Carvana Co. (NYSE:CVNA) Q1 2023 Earnings Call Transcript

Carvana Co. (NYSE:CVNA) Q1 2023 Earnings Call Transcript May 4, 2023

Operator: Hello and welcome to the Carvana First Quarter 2023 Earnings Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Meg Kehan, Investor Relations. Please go ahead.

Meg Kehan: Thank you, MJ. Good afternoon, ladies and gentlemen, and thank you for joining us on Carvana’s First Quarter 2023 Earnings Conference Call. Please note that this call will be simultaneously webcast on the Investor Relations section of the company’s corporate website at investors.carvana.com. The first quarter Shareholder Letter is also posted to the IR website. Additionally, we posted a set of supplemental financial tables for Q1, which can be found on the Events and Presentations page of our IR website. Joining me on the call today are Ernie Garcia, Chief Executive Officer; and Mark Jenkins, Chief Financial Officer. Before we start, I would like to remind you that the following discussion contains forward-looking statements within the meaning of the federal securities laws, including, but not limited to, Carvana’s market opportunities and future financial results that involve risks and uncertainties that may cause actual results to differ materially from those disclosed here.

A detailed discussion of the material factors that cause actual results to differ from forward-looking statements can be found in the Risk Factors section of Carvana’s most recent Form 10-K. The forward-looking statements and risks in this conference call are based on current expectations as of today, and Carvana assumes no obligation to update or revise them, whether as a result of new developments or otherwise. Our commentary today will include non-GAAP financial metrics. Unless otherwise specified, all references to GPU and SG&A will be to the non-GAAP metrics, and all references to EBITDA will be to adjusted EBITDA. Reconciliations between GAAP and non-GAAP metrics for all reported results can be found in our Shareholder Letter issued today, a copy of which can be found on our IR website.

And now with that said, I’d like to turn the call over to Ernie Garcia. Ernie?

Ernie Garcia : Thanks, Meg, and thanks, everyone, for joining the call. The first quarter was a quarter of significant progress for Carvana. A year ago, the automotive industry as well as the macroeconomic and market environment changed pretty dramatically, resulting in us significantly shifting our near-term priorities away from growth and toward profitability. This shift has impacted everything we do. It has impacted what we are focused on, it has impacted how much we are focused on, and it impacted the way we are managing the business day to day. And all these adjustments take time. First, we made a narrow set of operating goals inside the company that we knew would be necessary to hit our financial targets. Second, we tightened the connections between our technology and operating teams through shared goals, shared meetings and even shared office spaces.

These changes first have to show up in the projects the teams are undertaking. They move to operating metrics, and finally, they show up in financial results. And that is exactly how the progress has been unfolding. In the second quarter of 2022, we outlined our plan and discuss how we are organizing internally to tackle our goals. In the third quarter, we shared a number of operating metrics that we’re beginning to rapidly move in the right direction. In the fourth quarter, we began to see some of the earliest signs of meaningful financial progress. And now in the first quarter of 2023, the direction speed of the financial progress is undeniable. We reduced SG&A by over $100 million quarter-over-quarter and completed our year-long effort to cut $1 billion of annualized costs out of the business.

In addition, in the first quarter, we returned to our historical GPU and adjusted EBITDA margin trend lines and reported company best results for the first quarter in both metrics. We still have a long way to go to achieve our broader goals, but we are on the right path, and we are moving quickly. As we’ve discussed before, there are 3 steps in our plan to achieve positive cash flow and get Carvana back on track to becoming the largest and most profitable automotive retailer. Number one, drive the business to positive adjusted EBITDA; number two, drive the business to significantly positive unit economics; number three, after achieving objective number one and two, return to growth. As outlined in the letter, we expect to complete the first step in this plan in the second quarter.

The completion of this step is a milestone, not a change of direction. We’ll be using the same processes and focus we have benefited from over the last year to continue to see the plan through. We remain firmly on the path to fulfilling our mission of changing the way people buy cars and to becoming the largest and most profitable automotive retailer. The march continues. Mark?

Mark Jenkins: Thank you, Ernie, and thank you all for joining us today. Our first quarter results demonstrated significant progress on our path to profitability. We exceeded our goal of driving $100 million of non-GAAP SG&A reductions one quarter early, and we surpassed our previously communicated goal of greater than 4,000 GPU. In the first quarter, retail units sold totaled 79,240, a decrease of 25% year-over-year and 9% sequentially. Our decline in retail units sold, which we expected, was driven by four primary factors: one, reduced inventory size; two, reduced advertising; three, increased benchmark interest rates and credit spreads; and four, a continued focus on executing our profitability initiatives. Total revenue was $2.6 billion, a decrease of 25% year-over-year and 8% sequentially.

Due to the dynamic nature of the current environment, we will focus our remaining remarks on sequential changes. As we’ve previously discussed, our long-term financial goal is to generate significant GAAP net income and free cash flow. In service of that goal, in the near term, our management team is focused on driving progress on a set of key non-GAAP financial metrics that are inputs into this long-term goal, including non-GAAP gross profit, non-GAAP SG&A expense and adjusted EBITDA. In the first quarter, non-GAAP total GPU was $4,796, a sequential increase of $2,129 driven by increases across all components. Non-GAAP retail GPU was $1,591 versus $632 in Q4. Retail GPU included a $593 benefit due to an adjustment to our retail inventory allowance.

In addition, sequential changes in retail GPU were primarily driven by higher average days of sale, partially offset by wider spreads between wholesale and retail market prices, higher shipping revenue and lower reconditioning and inbound transport costs. Notably, we achieved our Q1 retail GPU despite selling vehicles that were, on average, more than 120 days old. Vehicles sold in Q1 that were less than 90 days old had retail GPU over 2,000, illustrating the benefit of normalizing inventory size and turning vehicles more quickly. Non-GAAP wholesale GPU was $1,236 versus $551 in Q4. Wholesale GPU included a $50 benefit due to an adjustment to our wholesale inventory allowance. In addition, we estimate that wholesale GPU benefited by $150 due to abnormal wholesale market appreciation in the quarter.

Beyond those factors, sequential changes in wholesale GPU were primarily driven by higher wholesale marketplace volume. Non-GAAP other GPU was $1,969 versus $1,483 in Q4. Sequential improvement in other GPU was primarily driven by a greater volume of loans sold in the quarter compared to Q4. In Q1, we sold slightly less than a normalized volume of loans as a result of uncertainty in the securitization market in March. The GPU impact of this less-than-normalized sales volume was largely offset by higher interest income and other improvements, leading to an approximately normalized other GPU in Q1. In Q1, we made significant progress reducing SG&A expenses for the third consecutive quarter, reducing non-GAAP SG&A expense by $119 million sequentially, following a $60 million sequential reduction in Q4.

These expense reductions were broad-based, including advertising, compensation and benefits, logistics and other SG&A. Non-GAAP SG&A expense per retail unit sold decreased by more than $900 sequentially in Q1, demonstrating significant operating leverage. Adjusted EBITDA loss was $24 million in Q1 or 0.9% of revenue. We expect to achieve positive adjusted EBITDA in Q2. After a strong quarter in Q1, we expect to drive greater than $5,000 of non-GAAP total GPU in Q2 as long as the macroeconomic and industry environment remains similar to Q1. Our strong GPU performance is powered by 3 fundamental drivers: driver number one, a more robust retail GPU model. We expect greater than $2,000 of non-GAAP retail GPU in Q2 driven primarily by our efforts to normalize inventory size, accelerate turn times and generate additional revenue from additional services.

In FY ’21, we generated approximately $1,700 of non-GAAP retail GPU. Since then, we’ve made fundamental improvements that we believe will drive higher retail GPU on a sustainable basis. First, we have continued to improve our customer vehicle sourcing with a higher share of retail units sourced from customers in Q1 2023 than in FY 2021. Second, we are generating more revenue from the unique services we offer our customers, including nationwide shipping and home delivery. Third, over time, we expect per unit reconditioning and inbound transport costs, excluding depreciation and amortization, to be below FY 2021 due to our continued focus on operating efficiency. Moving on to driver number two, expanded wholesale platform. We expect greater than $1,000 of non-GAAP wholesale GPU in Q2, split between Carvana’s first-party wholesale vehicle sales and ADESA’s third-party wholesale marketplace.

In FY ’21, we generated approximately $450 of non-GAAP wholesale GPU. Since then, we’ve made several fundamental improvements that we believe will drive higher wholesale GPU on a sustainable basis. First, in May 2022, we acquired ADESA, the second largest U.S. wholesale used vehicle auction marketplace. ADESA’s wholesale marketplace generated significant gross profit in Q1 and will be a long-term addition to our total gross profit. Second, our acquisition of ADESA has improved the efficiency of our offering of buying cars from customers and selling them in the wholesale market. For example, since Q1 2022, we have reduced inbound transport costs on wholesale vehicles by approximately $200 per wholesale unit sold or approximately $90 per retail unit sold, supported by ADESA locations.

Third, we continue to invest in our wholesale platform through product and process improvements with a continued goal of growing these businesses over time. Moving on to driver number three, strong finance and ancillary product execution. We expect greater than $2,000 non-GAAP other GPU in Q2, primarily driven by a normalization of loan sales volume. Since the beginning of Q2, we have sold or securitized approximately $1.3 billion of loan principal, an increase compared to Q1. In FY ’21, we generated approximately $2,450 of non-GAAP other GPU. While we have not yet regained this level, in the medium term, we see a significant opportunity to increase other GPU by improving our cost of fund spread relative to mature securitization market participants and by continuing to expand our ancillary product platform.

To summarize, our first quarter results and second quarter outlook reflect the return to our multitrack — multiyear track record of driving GPU improvements. We believe the gains we are demonstrating in 2023 are sustainable and reflect the significant fundamental improvements we have made in the last 12 months. We also see further opportunities for more improvements in GPU in the future. Moving on to our second quarter outlook. While the macroeconomic and industry environment continues to be uncertain, looking toward Q2 ’23 more broadly, we expect the following as long as the environment remains stable. On retail units, we currently expect a sequential reduction in retail units sold in Q2 compared to Q1 as we continue to normalize our inventory size, optimize marketing spend, make progress on our profitability initiatives — and make progress on our profitability initiatives.

On SG&A, we expect similar non-GAAP SG&A expense in Q2 compared to Q1. We continue to see significant opportunities to further reduce non-GAAP SG&A expenses over time. Finally, we expect to generate positive adjusted EBITDA in Q2, achieving the first step in our 3-step plan to generate positive free cash flow. On March 31, we had approximately $3.5 billion in total liquidity resources, including $1.5 billion in cash and revolving availability and $2 billion in unpledged real estate and other assets, including more than $1 billion of real estate acquired with ADESA. Our strong liquidity position, significant production capacity runway and our clear and focused operating plan positions us well on our path to achieve our goal of driving positive free cash flow and becoming the largest and most profitable auto retailer in the future.

Thank you for your attention. We’ll now take questions.

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Q&A Session

Operator: Today’s first question comes from Sharon Zackfia with William Blair.

Sharon Zackfia : I guess two maybe pretty quick questions. It sounded as if from the press release, you might have made really significant progress on the kind of percent of inventory that’s under 90 days. So hoping you can maybe talk to us about what percent of the inventory today is under 90 days versus what you had in the first quarter. And then secondarily, ad spend was really low. I’m wondering if that’s a low watermark for the year, if we should expect that to start to go higher?

Ernie Garcia : Thanks for the question. So I think on inventory, we’ve definitely made a lot of progress. We rapidly moved through a pretty significant portion of our aged inventory in Q1. And so we started with a much larger inventory than was sized to sales, and we made a lot of progress of the quarter. Our inventory is down year-over-year about 55% and was down 20% in just Q1 alone. I think a useful metric for thinking about our inventory size and what that means for profitability is just thinking about how large our inventory is compared to the cars that we’re selling at any given day. And if you kind of do that simple math and take inventory size divided by daily sales, in the quarter, we had about 65 days of implied turn time.

That contrasts with the actual turn time of 120 days that Mark talked about in his prepared remarks, that’s obviously a really big difference. And that leads to a pretty significant impact to retail GPU. In the letter, we provided a number where for the cars that were less than 90 days aged, which for that subset of cars, the average turn time is approximately 65 days. So it’s a useful number compared to our implied turn time. We had retail GPU of over $2,000. And so I think we’re heading into Q2 in a much better from an inventory perspective. I think that’s been a year-long effort to kind of get sales to catch up to our relative size and inventory. And I think we’re really pleased with the progress. We still have probably 1.5 quarters to go, maybe two quarters to go to get that all the way into alignment, but the size of the inventory relative to sales is now in alignment.

So I think we’re excited about that. On ad spend, that’s another area where there has been a tremendous amount of pressure on units in the business. We’re down approximately 64% year-over-year in ad spend. Quarter-over-quarter, we were down approximately 35%. So that was a big move as well. I think what we found is in this environment, cars are expensive, and consumers are a little bit less responsive to advertising. And so we’ve been retesting all of our various advertising channels. And I think the optimal that we are finding today are different from the optimal that we found in a more normalized environment, and that’s led us to pull back pretty dramatically on marketing. That’s exciting because I think we were able to show a customer acquisition cost of approximately $700 in the quarter, which is the lowest we’ve ever shown as a company by a pretty long way.

And I think if you look in deeper, we had our oldest cohort, we were in the low 300s. So I think there’s just a lot of progress that we’re seeing there, and I think we’re learning a lot about what the business model is capable of achieving. I think we continue to learn as we shrink our inventory and reduce our marketing spend, and I think we’ll continue to make adjustments over the next couple of quarters as we learn more. I think it is more likely there will not be large reductions in marketing spend from here. I think it’s also unlikely that it will shoot back up super dramatically, but we will continue to test it and evaluate what we learn from those tests, and then we’ll go from there.

Operator: The next question is from Ron Josey with Citi.

Ronald Josey : I want to maybe do a quick follow-up, Mark and Ernie, on just the inventory question from Sharon. But specifically, Mark, you mentioned higher incurred — an increase in vehicle sourcing from customers. And I think last quarter, we talked about perhaps, or maybe two quarters ago, overpaying for that. So talk to us a little bit more just about the sourcing of vehicles from customers. We are seeing more ads actually on social sites for Carvana on that. And so I wanted to hear just the sourcing of vehicles as overall inventory, call it, normalizes.

Mark Jenkins : Sure. Yes, happy to answer that. So yes, the comparison that we talked about in prepared remarks was Q1 2023 compared to 2021. So we certainly have continued to make progress on sourcing cars directly from customers over that time period. I think we feel great about that. I think we’ve talked about it before, but sourcing cars from customers is a great source of inventory because it’s a great selection of cars, very broad array of different makes, models, years, mileages. And then also, those cars tend to be more profitable than cars that you acquire at auction. So I think that’s an area of the business where we’ve had great success over the years. I think we feel like we’ve got access to a lot of cars, and we have a lot of customers coming to the site appraising vehicles with us. And so I think that’s obviously been a success story in the business over the last couple of years, and we’re looking to continue that success as we move forward.