ACV Auctions Inc. Q4 FY2022 Earnings Call

Good day, and thank you for standing by. Welcome to the ACVA Fourth 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. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Tim Fox, Vice President of Investor Relations.

Thank you, Operator. Good afternoon, and thank you for joining ACV's conference call to discuss our fourth quarter and full year 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 in 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 pleased with our fourth quarter performance, which capped off a year that required strong execution from the ACV team during a challenging market environment. And execute we did. ACV delivered 18% revenue growth and gained share in a market that declined an estimated 20%. We expanded our marketplace, exiting the year with over 24,000 dealer partners. Our VCI team reached an exciting milestone, performing over 1 million inspections in 2022. Our technology team launched a broad range of new solutions to drive growth and scale across our operations. And we achieved all this while expanding margins and exceeding our EBITDA guidance. As we turn to 2023, we are encouraged to see positive signs emerge in the automotive market with industry headwinds beginning to moderate. Our focus this year remains consistent on growing market share, expanding our competitive moat with leading-edge technology, increasing margins and driving scale to deliver on our EBITDA targets. With that, let's turn to a brief recap of fourth quarter and full year 2022 results on Slide 4. Fourth quarter revenue of $98 million was within our guidance range, and as expected, declined modestly year-over-year versus very strong results in Q4 '21. GMV of $1.8 billion declined year-over-year, primarily due to a 20% decrease in GMV per unit as wholesale prices declined from historical highs in Q4 '21. We sold 125,000 vehicles in our marketplace, which was in line with guidance and reflected the impact of a 1,000-basis point decrease in conversion rate versus Q4 '21. For the full year, revenue of $422 million increased 18% despite challenging market conditions in the second half of the year. GMV for the year increased to $9 billion due to a 20% increase in GMV per unit, while units declined modestly year-over-year, reflecting a 1,200-basis point decrease in conversion rate. On Slide 5, I will frame the rest of today's discussion around the 3 pillars of our strategy to drive long-term shareholder value, growth, innovation, and scale. I will begin with growth. On Slide 7, we're again providing context with the dealer wholesale market in relation to the broader automotive retail market. First, to illustrate the supply side of our market, we have provided data on new light vehicle volumes. As you can see in the chart on the left, SAAR increased sequentially in Q4, which is an encouraging sign that automotive production challenges are finally easing. However, as you can see in the chart on the right, volumes last year were down 8% year-over-year and 20% below pre-pandemic volumes. This decline in retail sales translated into fewer trades, which pressured wholesale auction listings during the year. Turning to Slide 8. Let's review trends for used vehicles. The retail used vehicle market was under pressure throughout 2022, as interest rates increased and retail prices remained elevated relative to historical levels. This resulted in used retail sales declining 11% year-over-year, which created additional headwinds on trading volumes and wholesale auction listings. On a more positive note, recent industry data has pointed to a solid start for the used retail market this year with volumes up month-over-month and year-over-year in January. These recent trends for new and used retail sales are positive signs for the wholesale market. However, the macro factors impacting supply in the market may persist throughout 2023, and we have factored that into our guidance. Now turning to Slide 9, we are also seeing some encouraging inventory trends that typically benefit the wholesale market. The chart on the left shows that the used vehicle supply has reached levels not seen since the onset of the pandemic. Why is this important? Dealers are in the business of selling cars, not storing them. As used inventories build and vehicles start to age, dealers leverage wholesale channels to sell their aged inventory. Dealers also tend to become less price-sensitive as inventories reach elevated levels, which improves auction conversion rates. We have started to see these dynamics play out in our marketplace in early 2023, which is a positive leading indicator for the wholesale market. The chart on the right illustrates that the supply of new light vehicles is also recovering, albeit off historically low levels. This is important for two reasons. The first and most obvious reason is that dealers require an adequate supply of inventory to satisfy consumer demand. The second reason is that when dealer lots are replenished with new vehicles, there is added incentive to reduce aged used inventory, which in turn generates more volumes for wholesale channels. The takeaway here from a market perspective is that we appear to have turned the corner. As I mentioned earlier, the persistent headwinds impacting wholesale volumes appear to be moderating. Next, on Slide 10 we're sharing additional insights into our business that reinforces our confidence in ACV's long-term growth opportunity. The chart on the left shows annual listings in our marketplace, which is a measure of dealer penetration and marketplace adoption. In 2022, we grew listings 20% year-over-year despite a 10% decline in retail sales. Listings growth was driven primarily by franchise dealer penetration, which increased 600 basis points year-over-year to just over 40%. Bear in mind, we are still in the early days of engaging with the majority of our dealer partners. Therefore, increasing wallet share across our marketplace is a large opportunity and key objective for this year. The figure on the right is the annual variance in ACV's conversion rates. As we highlighted over recent quarters, pre-pandemic conversion rates on our marketplace were quite stable and predictable. Then as supply, demand, and wholesale prices were impacted by pandemic-related factors, conversion rates increased significantly. While this increase was a growth tailwind in 2021, conversion rates declined significantly in the back half of 2022 as price depreciation accelerated, resulting in cautious buying behavior. To put this into perspective, the 1,200-basis point year-over-year decline in conversion rate resulted in a headwind of 125,000 units in 2022. As I mentioned earlier, we are encouraged to see this trend start to reverse in early 2023 and we believe conversion rates will revert back to normalized levels throughout the year. Turning now to Slide 11, we estimate that the U.S. dealer wholesale market continues to remain well below normalized volumes and contracted 20% year-over-year in 2022. Despite this market backdrop, we are executing on our key growth initiatives and gaining market share. Given an estimated market contraction of 20% and a 3% year-over-year unit decline, this implies that ACV grew market share by approximately 17% in 2022. Next, I would like to wrap up the growth section with highlights on our value-added services. On Slide 12, you can see that ACV Transportation continues to deliver strong results and is scaling into a great business. Our strong carrier network and fast cycle times resulted in attach rates once again exceeding 50%. In fact, our carrier partners achieved record cycle times during the quarter, benefiting both sellers and buyers in our marketplace and setting us further apart from the competition. Over 80% of our transports were automatically dispatched in Q4, an increase of 1,000 basis points from Q3. Our technology investments continue to drive both growth and operating efficiencies. These efficiencies resulted in another quarter with revenue margin in the low double digits, an increase from the mid-single digits in early 2022. As a reminder, our 2026 financial target assumes transport revenue margin of 15%, and our progress is clearly putting us on a path to achieve this target. Turning now to Slide 13, ACV Capital continues to experience strong demand in the market. Capital attach rates grew over 90% year-over-year in Q4, resulting in over 70% loan volume growth and average loan values increasing approximately 20% year-over-year. We have continued to ramp our investments to drive dealer engagement and scale to ensure that ACV Capital is an important growth and profit driver going forward. Turning to the second element of our strategy to drive long-term shareholder value, innovation. On Slide 15, I'll first recap some of the growth-oriented product innovations delivered in 2022. These innovations are focused on enhancing the dealer buying experience, increasing conversion rates, advancing our marketplace offerings, and expanding our TAM. Let me begin with the dealer buying experience. Marketplace 2.0 delivered a new UI with updated filtering, search, and notification features. Our advanced buyer solution, S.A.M., enhanced the buying experience through intelligent notification and auto bidding capabilities. We leaned in with tech to increase conversion rates by launching a new auction format and enhanced pricing data, creating a broader range of merchandising options for our dealer partners. Our Private Marketplaces solution experienced strong traction with some of the largest dealer groups in the country. This solution enables dealers to easily auction inventory within their network and leverage ACV's open marketplace for unsold units. In Transport, we launched a mobile carry app to provide carrier partners with digital tools to streamline their business, and we developed targeted lane pricing to improve spreads and drive margin expansion. We launched the ACV Capital portal, equipping dealers with 24/7 self-service access to critical data and to drive further adoption of our capital offerings. Lastly, we expanded our TAM with new solutions from our Drivably and Monk acquisitions, enabling dealers to transform their consumer sourcing experience with digital solutions powered by machine learning and data. These solutions also enable ACV, through our dealer partners, to engage upstream with the consumer prior to deploying our critical BCI resources. On Slide 16 are examples of tech investments that extend into our operations, delivering customer success while reducing costs. Our next-gen collection device APEX delivers significantly higher transparency into vehicle operating conditions while also increasing the inspection productivity of our teammates. We launched new virtual lift capabilities that target specific pain points in the inspection process. These capabilities leverage AI technology, raising the bar and ACV's inspection transparency while reducing arbitration risk. To further advance our inspection capabilities, we introduced Copilot and ArbGuard. These technologies leverage machine learning, predictive analytics, and data center to inform our VCI on vehicle-specific issues before conducting an inspection. Lastly, our technology investment in title processing is leveraging our in-house image recognition and data extraction, supporting title processing with higher efficiency and accuracy. Turning now to Slide 17, we have an exciting roadmap of innovation to further expand our competitive moat. Our primary focus on innovation this year is to further enhance and leverage our vehicle intelligence platform, which is powered by AI and machine learning in conjunction with our extensive and growing data repository. We'll continue to focus on increasing conversion rates by enhancing our programmatic capabilities and elevating the dealer experience with new self-service features. Our industry-leading inspection capabilities will raise the bar even higher with the full rollout of Apex, Copilot, ArbGuard and with Monk integrations that result in improved condition reports and lower arbitration exposure. We'll continue to expand our transportation platform and implement a loan management system to enable off-network financing in ACV Capital. And we'll launch this next generation of SaaS and data service offerings with a major upgrade of MAX Digital and deeper integrations of Drivably and Monk for consumer sourcing through our dealer partners. To wrap up on innovation, I think you'll agree that our team is delivering industry-leading technology to the market and into our own operation that expands our competitive moat and helps drive profitable long-term growth. With that, let me hand it over to Bill to take you through our financial results and how we're driving growth at scale.

Thanks, George. And thank you, everyone, for joining us today. We are pleased with our Q4 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 Q4 '21. Turning to Slide 19, I'll begin with a review of our fourth quarter results. Revenue of $98 million was within our guidance range and declined modestly year-over-year versus strong results in Q4 '21. To add some context to our revenue performance. Note that the Q4 '22 conversion rate declined 1,000 basis points versus Q4 '21, resulting in an approximate $18 million headwind. Adjusted EBITDA loss of $13 million or 13% of revenue beat our guidance range and EBITDA margin improved approximately 300 basis points versus Q4 '21. Turning to Slide 20. I will cover some additional detail on revenue. Total revenue of $98 million represented a 35% CAGR since Q4 '20. Auction and assurance revenue, which was 56% of total revenue, declined 3% year-over-year versus strong results in Q4 '21. The revenue performance reflects a 10% year-over-year unit decline due to conversion rate compression, partially offset by higher auction and assurance ARPU. Marketplace Services revenue, which was 35% of total revenue, declined 3%. ACV Capital revenue more than doubled year-over-year. However, Transport revenue, which is a much larger business today, was impacted by the decline in units year-over-year. Our SaaS and data services products comprised 8% of total revenue and grew 5% year-over-year. We are making significant improvements to the MAX Digital platform while also taking a more measured approach to customer acquisition to position ourselves for a reacceleration of growth as we exit 2023. Turning now to Slide 21, I will review costs in the quarter. Q4 cost of revenue as a percentage of revenue decreased approximately 400 basis points year-over-year. The improvement was driven primarily by our Transport business, which again delivered a low double-digit revenue margin in the quarter. Operating costs, excluding cost of revenue was effectively flat year-over-year in Q4. This reflects the significant investments we made in 2021 to support market expansion and technology initiatives and reflects our focus in 2022 on expense discipline as we optimized and scaled our business. Moving to Slide 22, let me frame our investment strategy and path to profitability. Our focus on spending discipline and operating efficiency resulted in a material decrease in OpEx growth in 2022. In fact, our adjusted EBITDA loss of $56 million was at the midpoint of our original 2022 guidance despite $30 million less revenue than initially anticipated due to the challenging market conditions. And we accomplished this while preserving our go-to-market and technology investments to ensure ACV is in a strong position as market conditions improve. Next, I will highlight our strong capital structure on Slide 23. We ended Q4 with $497 million in cash and equivalents and marketable securities and $76 million of long-term debt to finance our growing ACV Capital business. Note that our Q4 cash balance included $145 million of float in our auction business. As we discussed previously, the amount of float on our balance sheet can fluctuate meaningfully based on business trends in the final 2 weeks of each quarter and has a corresponding impact on operating cash flow. In Q4, cash flow from operations was $1 million, with a sequential increase in float contributing $7 million of positive cash flow. Consistent with the outlook we provided last quarter, cash used in operations declined significantly from $73 million in the first half of '22 to just $2 million in the second half of the year. Now I'll turn to guidance on Slide 24. For the first quarter of 2023, we are expecting revenue in the range of $107 million to $110 million. Adjusted EBITDA is expected to be a loss in the range of $12 million to $14 million. For the full year, revenue is expected to be a range of $460 million to $470 million. This range represents growth of 9% to 11% year-over-year. Adjusted EBITDA is expected to be a loss in the range of $30 million to $35 million and over a 40% improvement versus 2022, and we remain committed to achieving adjusted EBITDA breakeven exiting this year. As it relates to our guidance, we are assuming that new vehicle supply remains constrained in the near term that improves as production and inventory continue to recover throughout the year. We are also assuming that conversion rates increase from the historically low levels in the back half of 2022, as wholesale price depreciation moderates. Finally, we expect non-GAAP operating expenses, excluding cost of revenue and depreciation and amortization to grow at approximately half the rate of revenue growth. Let me wrap up on Slide 25 by reviewing our 2026 financial targets. We are very pleased with our execution in a very challenging macro environment, and we remain confident in our ability to achieve $1.3 billion of revenue and $325 million of adjusted EBITDA in 2026. Our confidence is reinforced by a number of factors, including strong dealer penetration and wallet share gains resulting in sustained market share gains. Opportunities to expand our TAM into adjacent markets, including commercial wholesale. Our broad technology platform enables durable long-term growth and operating efficiency. Consistent improvement in revenue margins and a commitment to balancing growth and investment as our business scales. We look forward to providing you with details on our long-term targets at our upcoming Analyst Day on June 1. And with that, let me turn it back to George.

Thanks, Bill. Before we take your questions, let me summarize. We are very pleased with our strong execution during 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, which positions ACV for attractive growth as market conditions improve. We are executing on our territory penetration plan and gaining traction with an expanding suite of offerings. We are delivering on an exciting product roadmap to further differentiate ACV and expand our addressable market. We are on track to achieve our near-term adjusted EBITDA target. And over the medium term, generate over $1 billion in revenue with attractive margins that we believe will drive significant shareholder value. We are committed to achieving these results while building 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.

Our first question comes from Chris Pierce at Needham & Co.

I wanted to get your perspective and that of the dealers you talk to regarding the improved February wholesale data. January showed better retail performance due to lower prices, and I'm interested in your thoughts on the future of retail prices considering the strength in wholesale prices. This will likely impact retail used units, so I'm curious how you and the dealers are viewing this situation.

Can you hear me okay, just to make sure?

I can hear you.

We had a slight phone issue there for a moment. I would say the year has started off well; January typically shows positive trends compared to what many dealers anticipated amid rising interest rates and concerns about a consumer pullback in the market. Both January and February have been somewhat better than dealers expected. There are likely several theories as to why this is happening. One possibility is that consumers are buying cars now, knowing that interest rates are expected to rise, even though prices have stayed high. That seems to be what the market indicates. Regardless of the reasons, what we're observing so far is that dealer sentiment remains strong. The market appears to be holding up better than what dealers anticipated.

Okay. And just could you comment on just kind of what wholesale prices going up could mean for retail prices? I know the relationship tends to be certain in one direction, but just kind of we had kind of a funky end of last year where wholesale retail spreads really widened out. I'm just trying to get at if dealers think that higher wholesale prices will necessarily flow through to higher retail prices. Or because of lower wholesale prices, we might not see that phenomenon, which would help retail units and help auction conversion, etc.

Yes. I think, Chris, if you see retail prices for used have hung in there pretty strong thus far this quarter, I think a few different industry reports have reported. I think wholesale has been strong and retail has been strong. I think there's been a pretty consistent correlation there.

Our next question is from Bob Labick at CJS Securities.

I wanted to start, you touched on a couple of these points, but maybe pin you down a little bit here in terms of where do you see kind of unit growth coming from. Like what buckets next year? Maybe you can rank them. I'm not asking for specific numbers of units, but is it same dealer growth, share of wallet? The biggest growth driver, is it new dealer sign-ups? Is it expanding TAM? Is it commercial? Like can you just like rank order the buckets of growth, where you see units coming from, please?

Yes, absolutely, Bob. I believe a measured approach to our growth has involved increasing the number of rooftops. However, a greater emphasis has been placed on capturing more wallet share from the dealerships. I've discussed this in previous earnings calls. There is still substantial potential for growth within the rooftops we work with at ACV, with over one-third of franchise dealers already engaged with us. Just by increasing our wallet share, we see a considerable opportunity. There are additional growth areas, but if I had to identify the key opportunities, I would highlight adding more dealers and concentrating on wallet share as the most significant.

Got it. Okay. Great. And then given the tight supply environment and just volatility, declining prices, etc., we've read there's been some kind of mix shift at auction, meaning maybe more $10,000 cars are trading, or $10,000 and below, but dealers are holding on to the $20,000 to $25,000 cars because they can't get them anyway. Is that the case? Or what are you expecting I guess in terms of the mix at auction next year? And how might that impact the P&L?

Yes, Bob, we've seen our mix shift helped from having sort of newer, more recent vehicles. Vehicles that are aged 3 years and younger as an example is one cohort that has actually grown pretty significantly from a percentage perspective. I know that probably seems strange as to why that would be, but dealers are starting to get new supply starting to come back. Used, aged is still relatively low, but starting to go back towards normal. And when you look at all the factors, dealers holding on to the right cars, the vehicles that match their specific mix of inventory, sort of their sweet spot, that's really what dealers always did prior to COVID. Prior before all of these sorts of industry challenges, so look at it as a return to normal. But yes, we are definitely growing our share with the newer vehicles in the marketplace.

The next question comes from Michael Graham of Canaccord.

It's great to see some of these trends turning around. I wanted to ask two questions. The first is just you mentioned share of wallet a couple of times as being an important factor this year. And I just wonder if you could outline a couple of the key success factors in sort of growing your share of wallet in your existing rooftops. And then I just wanted to ask, on the quarter, your GMV declined around 29%, but auction revenue was only down 3%. Just wondering if you could shed some light on what was going on underneath the hood there in Q4. Thanks.

Yes, certainly. I'll start there, Michael, and Bill can chime in on the auction revenue side. We're seeing strength and mix, as I mentioned before, so that's actually helpful on a moving forward basis related to ARPU. Bill, why don't you actually go first, and then I'll chime in?

Yes. Hey, Michael, you're right, our GMV per unit did go down pretty substantially. But actually, our ARPU increased 5% for example quarter-on-quarter. And most of that is essentially attributable to the price increase on buy fees that we passed through in October, if you remember. And that more than offset any reduction in GMV per unit. Same dynamic would apply year-on-year as well. We have really been able to mitigate any decline in GMV as a result. And in fact, for this year, we're expecting some modest, further modest declines in GMV per unit. And our ARPU we expect to be flattish year-on-year if we think about what's baked into our guidance as well.

And as far as wallet share, the types of things we're doing to focus on growing wallet share, one is having our inspectors show up to our existing customers more often. That's a pretty simple tactic. Second, add more value. Some of our product offerings, for example Drivably and for a few of our customers, Monk, these are consumer acquisition tools as part of our go-to-market, these consumer acquisition tools are asking the dealers for more share. Think about it as we offer more value, we're looking for more of your wholesale and a few other things might help us drive both our relationship and opportunity with our customers.

Our next question comes from John Colantuoni from Jefferies.

This is Vincent Kardos on for John. Thanks for taking my question. How are you thinking potentially about competition heading into '23 at a time when there's maybe just a little bit less of the pie to be shared by the various physical and digital auction providers due to depressed volumes in the industry? And then as a related thought, I'd be curious to hear your thoughts on kind of what you view as the most important areas for the business to improve in order to extend your early lead over some of the other digital players in the industry. Thanks.

Yes, certainly. When you think about competition, I think what you'll see is we've likely extended our lead in digital if you compare us to others in the industry. But as we all know, the largest share is still in the physical auction, so moving more to digital is sort of a key part of our focus over the next few years. And when you look at all the various capabilities we're bringing to the market, one of which is ACV Private Marketplace, it helps large dealer groups trade vehicles within a group. That's an example of ACV adding more value. Those cars first trade before going out into an open marketplace. That's one example of a product offering that is outside of our open marketplace that's helping us gain share. Our newer products like Drivably and Monk and how we're going to go to market later this year and early next year with MAX are all offerings that we are looking for market share from the wholesale side as well. We're bringing a broader approach and a broader partnership to our dealer partners that helps us differentiate from just a traditional auction company.

Our next question comes from Rajat Gupta of JPMorgan.

I just had a question on the OpEx guidance. I think it implies 5% year-over-year, excluding the cost of revenue. Curious like what is it governed by? Because you haven't given us a breakup of the revenue target in terms of volume versus pricing, so I was curious what's driving that OpEx increase? Is it more a function of the volume? Or do you feel like you have more cushion on investing because pricing is stronger? I'm just curious if you could elaborate on that. And I have a follow-up. Thanks.

Hey Rajat, it's Bill. There are a few factors contributing to the growth in operating expenses. Our operating expenses, which encompass marketplace operations, also include our inspectors. This quarter, we are expanding our inspector presence to align capacity with volume, which affects our operating expenses on our profit and loss statement. This is an essential element for supporting our growth. Additionally, we are making other investments on the go-to-market front to bolster our growth in sales personnel and major accounts, along with further go-to-market investments at ACV Capital. Although this growth is expected to be somewhat more subdued compared to last year. Overall, as we look at the growth we’ve projected for the business this year, we want to ensure that our financial model includes the necessary resources to support it. We have shown a disciplined approach in the past, particularly last year and in the last quarter, so any decisions regarding operating expenses will be based on strong justifications that support volume or return on investment. I hope that addresses your question.

Got it. That's helpful. Any way to frame in terms of the inspector growth versus volume growth kind of equation? Any way to size that? Like what kind of volume growth requires what kind of inspector growth from the base you are at right now?

Yes. It's kind of hard to give you a formula because it's not necessarily that precise in a lot of ways. What we have to do is basically build capacity in advance of expected volume. We can't just generate higher volumes in a territory and not have the capacity to support it. We basically, through our biz ops teams, look at projected volume across all of our territories across the country. And we'll make decisions as to where we selectively need to add capacity to make sure we can support that volume. I can't give you a formula that you can apply necessarily to the model per se, Rajat. Wish I could give you more clarity than that, but that's actually how we make those decisions.

Understood. Fair enough. As a follow-up, are you officially reiterating the 2026 targets? Or is that more of a placeholder from the Analyst Day? You're expecting a $35 million EBITDA loss in 2023, improving to $325 million in three years. I'm just curious if that outlook remains unchanged, or will there be an update on that at some point this year? If you could clarify, that would be appreciated. Thank you.

Yes. In our prepared remarks today, we are reaffirming those targets. We have not changed them. At our Analyst Day on June 1, we will conduct a thorough examination of the various components of the model and how it has progressed since last year’s Analyst Day in relation to achieving those targets. This will be a significant focus of our Analyst Day on June 1.

Our next question comes from Nick Jones from JMP Securities.

Great, thanks for taking the questions, two if I can sneak in here. I think, George, you mentioned there was about 1/3 of franchise dealers on the platform. How do you think about any limiting factors or kind of sophistication levels required by dealers to kind of double that number over time as you gain more share? And then when you go and try to build wallet share within dealers, kind of what's limiting their desire to kind of organically add more units or wholesale units to the platform? What's kind of stopping them from kind of organically doing that? Thanks.

When I think about what's the limit, I don't really put a limit on how many dealers could be working with us. You happen to think about how could we for example double. At the end of the day, it's really about dealers feeling good about moving their wholesale operation online, first and foremost. And if it's going to move online from a physical auction, them feeling more comfortable that ACV is also the winning choice there. And you've seen so far compared to our other digital competitors, we've been the preferred partner as it relates to digital. I think it's just a matter of time. And really, your second question is I think related in that we have significant wallet share on customers that we've been working with for 3 or 4 years. Very significant wallet share on customers that aren't new to the platform, aren't new to digital. To us, it's really just a matter of time. These other value-added services we're providing will also be helpful because what it does is you start to have a relationship with the dealer principles or the most senior level executives in the dealer group, not just the local decision-maker for that specific rooftop. Think about this as a twofold way for us to increase wallet share. One, just the inertia of time, approving digital and ACV are the right ways for you to dispose of your wholesale. And second, to be a broader partner for the dealership, which gives you an edge over the other competitors we have in the marketplace.

Our next question comes from Dan Imbro from Stephens.

Bill, I want to start with more of a financial question. I guess given the knowledge that inspector costs go into OpEx, just looking at the marketplace gross margin line, we saw some nice leverage in Q4 despite a year-over-year decline in volume. I guess is it fair to assume this year you should get even further leverage as volume begins to pick back up and you leverage some of those fixed costs? Or what are the incremental investments that might be needed that could limit that leverage as volume improves?

Hey, Daniel. As you know, we don’t provide guidance on cost of revenue or revenue margins. However, we are assuming in our modeling that we will continue to improve our margin profile and reduce our cost of revenue somewhat as we return to a growth mode. We've already made many of the investments necessary to drive that improvement. We will keep making new investments that may help us later this year and into next year as we aim to reach our target model, which we’ll discuss further at our Analyst Day in June. We have shown a significant improvement in our margin profile, particularly this quarter, with a year-over-year increase of over 400 basis points in reduced cost of revenue, and we saw a positive quarter-on-quarter improvement as well. I wouldn’t assume that we can sustain that level of year-over-year improvement in 2023, but we do expect a continued upward trend in our margin profile as we become more efficient. Scale certainly contributes, and all the investments we continue to make are also factors. Additionally, we have demonstrated some pricing power, which is another element in enhancing margins. We have discussed Transport extensively, and our Capital business, which is a high-margin area, will keep growing, so all these factors combined are beneficial.

Got it. That's helpful. George, I'd like to ask one more question regarding your strategic initiatives. Reflecting on the innovation growth pillar you mentioned, last year, Apex contributed to gaining market share. In the slide deck, you highlighted Copilot and ArbGuard specifically. Could you elaborate on how these tools enhance your portfolio compared to what you currently offer? Additionally, how do they stack up against larger incumbent players and omnichannel competitors? Do they provide significant advantages in the wholesale channel, and how do you see this evolving as you continue to innovate?

Hey, Daniel, great question. These are differentiated technologies. And to put it in simple terms, you're about to inspect a vehicle, and let's say that specific vehicle had transmission issues 20% of the time. Well, instead of every one of our inspectors becoming an expert after let's say 4 years and doing thousands of inspections, every single inspector becomes an expert before they inspect that one given vehicle. If you look at last year alone, we inspected 1 million cars. The data moat that we're harnessing is really incredible. We don't really believe there's anyone in the world who is listening to as many vehicles, sensing vibration issues, and other types of issues from this new technology we've just recently launched. The way we're harnessing our data and the way we're structuring our data allows us to first and foremost moderate our arbitration costs over time. And that would be the benefit we'll see in our financial statement over the next few years. Not all at once, but think about a little bit, small benefits over time. And number two is, buyers gain more confidence because they're having less arbitration issues, so that creates higher buyer satisfaction. And three is, these technologies could be used outside of the auction marketplace. As a matter of fact, that's probably the most frequently asked thing from dealers in this past NADA show was dealers asking us to tweak our product roadmap this year because they want to use this technology outside of the auction. Meaning when they're having the cars come into their own store, whether they're retail or wholesale. Yes, I think great questions, and the more we invest in technology, the more differentiation, the more value we're providing to dealers across the market.

And if I could tack on a follow-on, I guess how is the hiring ability for inspectors today? I mean technicians across auto were in various supply. Is it more difficult to find people to do these inspections? I think about Bill's answer earlier, needing more inspectors to fuel growth. Just trying to think about how available is that labor? And is that loosening up at all yet?

I would say that for 80% to 90% of the country, our hiring has remained consistent. Our time to fill roles is still very strong. However, it's important to note that we are not hiring as many inspectors each month as we were about a year ago. We currently have over 800 inspectors, which is a solid number nationwide. The short answer is that we aren't experiencing difficulty in hiring. We don't require as much of a mechanical background as you suggested for a true mechanic. We can provide considerable training. Regarding your earlier question about the validity of our investment in tools, these tools allow us to take someone with a background in cars but not extensive mechanical experience and train them to become an excellent inspector.

Our next question comes from Ron Josey from Citi.

I just wanted to follow up with George and Bill regarding the factors driving improvements in conversion rates. I think I heard you mention enhancing programmatic capabilities this year. Could you provide more details on what can increase conversion rates? Additionally, George, following up on your point about utilizing data outside of the marketplace, since we first connected before the IPO, it's been all about leveraging data. How close are we to actually achieving that, especially since dealers are requesting this product? Is this something we could see happening in the next couple of years? Thank you.

Yes, Ron. We're not expecting much improvement in conversion rates for the second half of the year. I want to emphasize that our conversion rates are already quite good, so we don’t require significant enhancements this year. To address your question directly, last year we witnessed a sharp drop in prices that substantially impacted the wholesale marketplace, causing conversion rates to fall below traditional levels. This year, we anticipate more stability. Although used car values are relatively strong this quarter, especially towards the year's end, we expect them to decline. However, we believe this decline will be moderate. Supply won’t return all at once, and the market is learning to navigate the current conditions effectively. We're at a stabilization point where dealers recognize that values will decrease, conversion rates remain strong, and overall, we’re in a solid market environment. Did you have another question? I'm trying to recall.

That's very helpful. I wanted to follow up on your comment about utilizing the data corpus you've provided. Thank you.

On the data side, we are making significant strides in developing advanced AI capabilities in the automotive sector. Our recent acquisition of Monk has been fantastic, and although we are still in the early stages, the technology we are developing is impressive. This year, it hasn't significantly impacted our revenue or costs, but our R&D team is working on AI solutions that can assess various vehicle conditions, such as detecting broken glass or missing parts. Our machine learning and AI developments are creating a strong competitive advantage for us, and dealers are expressing interest in using these tools for their own purposes. However, we are not quite ready to offer these capabilities as standalone services yet, and we are brainstorming on how to do that. We anticipate potentially bringing some of these solutions to market by late this year or early next year. We are focused on our primary market objectives and are cautious about increasing our workforce significantly this year, as Bill mentioned, we are moderating headcount. We expect to achieve some of these key objectives by late this year or early next year, and we believe that moving at this pace is appropriate. Our offerings provide significant value to dealers at a low cost compared to other available technologies. We have great opportunities ahead to strengthen our relationships with dealers, and I expect to share more details about this during our Investor Day.

Our next question comes from Gary Prestopino from Barrington Research.

George, it looks like according to the data that I have that your dealer penetration somewhat accelerated in Q4. I think I had it at 33% in Q3 and up to 40% in Q4. What accounts for that? Do you have more feet on the street? Or just what would account for that acceleration?

I don't have a specific reason for the acceleration in Q4, but historically, we've seen variations in quarterly performance. Overall, our annual growth in ACV has been consistent, particularly in dealerships where we've increased our share of wallet. It seems to be a combination of factors contributing to this growth, including the broad value-added services we're developing. However, I can't identify a particular reason for the acceleration in Q4 at this moment.

Great. Thanks, Gerald. I'd like to thank everybody for joining us today on the call. Note that we're going to be participating in JMP's Tech Conference in San Francisco on March 7. And as Bill mentioned and George mentioned, we'll be hosting our 2023 Analyst Day on June 1 in New York. Registration details can be found in either the press release or on our IR website. We look forward to seeing you on the road hopefully in the next few months. And thank you again for your interest in ACV, and have a great evening.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.