causing higher transportation losses and risk of further delayed arbitration from unsatisfactory vehicle quality. By prioritizing positive unit economic transactions and minimizing problematic ones, we also achieved positive transportation margins in the first quarter as well, improving approximately 3,500 basis points quarter-over-quarter.

As a reminder, transportation margin is largely passed through. These improved margins stem from a combination of a favorable price environment for dealers as well as a drop in arbitrations, unwinds and rematch rates, which have reduced the occurrence of dead legs instances where we incur the cost of transportation but receive no revenue. Our efforts resulted in an approximately 55% reduction quarter-over-quarter of dead legs.

As our KPIs continue to trend in the right direction, we are creating a sustainable path to profitability. This quarter, we meaningfully exceeded our forecasted revenue and EBITDA plans for our Digital Wholesale segment. We generated $64.8 million in revenue and had an EBITDA loss of $1.7 million. Our performance this quarter was driven by operational improvements and higher-than-forecasted dealer-to-dealer transaction volume as buying conditions improved in February and March.

While tight dealer inventory and declining wholesale and retail prices to begin the year helped us keep volumes low, we did see greater dealer confidence in the back half of the quarter with seasonally strong consumer demand and rising wholesale prices following a 7-month decline. These factors, along with modest reengagement from some rental fleet customers, albeit at controlled volumes, caused dealer-to-dealer transactions to rise quarter-over-quarter while we deliberately reduced Instant Max Cash Offer, or Instant Max for short, transactions by over 50% from the prior quarter. We ended the quarter with 17,505 transactions, down approximately 5% quarter-over-quarter. The overall reduction in volumes resulted in gross merchandise sales, or GMS, of $445 million.

Although we are pleased with our results, we are aware that external factors have played a meaningful role. That is why our decision-making continues to prioritize establishing a profitable platform that can thrive in any environment. We are concentrating on operational improvements over volume growth to ensure our platform is dependable for dealers to conduct transactions with confidence.

In doing so, earlier in Q1, we launched a new option for dealers called 24-hour approval. This capability allows dealers to review vehicle details, photos and vehicle history before making a purchasing decision, which provides dealers additional comfort in a volatile price environment. In the first quarter, 24-hour approval facilitated a significant number of transactions while simultaneously improving dealer confidence and satisfaction.

Moreover, as we continue to improve our operations, we remain committed to ensuring that all transactions are executed with the highest level of quality. This focus on quality and improvement is showing signs of positive traction with our customers as we have seen dealers reengage our platform.

By implementing operational enhancements and taking a meticulous approach, we are establishing a stronger foundation for our CarOffer business as a trusted platform for dealers buying and selling needs. Across the business, we are very pleased with our first quarter results. We made significant strides on the path towards realizing our vision of creating a profitable end-to-end transaction-enabled platform that provides consumers with the trust, transparency and choice they need to confidently shop finance, buy and sell a vehicle and empower dealers with innovative tools to source, market and sell vehicles.

The unique combination of our resilient foundational listings business, differentiated Digital Wholesale business, and innovative Digital Retail offerings create a unique value proposition as an automotive ecosystem that serves our customers’ life cycle needs. The year began on a positive note. Our achievements this quarter showcased our resilience in overcoming both internal and external challenges to create a more robust and profitable foundation for the future. We are excited for the opportunities that lie ahead in 2023 and we are focused on creating a unique value proposition for our consumer and dealer customers and delivering long-term value for our shareholders.

Now let me walk through our financial results. I’ll provide a detailed overview of our first quarter performance, followed by our guidance for the second quarter. Total first quarter revenue was $232 million, $17 million above the high end of our most recent guidance range. Total revenue was down 46% from the year ago period. Marketplace revenue was $167.1 million for the first quarter, up 2% and from $163.3 million in the prior year and up 1% from $166.2 million in the prior quarter.

The increase in Marketplace revenue compared to the prior year was primarily due to signing on 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. As anticipated, growth in subscription revenue was largely offset by a decline in advertising and consumer finance revenues.

Wholesale revenue was $25.2 million for the first quarter, down 72% from $91 million in the prior year, but up 6% from $23.7 million in the prior quarter. The year-over-year decline in wholesale revenue is due to the self-imposed slowdown to ensure that the right processes and policies are in place to enable scalable and predictable growth. Quarter-over-quarter, however, we saw a slight increase in dealer-to-dealer transactions due to seasonally strong consumer demand, rising wholesale prices and modest rental fleet participation. Lastly, Product revenue was $39.7 million for the first quarter, $8.7 million above the high end of our most recent guidance range.

Product revenue was down 78% from $176.3 million in the prior year and down 59% from $96.8 million in the prior quarter. The year-over-year and quarter-over-quarter declines are due to our purposeful slowdown in transaction volumes this quarter for Instant Max Cash Offer with a greater emphasis on operational rigor.

Through higher quality inspections, we saw a meaningful reduction in arbitration rates and consequently, arbitration revenue during the first quarter as well. 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 first quarter was $64.8 million, down 76% from the prior year and down 46% from the prior quarter.

I will now discuss our expenses and profitability on a non-GAAP basis, which backs out our stock-based compensation expense, amortization of acquired intangible assets and net income or loss attributable to redeemable noncontrolling interest. First quarter non-GAAP gross margin was 69%, compared to 44% in the year-ago quarter. The change in non-GAAP gross margin year-over-year is primarily due to the shift in revenue mix to our high-margin Marketplace business.

Total first quarter non-GAAP operating expenses were $123.8 million, down 1% year-over-year. Non-GAAP sales and marketing expense was down 13% year-over-year to $72.5 million. The decrease in marketing expense reflects our decision to limit marketing investment for Instant Max Cash Offer, partly offset by a slight increase in spend related to the launch of our new brand campaign at the beginning of the year. Our first quarter non-GAAP product, technology and development expenses grew 25% versus the year ago period to $30.3 million.

Similar to previous quarters, the increase is primarily due to an increase in employee-related costs as a result of a 6% increase in head count from the year ago period coupled with the commencement of our lease in February for our new corporate headquarters in Boston. We expect product, technology and development expenses to remain at these levels as we continue to develop and grow our expanded Digital Retail product offerings to build our end-to-end transaction-enabled platform.

We generated non-GAAP operating income of $36.6 million in the first quarter, reflecting operating margin of 16%. Consolidated adjusted EBITDA was $40.8 million in the first quarter, $13.8 million above the high end of our most recent guidance range. This was due to continued strong Marketplace subscription performance, prudent and effective expense management, favorable wholesale market dynamics and improved CarOffer operations.

Non-GAAP diluted earnings per share attributable to common shareholders was $0.26 for the first quarter, $0.07 above the high end of our most recent guidance range. On a GAAP basis, we generated first quarter gross margin of 67%, compared to 42% in the year ago period. The expansion in gross margin versus the prior year period is due to the shift in revenue mix to the higher-margin Marketplace business.

In the first quarter, we incurred total operating expenses of $140.9 million, down 9% year-over-year. As I mentioned earlier, the decrease in operating expenses reflects a strategic reduction in sales and marketing expense in addition to a 46% year-over-year decrease in stock-based compensation expense due to the revaluation of certain liability-based stock awards.

First quarter GAAP operating income decreased 47% year-over-year to $14.1 million. First quarter GAAP consolidated net income was $11.9 million. Net income attributable to CarGurus totaled $16.1 million and first quarter GAAP net loss attributable to redeemable noncontrolling interests was negative $4.3 million. We ended the first quarter with $456.7 million in cash and cash equivalents, a decrease of $12.8 million from the end of the fourth quarter.

We generated $66.3 million in cash from operations in the first quarter and $60.5 million of non-GAAP free cash flow, which includes capitalized website development and capital expenditure costs of $5.9 million. Cash provided by operations in the first quarter was primarily driven by our results and a $38 million cash increase in our working capital accounts. During the first quarter, we repurchased 4 million shares for an aggregate purchase price of $65.2 million. As of March 31, we had approximately $166.2 million available for additional share repurchases.

I’ll conclude with the outlook for the second quarter. We expect our second quarter revenue to be in the range of $220 million to $240 million. We once again expect strong Marketplace subscription revenue to be offset by headwinds from consumer financing and OEM advertising. In our Digital Wholesale segment, we continue to prioritize operational excellence over volumes. In Q2, we are forecasting a softening in the wholesale market, along with a continued decline in arbitration revenue driven by improved operational performance. As a result, we expect second quarter revenue for our Product line item to be in the range of $26 million to $36 million. We expect our second quarter non-GAAP consolidated adjusted EBITDA to be in the range of $34 million to $42 million and non-GAAP earnings per share in the range of $0.22 to $0.25.

As we continue to make operational improvements that are sustainable for our CarOffer business, we expect to reach EBITDA breakeven to profitable for our Digital Wholesale segment during the second quarter. Moreover, as it relates to our operating expenses, we expect Marketplace EBITDA to be lower quarter-over-quarter as we will have a full quarter of our lease expense and increased marketing spend related to our brand campaign. However, as we’ve previously mentioned, 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.

In the first quarter, we significantly exceeded our expectations. We’re proud of our results and our team’s ability to react quickly to overcome challenges. Our achievements and advancements would not have been feasible if it weren’t for our incredible employees globally, whose unwavering commitment and hard work have been instrumental in driving our progress in achieving our results.

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

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from Marvin Fong with BTIG.

Marvin Fong

I’d just like to start on CarOffer. I recognize a lot of progress was made there and I did hear about your commentary for the second quarter. But I guess, absent just sort of the end market conditions, I mean, how are you feeling, in general, about the progress you’ve made there and about your — the timing and willingness you have to really start leaning back into that business and putting some volume back through the channel, particularly on the Instant Max side.

Samuel Zales

Marvin, I’ll take it. It’s Sam Zales. Nice to talk to you. Thanks for the question. I think I had said the first as a straightforward answer, we couldn’t be more pleased with the CarOffer business and its turnaround over the last couple of quarters. I think we had said to you that we want to run a profitable business that’s predictable and drives a happy path, a great customer experience and more profitable transactions than less. And you can see the progress we’ve made. It’s been remarkable.

I’ll highlight a couple of reasons why that’s been such a success. And I want to thank the CarOffer team in Dallas and really our sets of many business unit teams at CarGurus who’ve traveled to Dallas to do a lot of work over the last couple of quarters to focus on people, processes, systems and products to really call what I would say, CarOffer 2.0 for the business.

It started with data and getting our access to all of the information on the parts of our transaction process that we’re working and need to be improved — and needed to be improved, and those results and the data that we accessed allowed us to really attack every part of the transaction flow to improve our performance.

It started with inspections. And as we talked about creating mechanical, electrical, frame damage, every kind of system check that we needed to, we improved our opportunity to understand which transactions or which vehicles should fail, and we failed many more of those transactions, and it avoided arbitration and turned around our entire arbitration process to create confidence in the buyers and sellers using the platform.

Arbitration rates are down dramatically, as you heard in the comments, 70% reduction. Our arbitration losses obviously go down because we’re working with partners and removed a lot of that inventory that was sitting and depreciating and that’s been the success of a very low arbitration rate going forward. Our rematch rate has been phenomenally better. That rematch rate, as you know, is finding the next dealer in the platform to use to try to create a transaction. We’ve reduced that process because of the inspection quality that we’ve done upfront with our partners.

And finally, turning transportation, which was a negative gross margin business into a positive one has been a phenomenal turnaround, all of that driving the path to profitability for this business. As I mentioned a couple of quarters ago, it will take us a few quarters, and we’re not done with all of that work. It’s a remarkable turnaround. It’s a tremendous confidence building for our customers on both sides of the buy and sell transaction.

But we have more work to do. And so we’re not going to take the reins off and run scale volume through that to see if it pressure tests our profitability path. We feel very strongly we can run a profitable business at lower volumes, and we’re going to do that. Our priority is to run a profitable business there and then scale up the business with much more volume. And so I think you’ll see us continue to push forward on volumes, but we’re going to continue on this path to running a profitable business and very proud of the results we have. I hope that answered your question.

Marvin Fong

It did. And kudos on all the progress you guys have made. If I could do a follow-up question. You’ve mentioned that the rental agencies have come back. I think you’re controlling their participation. And actually, I think it’s interesting to hear they came back since I’ve been hearing that the OEMs have been giving fleet a good allocation in terms of production volumes.

So just curious how has your thinking evolved on the rental agencies being — how much of a part of the mix they’re going to be on sort of an ongoing basis. And as things stand now, are they being more rational in terms of bidding than they were, say, this time last year? Just kind of give us some additional color, that would be terrific.

Samuel Zales

Yes. Thanks, Marvin, it’s Sam again. Our process is the same in being this predictable and profitable business that we want to create at CarOffer, which is to be thoughtful about any 1 partner taking on more of the Marketplace than any other. I think when you have an instant trade platform that works as well as it does with our technology, but you add to it the incredible improvement in inspections and the quality of the vehicles going through the platform, the players, like the rental agencies, will say, “I am getting more distribution from the OEMs. But if I got to fulfill volume as the market continues to grow, and we — and I have an opportunity in the summertime to fill up my rental fleets, I’m going to do that with the best partners out there.”

So we controlled their activity coming in. They were watching their impact on the other players in the marketplace. And you saw our overall success of having more and more buyers and sellers succeeding on the platform because of our operational work. We’re going to bring them in and bring them in at a tamped level where we control the volume and make sure that we are still in that marketplace that’s creating that confidence build in all of our customers as we go forward.

So we’ll bring them in but watch and control how much we let them participate. And we hope that we’re fulfilling that need as a secondary source beyond the OEMs and the new car distributions that they get. And they’re saying, you’ve got quality vehicles that are late-model vehicles that I want to put on my rental fleets, then we’re going to service those, but do it in a controlled way with this tremendous operational improvement that we’ve created.

Operator

Our next question comes from John Colantuoni with Jefferies.

John Colantuoni

Wanted to start with pricing. It’s been up nicely, although U.S.-paying dealers has declined marginally in the past 2 quarters. How much of that have — would you attribute to seasonality and the challenging macro environment versus your efforts to take some pricing? And second question is, it looks like in the second quarter, your outlook implies sort of moderately lower revenue in Product and maybe just add a little color around that.

Jason Trevisan

Sure. Thanks for the question, John. It’s Jason Trevisan here. So we — as you’ve heard, we have been focused on capturing the value that we’re confident we deliver to dealers. We consistently hear, through our own survey and research work as well as through third parties, that we, in most cases, are delivering, not only the highest volume, but also the best ROI as well. And so we have focused there as well as on package levels and cross-selling other products. So not just on pricing, but pricing is one.

I think we may have said in the prepared remarks that in our annual business reviews, we’ve held firmer on price. And so by doing so, that certainly instigated more churn than otherwise would have. And if you were to strip out what we call the — that churn, which is involuntary churn, then we would have actually seen dealer adds. And so we’re not quantifying it to an exact number, but I would say that we are making a conscious decision to stand firmer on capturing the value. And if that means near-term churn, then we’re comfortable with that as we focus on MRR, really, rather than dealer count per se.

And we also, though, believe that over time, and we need to earn the business back, but that over time, dealers will recognize that ROI and return to us. Dealers, admittedly, are very focused on their own margins. They enjoyed a period of, I think, probably record-setting dealer net income margins and operating margins. And so as they come off of that high that they’ve experienced in COVID, in the back half of COVID here, we certainly are seeing some dealers and some small segments who are focused on cutting costs in order to try to maintain that margin. I don’t — to be determined if that’s a sustainable strategy or not, but that did contribute a little bit in Q1. And I apologize, could you restate the second question?

John Colantuoni

Yes. Just second one, just a quick one about Product revenue. In your outlook, it looks like you’re looking for a sequential moderation in the second quarter. Just curious if you could add a little bit of color around why that’s going to happen.

Jason Trevisan

Sure. We are forecasting that, and it’s partly driven by our marketing spend, our expected marketing spend levels. It’s also influenced by our forecast on market conditions and consumer sentiment to — or appetite to sell. And then also within the quarter, there are dynamics that occur that are not — it’s not, like, flat for each month of Q1 and flat for each month of Q2. So there’s just some small gyrations in there as well. We — much like Sam’s comments, we’re just focused on making sure that we have a consistent repeatable way to generate profitable transactions and not get — not surprised with too many negative transactions or bad transactions. We’re proud of the gross margin that we experienced in Q1 on C2D.

Operator

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

Tom White

Maybe just following up on the last question there, Jason. I guess reading through the tea leaves on the Product segment guide, it sounds like you guys are maybe anticipating that used vehicle pricing or wholesale pricing kind of declines here or maybe becomes more volatile. Can you just talk a little bit about how the recent volatility that we’ve seen there is impacting dealer appetite or how you expect it to impact dealer appetite to do transactions in the second quarter?

And then just a follow-up, it sounds like encouraging news on how the ABRs are going. And could you maybe just parse out a little bit, like, when you take these cohorts that were sort of undermonetized and you kind of expand revenue for them, is it mostly from just higher unit pricing for listings? Or, like, maybe just help us understand, like the — how much of it is higher unit pricing for listings versus cross-sell or upsells?

Jason Trevisan

Sure. Thanks, Tom. I’ll take the first one and then maybe Sam can take the ABR — the question on ABRs. So dealer appetite for — dealer appetite changes from unit pricing changes in wholesale has typically been that we’ve seen, if prices are dropping, there’s less dealer appetite to transact. And while for every, obviously, buyer — or for every seller, there’s a buyer, we have seen volumes in the industry, but also, on the CarOffer platform, track fairly closely with that.

And I think that logic is if a dealer sees pricing has dropped in the last week or 2, their expectation largely is that prices may continue to drop for the subsequent week. And so they are less inclined to take on an asset that may lose value before they’ve even prepared it for sale. I think it’s a little different for consumers in the Instant Max model where their consumers are less tuned into what car prices have done in the last week or 2, and they’re more tuned into just the absolute dollar value they’re offered.

And if dollar values are higher when they — versus when they maybe last checked it, then they’re going to be more inclined to transact. So there, it’s less about the trend and more about the absolute price levels at that time relative to where they may have been 3 months ago when they happen to check it.

So now that doesn’t mean that transactions stop. It just means that dealers take a different lens to it and a lot of what we’ve done in the last 3 months or 6 months at CarOffer is build the business to be healthy and profitable when prices, over that time, have really been consistently declining with an exception period in Q1 for a little bit versus what we had been building for, for the prior, call it, 2 years when prices had pretty much increased through that whole time.

Samuel Zales

Jason, I’ll jump in. Tom, the question was on the ABR’s annual business reviews and the success of that. We’re really, really proud of the results that are going on in that front. You’ll recall, having known us for years that we moved away for the last couple of years from that old renewal process. First of all, the timing wasn’t great with market conditions coming out of COVID. But second of all, that we wanted to become much more consultative in this process to actually provide dealers with insights about their merchandising and their success.

We think we bring the largest — we know we bring the largest audience to them. We think we bring the most down-funnel shoppers. We bring the highest return on investment for their marketing dollars. So we’ve been much more consultative with them in providing these insights to help them get the most out of their package.

And so what we’ve done is seen — you asked about the QARSD growth, and the pricing growth, it comes in 2 forms. The first is getting dealers to a higher-paying package, a premium package or subscribing to a new product. The success of Digital Deal has been phenomenal, our fastest-growing Product out of the gate for the company. And the reason we’re doing that is we’re bringing tremendous ROI, those close rates of 2 to 5 times the close rates of our regular e-mail leads.

It tells you that you’re bringing a product to market that we can continue to increase price on, but package it up for a dealer to say, “Oh, I’ve got that plus Area Boost. I can broaden my share of market that I’m selling to outside of my local market and get those great Digital Deal and digitally initiated consumers to close with me. I’m going to spend more on that product.”

We’re selling the premium packages that we have. Or in some cases, as we mentioned, we’re going after underpriced dealers. We know they’re far below where they should be paying and the ROI they’re deriving is not a fair balance with our ROI from the program, so we’re going to increase unit price on some of those dealers who can say, “I’m staying at the same package, but my price goes up.” That’s good enough for us as well. So we’re very, very pleased with where we are in the ABRs, we’ll continue to grow those as we go forward.

Tom White

That’s great. Super quick follow-up. On the voluntary churn you highlighted, am I right to presume that, that’s mostly, like, smaller independents and so it — maybe it impacts dealer count but less of an impact on MRR?

Samuel Zales

Voluntary churn, we — I think we mentioned in — was sort of across the board. I think following where the market is right now, inventory is down, margin preservation coming out of the really positive results Jason just mentioned for the dealer community in 2022. So we saw that across the board.

Where we saw the change, though, in our net dealer adds was pushing the ABRs and saying we’re not going to accept a dealer who’s underpriced, not paying a fair and reasonable price for the program. So involuntary is where we saw that impact our net dealer adds. The voluntary hit across the board as it always has in our business at a very low level, but one across the different segments.

Operator

Our next question comes from Ron Josey with Citi.

Ronald Josey

Jason, I wanted to take in a question. I wanted to ask a little more about CarGurus’ brand ad campaign now that you’re seeing demand and newer tools drive greater overall results and just awareness. We’re seeing the fact that traffic went up. Talk to us more about the brand campaign and the efficacy of it as we see top line growing.

Jason Trevisan

Sure. Thanks for the question, Ron. So as a reminder for folks that really kicked off at the beginning of this quarter, so we’re — or at the beginning of Q1 rather. So we’re only a few months in. It is — its goal, as we’ve shared, is one, to really tout the fact that we have so much more capability and options on our site for consumers to shop, finance, buy and sell, and so we wanted to share that.

We also are expecting to grow our unaided brand awareness and broader brand awareness and just make more of an emotional connection rather than what historically had been oriented toward a very pragmatic sort of functional approach to branding. And we’re doing all of that in an environment where some of the large spenders that existed in our category a year ago or 2 years ago are spending much less. And so we see an opportunity to capture much more share of voice.

It’s still, honestly — to be honest, early. We’re — a few months in, we’ve certainly started to do research and read what’s happening, and we’re excited by it. It’s still early to see the needle moving extraordinarily on, say, unaided awareness or even aided awareness. But we absolutely believe that it is laying the groundwork to establish more trust, which is really important as we ask consumers to do a lot more on our website. Historically, we asked them to do — enter e-mail information or phone number and that was the extent of it. And now we’re asking them to consider putting down a deposit or getting a hard-pull financing with us.

And so it’s an imperative foundation to our strategy. And we are — I would say we’re excited by the early research, but I would also say it’s really pretty early still. In terms of spend expectations for the year, I mean, we’ve given a lot of guidance around that, broadly speaking. But it’s also — advertising and brand in particular is one of those things where if it’s working right and if it’s producing the results, then that remains one of the more fungible and variable elements of anybody’s P&L. And so if things are going well, we may decide to get more aggressive. And if not, we may decide to get more conservative. So we try to give guidance, but we also try to remain nimble as a company.

Operator

[Operator Instructions]. There are no further questions at this time. I would like to turn the floor back over to CEO — oh, I’m sorry. There’s a question. Next is from Nick Jones with JP — JMP Securities.

Nicholas Jones

Great. Guys, just taking a big step back with kind of wholesale prices increasing year-to-date, I think, more than people expected, how is kind of industry normalization changing in your minds in how might kind of the rest of the year progress? Do we ever kind of get back to prepandemic normal?

Jason Trevisan

Sure. I can take that, Nick. Thanks for the question. When talking about wholesale pricing, there is a relative — there’s a conversation around relative pricing, and then there’s a conversation around sort of longer-term sort of absolute pricing. From a longer-term absolute pricing perspective, we’re still well above where we were pre-COVID. And so if we’re at 20%, 25%, 30% above where we were pre-COVID, then I think the question remains, if there is a reversion to the pre-COVID mean, and I think most people would say, well, simply due to inflation, we’re probably not going back to pre-COVID because of chip issues. We’re not going back to pre-COVID.

And so then the question becomes, okay, do we have 5 points, 10 points more to get to a new post-COVID level — normalized level? And I think that’s the debate that’s happening now. Is this a new water level? Or does it still have a little bit more to drop? But I don’t think anybody is thinking it drops all the way back to parity with pre-COVID.

Then you look at the relative lens. And on the relative lens, which is what I referenced earlier is what dealers can be very sensitive to if it’s dropping for two weeks in a row, they may be more reluctant to keep activity levels high in wholesale. And there wholesale saw — we had seen a pretty steady decline in the second half of last year. And in Q1, we started to see some increasing of unit pricing. And then you also heard us talk about forecasting some softness and we’ve seen that in a number of other companies’ reports as well.

And so expectation for wholesale and retail is to — well, certainly for wholesale is to have peaked in Q2 or to peak in Q2. And then perhaps a flattening or steady decline post that. Right now, the market’s coming — I think most third-party metrics would say that the prices are coming down and sales activity is a little bit lower with lower inventory and declining prices. But you also then need to start to go from sort of microeconomics to macro and say, okay, but at the same time, OEMs are pumping a lot more new cars into the market.

And when that starts to happen, it’s only a matter of time before those become wholesale trade-ins as well. So there’s no question it’s a — unit pricing and inventory levels in wholesale has been more volatile in the past 2 years than probably ever. But it does seem as though there’s more stabilization now than there was last year, but there might still be some price declines in aggregate to occur yet.

Operator

There are no further questions at this time. I would like to turn the floor back over to CEO, Jason Trevisan, for closing comments.

Jason Trevisan

I would just like to thank everyone on the call today. Thank you for your thoughtful questions. In particular, I want to thank all of our employees. We just finished talking about volatility and there’s certainly a lot of activity around our industry and many industries, but we’re really excited about our results from Q1, as you’ve heard in our remarks today, and we’re excited about all the activity that we have going on in our business. In May, we will be at the Jefferies and JPMorgan conferences. And so we look forward to seeing investors at those events. Thank you very much.

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.