CarGurus, inc (CARG) Q2 2021 Earnings Call Transcript

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CarGurus, inc (CARG -0.55%)
Q2 2021 Earnings Call
Aug 5, 2021, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, and welcome to CarGurus Second Quarter 2021 Earnings Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Kirndeep Singh, Vice President and Head of Investor Relations. Please go ahead.

Kirndeep Singh -- Vice President and Head of Investor Relations

Thank you, operator. Good afternoon. I'm delighted to be welcoming you to CarGurus Second Quarter 2021 Earnings Call for the first time as the Head of Investor Relations. 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; Scot Fredo, Chief Financial 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 third quarter 2021, management's expectations for our future financial and operational performance and innovation, our business strategies and growth strategies, our expectations for our car offer acquisition, the value proposition of our product offerings, our growth investment performance and profitability in international markets, the potential impact of the COVID-19 pandemic and other macro level industry issues on our business and financial results 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 is available in our earnings press release distributed after market close today and in our most recent reports on 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 forward-looking statements, except as required by law. Further, during the course of today's call, we will refer to certain non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our press release issued today. Our updated investor presentation can be found on the Investor Relations section of our website.

With that, I'll now turn it over to Jason.

Jason M. Trevisan -- Chief Executive Officer

Thank you, Kimdeep, and thank you, everyone, for joining us this afternoon. Before I begin, I'd like to officially well Kimdeep as our new Head of Investor Relations. She joined us in May, and we are excited to have her join our CarGurus team. At CarGurus, our vision has evolved beyond being the most trusted and transparent marketplace to being the single best platform for consumers and dealers to buy and sell vehicles. We're well positioned to do this by adding digital retail and digital wholesale end-to-end transaction capabilities to our industry-leading listings marketplace.

The power of a transaction-enabled marketplace allows consumers to confidently shop, finance, buy and sell from the comfort of their homes, and dealers to instantly acquire, market and sell at competitive prices with nationwide reach. With this vision as our backbone, I'm thrilled to report CarGurus delivered outstanding results for the second quarter 2021. Our core Listings business demonstrated durability and resiliency despite industrywide macroeconomic headwinds, while growth accelerated in digital wholesale with our CarOffer platform. The semiconductor chip shortage has impacted new and used vehicle inventory globally and is expected to continue to do so in the near term. Nevertheless, our business exceeded our expectations and had the most profitable quarter to date. We are pleased to see improved margins from our foundational core business.

CarOffer's tremendous growth and non-GAAP profitability, increased dealer adoption of our digital retail capabilities, and last week, we launched CarGurus' instant Max cash offer. As we continue to expand our product portfolio, we believe we are well positioned to capitalize on these offerings and provide our dealers and consumers with end-to-end solutions to meet their evolving needs. Now I'll walk through our results, beginning with our foundational core Listings business. Our U.S. Listings business demonstrated remarkable resiliency and efficiency despite industrywide headwinds. We remain incredibly efficient in our marketing spend, which helped drive improved margins both year-over-year and sequentially. While the chip shortage caused us to pause our normal renewal rate increases and also resulted in a decline in paying dealers, overall, we're pleased with the durability of the core business and are thrilled to have achieved our marketplace subscription and revenue plans this quarter.

As we mentioned last quarter, we remain focused on attracting lower-funnel, high-intent shoppers to our site who are more informed and ready to purchase. CarGurus's upcoming 2021 Buyer Insights report revealed CarGurus is at three times more likely than other major U.S. automotive marketplaces to be the final auto shopping site visited by consumers before purchase, further solidifying the value proposition we provide to dealers. As we continue to drive lower funnel traffic to our site, we have seen an increase in leads to paying dealers year-over-year of 7%. Our ability to provide more leads, while the number of average monthly unique visitors and sessions are down year-over-year, demonstrates the quality of our traffic and improved efficiency in our consumer acquisition strategy.

As we focus on high-intent consumers and providing more targeted and relevant consumer content, we believe we are generating higher-quality leads for our dealer base. We also continue to realize durable efficiencies by spending judiciously. In line with our strategy to monetize leads via growing paying dealers and increasing quarterly average revenue per subscribing dealer, or QARSD. In Q2, we spent marginally less on marketing compared to last quarter, driven primarily by a reduction in our APA spend. While we plan to remain prudent in our consumer marketing spend going forward, we anticipate that we will need to invest more in marketing as inventory constraints ease in the coming quarters. As the number one trafficked U.S. automotive marketplace for Q2 2021 according to comScore, CarGurus is an integral part of the dealer ecosystem and remains the preferred Listings platform. Even while dealers materially pulled back marketing and advertising spend in aggregate, we saw a minimal net dealer decline of 421 paying dealers in the U.S., down just 2% quarter-over-quarter.

Recognizing the uncertainty dealers face, we once again supported dealers by generally pausing rate increases during renewals despite our growing lead volume. Even so, we saw improved QARSD both quarter-over-quarter and year-over-year. QARSD was $5,550 for Q2, representing a 2% increase quarter-over-quarter, primarily attributable to revenue expansion within our existing dealer base, including same product rate increases as well as upgrades to our premium Listings products even during a period of challenged inventory. Turning to our international markets.

We are thrilled to report that we delivered on our commitment of reaching profitability in Canada and expect to continue to grow top line revenue and remain profitable in that market. The momentum from our international business in Q1 propelled our Q2 growth. Our achievements in Q2 were primarily the result of improved unit economics amid rapid lead growth and increased efficiency in our traffic acquisition strategies akin to our U.S. business. As we grow our presence as the household Listings name internationally, we continue to capture greater consumer mind share. Average international monthly sessions were up 3% year-over-year.

Like in the U.S., we are focused on bringing high-intent shoppers to our site to provide higher to our dealer base. We grew total international leads by 12% quarter-over-quarter, and leads to paying dealers grew 21% during the same period. We continue to provide enhanced value to paying dealers by improving both the quality and quantity of our leads, while capping leads for those utilizing the premium package.

This approach has incentivized dealers to join our paid platform, resulting in increased dealer enrollment year-over-year. Despite the global chip-related inventory issues, we saw net new dealer adds in Canada with some modest churn in the U.K. quarter-over-quarter. We saw strong QARSD growth as a result of revenue expansion from international paying dealers after having provided dealers in the U.K. discounts in the month of February due to extended lockdowns as well as improved adoption for listing add-on products. International QARSD was up 34% quarter-over-quarter.

Even during an ongoing global chip shortage, the international markets exceeded our expectations in Q2. We remain excited about the opportunities in both Canada and the U.K. and about providing our international dealers and consumers with transparent, efficient and competitive solutions. Our profitability in Canada validates our hypothesis that our model can be successful in other markets, and we look forward to growing and investing in our international business further. CarGurus is the market leader in the U.S. listings business. And as the macro environment normalizes, we look forward to our core business, both in the U.S. and internationally, meaningfully reaccelerating as we seek to resume renewals, upsell additional products and capture an even larger percentage of dealer share of wallet. Moving on to our wholesale business.

We could not be more thrilled with the rapid growth and adoption of CarOffer. CarOffer's instant trade platform allows dealers to transact automatically and at any time, using rules-based strategies rather than time-consuming auction to create a buying and selling experience that is unlike any other dealer-to-dealer wholesale marketplace today. The matrix enables dealers to buy and sell using limit orders, savings on the time and expense of physically going to an auction. In addition, CAR offers flat fee pricing structure to save dealers hundreds of dollars per unit in option fees, especially from more expensive frontline-ready units. With efficiency at its core, every CarOffer transaction is supported by robust back-end operations, including a thorough inspection process, reliable and timely transportation and seamless payment processing.

Having completed our acquisition only two quarters ago, we are still in the early stages of leveraging the power of the combined CarOffer and CarGurus platforms, creating a more efficient and transparent solution that better integrates the retail and wholesale segments in powerful ways. The need for the industry's first instant trade platform for vehicles is evidenced by CAR offers rapid growth and adoption. We are incredibly impressed to see a business that has been operating for less than two years, achieved strong top and bottom line growth. In Q2, CarOffer's momentum drove sequential month-over-month revenue and transaction growth. As the business continues to scale, we are investing heavily in hiring dealer sales and training and implementation teams to onboard and support dealers to gain the most leverage from this innovative platform. The increase in demand is further validated by the 210% quarter-over-quarter growth in revenue and the approximately 50% increase in enrolled rooftops quarter-over-quarter. At the end of Q2, we had approximately 5,500 enrolled rooftops.

We also reported the Q2 aggregate sale price of all vehicles sold by dealers in the CarOffer platform, also known as gross merchandise sales, of approximately $1 billion, a material increase of 289% quarter-over-quarter. Similarly, we saw transaction volume increase approximately three times quarter-over-quarter as well as heightened adoption for ancillary products as dealers continue to look for solutions to source inventory and drive profit. We do anticipate these trends will stabilize as the semiconductor chip shortage is expected to normalize later this year. We are beginning to see early signs of this with a number of transactions in July, modestly declining month-over-month.

The true potential of CarOffer is unlocked when you combine the Instant Trade technology with CarGurus's vast networks of dealers and consumers to create a truly differentiated offering. As we tap into our collective power to provide consumers and dealers with enhanced capabilities and product offerings, we recently announced the launch of CarGurus' instant max cash offer. Beginning in select markets, consumers in Florida, Massachusetts and Texas can sell their vehicles to our participating dealers 100% online.

We are harnessing the CarOffer buying matrix technology and our combined network of dealers with their standing buy orders for vehicles to instantly present consumers with the highest offer available through thousands of dealerships. Matched vehicles are conveniently picked up via a white glove concierge service inspected and delivered to the dealer's lot, helping save both time and money. This new offering disrupts the way consumers and dealers think about vehicle trade-ins and sales. CarGurus's Instant Max' offer is an efficient inventory acquisition channel, that will give dealers nationwide access to a previously unattainable source of inventory, allowing them to compete with online retailers. Meanwhile, consumers can sell confidently online by receiving the highest instant offer from a network of dealers, minimizing the need to haggle or question if there are better offers. Consumers now have a more competitive online sales option with CarGurus's instant max cash offer, the industry's newest solution to an outdated, inefficient and opaque process.

Here's what our happy customer, Erica from Florida had to say about the experience, "I am just over the moon excited about the process. I'm very thankful. I would do it again if I have a vehicle again to sell in the future. CarGurus is the only company that I will contact. You guys are amazing." Collectively, with CarGurus' Instant Max cash offer and our retail wholesale pricing tool, we believe we are uniquely positioned to capture a considerable portion of the peer-to-peer, consumer-to-dealer and dealer-to-dealer markets. CarGurus is the only U.S. marketplace where the largest network of dealers and the largest consumer audience can transact instantly and at scale using our instant trade and prebid technology. Our differentiated capabilities allow dealerships to remain competitive and thrive as the landscape for car buying evolves. COVID-19 dramatically accelerated the adoption of digitally initiated transactions by consumers interested in completing more elements of car shopping online.

We believe these new offerings, along with our digital retail toolkit level the playing field for dealerships and will help them not only gain access to a new source of inventory but also gain a competitive position amid this new digitally initiated environment. So now let's discuss digital retail. The COVID-19 pandemic shifted the paradigm for vehicle purchases and accelerated both consumer desire and dealer adoption of digitally initiated retail capabilities. With more than 60% of consumers interested in completing some element of the car buying process online, we have expanded our toolkit to enhance the car buying process for consumers, while providing dealers with resources to best capture this growing subset of the consumer audience.

We are pleased with the growth and adoption of our digital retail capabilities to date. Area Boost has seen considerable adoption, with 78% of U.S. households defined by consumers in a designated market area, having access to at least 30,000 delivery-enabled listings and up to 60,000 vehicles available for delivery in many major metropolitan areas. This equates to a vast selection of vehicles available for delivery nationwide that we believe favorably measures up to other platform offerings.

Additionally, we continue to see meaningful dealer uptake of consumer financing capabilities as they look to capture more prequalified leads. Prequalified financing leads are 60% more likely to result in a purchase and close faster upon engaging with the dealer. With growing adoption for both Area Boost and consumer financing combined revenue increased 47% year-over-year. Charles Smith, General Sales Manager at Mac Hake Auto Group, recently said, "CarGurus' prequalified leads move through the sales process quicker than consumers who aren't prequalified. They've mentally taken ownership already. They come in more committed to close and finalize their transaction." It's by far an easier sales process. In April this year, we announced early access for our latest offering, CG Convert.

CG Convert allows car shoppers to start their purchase from a CarGurus vehicle detail page and get to a near penny predict personalized deal on the vehicle they are interested in purchasing. Shoppers can then schedule an appointment on our site with the dealership to finalize their purchase quickly and transparently. We are pleased to see a continued increase in dealer adoption for CG Convert. Consumers utilizing CG Convert are 3 times more likely to apply finance in advance as a part of their digital checkout, improving the overall quality of down funnel prequalified leads provided to dealers. Moreover, of the CarGurus shoppers that completed their personalized deal online in June, chose to have their vehicle delivered, further bolstering our ability to monetize our digital retail capability. This is just the start for digital retail. In the near term, we are continuing to invest in digital retail from a partnership, technology and headcount standpoint. Driven by consumer and dealer demand for digitally initiated solutions, we view this as a sizable market opportunity.

We believe we are best positioned to capture significant market share with our unmatched selection of inventory and competitive purchase and trade-in pricing. Couple that with a vast consumer audience empowered by freedom of choice, convenience and trust and we believe we have a platform that is poised for success as a transactional marketplace. We expect 2021 will mark the transformation of the digital retail opportunity for dealers who are unable to provide these solutions to consumers on their own and/or which to acquire more shoppers through our platform. We look forward to releasing more of our digitally initiated offerings later this year as we further advance our digital retail capabilities. We are thrilled with our Q2 results. While we did anticipate some headwinds this quarter from the global chip shortage and depleted auto inventory, we are pleased with the efficiency and resiliency of our core business and that the momentum of CarOffer offset these headwinds and exceeded our expectations. Now more than ever, we feel that CarGurus is becoming a fully integrated transaction-enabled marketplace for consumers and dealers.

As we continue to build out our capabilities, we believe our consumer and dealer audiences, unrivaled ROI and an unparalleled digital wholesale and digital retail solutions have led us to an inflection point in the company's history, and we are excited to unlock a truly differentiated offering for consumers and dealers over the near term as a retail and wholesale shopping experience. As we complete another quarter of remote work because of the COVID-19 pandemic, we are hopeful at the prospect of reuniting our team together once again. We are keenly aware of the difficulty experienced by everyone in the last 1.5 years. I'm beyond grateful for the team we have at CarGurus and CarOffer for their relentless dedication and commitment. We've hit many milestones since we began working remotely and these achievements would not have been possible without our incredible employees globally who embody our core values day in and day out.

With that, I'll turn it over to Scot to discuss our financial results.

Scot Christopher Fredo -- Chief Financial Officer

Thank you, Jason. I will provide a detailed overview of our second quarter performance, followed by our guidance for the third quarter of 2021. Before discussing the details of the quarter, I would like to highlight that all year-over-year values are compared to as reported Q2 2020 numbers which include COVID-19 induced billing discounts given last year of approximately $47 million. Our second quarter 2020 press release has an adjusted pro forma reconciliation of those discounts added back for comparison purposes.

Total second quarter 2021 revenue was $217.7 million, up 130% year-over-year and nearly $26 million ahead of the high end of our most recent guidance range. Our marketplace subscription revenue grew 80% versus the year ago period to $144.2 million. As Jason mentioned earlier, this was in line with our expectations for the quarter based on the inventory issues affecting the industry and our dealer customers. Other revenue in the second quarter grew 397% year-over-year to $73.5 million. This is where we demonstrated outsized performance driven by CarOffer that significantly exceeded our forecast for the business. Our guidance included an estimate that CarOffer would roughly double from Q1's $18.5 million pro forma revenue. But as you can see in our investor presentation and as reported in our 10-Q, the revenue for the quarter was $57.3 million, a 210% increase from Q1.

That's a remarkable result from the CarOffer team as well as the efforts from the CarGurus team that is helping accelerate growth while demand for inventory solutions remains a priority for most dealers. Our U.S. business generated $134.1 million in marketplace subscription revenue in the second quarter, and our international business generated $10.2 million in marketplace subscription revenue. The U.S. accounted for 95% of total revenue in the second quarter. U.S. revenue increased 130% versus the year ago period to $206.6 million. And our international revenue increased 124% year-over-year to $11.2 million. The increase in U.S. revenue is largely attributable to increased revenue in the quarter from CarOffer. Additionally, the year-over-year growth in both U.S. and international revenue is also in part due to the fee reductions we provided our paying dealers in Q2 2020 and in response to the challenges the COVID-19 pandemic created for our dealers.

Turning to paying dealer count. We ended Q2 with 3,727 total paying dealers, representing a decrease of 486 dealers from Q1 and an increase of 469 versus the year ago period. In the U.S., we finished the quarter with 23,950 paying dealers, which is a decrease of 421 dealers from the end of the first quarter. The decrease in paying dealer count is primarily due to the macroeconomic conditions related to the semiconductor chip shortage which caused dealers to pull back on their marketing spend as they remained inventory constrained. It's worth noting that in Q2, dealer retention was in line with Q1 when we grew paying new accounts. The primary driver behind declining counts from the end of Q1 is that we saw fewer new dealers join the CarGurus platform as a paying dealer while inventory remains constrained. In our international business, we finished the second quarter with 6,777 international paying dealers, a decrease of 65 from the end of the first quarter. Our international business saw strong dealer adoption in Canada with modest dealer churn in the U.K.

We continue to monitor the chip issue and inventory shortage closely and expect that inventory levels are likely to return to more normal levels later this year. In July, we saw U.S. and international paying dealers remained relatively stable with Q2 ending counts, and we are encouraged by this recent trend. In the second quarter, U.S. QARSD was $5,550, representing a 2% increase compared to the prior quarter and an 82% increase compared to the year ago period. The quarter-over-quarter growth in QARSD was primarily driven by revenue expansion among existing franchise dealers, including dealers that upgraded to our premium Listings products featured or featured priority. International QARSD was $1,491 representing a 34% increase compared to the prior quarter and a 132% increase compared to the year ago period. Quarter-over-quarter international QARSD growth was primarily driven by discounts provided in Q1 to U.K. dealers as well as revenue expansion among dealers in Canada.

I will discuss our expenses and profitability on a non-GAAP basis, which backs out our stock-based compensation expense, amortization of acquired intangible assets, restructuring expenses acquisition-related expenses and net income attributable to redeemable noncontrolling interest. Second quarter non-GAAP gross margin was 77%, down roughly 900 basis points compared to the previous quarter and 1,383 basis points versus the year ago quarter. Change in non-GAAP gross margin quarter-over-quarter was due to two primary factors: First, CarOffer accounted for a larger percentage of our business this quarter.

And second, gross margin for CarOffer is and will be lower than gross margin for our core Listings business. Nonetheless, our CarOffer gross margin roughly doubled quarter-over-quarter to 32% on a non-GAAP basis, and our core business gross margin remained flat. The gross margin contraction from the prior year is primarily attributable to the addition of the Coffer business. Total second quarter non-GAAP operating expenses were $98.6 million, up 61% year-over-year. Non-GAAP sales and marketing expense increased 85% year-over-year to $62.6 million and represented 29% of revenue, down from 36% of revenue in the year ago period.

The increase in sales and marketing is a result of increased consumer marketing spend, which was minimized in the prior year due to cost savings efforts implemented in the second quarter of 2020 in response to the COVID-19 pandemic. In comparison to the prior quarter, we remained incredibly efficient in our traffic acquisition strategies, resulting in savings quarter-over-quarter, primarily driven by the reduction in our marketing spend. Our second quarter non-GAAP product, technology and development expenses grew 35% versus the year ago period to $21.4 million.

The investments we are making in our technology team supports several initiatives, including our core Listings marketplace business, both domestic and international as well as CarOffer and digital retail. We continue to allocate resources as needed to manage near-term business needs and support longer-term growth initiatives across all three areas of our business: listings, digital wholesale and digital retail. We generated non-GAAP operating income of $68.9 million, representing a margin of 32% and roughly $29 million ahead of the high end of our guidance range. Non-GAAP diluted earnings per share attributable to common stockholders was $0.41 to the second quarter, $0.16 above the high end of our guidance range.

On a GAAP basis, we generated first quarter gross margin of 77% and incurred total operating expenses of $129 million, up roughly 69% year-over-year. The increase in operating expenses was primarily driven by an increase in our expenses compared to the prior year's cost monetization efforts in response to the COVID-19 pandemic. Second quarter GAAP operating income increased 342% year-over-year to $38.5 million. Second quarter GAAP net income attributable to common shareholders totaled $28.1 million. Geographically, second quarter U.S. GAAP operating income was $40.2 million, up 162% year-over-year.

We had a GAAP operating loss of $1.7 million in our international business compared to a $6.6 million loss in the year ago quarter. We ended the second quarter with $269.6 million in cash and investments, an increase of $28.9 million from the end of the first quarter. Increase in our cash balance was driven primarily by our second quarter profitability. We generated $37.5 million in cash from operations in the second quarter and $32.9 million of non-GAAP free cash flow, which includes capital expenditures and capitalized website development costs of $1.1 million. I'll close my prepared remarks with our outlook for the third quarter of 2021.

We expect our third quarter revenue to be in the range of $210 million to $216 million, non-GAAP operating income in the range of $53 million to $57 million and non-GAAP earnings per share in the range of $0.30 to $0.32. After such a large beat of our Q2 guidance, I want to expand on why our Q3 revenue guidance is not increasing quarter-over-quarter. First, the inventory constraints continue to create a challenging environment for dealers in the near term, and we ended Q2 with net paying dealer declines, which in a subscription business, that's the run rate lower for Q3 lower than Q2.

Second, with the anticipated seasonal slowdown in car shopping in the second half of the year, our core Listings business as well as the car per wholesale business may be directly impacted. As I mentioned earlier, we are encouraged by recent trends of paying dealer counts, in July and as inventory returns to anticipated normal levels over the near term we believe we will eventually see net positive paying dealer count additions each quarter like we saw in Q1.

One final comment as you adjust your models. I would like to point out that transactions from our recently announced CarGurus Instant Max cash offer will be accounted for on a gross basis, meaning we would include the gross value of the vehicle in the transaction as well as the transaction fees. This has the potential to meaningfully impact revenue numbers in upcoming quarters. But since this product just launched in three states; these transactions are excluded from our Q3 guidance figures and could result in upside if we see significant consumer and dealer adoption in our initial limited market release. With that, I will echo Jason's sentiment that we are incredibly excited for the future and growing the business as a fully integrated transaction-enabled marketplace for consumers and dealers.

Now I'll turn it back over to the operator, and we can open up the call for Q&A.

Questions and Answers:

Scot Christopher Fredo -- Chief Financial Officer

[Operator Instructions] And the first question comes from Dan Kurnos with The Benchmark Company. Please go ahead.

Dan Kurnos -- The Benchmark Company -- Analyst

Great, thanks. Good evening, Obviously, nice quarter, guys. Unfair question, Jason, I guess, just out of the box, Instant Max, just help us think about sort of road map, what you're looking for timing, kind of how you set the buy box relative to what is on the CarOffer platform margins? Is anything that just helps us think about the way that you are setting it up. And then obviously, being consumer facing, you guys, again, maybe a little early to ask this, but just in terms of the way that you guys look at kind of marketing spend and your historical acknowledge sort of lower unaided brand awareness.

This obviously brings a whole new leg to the stool for you guys has been excellent at customer acquisition. Does this end up driving incremental marketing efficiencies? You put some more money behind this depending on how the pilot goes, just help us think through the way that you get this program into the marketplace and maybe some of the follow-on effects it could have on sort of the quarter, the core business.

Jason M. Trevisan -- Chief Executive Officer

Sure. Thanks, Dan. Jason here. There is a lot in that. So I'll try and parse some of it out. So on the -- yes, on the Instant Cash Max offer, we've launched it in three states, and we'll expand beyond that in the near term, but we're excited about the very early traction that we're seeing in those three states. It is seamless. I mean it's concierge service to the consumer and they get the offer immediately and upload their docs and we schedule the pickup. And so it's very easy for them. You mentioned a buy button in your question. I mean, this is sort of the sell button, I guess. But it is as close to a cell button as there is out there. This absolutely can drive marketing.

I mean -- and by that, I mean, we do plan to market this service -- And we do believe that this gives people another reason to come to us. And so by that token, from a broader perspective, it could also drive marketing efficiency because we now have more solutions to market to consumers, more reasons to come to our site. And hopefully, we when we help someone sell a car that we then are a natural partner for them to go buy a car, to help them buy a car. So we think it's big in its own right. And we think that it fits really nicely as a complement to how we help consumers find a car they want to buy. And as you heard from our remarks, we're going down the path of helping them actually buy. So we view ourselves as working toward this transaction model that allows them to sell with the click of a button and buy with a click on the button.

Dan Kurnos -- The Benchmark Company -- Analyst

That's helpful. And just to be clear -- I mean, since you guys have owned it for a while in what, six months now or whatever it is, just on CarOffer and thinking about it, I think, Scott, thanks for the color on the 3Q guide, just I mean, should we be modeling that as sort of similar seasonality? I know it's early? Or might there be puts and takes depending on let's assume there's a normalized environment. Just trying to think going forward, how we should think about how CarOffer would flow throughout the year.

Jason M. Trevisan -- Chief Executive Officer

Yes, I'll give some feedback, and Sam can jump in if he wants to. So what I'd say is if they were at maturity, which they're not in hyper growth mode, especially the past six months, really nine months. I would say that sort of normal seasonality would kick in, in the second half of the year. And since it's not a subscription business, 100% transactional, that's something that you could see a second half softening versus first half. I think there's -- these aren't normal tons and also in the evolution of the company.

There's still strong adoption going on. But I think it's a mix of dealer adoption and also throughput on a per-dealer basis. So we're looking at that, trying to get our arms around it with that team. So these aren't normal times. In the evolution of the company, there's still early. But under normal circumstances, and the business was more mature, I'd say, yes, we'd see typical softness in the second half of the year

Dan Kurnos -- The Benchmark Company -- Analyst

Got it. super helpful. Thanks, guys.

Operator

The next question comes from Ralph Schackart with William Blair. Please go ahead.

Ralph Schackart -- William Blair -- Analyst

Good afternoon. Thanks for taking the question. Jason, in the prepared remarks, you talked about the business reach an inflection point with some of the products and services today. Then on the call, you talked about, I think, adding some more services or products. Maybe you can kind of just frame the opportunity going forward, what would some of those products and services be perhaps if I think about sort of a consumer going to a dealership? You have tax title plates, etc. So just trying to understand if you're one day trying to be sort of a one-stop shop for a white label for a dealership and/or is the consumer to do all the transaction on your website or your marketplace. Would sort of love your thoughts on that.

Jason M. Trevisan -- Chief Executive Officer

Sure. Ralph, Good to hear from you. Thank you. Yes, we intend -- I mean when we talk about digital retail, it's us empowering empowering and enabling dealers to sell their inventory online through us. And so all of the aspects of the transaction that you just mentioned a few, Tax Title, there's the transaction itself, there's the other F&I products, there's trade-in, all of the steps that you can think of, we would enable the dealer to do those at their inventory on our site. And we would be the group that is helping the dealer complete all of those steps on our platform seamlessly to the consumer. And so that is when people talk about the buy button, that is the buy button. That's what we're working toward.

And when we have that -- and a great example is trade-in with CarOffer as the backbone is a perfect example of how we think we're going to have a competitive edge with our digital retail offering because we're going to give the consumer, we believe, more choice in the form of more inventory for more dealers rather than single dealer inventory. We're going to give them likely more choice of financing and other options across dealers. With that choice typically comes better pricing. And we're also going to give them the convenience and sort of optionality to complete it fully online or to go into the dealer, if they do want to go into the dealer.

And then a layer of trust as well with the consumer handling that we are planning to and have started to build out so they can have sort of all the benefits of selection and choice and then a single point of trust to come to, which would be us. So and again, trade in -- the example I used on trade-in works when you're Ka selling it to the dealer from who you're buying, and that has certain advantages if it's not a seamless transaction like that where you're doing a trade-in, then we do have other options in P2P and some Cash Max offer as well. So we've said it in these remarks but we really do intend to have and believe we will have the most complete platform for both consumers and dealers to buy and sell their cars. -- and that may take the form of dealer to consumer or consumer to dealer, dealer to dealer. But when people think about buying or selling a car, we want them to use us.

Ralph Schackart -- William Blair -- Analyst

Really helpful. Just maybe one more for Scot. Could you just remind me, you talked about CarOffer gross margin scaling? Just kind of remind me where we think those could go longer term and sort of what's the, I guess, the COGS component within that business versus sort of the listing business?

Jason M. Trevisan -- Chief Executive Officer

Sure. We haven't said where it's going. So I can't really comment there. within that business is -- on the people side, there's onboarding service folks that we have that basically bring the dealers up to speed, give the training on the matrix and so forth. Then there's pass-through costs for inspections and delivery. Those are the major items.

Ralph Schackart -- William Blair -- Analyst

Okay. Actually, if I could sneak one more in just on the instant cash offer that's in three states. Can you provide maybe any color or a sense of the rollout plan? I guess, why those three states? And are there any sort of regulations as you go state to state with the other product?

Jason M. Trevisan -- Chief Executive Officer

I can take that. And Sam, if you want to add. There are some regulatory considerations to make, but three states in this case was we wanted to pilot to make sure that operationally, we were providing a great experience. Those three states happen to be -- two out of the three have to be larger states where we have a lot of dealer penetration. And so it's actually like a pretty good chunk of the country, more than 350 for sure. And yes, we expect to roll out more states in pretty short order. So we expect to make quite a bit of geographic expansion progress this year.

Ralph Schackart -- William Blair -- Analyst

Right. Thanks, Jason. Thanks, Scott.

Operator

The next question comes from Jed Kelly with Oppenheimer. Please go ahead.

Jed Kelly -- Oppenheimer -- Analyst

Hey, great, thanks for taking my questions. Just, Scot, maybe on a follow-up, can you just discuss what drove the gross margin improvement in CarOffer? And then when we're looking kind of over the next couple of quarters at CarOffer, should we think about it growing past seasonality trends just because you're -- the velocity of new dealers you can add? And how should we view that versus seasonality?

Jason M. Trevisan -- Chief Executive Officer

Yes. I mean, so on a growth standpoint -- I'll let Sam take that after because that's something that the team and us sort of figuring out. Dealer adoption, I think, has gotten a bit of a tailwind for sure. There's some inventory situation. There's probably some dealers out there that, that otherwise may not have jumped on care, but are certainly trying it now while they're searching for inventory. But I'll let Sam touch on that further. With regards to -- the improvement in margins. Part of it is scale. We've just had so many dealers jumping on and the team has updated capacity from an onboarding standpoint. So we've done well there, and we put more resources into what we'd say are more account management, customer success in sales versus what would be cost of goods sales versus that would sort of be traditional onboarding. So a reclassification of some resources also moved out a little bit.

Samuel Zales -- President and Chief Operating Officer

Jed, I'll jump in. Thanks for your question on future growth with CarOffer. We don't -- I don't want to project exactly where that's going to go. You know that the major players in the auction industry sees seasonal downside in the later part of the year, the last four months or so. The thing I can say, as you're asking really thoughtful questions, they are growing through and blowing through some of the expectations we had, certainly our expectation of enrollments from customers just jumping on that program. It's truly an innovative capability. There's no instant trade platform anywhere in the marketplace. So the enrollments, the installations crushed our expectations, the transactions that those dealers are trading on.

You heard about the $1 billion gross merchandise sales in the last quarter. It's just an incredible set of results. So I can't predict so early in the adoption curve that it will blow through all of that seasonality. I will say CarGurus is just in an early stage of getting our customers signed on to the CarOffer platform. The CarOffer team is doing such a great job signing dealers on a day-to-day basis. So dramatically, we haven't even optimized the CarGurus adoption of the platform. We're moving and achieving that first phase of integration, but there's so much more to go. And as enrollments go, transactions go and transaction fees and revenue go, so we're really excited about the next phase of the integration.

Jed Kelly -- Oppenheimer -- Analyst

That's very helpful. And then just as you think about getting more vertical or getting further down the transaction funnel with the consumer -- I mean, how are you managing your relationships with the dealers? Are you seeing any pushback or are they pretty accepting of this? I mean the dealers do like to own the customer. So how is this -- how are you managing that tricky spot with the relationships?

Samuel Zales -- President and Chief Operating Officer

Jason, are you going to take it? Or do you want me to jump in?

Jason M. Trevisan -- Chief Executive Officer

No, go ahead.

Samuel Zales -- President and Chief Operating Officer

I'll jump first, which is, Jed, I think Instant Max cash offer is a perfect example of a win-win in the marketplace. You're helping dealers who are saying there are other big retailers who are winning consumer sales and when they're selling my vehicle, we need a tool to help us get there and get us to complete favorably. Now they have the opportunity to look at $35 million, $32 million, $38 million, whatever the number is each month, that are coming to our site who are interested in selling their vehicle and winning that new source of inventory. So as consumers move digitally and say I'm more comfortable selling my vehicle online, and we have this white glove capability for inspection payment and pickup in a consumer's drive way. What an opportunity for dealers to say, I've got the biggest challenge in 30 years in inventory acquisition.

If you can give me access to those 35 million consumers, I'm the happiest dealer in the marketplace. So we're opening up a channel we hoped we would. It's probably quicker than we expected. And so the win-win there is consumers having the opportunity to say, "I'm comfortable selling online, you're giving me a max cash offer because those dealers are putting their bids into the buying matrix and I'm going to get something better than just going to one single retailer. And so these dealers are saying, "I'm now competing with some of those big name players who are buying consumers' vehicles. So that's a win-win for the marketplace. I think as Jason said, we go down the path of digital retail. We're doing the same here. We're going to enable dealers to get in front of a preapproved consumer financial preapproved and then facilitate that transaction with that dealer and help them sell more vehicles. So I think -- These are win-wins and our positioning in the marketplace. We're helping both sides of the marketplace facilitate transaction.

Jed Kelly -- Oppenheimer -- Analyst

Thank you.

Operator

The next question comes from Nick Bacchus with Raymond James. Please go ahead

Nick Bacchus -- Raymond James -- Analyst

Hey, guys, congrats on a good quarter. Thanks for taking my question. So on the number of paying dealers in the U.S., you talked about chip shortage driving a lack of inventory and hurting that number driving that sequential decline. Could you just give more detail on your thoughts on the supply situation moving forward? It seems like you think it's going to start to improve into the back half, kind of how are you thinking about that? And what does guidance build in for dealer count kind of directionally in the third quarter? And how are you thinking about that metric into the back half of the year in general?

Scot Christopher Fredo -- Chief Financial Officer

Nick, it's Scot. I'll take that. So we don't get too specific on what we're guiding to with the number. But for the quarter, as I mentioned in the prepared remarks, with subscription revenue, you're sort of walking in at the basis and we're losing some dealer count in the core business that sets a lower basis than we walked into Q2 with. So that explains some of the revenue. I think the really positive thing that we saw, though, is our versus Q1 and Q2, our retention rate with dealers was about the same or if you inverse that churn didn't get any worse. It really -- what changed from Q1 to Q2 is when the inventory issue bubbled up.

What sort of stopped first was new dealers moving out to the platform. And that's really what changed for us from a paying dealer count standpoint going from a net positive in Q1 to a net negative in Q2 is we didn't get as many new dealers on a we saw in Q1. But as I mentioned, retention churn roughly the same quarter-to-quarter. So as we look into second half of the year, and specifically Q3, like the inventory issue hasn't abated yet. We've seen some very modest movement in the right direction with used inventory slightly ticking up. Obviously, new inventory is still sluggish because they are waiting on chips, but we have seen some positive momentum would used inventory. And as that creeps up, that could help us move those dealers that are either sitting there on the freemium platform, just sort of waiting to need to market again to jump back in. So no specific guidance there, but that's what we're seeing. I'll let Sam jump in. He's probably got some more commentary from the front lines with the sales team.

Samuel Zales -- President and Chief Operating Officer

Scot, not much more to add, Nick. I appreciate the question. As Scot said, that hearty customer retention is spilling into July as we hit in the third quarter. So I feel very good about where we are. Scot talked about the macro trends, we do believe new car manufacturing will start to kick in again in the next short period of time. That will help, but it's not going to ease the situation of a 30-year low in our industry immediately. But we do feel very good, as Scot said, about customer retention. Now the effort is getting dealers to come back on board and saying, "I'm comfortable spending." Remember, with our lead growth, as high as it is, you can give seven leads per vehicle, and that's not going to help that car gets sold. So we're being thoughtful about how aggressively, we can grow our consumer audience. We're doing it really efficiently and very well for dealers, and that lead volume has been really successful. Dealers are now saying, as inventory comes back, as Scot just said, I'm more interested in spending and we're seeing that as a hopeful trend as we go forward.

Nick Bacchus -- Raymond James -- Analyst

Got it. Very, very helpful. Just quickly, sales and marketing. Obviously, you guys have made significant strides there in terms of marketing efficiency last year and into the first half of this year. How are you generally thinking about kind of the right level of sales and marketing percentage? And how durable are the gains you've made? Or do you get some of those back as you press the accelerator on marketing spend going forward?

Jason M. Trevisan -- Chief Executive Officer

I can take that. Thanks for the question. Yes, so I think we are all the way -- and regardless of the environment of COVID environment or inventory supply, consumer behavior, we are always looking to do two things: one, make our consumer experience as efficient as possible; and number two, from both the traffic acquisition all the way through to the connection with the dealer, making the leads as high quality as possible. So efficiency and quality such that what we are delivering to the dealer is something that is high leverage for them that they're not spinning their wheels on low-quality leads. We have made a lot of progress in -- on both of those fronts. And so you just acknowledge some of that on the efficiency side.

What I think I'm also just as proud of and it's hard to tell from the numbers is that we firmly believe we're also improving the quality quite a bit. You heard a couple of data points of prequalification lead quality as well as in the CG Convert propensity to convert to a sale. So that efficiency, all else being equal, and quality have trended in terrific directions throughout. There are these times, though, where macro factors like COVID, like the inventory supply do impact the level of spending that we think makes sense. And what I mean by that is that we're looking at hundreds of metrics, a lot of metrics that speak to dealer level growth rates and dealer segment level growth rates so that we are delivering to the dealer product and a service that is always growing in value, but is also somewhat predictable and consistent for them, so they can plan their business around it as well.

And so in an environment where there's lower inventory, there are not as many as -- they don't have as many cars and therefore, you could argue not only do I need as many leads, but having too many leads on one piece of inventory is not even helpful to them because they can only sell a car once. So we think again, all else being equal, efficiency and quality have improved a lot, but this certainly has been a time most recently because of inventory, where we were able to be more efficient in marketing because the units were low, the consumer demand was high. And so I wouldn't say that I think some of that efficiency goes away. But I think in reaction to some of the macro trends, we -- we said this, I think, in the remarks, we do expect to grow our marketing as the market sort of normalizing.

Operator

The final question today comes from Doug Arthur with Huber Research Partners. please go ahead.

Doug Arthur -- Huber Research Partners -- Analyst

Yeah, thanks. Just Scot, on the revenue guidance for the third quarter, and I understand the caution on the subscription business based on everything you've talked about on the macro level. What I don't quite get is the implied number for CarOffer. I mean you're growing. You talked about the auction business, the seasonality and all of that, but you're growing at a very rapid rate and your guidance for the third quarter, basically assumes a full stop in growth, I mean, sort of flat sequentially. Is that what you're intending to imply?

Jason M. Trevisan -- Chief Executive Officer

Well, full stop -- thanks, Doug. Full stop is a strong word. But I think the inventory issue, sort of that bubbled up in earnest in April. And I think that just changed dealer behavior in a dramatic way and was a huge tailwind to a business that was already growing really fast. But I do think we are seeing early impact of seasonality. Also, I think there's some caution with dealers with regards to the pricing being so high. And so some dealers are being judicious about how much inventory they want to buy at these prices and is consumer demand going to be sustainable. So I think there's a -- It's a unique time right now with peak pricing, the lowest inventory.

I think that dealers are monitoring both wholesale pricing and consumers of willingness to pay at these all-time highs for pricing used vehicles especially. So also, we have some insight with regards to what we've seen in July, right? And so there's some modest -- we saw a month-over-month increases all year long for a CarOffer. And we've seen, as Jason mentioned, a slight -- less growth from June to July than we saw in other months. So with that insight, we're just being a bit more prudent.

Doug Arthur -- Huber Research Partners -- Analyst

But the operative word is you saw growth in July over June.

Jason M. Trevisan -- Chief Executive Officer

No. I think Jason's prepared remarks that we saw a slight slowdown.

Operator

This concludes our question-and-answer session. I would now like to turn the conference back over to management for any closing remarks.

Kirndeep Singh -- Vice President and Head of Investor Relations

Thank you very much. So this is Jason. I just want to thank everyone for joining us today on the call and for your thoughtful questions. I want to thank again all of the CarGurus, CarOffer employees for all your hard work. We're so proud of the team and what we've accomplished. And we appreciate your interest in CarGurus, and we look forward to talking with all of you again next quarter. Thank you very much for your time.

Operator

[Operator Closing Remarks].

Duration: 61 minutes

Call participants:

Kirndeep Singh -- Vice President and Head of Investor Relations

Jason M. Trevisan -- Chief Executive Officer

Scot Christopher Fredo -- Chief Financial Officer

Samuel Zales -- President and Chief Operating Officer

Dan Kurnos -- The Benchmark Company -- Analyst

Ralph Schackart -- William Blair -- Analyst

Jed Kelly -- Oppenheimer -- Analyst

Nick Bacchus -- Raymond James -- Analyst

Doug Arthur -- Huber Research Partners -- Analyst

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