Ladies and gentlemen, thank you for standing by, and welcome to the ACVA Third Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question and answer session. [Operator Instructions] I would now like to turn the call over to your host, Tim Fox, you may begin.

Thank you, operator. Good afternoon, and thank you for joining ACV's conference call to discuss our third quarter 2022 financial results. With me on the call today are George Chamoun, Chief Executive Officer; and Bill Zerella, Chief Financial Officer. Before we get started, please note that today's comments include forward-looking statements, including statements regarding future financial guidance. These forward-looking statements are subject to risks and uncertainties and involve factors that could cause actual results to differ materially from those expressed or implied by such statements. A discussion of the risks and uncertainties related to our business can be found in our SEC filings and today's press release, both of which can be found on our Investor Relations website. During this call, we will discuss both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP financial measures is provided in today's earnings materials, which can also be found on our Investor Relations website. And with that, let me turn the call over to George.

Thanks, Tim. Good afternoon, everyone, and thank you for joining us. We are very pleased with our third quarter performance, with revenue in line with guidance and EBITDA exceeding guidance on Slide 4. Our market momentum continued in the third quarter with revenue of $105 million, a year-over-year growth of 15% versus strong results in Q3 '21. Despite a modest year-over-year decline in units, GMV grew to $2.1 billion due to an increase in ARPU, which was driven by a strong vehicle mix and also wholesale price inflation. Overall, we are very pleased with our execution in Q3 and our progress and key strategic initiatives. We delivered strong results despite an automotive market facing continued supply constraints, weakening retail demand, and vehicle price appreciation. Because market conditions are expected to remain challenging in Q4, we have assumed that wholesale volumes and conversion rates will be compressed through the balance of the year. Our guidance reflects this more cautious view of current market conditions while also reflecting a balance between investing in growth and maintaining a clear path to profitability. Turning to Slide 5. To frame the rest of our discussion today, we will focus on the 3 pillars of our strategy to drive long-term shareholder value, growth, innovation, and scale. I'll begin with growth. Moving to Slide 7. I'll begin with a brief overview of the dealer wholesale market and the important role retail automotive plays as a wholesale supply source. U.S. retail vehicle market is composed of 16,500 franchise dealers and 38,000 independent dealers. And together, they historically sold over 45 million new and used vehicles annually. These retail consumer transactions are typically accompanied by a trade that, in turn, is sold into the wholesale market. Dealers also rely on the wholesale market to dispose of aged vehicle inventory…

Thanks, George, and thank you, everyone, for joining us today. We are pleased with our Q3 financial performance. We delivered revenue in line with our guidance with upside to adjusted EBITDA despite the challenging macro factors George outlined earlier on the call. We also demonstrated the strength of our business model with revenue margin and adjusted EBITDA margin expansion versus Q3 '21. Turning to Slide 19, I'll begin with a review of our third-quarter results. Revenue of $105 million was at the midpoint of guidance, representing year-over-year growth of 15% versus strong results in Q3 '21. Adjusted EBITDA loss of $12 million or 11% of revenue beat our guidance range, and EBITDA margin improved approximately 200 basis points versus Q3 '21. Turning to Slide 20. I will cover some additional detail on revenue. Total revenue of $105 million represented a 25% CAGR since Q3 '20. Auction and insurance revenue, which was 53% of total revenue, grew 7% year-over-year versus solid results in Q3 '21. Year-over-year growth in auction and Assurance ARPU of 13% was driven by higher GMV due to the strong mix of vehicles sold on our platform and the bus increase we instituted last December. Marketplace Services revenue, which was 38% of total revenue, grew 26% year-over-year, reflecting strong adoption of our ACV transportation and capital offerings. Our SaaS and data services products comprised 8% of total revenue and grew 20% year-over-year, driven primarily from growth in our MAX Digital business and the adoption of data-enabled inspection services. Now turning to Slide 21, I will review costs in the quarter. Q3 cost of revenue as a percentage of revenue decreased approximately 400 basis points versus Q3 '21. The improvement was driven primarily by our Transport business, which delivered a low double-digit revenue margin in the quarter. To reinforce…

Thanks, Bill. Before we take your questions, let me summarize. We are very pleased with our strong execution during these challenging times in our industry. And we are especially proud of our ACV team that has delivered these results. We continue to gain market share by attracting new dealers to our marketplace and by gaining wallet share within our existing customer base, which positions ACV for strong growth when market conditions improve. We are executing on our territory penetration plan and our suite of marketplace offerings are gaining traction. We are innovative in delivering an exciting product roadmap to further differentiate ACV and expand our addressable market. We are on track to generate over $1 billion in revenue with attractive margins through a proven business model that we believe will drive significant shareholder value. We will remain committed to continue to build a world-class team to deliver on our goals. With that, I'll turn the call over to the operator to begin the Q&A.

[Operator Instructions] Our first question comes from Vincent Cardell of Jefferies.

This is Vincent on for John Colantuoni at Jefferies. Do you think you can talk about what you're seeing in terms of any developments in Q4 or so far to headwinds to wholesale conversion rates? And then maybe you could get us -- help us get a sense of sort of where headwinds are hitting the hardest? How are headwinds impacting customer engagement and retention versus kind of the impact that you're seeing to the sales teams as they try to enroll new dealers?

Vincent, it's George. I'll start, and then if Bill wants to chime in. So Vincent, if you look at the Black Book data that recently came out, what it really informs is that what we really have seen is conversion rates have continued to decline, and then this sort of started to level out a little bit. I think in the last 24 hours, it showed it went down minimally. And we're not going to speak much to Q4 beyond by saying like our conversion data in Black Books is mirrored pretty consistently. So high-level thought is we could be as we could have solved the trough sort of how we're thinking about it, and we're sort of leveled out on conversion. And then the second part of your question there is, even though we've continued to gain dealers, when you look at our market expansion, I really -- I'll answer a question in a couple of ways. So one, we now have 1/3 of franchise dealers across the country starting to use ACV, some more so than others. Some we have limited wallet share. So we have a lot of wallet share. So what does that say? That's because dealers are looking for ways to wholesale their vehicles differently. At the same time, we are starting to see listings per liter. If you look at it from 100% of their wallet share, listers across the industry, listings have started to decline. And that's mainly related to the macro environment where dealers are selling less cars, a combination of used plus new. So even though we've gained listers and even though we've gained listings this year by over 24%, we are starting to see the number of wholesale cars available per lister decline. So those are something like the macro things going on, but you're seeing, compared to the others in the industry, we bode well, and we've done a great job of taking share and gaining more relationships and also starting to take more wallet share. Philip, anything else you want to add?

Yes. So what I would just add, then just based on what George took you through in terms of the context of our guidance, we are assuming essentially that conversion rates are basically flat with Q3 and, again, remain at this, call it, depressed level versus our historical conversion rates. But we have assumed that listings liftings per liter, as we call it, does decline based on this macro environment that we're all kind of dealing with today. So that's kind of the underpinning for our guidance for Q4, essentially.

Our next question comes from Chris Pierce.

Just had a question on as vehicle prices depreciate higher arbitration. I'm just kind of curious what you guys are seeing, what safeguards do you have in place? And is that something more of a -- we should think of as a growing pain, and you guys are somewhat past it with the caveat that you always have to be vigilant around it?

Yes. Chris, I'll start on this. Thanks for the question. Great question. You've probably seen throughout the industry that there tends -- you have a risk for higher arbitration as price decline. With us, quarter-over-quarter, we actually improved in a market where the prices were going down, when you look at the investments we've made in technology and our inspection platform, we look at the discipline in our operations. When you look at the way we're operating the business, we actually improved. And in a tough market, that's not easy. So Chris, when you really think about, we've really invested very significantly in this inspection technology. We've invested in a national inspection team, they are all employees of ours who are working hard out there, who are doing all the right things. We're not relying on any third parties. When you look at the internal processes we have to make sure we have good actors, not bad actors on the platform. We've got tremendous discipline here at. We still have room to grow. We got still improvements that we can sort of improve throughout the next year. And we have not achieved all of our goals and objectives. But maybe Bill can sort of chime in a little bit more on this.

Yes. What you -- Chris, what you'll see in the supplemental data is that we actually took our -- what's in our P&L is basically our assurance cost of revenue, which is effectively arbitration costs down quarter-on-quarter from $14.6 million to $12.2 million. And if you look at it on a per-unit base, we were down almost 10% on a per-unit basis. So actually, we've made some great strides in terms of driving those costs down despite what's a pretty challenging environment today. So you'll see some of that in the math in terms of the data.

And then just one more, if I could. Bill, you mentioned the buy fee increase last December. If I look at, let's say, KAR's 2019 brick-and-mortar auction fees, you guys are still 10% to 12% below there. Is that something that -- I know you're not going to commit to annual price increases, but I'm just curious how you think about the evolution of pricing on the platform as you kind of grow the platform?

Yes, it's a good question. And you're right, we do have some headroom there. And in fact, we did pass a smaller increase in our buy fees this quarter which, again, tends to mitigate any downside we have on ARPU to declining prices for vehicles. So we've got some headroom there, and we'll see how we -- what we decide going forward in terms of whether we continue to march that upward over time. I mean, we're also all subjects, not just us, but all our competitors are subject to inflationary costs, right? So we've been able to pass some of this through pretty successfully, and it helps us, again, mitigate any downside on ARPU for us going forward.

Yes. And Chris, I'll just add a little more on that. So our philosophy is don't be a pick. We do have opportunity to increase and with both small price increases we made over the last 14 months. we had very limited commentary from the dealer community, comments like surprised I didn't increase it more. Comments like that's still extremely fair. So to your point, we still have -- we still are charging fees, lower than markets where -- and we'll be smart about this for the next few years. We should earn the market value for what we're doing in time, but we'll be smart about it, and we'll do it carefully. And we'll do it in a manner where dealers actually also feel like we're being fair to the whole thing. So Chris, so far, so good as we've increased ARPU within a market where GMV was actually challenged.

Our next question comes from Naved Khan with Truist.

So 2 questions from me. Maybe just on the -- just to kind of piggyback on your response there about price increase that you did. Just to clarify that that happened in Q4? Or did you also benefit from it in Q3? Just trying to figure out the timing. And then second, really, just on the innovations that you kind of highlighted, when can we expect to see the benefit in terms of maybe higher efficiency in the field in the inspection process as you start to use these?

Okay. This is Bill. So I'll take the first question, and then I'll pass it to George. Yes. So that buy fee increase actually was earlier this quarter. So it was literally just a few weeks ago. So we'll get the benefit for most of the quarter, but not all of it. Meaning the...Yes, sorry, it didn't impact Q3.

And your second question, I believe you're asking about sort of the efficiencies and gaining scale with our inspection team. Is that really what your question is around?

Yes. And even maybe leveraging some of the innovations here you highlighted, whether it's or other things that you can do to kind of make the process more efficient, faster, maybe.

Yes. Thanks for clarifying. So we're still investing. So I'll give you a couple of different categories. APEX, and then there'll be yet an adjacent thing we'll be working on, where there's some other data in the vehicle where we get hit a little bit more manual today. Think about each part of the inspection. Any part right now could take us, let's say, 4 to 7 minutes per sort of application or device or utilization. So in the aggregate, we might be spending between 20 and 40 minutes per inspection with an objective of eventually getting it down to where each and every vehicle is taking you under 20 minutes. And these investments we're making are so early. So we won't see like massive benefit in Q4 or even Q1. But when I think about between now and the end of next year, the investments in APEX, the investments in us curating the type of inspection that we should do on a low-priced vehicle versus a fairly high-priced vehicle. The inspection we should do is based on that vehicle type. So this new investment is a new product that we internally called copilot for right now allows us to say based on this Nissan, which has the following issues, go look at the following things. So still early. Some of this, we've just built. We're really excited about it. But we've got objectives internally that we're going to hit next year. And you can see the discipline we have here at ACV. We say we're going to do something. We're going to go do it. And we've built this tech to help us get more and more efficient on the time it takes to infect the vehicles. But at the same time, you probably see by doing some studies on the industry, you don't want to then get kill you in arbitration. So you need to be efficient, but you also need to get the data you need or else the car is going to come back, and it's going to hurt you. And you don't want any surprises. So we're -- that combination of efficiency, but getting the data we need, we think we're years ahead of anybody else in the marketplace.

Our next question comes from Rajat Gupta with JPMorgan.

Maybe this is like a twin question maybe, but trying to understand like how you're managing your cost structure, your OpEx in the context of what you're seeing in terms of conversion rates and listing. You've obviously given the fourth quarter guidance. But I'm curious like how are you planning for 2023? Are you planning -- are you viewing the fourth quarter as a trough for the business. expecting 2020 to be a recovery year? And in that context, like how do you plan to manage your expense structure? I mean, are you -- is your OpEx at a level enough that you can just grow into that into whatever the volume outlook is for 2023? Or do you think you might need to make more cuts? So just tying both like just budgeting maybe for 2023, if you could just help clarify that? And then I have a follow-up.

It's Bill. Yes. So look, obviously, on our last call, we talked about the fact that we're exiting this year at a $40 million lower OpEx run rate than what we guided to when we entered into the year. That said, to answer your question more specifically, there are other opportunities for us to continue to optimize the business going into next year. And that's really across the company, but I'll just give you a few examples just to give you a flavor for this. So if you look at arbitration costs and our inspection costs together, right, this year, that's about $130 million, roughly evenly split between the 2, okay? Arbitration costs, we answered that question earlier in terms of driving those costs down from Q2 to Q3. So there's already great strides that we're making in terms of reducing the frequency and the size of arbitration claims. But really going forward, there's the ability to continue to leverage a lot of the technology that George highlighted in his prepared remarks. So there's a lot more room for improvement. And I would argue in the context again of the environment that we're doing in with is particularly impressive when you consider this backdrop in terms of us being able to drive those costs down where you're seeing those costs going up in a lot of other cases. So that's number one. Number two, on the inspection front, obviously, we've got a big team out there on the inspection side. And we've been pretty focused on making sure we manage that as well as possible going forward, and we've made some adjustments to our cost structure in the last quarter. But even if you look at our current team out there, we're still averaging across the country, 6 inspections per…

I could go further into how we're thinking about 2023, or you could have a follow-up question, up to you.

Yes, maybe like any comments on like the fourth quarter trough and 2023 would be helpful.

So the way we think about 2023 is we really put it into 2 buckets. One is what are the external factors we can't control. And that sort of OEM production of units, consumer borrowing, used car values, what's happening in the market. Those are the things that we can't control. And then we think, okay, what can we control? And what you're going to see us really lean in on between now and we come back and deliver our annual plan is, one, let's talk about market share. Even when you look at today, we're gaining the right to go out and work with more dealers, a third of the dealers out there are starting to work with ACV. But today, we're only 7%. We only have 7% share. So when you look at first and foremost, we've done a fantastic job bringing on more dealers, fantastic jobs starting to earn more wallet share. We're going to hold ourselves accountable to taking even more next year. And that's sort of first and foremost, both for -- when I think about mature territories, that means more wallet share. And I think on new territories, it means we really accelerating the dealer penetration while also increasing wallet share for those that are dabbling with us. When you think about -- in addition to taking share, we also think it's about adding more value, which you've seen us consistently do. I mean, we've been delivering more products adding more value, products like private marketplace and others. Dealers are starting to work with ACV because of these value acts in a market that's contracting and challenging. Our value-add approach is helping us win. You're seeing us focus on scale, quarter after quarter, right? When you think about how we've focused on scale, whether…

Yes. I would -- just a couple more items, Rajat. So I talked about the cost side of the equation. So in terms of the revenue and margin side, things that we're thinking about and feeling good about going into next year. So the 5 increases that we just passed on will further kind of mitigate any downside that we have on ARPU. So we're not necessarily entirely insulated from a reduction in used car prices, but we're certainly going to mitigate part of that as it would affect our ARPU. And secondly, so we're going into next year with a much better margin profile in our transport business. We came into this year with it being essentially breakeven. We're going to go into next year with low double-digit margins. And again, since it's on a gross revenue basis, that can be relatively material to our margin profile. So I just wanted to throw that in as well, just to give you a little more context for all sides of the P&L.

I got it. But are you like viewing fourth quarter as a trough for the industry? I don't know, like George, was that kind of implied in your answer for now?

None of us know what next year is going to bring us. What I'm telling you, Rajat is how we're going to hold ourselves accountable. I mean, the market might get worse. None of us know right now, right? Trying to -- there is predictions on politics for the last couple of days that didn't happen, right? It's really -- think about more... We're going to hold ourselves accountable to growth. And that's really more like a mind share because you know what, the market might get worse, who knows? We are seeing new car production, by the way, start to come back. That's one little positive. And we're starting to see, by the way, some programs come back. So it's not like what some of the dealer groups out there, like when I think about what some of the great franchise dealer groups out there to go next year, they're not predicting it going down, that's positive. They predict -- some of them are predicting a couple of points higher in volume. So some of our largest customers are predicting higher volume units next year. That's positive. I think new car dealers do have a slight advantage over used next year as it relates to selling cars only they'll come with programs like 0% interest, 1.9% financing. We even saw in the last 24 hours, a couple of the manufacturers come out with a rebate. I mean, we haven't seen that in almost 2 years. So all of that implies I think next year could be a better year. But whether it is or not, we're going to hold ourselves accountable for taking more shares.

Our next question comes from Eric Sheridan with Goldman Sachs.

I do want to follow up on that last answer because there was a lot in there. If you think about what's in your control, which was one part of the bucket, you said, what do you see as the critical pieces of execution that you're holding yourself to that you think would be most determinative in terms of a year from now, we're sitting here, and you gained dealer share as a result of those efforts 12 months on versus where you sit today, and you've already gotten a fair bit of dealer share. But to put a little bit more sort of elements of what pieces of execution you're the most focused on that you think would yield that share 12, 18 months from now? And then in terms of the externalities, I totally get the volatility of the environment and the unknown variables. When you look at those variables, though, which now of those variabilities do you think is the most important to unlock elements of the supply-demand dynamic that you would be -- that would be most advantageous to you? Is it the OEM supply? Is it the consumer demand piece tied to interest rates? Which externality do you think would result in the biggest unlock over the next 12 months?

Yes. Certainly, Eric. Thanks for the question. So when I think about our execution and as we start to prepare for next year, one is dealers are going to be looking for more and more guidance, right? What is the value of this asset? And we -- what we're delivering is a series of enhancements. One is price expectations. Two is, when should they be launching the car? Three, the duration of that car should be launched for 20 minutes, should be launched for 2 hours. Fourth, should they sell within their group first, meeting within a large dealer group, should they even do an auction yet? Should they first try to keep it? So think, Eric, us delivering on us becoming at the end of the day, the intelligence platform for the dealer. And we've got -- we're way ahead of the competition. And we -- whereas up until I would say recently, it's been ACVs , I would just say the sort of random 20-minute auction. And now we're adding -- we spent the money to have several hundred engineers. We've been building away. Hopefully, all of you can appreciate the amount of products you're seeing us deploy quarter after quarter. And we're going to expect some results from all this, and I'm already sensing it from the testing and the opportunities. I'll give you one example. 2 dealer groups in the U.S. now dealer franchise dealer groups are some of the largest buyers on ACV. That happened right after we launched ACV private marketplace. So not only were they starting to sell cars, but they became some of our largest buyers to think one product -- so bucket number one, Eric, is execution on our product delivery, getting into the hands of our dealers because that offer…

Our next question comes from Daniel Imbro with Stephens.

We've had a lot of discussion of kind of the high level. So just a couple of kind of clarifies the financials. You talked about this internal kind of dealer offering a few times, George. Obviously, that's growing with the franchise groups. How is the profitability of that channel? Is that grow next year? Is that going to be a drag to revenue per unit or the big group gets better pricing? And then any kind of help on scaling like what percentage of volume is it this year? Where do you expect that to go next year as you grow that business?

So Daniel, to think about it, it's not a drag. It's more like a wash. But more importantly, I'll give you like the goals, objectives of a dealer I was talking to this morning, okay? Their objective would be of the trades coming in and of the aged inventory. They can keep 15% of those cars. So they would have wholesaled inside their group. That would be like very successful. So that specific group wholesale 100,000 cars between trades and aged vehicles, they can keep 15%. So think Daniel, most of the cars end up an open auction anyway. Their goals and objectives are reasonable. Like these dealer groups are smart. They don't want to actually keep in retail a car that's got material issues. It doesn't fit within the -- it's going to hurt their brand. Just about all of them are very reasonable. So Dan, think about it as lots of cars inspected, we got a nominal fee, then we actually -- it works well into the way we already kind of charge them a small fee, and then we go out, and we then get our other fees for, let's say, wholesale in the vehicle. So when you actually look at it from the front to us inspecting to them, they actually go to the open marketplace, it actually does not hinder our unit econ. -- but I think to look at it simply as their goals and objectives are reasonable. And since their gold injectors are reasonable, that's when a partnership works out.

And then just you mentioned, Bill, in your comments, the transportation margin took a big step higher, kind of low double digits this quarter for mid-singles last quarter. Where can that go longer-term kind of what drove the improvement? Was it the decline in fuel prices? Was it just the scale of the business? And then could that keep take higher on transport, or is this kind of where it should be?

Yes, thanks for that question. So first, what drove the improvement? So number one, and this is something we kind of pivoted a few quarters ago, we started moving from just focusing on increasing the attach rate because we hit our targets at that point in time, several quarters ago, to really focus on maximizing spread. So it was kind of just a conscious change in our orientation for the team in terms of what they need to focus on. But if we look at what some of the other drivers are, through technology and data intelligence, we basically deployed these capabilities to do auto dispatch, which was 70% of our transactions now last quarter. So that's a huge percentage of our transactions that just happen automatically. We're matching loads also, which is requiring less human intervention, including improvements in how we price through different lanes. So that's number two. And then number three, we're also optimizing deliveries through better carrier management. So these kind of collectively are allowing us to drive those margins up a lot faster than we actually expected. The target transport margins are 15% by 2026. So we're kind of well ahead of schedule. Right now, we're pretty happy to be in the low double digits. We think that's certainly very sustainable as we go into next year. Whether we can continue to improve that next year, we'll see. But we're already within striking distance so far, long-term targets. So we're pretty happy. And again, that's been a nice tailwind to our overall margins for the business.

Ladies and gentlemen, this does conclude the Q&A portion of today's conference. I'd like to turn the call back over to Chamoun for any closing remarks.

Thanks, and I'd like to thank everybody for joining us on the call today. Please note that we'll be on the road at several investor conferences this quarter. You can find all the details on our Investor Relations website. So we do look forward to seeing you on the road, hopefully. And thank you again for your interest in ACV, and have a great evening.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.