Carvana Co. (NYSE:CVNA) Q1 2024 Earnings Call Transcript

Carvana Co. (NYSE:CVNA) Q1 2024 Earnings Call Transcript May 1, 2024

Carvana Co. beats earnings expectations. Reported EPS is $-0.41, expectations were $-0.76. Carvana Co. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello and welcome to the Carvana First Quarter 2024 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to hand the call to Meg Kehan, Investor Relations. Please go ahead.

Meg Kehan: Thank you, M.J [ph]. Good afternoon, ladies and gentlemen, and thank you for joining us on Carvana’s first quarter 2024 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 discussed 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 and Form 10-Q. 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 our GAAP and non-GAAP financial metrics for our reported results can be found in our shareholder letter issued today, a copy of which can be found on our IR website.

And 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. Q1 was an incredible quarter for Carvana and one that is worthy of reflection. My plan is to first share some of the highlights from the quarter, and then to discuss the long-term implications of our recent performance. First the highlights from the quarter. In the quarter we achieved adjusted EBITDA margin of 7.7%. By this measure, in Q1, we not only set new all-time company records, but we also became the most profitable public automotive retailer in the U.S for the first time. We returned to growth growing retail unit 16% year-over-year despite decreasing marketing dollars by 4% and having constrained inventory. We completed our first quarter with adjusted EBITDA exceeding CapEx and interest expense, achieving this milestone by a significant margin.

We achieved GPU that exceeds our previous record from Q2 2023 after normalizing for last Q2’s excess loan sales volume, achieving a GAAP gross profit margin of 19.3%, above the high-end of our long-term financial model. We significantly levered marketing spent, operations expenses and overhead expenses, the last of which were held flat in absolute dollars, despite 21% sequential growth. And combining our GPU and expense leverage, we also validated our long-term finance model that we put out 6 years ago and clearly with the path to significant additional financial gains from here. These gains will be driven by both leverage on our fixed overhead costs, and additional fundamental gains in both operational expenses and GPU. We see opportunity for large improvements in our adjusted EBITDA from here.

We achieved all of this in a difficult automotive environment at a time when most in the industry are moving backward on both unit economics and volume. The long-term implications of this quarter are significant. We continue to deliver experiences that our customers love. The strength of our customer offering has always been apparent in our growth, which even with the last 2-year hiatus has earned us the honor of being the fastest growing automotive retailer in U.S history. As we get bigger and more efficient, the experiences we deliver get even better and simpler. Constantly improving customer experiences has always been centrally important to us, and it will remain central important to us in the future. It is one of our most important feedback loops.

We are positioned to grow significantly from here. The part of our business that is most difficult to scale is reconditioning, because it requires significant physical space construction and zoning approvals. Across our current inspection and reconditioning center infrastructure, we have capacity for 1.3 million units per year, over 3x our current volume. Beyond that, our ADESA locations, we have the ability to increase our production capacity to a total of approximately 3 million units annually. To unlock this opportunity, we’re developing a playbook to bring our full suite of retail reconditioning and logistics, technology and processes to ADESA locations. We recently completed our first conversion of an ADESA site in Buffalo, New York to a Carvana reconditioning center, and now this site is leveraging CARLI, our proprietary reconditioning software and our proprietary processes to recondition retail units.

We believe we have a model to get better as it gets bigger and ADESA is a key part of that story. Reconditioning cars at more ADESA locations over time reduces inbound transportation, which positively impacts cost of sales and retail GPU, and decreased outbound transportation, reducing SG&A per unit and decreasing delivery times for our customers, increasing conversion and decreasing marketing costs. This is also a good feedback loop. Competitively, we sit in a better position that we have at any point in our history. Through our own experiences and those of the various companies who have sought to do something similar to us, the last few years have resoundingly proven just how difficult it is to build a business this complex to drive it to scale to achieve strong unit economics and to deliver high-quality customer experiences.

Building a business like Carvana is very hard and hard is the ultimate competitive mode. Our addressable market remains an enormous opportunity. 40 million used cars are bought and sold on average each year. There are tens of thousands of car dealers offering customers similar experiences to one another with similar business models. Carvana offers a differentiated experience, supported by a differentiated cost structure and driving a differentiated business model. That differentiated model just delivered approximately $1 billion in annualized adjusted EBITDA, and we are still a long way from the full financial potential of our business model and its scale with just 1% market share in this enormous fragmented market, we are extremely well-positioned.

Today is an exciting day for Carvana. The size of our opportunity and the strength of our positioning are clear. Now it’s our job to make sure we make the most of it. Our team is ready to march continues. Mark?

Mark Jenkins: Thank you, Ernie, and thank you all for joining us today. The first quarter was a milestone quarter for proving the long-term earnings power of our online retail model. We set company records on adjusted EBITDA and adjusted EBITDA margin. We achieved industry leading adjusted EBITDA margin for the first time. We drove significant GAAP operating income, and we generated adjusted EBITDA that significantly exceeded capital expenditures and interest expense. Our results in Q1 were exceptional. But we also see significant opportunities to improve margins with scale and continued efficiency gains over time. We provide additional details on these opportunities in our shareholder letter. Turning to our first quarter results.

We entered Q1 squarely focused on unit economics and profitability initiatives. Despite this focus, we saw strong customer demand in part due to several fundamental gains and conversion and customer experience that we made over the preceding quarters. Retail units sold increased by 16% year-over-year and 21% sequentially, reflecting significant market share gains on both a year-over-year and sequential basis. Revenue increased by 17% year-over-year and 26% sequentially. This unit and revenue growth was more than we targeted, given our continued focus on profitability initiatives entering the year. That said, our teams have handled it well, and responded to increased sales, while also demonstrating leverage on operations expenses. We are excited by this and believe there’s more to come.

Our growth in Q1 has had multiple impacts on our inventory. First, our results in Q1 demonstrated how efficient our nationally pooled inventory can be. In March, the average car we sold was only visible to customers on our website for 13 days before being purchased, nearing our all-time monthly low on this metric. Second, our inventory is currently smaller than we would like, resulting in less selection available to our customers. All else content, we believe this is negatively impacting our sales volumes today. To respond, our teams have begun increasing production across the country. In the near-term, our focus will remain on growing production to increase selection to more optimal levels for our customers. Our strong profitability results in Q1 were driven by meaningful fundamental improvements in GPU and SG&A expenses.

In the first quarter, non-GAAP total GPU was $6,802, a sequential increase of $1,072 and a new first quarter record. Non-GAAP retail GPU was $3,211 versus $2,970 in Q4, a new company record. Our strength in retail GPU continues to be driven by fundamental gains and consistent performance in several areas including non-vehicle cost of sales, customer sourcing, inventory turn times, and revenues from additional services. Non-GAAP wholesale GPU was $1,153 versus $881 in Q4. Sequential changes in wholesale GPU were primarily driven by more favorable depreciation rates and first quarter seasonality. Non-GAAP other GPU was $2,438 versus $1,879 in Q4. Sequential changes in other GPU were primarily driven by more normalized loan sale volume relative to originations, lower securitization credit spreads and credit scoring and pricing optimizations including credit tightening in Q4.

Non-GAAP SG&A expense was $390 million versus $376 million in Q4. Q1 was an exceptional quarter for demonstrating the power of our model to leverage SG&A expenses. Retail units sold increased by 21% sequentially, while non-GAAP SG&A expenses increased by less than 4%, leading to a nearly $700 reduction in SG&A expense per retail unit sold. We continue to see opportunities for significant SG&A expense leverage over time and as we scale. Adjusted EBITDA was $235 million in Q1, a new company record. This result included small one-time headwinds that were larger than any one-time tailwinds. It is important to note that the change in fair value of our Root warrants does not impact adjusted EBITDA. Demonstrating the quality of our adjusted EBITDA, we also generated $134 million of GAAP operating income in Q1, a new company record.

As mentioned previously, in Q1, we generated adjusted EBITDA that significantly exceeded capital expenditures and interest expense. This milestone means that in Q1 we officially achieved the goal we set out in May 2022, to drive significant positive cash flow after interest expense. Moreover, we achieved this goal at 360,000 units of annualized volume in line with our expectations. Given our strong liquidity position and operating results, we currently plan to pay cash interest on our 2028 and 2030 senior secured notes on both semiannual payment dates in 2025, reducing long-term cash interest expense and supporting our plan to delever over time. Turning now to our second quarter outlook. We expect the following as long as the environment remains stable, a sequential increase in our year-over-year growth rate of retail units sold and a sequential increase in adjusted EBITDA.

This outlook does not anticipate any material one-time benefits or costs. With our strong results in Q1, and outlook for Q2, we expect to comfortably deliver on our outlook of year-over-year growth in retail units sold and adjusted EBITDA for full year 2024. To conclude, our team’s strong execution has positioned us well to pursue our financial goals. When we focused our growth, we joined Amazon, Google and Meta as one of the four fastest companies to join the Fortune 500. When we focused on profitability, we increased quarterly adjusted EBITDA by more than $500 million in under 2 years and catapulted to industry leading margins. We are now focused on our long-term phase of driving profitable growth and pursuing our goal of becoming the largest and most profitable auto retailer and selling and buying millions of cars.

We are excited about what’s ahead. Thank you for your attention. We will now take questions.

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Q&A Session

Operator: [Operator Instructions] Today’s first question comes from Rajat Gupta with JPMorgan. Please go ahead.

Rajat Gupta: Great. Thanks for taking the question and congrats on a great quarter and improving a lot of the [indiscernible].

Ernie Garcia: Thank you, Rajat.

Rajat Gupta: [Indiscernible] good as on that. So I had one question. Just — looking at the first quarter results and comparing it to the fourth quarter units, almost like 15% sequential growth, or 20% sequential growth. Curious was that all primarily driven by better selection, faster deliveries. Was there anything that you saw changing in the used car market itself that supported that greater than seasonal pick up? Are you just curious if you can characterize that growth during the first quarter a little more relative to what we’re seeing in industry trends? And I’ve a quick follow-up. Thanks.

Ernie Garcia: Sure. So let me start with this. I mean, I think we’re still moving down in marketing dollars. Our inventory is clearly constrained, we put aside our shareholder letter that for cars that make it up on our website, they’re being picked up by a customer in 13 days on average right now, so we’re definitely constrained. And so I don’t believe the best explanation of growth is one of these levers is being pulled. I think, potentially a better explanation of growth is that it’s a return back to the kinds of things that drove our growth for many years prior, we grew extremely fast from 2013 to 2021. I think there were probably many things going on there. But I think the two most important because they’re most sustainable were, one, we deliver to customers that experience they love.

It’s highly differentiated and hard to replicate. And one for which I think consumer preferences are constantly migrating toward, and then I think two, there’s positive feedback in our business inherently. And I think over the last 2 years through ’22 and ’23 that positive feedback was going the wrong way on us as we were shrinking inventory, and we are shrinking marketing dollars, and we were pulling in, and we are really focusing on profitability. And I think over the last several quarters, that’s at least kind of the wins have gotten still. And so I think that’s probably our best explanation. In addition to that there have been countless improvements across the business, you’re seeing many of those in the financial numbers. You can see our operating expenses going down, you can see our GPU going up.

That’s the result of a lot of work from a lot of teams, where they focus on customer experiences and efficiency gains, and just made little improvements over and over again for the last several years. And I think that drives better customer experiences, it drives higher conversion, and it drives better economics. And we think all of that is playing into what we’re seeing today.

Rajat Gupta: Got it. Got it. That’s clear. And then I think in your prepared remarks, you mentioned that you plan to grow EBITDA margins from here. So is it fair to assume the 7.7% is a whole point. On a quarterly basis, or was that more of like an annualized comment, I mean just curious, how should we think about — you’ve obviously given us like some guidance on second quarter, but curious, does that also mean margins are also naturally up sequentially. and it’s just not EBITDA, that’s up.

Ernie Garcia: Sure. What will — so I think we’re going to stick with the guidance we provided, the guidance we provided for Q2 is an EBITDA dollars and we expect it to go up. But then I think we also provide some color. We provided a table in the shareholder letter that we hope is useful that quantifies three relatively straightforward extrapolations. We believe relatively straightforward extrapolations from our Q1 results to give kind of some visibility into where we think things can go. And so those three changes were one, we start with 7.7%, adjusted EBITDA margin, we did actually under sell loans in the quarter versus what we originated. If we assume that we would have sold those loans at a at a similar premium, which would be our expectation to loans we sold in the quarter, that would have gotten us up to 8%.

And then, number two, we kind of provide a data point where your average marketing dollars divided by revenue was 1.8% in the quarter. That’s — that already compares pretty great to our long-term model that we put out 6 years ago, where we expect it to be between 1% and 1.5%. But if we look at our four oldest cohorts where we tend to have higher market shares, and lower marketing spend, it was down to 1%. And we think that clearly liked the way to getting down to the low end of our finance model over time. And so that’s point 8%. And then you also saw on the quarter that we held our overhead expenses flat in dollar terms at approximately $150 million. And that led to significant leverage on a per unit basis, given the 21% sequential growth.

And so if we assume that we grow into the infrastructure that we have across the business, we have inspection centers that we’re ready to grow into, we have excess multi car haulers. As a result of our path in the last couple of years, we’ve got the market operations hubs to support significantly more growth. We think there’s over 3 points of possible leverage there. And then that also leaves out the fundamental gains that we’re continue to work very hard on across the business in driving down operations expenses and driving up GPU, where all the teams that have done all this incredible work over the last 2 years make all these games have exciting projects that they’re still working on today. So I think we look at all that and we’re extremely optimistic and extremely excited, frankly, about the medium term.

I think we got a lot of work to do to make sure that we unlock all that value, but we’re working hard to do it.

Rajat Gupta: Great. Thanks again and good luck.

Ernie Garcia: Thank you.

Operator: Thank you. The next question is from Chris Bottiglieri with BNP Paribas. Please go ahead. Chris, your line is open.

Chris Bottiglieri: Sorry, I was on mute. I’ll start over again, sorry about that. So obviously, really impressive unit economics amongst the highest in retail that we’ve ever seen. Curious how you think about sustain is versus reinvestment? Is there a level like when you have 3,000 plus retail GPU, why is that at the right level versus say taking it lower and have you looked at elasticity? And what it could mean, if you sacrifice some of the GPU to drive higher units? Curious how you think of that balance.

Ernie Garcia: Sure. Well, first, this is our 29th call that we’ve done as a company after being public. And I think now after Rajat, we’ve got five great quarters. Your first comment was ambiguous. So would we qualify that as a great quarter or no?

Chris Bottiglieri: You can add me on that list.

Ernie Garcia: Thank you. Appreciate it. Thanks. Okay. I think this is what I would say, I think we’re very excited. We’re in a great spot. I do think that today we are a bit constrained, most notably in inventory. But also as we’ve spoken about last several quarters, we have not been positioning for growth just yet, right. We’ve been focused on driving the economic gains that we are seeing today. And that’s been part of a plan that kind of have annual cycle that is up in June. So most of our operating teams really have not been focused on growth at all, They’ve been focused on kind of staying in a similar spot and then basically responding to the demand that has kind of been — has just been showing up kind of absent us pulling it forward from customers.

And so I think where we are today is we have to start to position the business for growth over time. We’ve been working on trying to catch up on inventory. I think an interesting somewhat hidden stat in the business is because we were shrinking inventory so much a year-ago, even though our inventory is roughly flat and our sales were up year-over-year 16%. The cars that we have reconditioned year-over-year are up closer to 50%, and that’s because last year, we were really pulling down on that capability because we were trying to shrink our inventory and get back in line. So that part of the business has begun to flex that muscle and you’re seeing the results in retail GPU that you see today, that’s happening while they’re working hard to grow and support that 50% growth year-over-year.

The rest of business have little bit work to do and we are also buying on inventory. I think until we catch up, I think it’s pretty clear, what our move is supposed to be. We are supposed to kind of make normal adjustments with the market as we go. I think once we catch up, there may be other moves that we can make, but we will have to make that call at that time. We clearly think we are constrained and we clearly think it we have more cars to sell and we are — build more capacity. We would be selling more cars that would be leading to additional EBITDA.

Rajat Gupta: Got you. Okay. Thanks, Ernie. Great job at number seven. Take care.

Ernie Garcia: Thank you. Please we will take the dollar.

Operator: Thank you. The next question comes from Sharon Zackfia with William Blair. Please go ahead.

Sharon Zackfia: Hi, good afternoon. I’m not going to keep showering you with complement, so that’s going just end here on the quarter.

Ernie Garcia: Thank you.

Sharon Zackfia: So, I guess two questions. On the GPU its obviously very, very good and I know you’ve done a lot of work on reconditioning, you mentioned CARLI in your prepared comments. Can you give us kind of any insight on where Recon per car is all in today relative to maybe several years ago and how much more you think, you can harvest in terms of efficiency there and then I have follow-up.

Mark Jenkins: Yes, I can hit that. So, I think Recon is one of the places where we’ve made very significant gains. I think we’ve talked a bit before about some of the gains relative to 2021, and there we are down hundreds of dollars relative to where we were in full year 2021. So there’s been some meaningful gains there. That is, I would note, that’s a significant reduction in per unit cost, while overall cost inflation and wage inflation around the industry and economy has generally led to higher costs. And so that’s really just a technology driven efficiency gains, process driven efficiency gains and the result of a lot of the efforts that we’ve made over the last couple of years. So I think we feel really great about that, and that’s absolutely part of the strength in retail GPU.

Ernie also hit on, I think, a stat that we’re feeling really good about, which is we are ramping production now to respond to demand and we’re not seeing those costs tick up. And so I think that’s something that also speaks to the quality of the technology, the quality of the management and the teams out in those inspection and reconditioning centers. And so I think that some commentary on where we are and where we’ve been. In terms of where we can go, we absolutely see opportunities to further drive down per unit reconditioning costs. I think that takes a couple of forms. One is simply continue to pursue further efficiencies through technology and process improvements. And I think we see opportunities there. I think we also see some opportunities as we start to scale into this infrastructure to get some fixed cost leverage on the cost of sales side as well.

That’s not nearly as large as the fixed cost leverage that we hope to achieve in the SG&A part of the business, but we see some opportunities there as well as it relates to Recon.

Sharon Zackfia: I guess the follow-up is in the shareholder letter, there was a lot of commentary around ADESA and your original vision there, which obviously was maybe deferred a bit, just given the cash reality that you faced for the last 18 to 24 months. So how do we think about kind of that vision coming to fruition in terms of timing? I mean when will we start to see ADESA sites start to convert to something more meaningful where you can harvest efficiencies from them.

Ernie Garcia: Sure. Well, let me take that one and I want to start with this. I think something that’s very important to the success of the business today and to us achieving kind of best in industry EBITDA margins this quarter, is that we do have a large network kind of underneath all the things that we do. That’s the network of reconditioning centers, it’s a network of long-haul logistics, it’s a network of last mile logistics to deliver cars to customers and pick them up. And so ADESA is already playing a very important role there. We’ve got 30 of the 56 ADESA locations where we have last mile logistics, including buying cars from customers going and picking them up, sometimes customers dropping them off, delivering cars to customers.

And then we’ve got 9 of these locations where we have multicar haulers that are able to kind of run their logistics routes through those locations, making us more efficient across the country as a business. And then we’ve also now begun to develop this playbook of adding Carvana reconditioning at the Buffalo site, which we’re very excited about because that’s something that we think unlocks approximately 2 million units of reconditioning capacity across those ADESA sites as we roll that out nationwide. And so I think that’s very foundational, right? It is very difficult to get many sites that are large enough to run our business at scale and to get them zoned and appropriately located across the country that maybe doesn’t sound from a distance like it’s hard, but it’s something that’s very hard and takes a lot of time.

And so I think it’s already showing up in the Carvana results. And then I think the ADESA team is also doing a great job. And that core business of ADESA, the wholesale business is also going very well. And then I think we’re also mutually benefiting from kind of the vertical integration of us being able to buy more cars from customers and then sell them at their locations which has positive feedback for the auction business and removes auction fees for us. So I think there’s a lot of great stuff that’s happening there. And I do think it’s a big part of our story as we move forward in time because it is very hard to build a business like this that delivers this kind of financial results without a very large network underneath it that powers it.

Sharon Zackfia: Okay. Thank you.

Ernie Garcia: Thank you.

Operator: Thank you. The next question comes from Chris Pierce with Needham. Please go ahead.

Chris Pierce: Just following up on that, what — is there anything specific about the ADESA Buffalo site that allowed you to pick that one first. Like how repeatable is that playbook with the other 56 sites that are out there? Like how many of these mini IRCs could you top up to kind of strengthen the network that you spoke to?

Mark Jenkins: Sure. What I think — there’s a number of reasons we pick that side. I don’t know if we want to dive into all those in detail. But I think the absolute belief is that it is repeatable across the majority of ADESA sites. And we felt like that was a good place to start for a number of reasons relating to both ADESA and to Carvana’s needs.

Chris Pierce: Okay. And then just as a follow-up, what does growth look like from here? I know you’re talking about increasing production, which means you’re buying more cars from customers to get more cars on the site. But like do you need more technicians? Do you need more — like, is there anything you need more of? Or like what kind of — or you’re just literally just using excess capacity that you already have or adding a second shift? Like what does growth really look like from here?