Carvana Co. (NYSE:CVNA) Q3 2023 Earnings Call Transcript

Carvana Co. (NYSE:CVNA) Q3 2023 Earnings Call Transcript November 2, 2023

Carvana Co. beats earnings expectations. Reported EPS is $3.8, expectations were $-0.85.

Company Participant: Ernie Garcia – Chief Executive Officer Mark Jenkins – Chief Financial Officer Meg Kehan – Investor Relations

Conference Call Participant: Chris Pierce – Needham Michael Baker – D.A. Davidson Seth Basham – Wedbush Securities Ron Josey – Citi Rajat Gupta – J.P. Morgan Chris Bottiglieri – BNP Paribas Michael Montani – Evercore ISI Daniel Imbro – Stephens

Operator: Good day, and welcome to the Carvana, Third Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. 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, Varsh. Good afternoon, ladies and gentlemen, and thank you for joining us on Carvana’s third 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 third quarter shareholder letter is also posted to the IR website. Additionally, we posted two sets of supplemental financial tables for Q3, 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 GAAP and non-GAAP 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.

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 third quarter was another great quarter for Carvana that continued the clear momentum we’ve had since we rolled out our plan 18 months ago. Over that period of time we have cut $1.2 billion in annualized SG&A expenses out of the business, which has dramatically improved our efficiency, while also reducing annualized inbound transport and reconditioning COGs expenses by about $250 million annualized, which has driven up our GPU. These efforts have combined to powerful effect. Over the last two quarters, we have generated $300 million of adjusted EBITDA, with about $200 million of that excluding non-recurring items. These are important numbers. They send a clear message that the plan our team laid out 18 months ago was the right one.

They send a clear message that our team is executing at a very high level. And most importantly, they send a clear message about the long-term power of our business model. Since we went public in 2017, we have been clear about our goals to sell millions of cars and to become the largest and most profitable automotive retailer. Two years ago, there was a general belief in our ability to become the largest, but the questions remained about our ability to be the most profitable. While those two questions won’t be definitively answered until we actually cross both milestones, the last two quarters provide a lot of support for our belief that we will ultimately be the most profitable automotive retailer as well. In today’s shareholder letter, we are providing clear evidence of this with our breakouts of our overhead and operational expenses over time.

The takeaways from the data are the following: One, in Step 1, we successfully right-sized the operational components of the business and began making significant progress in reducing our operational expenses per unit. Two, our efficiency gains are continuing in Step 2, with our unit economics rapidly becoming a significant competitive advantage. And three, our current fixed-cost utilization is low, providing a very clear path to both significant scale and significant cost leverage when we turn to Step 3 of our plan. Our plan is working, and we are going to see it through. While it is unquestionably tempting to turn our attention back to growth, we believe it is a better long-term decision to remain disciplined and continue harvesting the efficiency gains we see in front of us before shifting our organizational focus and moving on to Step 3.

In the fourth quarter, we expect to continue making fundamental gains through various projects that comprise Step 2. We also expect volumes to reduce relative to Q3 due to normal seasonality and potential industry softening observed over the last four weeks. Despite this, we continue to operate in our target unit range for Step 2. The sum of these dynamics leads us to expect to produce another great quarter, but as in past Q4s, we expect lower industry-wide volume, coupled with higher industry-wide depreciation rates to cause lower adjusted EBITDA than we have achieved in the past two quarters. Looking forward, we are excited. The difficulty of 2022 wasn’t how we imagined our path in the beginning, but that doesn’t mean it wasn’t good for us.

Through it, we have come together to do our best work. We have learned the power of focus. We have gained a new appreciation for discipline. We have learned an even greater sense of urgency. And now, as a result, we have competitively differentiated unit economics. 2022 has added to our arsenal. It has made us better. And while that is a change, there is a lot that remains exactly the same. We are still an ambitious group of people who care. We are still willing to roll up our sleeves and do the hard work to achieve our goals. We are still delivering new experiences to people buying and selling cars that they love. We still have a business model that is incredibly difficult to replicate and that mechanically gets better as it gets bigger. We are still just a small player in the largest retail market in the world, and we are still on the path to selling millions of cars and 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 third quarter highlighted the significant and sustainable progress we have made on our path to profitability. We set third quarter company records for total GPU and adjusted EBITDA, both with and without nonrecurring benefits. As part of our earnings materials, we provide a detailed look into our Q3 results, our three-step plan, and the components of our cost structure. I’ll start by summarizing three key takeaways. First, in the last two quarters, we have clearly demonstrated the profitability of our online business model. In Q2 and Q3, we generated more than $300 million of adjusted EBITDA, which includes approximately $110 million of non-recurring items.

We did this despite carrying costs of an infrastructure that supports 3x retail unit growth, and despite a difficult used vehicle industry backdrop. Second, our focus on driving fundamental operating efficiency in Step 2 is generating significant unit economics gains. Of particular note, we have reduced non-vehicle retail cost of sales and operations expenses by $1,000 per retail unit in just the last two quarters, and we see opportunities for further gains from here. Third, we have significant excess capacity in our existing infrastructure to support multiples of profitable growth. We expect this growth to be paired with significant operating leverage as we leverage our underutilized overhead costs. Moving to our third quarter results. In the third quarter, retail units sold totaled 80,987, a decrease of 21% year-over-year and an increase of 6% sequentially.

Total revenue was $2.773 billion, a decrease of 18% year-over-year and a decrease of 7% sequentially. As we’ve previously discussed, our long-term financial goal is to generate significant GAAP net income and free cash flow. In service of this goal, in the near term, our management team remains 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. Due to the dynamic nature of the current environment, we will focus our remaining remarks on sequential changes in these metrics. In the third quarter, non-GAAP total GPU was $6,396, a sequential decrease of $634 driven primarily by smaller benefits from non-recurring items.

Total GPU in Q3 was positively impacted by approximately $500 of non-recurring benefits, which we describe in more detail below, compared to approximately $900 of benefits in Q2. Non-GAAP retail GPU was $2,877 versus $2,862 in Q2. Sequential changes in retail GPU were positively impacted by a $250 reduction in non-vehicle retail cost of sales and a 25 day reduction in retail average days of sale, both at the favorable end of our previous outlook range, as well as wider spreads between retail and wholesale market prices, partially offset by higher retail depreciation rates and a smaller inventory allowance adjustment benefit compared to Q2. Notably, our strengthened retail GPU continues to be driven by several fundamental improvements in our business compared to our previous high watermark of FY 2021, including lower reconditioning and inbound transport costs, a higher customer sourcing rate, and higher revenue from additional services.

Non-GAAP wholesale GPU was $951, in line with our outlook, versus $1,228 in Q2. Sequential changes in wholesale GPU were primarily driven by higher wholesale market depreciation rates in Q3 compared to Q2, which negatively impacted wholesale vehicle volume and gross profit for wholesale units sold, as well as seasonal changes in wholesale marketplace volume. Non-GAAP other GPU was $2,568 versus $2,940 in Q2. We estimate that a higher than normalized volume of loans held and sold in Q3 increased other GPU by approximately $400, other things being equal, compared to a $650 benefit in Q2. In addition, other GPU in Q3 was primarily impacted by lower origination rates relative to benchmark interest rates, partially offset by lower credit spreads.

In Q3, we continue to make progress lowering SG&A expenses, reducing non-GAAP SG&A expense by $13 million sequentially. Notably, we reduced non-GAAP SG&A expense per retail unit by more than $400 sequentially, while growing retail units sold by 6%. In our shareholder letter and accompanying materials, we provide additional details on the components of our SG&A expense, including a breakdown of operations expenses, which are more variable in nature, and overhead expenses, which are more fixed in nature. Our significant sequential operating leverage in Q3 was driven by both continued improvement in operational expenses, as well as leverage in the fixed component of our cost structure. Adjusted EBITDA in Q3 was positive $148 million or 5.3% of revenue.

The aggregate impact to adjusted EBITDA of the previously described nonrecurring items was approximately $40 million. On September 1, 2023, we closed the previously announced corporate debt exchange offer with 96.4% of note holders agreeing to exchange $5.52 billion of our unsecured notes for cash and new secured notes, reducing total debt by over $1.325 billion, extending maturities and decreasing required cash interest payments by more than $455 million per year for the next two years. On September 30, we had approximately $3.2 billion in total liquidity resources, including $1.6 billion in cash and availability under revolving facilities and $1.6 billion in secured debt capacity and unpledged beneficial interests. Turning now to our fourth quarter outlook.

While the macroeconomic and industry environment continues to be uncertain, looking toward the fourth quarter of 2023, we expect the following as long as the environment remains stable. A sequential decline in retail units sold, driven primarily by industry and seasonal patterns, non-GAAP total GPU above $5,000 for the third consecutive quarter, and positive adjusted EBITDA for the third consecutive quarter. Looking toward 2024, we expect to drive significant total GPU and adjusted EBITDA for the second consecutive year. We are excited about the path we are on, and we look forward to making continued progress toward our goal of becoming the largest and most profitable auto retailer. Thank you for your attention. We’ll now take questions.

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Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Chris Pierce with Needham. Please go ahead.

Chris Pierce: Hey, how you doing? Non-GAAP – hold on a sec. Non-GAAP SG&A per unit. Can it continue to go down in Q4 on the lower number of units you’re guiding for? And if it can’t, would that be a signal internally to turn on growth?

Ernie Garcia : Sure. I would say you can see that we’ve pushed down our dollar spend pretty consistently over the last several quarters. I think we’re extremely happy with the dollar reduction this last quarter that we saw. It came in the form of basically a $200 operational expense saving per unit, and kind of that being offset by roughly 5,000 additional units quarter-over-quarter. So we’re clearly making pretty significant gains there. I think that we absolutely believe that through Step 2 we have additional gains to be made. We expect those gains to be across the board, both in our corporate expenses and in operational expenses. But I think as far as kind of that detail of disclosure, we’re going to stick with the guidance that we’ve provided.

Chris Pierce : Okay. And then just broadly, what would turning on growth mean? Because you have to get the cars to sell the cars. So is that something – or would turning on growth be increasing advertising to sell more cars in different geographies at a higher rate or would it be sourcing a greater number of cars from consumers? I’m just kind of curious how you would go about it to the extent you’ve had those conversations.

Ernie Garcia : Sure. So let me start with – I think roughly a year and half since we kicked of with this plan. We internally called that Project Catapult. And basically everyone across the business had a series of goals in every operational group that they were aiming to hit, many of them with monthly targets and most of them with weekly targets that we were marching to basically through Q2 of this year. We also then kicked off what we call Operation 100, which is the next series of our goals across every single one of our operational groups. That also has very clear targets, some of them monthly and most of them weekly, through Q2 of next year. I think that has clearly led to tremendous gains. That level of focus the discipline that we’ve had, of making sure that we are maintaining operational excellence and that across all locations in the company we’re performing at the best level of any locations across the company.

I think it’s clearly led to tremendous benefits and I think that focus has been very, very valuable. So I think the most important thing that we will do is in time to turn to growth and Step 3 is basically to just reset the entire company focus on growth goals. So I think instead of everyone being focused on, how am I going to drive additional efficiency and all those targets, being focused on how are we going to get more efficient as a business, they’ll instead be focused on how do we make customer experiences even better? How do we drive growth? How do we position the company to grow? And so I think that is the number one thing that we will switch when we move to Step 3 from Step 2. I think the gains that we’re seeing are still very significant and so we believe it makes sense to stick in Step 2 for a bit longer.

I think when it is time to grow, I think advertising, inventory are absolutely two very big parts of that equation. I think we grew from 2018 Q1 through ‘21 Q1 at approximately a 70% CAGR. During that entire time, we were clearly growing inventory pretty quickly. That was leading to increased conversion. We are growing advertising pretty quickly. I think that was partially because those customers converted even more efficiently as a result of that extra inventory and our brand was building. And so we benefited from positive feedback throughout that entire period. Over the last 18 months, the opposite has been true. Over the last 12 months, we’ve shrunk inventory by 50% and we’ve shrunk advertising by 50% and that’s clearly pushed a bit in the opposite direction.

But when it’s time to grow, we expect to again grow inventory. We expect to again grow advertising. I think there are other elements of positive feedback that we expect to kick off as well, and we think that that will drive a big part of that growth.

Chris Pierce : Okay, thank you.

Operator: The next question comes from Michael Baker with D.A. Davidson. Please go ahead.

Michael Baker: Hi, thanks. So you said a lower cost structure is a competitive advantage. How does that show up? To me, that means you can get aggressive in price to win back shares. Is that the right way to think about it or is there another way we should interpret a lower cost structure being a competitive advantage? And maybe just as a second question, I’d like to call it a follow-up, but it’s unrelated. I also heard you say the last four weeks have been weaker. If you could just talk about the trends through the quarter and early into the fourth quarter. Thanks.

Ernie Garcia: Sure, so let me start with that. I think unit economics we view as a competitive advantage. So I think I would extend that not just to cost structure, which we’ll hit in a moment, but also to GPU. I think a huge advantage of our business model across all of time has been our vertical integration. We’re able to give customers a very high quality, very simple experience, and we’re able to monetize much more of that experience than many others in the industry as a result of that vertical integration. And I think those benefits are showing up very clearly in our GPU. We just had record Q3 GPU on the order of $6,000. We had record Q2 GPU as well. So I think unit economics start there and we’re able to achieve those GPUs despite giving our customers significant discounts versus many of the largest players in this industry.

So I think that’s the starting point, I think, of the power of our model. I think now if we kind of fold that into expenses, you can see the gains that we’ve made in operational expenses. We’re extremely proud of that. That’s obviously not a super easy thing to do, especially while holding volumes flat. We’ve dropped our operational expenses by $200 from Q2 to Q3. We dropped them by $200 from Q1 to Q2 before that. And we’re now at a place where those operational expenses are actually lower than where they were in Q1, ‘21, and lower by about $100, give or take, versus Q1, ‘21. That’s good, but it doesn’t sound like it’s incredible progress, but I think it’s much better when you take into account the fact that there’s clearly been quite a bit of inflation over that time.