Carvana Co. (CVNA) Earnings Call Transcript & Summary

Perfect. Well, thanks, everyone, for joining us. I'm Sharon Zackfia. I'm really happy to have with us today Ernie Garcia, Chairman, CEO and President of Carvana; and Mike Levin, Head of Investor Relations. Ernie has a few comments to make and a formal presentation, and then we'll do a fireside chat. But before handing it over to Mike for their disclosures, I need to tell you that we have a full list of research disclosures and potential conflicts of interest at williamblair.com. Mike?

Yes. And before we head into the good stuff, today's discussion may include forward-looking statements within the meaning of the federal securities laws, which are subject to risks and uncertainties that may cause our actual results to differ materially from such statements. A detailed discussion of the material factors that may cause actual results to differ from forward-looking statements can be found in the Risk Factors section of Carvana's most recent 10-K and most recent 10-Q filed with the SEC. The forward-looking statements and risks in this presentation 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. And now I hand it over to Ernie.

Great. Thank you, Sharon and Mike. So first of all, let me start with the goals for today. I think at this conference in the past, we've met a lot of new investors. And so I apologize to existing investors. This may be kind of running through a bunch of material you already know, but our goal is to give a general overview to new investors and then also talk about a long-term vision. So first and foremost, our mission is to change the way people buy cars. I think people always look at us as an online retailer. I think in this world where there's so much focus on e-commerce in general, I think that's even more true. And I think that is a functional description of what we do. But the reason we do what we do is we wanted to create a business that gives customers a better experience. And we felt like in order to do that, we had to have a differentiated experience and differentiated technology that would really give us the opportunity to give customers that something that is really different. And then we found that the best way to do that is to utilize new technology that better serves modern customer preferences and then build on top of a new supply chain that has a bunch of efficiencies that the existing automotive supply chain doesn't have. So that's how we go about achieving that. Our strategic [Technical Difficulty] for everything we do, we want to make sure we give customers the best experience available anywhere. In everything that we do on the site, the financing experience, trade-in experience, the way we try to present the cars, we try to make sure that we are just giving customers the best experience available anywhere. That's something that we put a real investment in. We want to give customers the best selection possible. So once you are selling cars sight unseen, that unlocks the ability to no longer require that the car is physically next to the customer, and that enables a different supply chain and a different kind of selection. So we've historically had over 30,000 cars in the site. Coming out of coronavirus, we stopped buying cars for probably 45 days, give or take. And so our inventory today is smaller than that, but we plan to build back to that level and continue to build from there. And we think that's a big differentiator relative to the status quo for customers buying cars. And then we also want to give the best value. The benefit of having this model and utilizing technology and vertically integrating is that it reduce a lot of costs out of the system, it lowers variable costs and enables us to give customers the best value they can get anywhere. And so these are always the 3 pillars of everything that we're trying to achieve and the way that we think about every problem that we tackle. We do have this highly vertically integrated model. So I'll start on the top left. We have large-scale reconditioning centers. We have 8 of them around the country. These centers are approximately 75 to 100 acres. We can produce north of 1,000 cars per week out of each of these centers. At those centers, we recondition the cars. We certify them. We photograph them, prepare them for sale. And then they are parked while they're up on the website to be sold to customers, and then that is where our logistics network starts. We also have a kind of first-party logistics network. So all the trucks that are leaving all the inspection centers and going out to our 260 markets, they're doing so on preset schedules. Those are trucks that we own. And because they're leaving at preset schedules, we can tell customers things like if you buy this car in the next 30 minutes, it can be delivered tomorrow at 4 p.m. So we can give customers a lot of clarity to exactly what's happening. And then once the car gets into the market, we also have single-car haulers, where an advocate, who's a uniformed employee, will deliver that car to the customer's door. We've got a leading fulfillment experience, which includes both delivering cars to customers' doors and these vending machines that are out there and seem to be representing our brand. We've got a proprietary financing platform. In everything that we do, we try to make sure that we are designing our systems to give customers the simplest and best experience possible. And then we're trying to also make sure that we do all the things that we have an expertise to do so that we can get access to as much of the economics as are possible. And so that financing platform enables that. And then the experience itself is fully transactable. So customers can go to our site. They can find the car they love. They can get a trade-in value in minutes. They can get a proof of financing in minutes. They can sign contracts. They can schedule delivery. So all that technology is owned by us, controlled by us and is set up to give customers that great experience that we're shooting for. So far, that's worked out pretty well. So we have over 50,000 reviews on our site. Our average rating is 4.7 stars. Our NPS is 82. I think this is something that we're tremendously proud of and something that we think is really our most important report card. When we set out to build this business, we set out to build the business from the ground up to deliver better experiences to customers. We set out to build a business that had better unit economics and that was scalable. And we've been scaling very fast for a long time. We've had 6 straight years of over 100% revenue growth. And to do that while simultaneously maintaining an 82 NPS is something that we're really proud of, and we think it speaks very well to the business that we've built and the way that the group has executed. Diving into some numbers a little bit. So the bar graphs on the left, we've got total markets, retail units, vending machines, total revenue. You can see that we've been growing very quickly for a long time exponentially. And in addition to delivering great customer experiences, what we're really proud of as well is if you look over to the right, we've also rapidly improved our unit economics the entire time. So our gross profit per unit has been on a nearly linear walk since 2015, just marching up quarter after quarter. If you look at the bottom right, our net loss and EBITDA margin have also been continually improving. And so to do that while growing as fast we've grown is also something that we speaks -- we think speaks very well to the business model and the team. This just dives in and gives you a little bit more detail. I think the most interesting data point here is Q1 '20. So obviously, we ran into coronavirus in March, and so that spoiled our plans a little bit for what we were expecting out of Q1. But despite that, we still grew at 45% when the vast majority of automotive retailers were shrinking. We think that obviously speaks to the momentum that we had inside the business, and that's something that we're also proud of. Diving in again, a little more detail on gross profit per unit. Over to the left, you can just kind of get a zoomed-in view of how quickly we've been expanding that. In Q1 2020, again, despite coronavirus and all the headwinds that generated, we were still up over $200 year-over-year. So that forward momentum has continued. Obviously, coronavirus has created some changes to our expectations, but we're very proud of the way that we've been able to progress through that. And then over to the right, you can see there are still many, many levers that are the same levers that we've utilized over the last 7 years to drive our GPU up. All those levers still exist. We still think there are significant gains, and we expect GPU to continue to move up over time. Overall, we think there's just unbelievable opportunities for growth inside this business. We can obviously drive lots of revenue inside of our existing markets. We're still very small, even our most mature markets, relative to the market itself. We can enter new key geographical areas. We currently have 70% to 75% population coverage. There's additional growth there. We think that we're still very early in the game in innovating and extending our technology leadership and just giving customers the best experience they possibly can. It's really simple by utilizing modern technology. We think the experience that we've built is better than anything else out there. And we also think that there's a ton of room to improve from here and continue to separate ourselves from the status quo. We think brand is an enormous opportunity in this market. There just aren't many large national brands in automotive retail. And it's not like that in many other retail verticals, so we think that, that's a really big opportunity and something that we will continue to invest in. And then there's all kinds of opportunities around the core business that we're building, opportunities for additional GPU and additional drivers of growth, and we'll continue to focus on that as well. Our long-term model, I think, is an interesting and useful thing for us to present for you to understand what we're shooting for. So we've put out this goal of shooting for 2 million-plus units per year. Both that 2 million and the plus are important. We think that there's a really, really big opportunity in this market. And then we're shooting for gross margins between 15% and 19%. You can see that in 2016, we're at 5.3%. And for full year '19, we're at 12.9%. So we've made a lot of progress there. Over time, we also expect to get to EBITDA margins between 8% and 13.5%. You can see that in '16, we're at negative 23%, and we improved that all the way to negative 6% in 2019. So lots of improvement there. And obviously, that was happening while delivering those great experiences and growing very quickly. So we're very proud of that. In summary, this market is absolutely enormous. So on the used car side, it's $760 billion. When you add in new or if you -- depending on how you want to look at auto, you've got well over a $1 trillion market. It's enormously fragmented. The largest player has less than a 2% market share. The largest 100 players have between 7% and 9% market share depending on what data source you're looking at. We're delivering the best customer experience out there. 96% of our customers say they would recommend our service to a friend. We've got those 50,000 reviews out there. We've got a proven go-to-market strategy that delivers a great experience to customers. We've been rolling out very quickly. So we've got 261 markets overall. We're vertically integrated, which we think is important because it gives us control over that experience. It gives us access to the best unit economics and enables us to have control of our scalability. So we have 8 existing inspection centers. We have 24 vending machines. And then we've been growing very, very quickly, as we discussed ad nauseam in this presentation. And with that, I'll pause, and we'll take your questions.

Thanks, Ernie. So I guess, first, a question on the pandemic. Obviously, creates opportunities alongside challenges. Can you talk about what you've learned about Carvana during this time and where the greatest opportunities and challenges have been over the past few months?

Sure. I mean I've been tremendously proud of the way that Carvana has responded to coronavirus. I think that was a kick in the teeth that nobody expected, and it required very fast action and quick decision-making across the entire business. I think that what matters most in the long run to this business, in my opinion at least, are kind of these 3 key pillars of we have to have great technology, we have to have great operations and a great supply chain. And then we have to have a really strong culture that delivers great customer experiences and where people inside the company are excited about what we do, and you'll come in every day fired up to try to get better. And I think that, that culture really showed up with coronavirus. We -- I don't want to dive into too much detail, but we did a lot of things as a company that I think are really, really cool, that were culture building in a moment that could have been culture destroying. And then I think people showed up and worked really hard and made incredible strides very, very quickly. So I think I learned a lot about the company, and I think everything that I feel like I learned was great.

Now that one of the decisions you made was to wind down inventory pretty quickly, and we're getting some questions online about sales have rebounded, have you struggled to get back the inventory you need to maintain sales? And by the same token, you also kind of tightened credit more so than most other players out there. And so how are you feeling about that credit at this point? Have you started loosening? I think on the last call, you said it might have been impacting your volumes by upwards of 25%.

Sure. So I think we quickly reacted when we saw the impacts that coronavirus was having. And so that included tightening credit. It included stopping buying cars from customers and buying cars in general. And so that clearly has had impacts. And the bounce back has been much faster than certainly I would have imagined, whether it's the bounce back in demand or the bounce back in vehicle prices, the bounce back in volume at auction. So I think that has positioned us to where we have less inventory than we wish we had today by, to be honest, a pretty significant margin. So I think we are working hard and we have work to do to build our inventory back up. That is clearly constraining sales versus what they would otherwise be. On the credit side, we definitely tightened quite a bit. We've loosened up around the edges, but the majority of our credit tightening we've maintained. I think that is a lever that we know that we can pull basically at any time. I do think that right now, trying to understand what's going on in the macro economy is very, very hard. I think this is -- in my career at least, I feel like this is the haziest view into what the real world actually looks like that we've ever had. There's just been -- the stimulus dollars that have been injected into the economy are very, very large even compared to the sum of economic activity that we would have expected over the last 2.5 months. And so I think it makes trying to understand exactly what's happening a little bit difficult, and I think that, that suggests that we shouldn't totally bounce all the way back to what our views were immediately pre-coronavirus. So we have loosened credit a touch, but we've got a lot more room there, and I think that we're going to continue to observe and see what the world looks like as we start to move out of some of these different stimulus, away from the stimulus checks that everyone got, as we move through July and the increased unemployment starts to wear out. And we just want to get a sense of where people are, how other finance companies react. And so we have that lever, but we'll be careful about pulling it.

What does the line of sight look like to getting inventory where you'd like it to be? And how long do you think that will take?

So I think we have to break that down into 2 components. Component one is how quickly can we produce more cars and get them up onto the site. And we've got a really good plan that I'm very excited about to try to produce cars quickly. That doesn't happen overnight. So that's going to take a little bit of time, but we're working hard to be able to rapidly increase the speed at which we can produce cars. And that's a very, very big focus inside the company right now. Because I think when you start to extrapolate what sales might be given underlying demand, if we had a larger inventory and if we did have looser credit, I think you start to get to really, really exciting places potentially at least. We don't know exactly how that will play out as we grow our inventory and lose some credit, but it looks like it could be very exciting. And so a major focus for us is to try to get production up. The other side of that equation, though, is how quickly are we going to sell cars. And the faster we're selling cars, that's going to put more pressure on our ability to build up inventory. So I think our goal is to go as fast as we can on both. Our goal is to produce cars as quick as we can, and then hope the demand is as strong as it possibly can be and then we'll see where that all balances out.

On the recondition front, so we're getting a lot of questions related to Vroom coming up on the feed here. And obviously, Vroom has taken a bit of a different stance as it relates to outsourcing some of their reconditioning needs. I believe you are still doing it all internally yourselves. Can you talk about the decision to do that and where the strengths or advantages lie in choosing to build these massive reconditioning facilities and own and operate them?

Sure. Well, first, congratulations to Vroom. They got their IPO done yesterday, and they popped over 100%, I think. On our IPO day, I believe we were down about 1/3. So day 1 stock performance goes to Vroom. So we'll give them that nod. I think -- listen, I think there's a lot of ways to go about building this business. I think the goals of delivering a great customer experience, simply not having to have the cars physically next to customers when they're being sold, I think, is a really big goal in a really big market with a lot of upside. And then the question is how do you want to go about doing that. We have elected -- goal number one is deliver great customer experiences. Goal number two is ensure that you have great unit economics. And goal number three is ensure that, that business that you built that has great unit economics and delivers great experiences is very scalable. And I think when you have those goals, you have to decide how you want to go about designing your business, and we thought really hard about the way that we've gone about designing ours and we feel good about those choices. Along the way, we've tried to be as thoughtful as we possibly can about revisiting all the choices. I think something humans aren't great at in general is revisiting choices they already made with an open mind, but we constantly try to do that. We do the best that we can. And I think that we feel really good about the choices that we've made and the way that we've structured the business. There are multiple ways to skin a cat. And I think what I would say as well is to us, the number one risk that we've talked about for us over the last several years is execution. And I do think that, that remains for us the biggest risk, and our guess would be that will be the biggest risk for anyone else that wants to enter this business. It's not a simple business, and I don't know that it's won or lost in business model design. I think that's obviously an important input, and it impacts your execution, but execution is the most important thing.

"So there's a widely held belief that the environment we're in right now is accelerating shifts to digital for used car sales. I presume you will agree with that as well. And how do you expect the traditional dealers to acknowledge that or change their models? And how does that competition involve -- because that's -- we can talk about Vroom, we can talk about others, but the lion's share are these traditional dealers. So do you think that they're going to start to emulate more of what you're doing? And what are the hurdles to doing that?"

Well, I want to be as focused on us as we possibly can be and just build our model to be as scalable as possible. And so that is where our focus is. I do think -- it's not -- this is a tough business to build. It's a very different approach than the traditional approach. The traditional approach is an approach that is built around an assumption that not only do you make money every day, but you make money on every single transaction. And you go out and you buy kind of the same real estate that everyone else is buying, and you buy or you build the same building that everyone else is building and use the same third-party software solutions everyone else is using, and it's all kind of variable costs. You go out, you get a loan and that's how you kind of buy the land and the building. And then you pay for software, and it's kind of monthly expense. And there's not a lot of investment inherent in that model, so I do think trying to pivot to an e-commerce model is very, very hard. And I also think if you have tens of thousands of players who are trying to pivot simultaneously to a model, it's very hard to differentiate yourself even if you are able to pivot to that model. So I think that's a very difficult transition. I think you can think of car dealers as being entrepreneurs. And I do think that they are a resilient bunch that has made it through many different cycles, and I'm sure that they're going to work hard to figure out how to do it. But I do think that we designed this business model because we think it's the best way to give customers a great experience, and we think that it works really well at scale. We think that preferences were moving in our direction before coronavirus, and then it seems highly likely that this is accelerating those trends. So I think we feel great about where we are, and we're focused on us instead of being overfocused on competition.

Some other questions we're getting have to do with the finance business and the structure of the Ally forward flow versus the securitization market and how that differs for you and like what you guys [ think ] there.

Sure. What -- I think -- the way that I like to think about that, I mean, obviously, all these capital markets are connected. And the sum of all cars that are sold and then financed, that risk is all held somewhere inside of this broad system. And I think that -- to me, I like to think about the ABS markets as being the most liquid of the markets where you can go and kind of place that credit risk. And I think that because of that liquidity, in good times, it gets very, very tight. And so the pricing is very, very good, and you can monetize it most completely. And then in tougher times, capital can flee very quickly out of that market. And so all of a sudden, the spreads can widen out quite a bit. And I think with something like Ally -- Ally is in this business. This is what they do, is they take consumer credit risk. And so I think in the best of times, the spreads that they will require are probably a little bit wider than the ABS markets. But in tougher times, they're probably a little bit lower than ABS markets. And so we try to make sure that we have diversified access to these different capital sources so that we're positioned well to handle that in good times and in bad. And part of what that means, it means that in good times, you can't just go all the way to the cheapest possible market. You've got to kind of continue to maintain your relationships when the market's a little bit more expensive. But that clearly has paid off for us going through this period. And so we feel really good about that strategy and really good about the relationships that underpin it.

There are a few questions here that are fairly similar. "So you obviously raised some capital in recent months. What are the 1 or 2 things you hope to invest in to improve the customer experience and make that even better?"

So I would say we had a plan that we felt really good about heading into all this. And I don't know that our plan or our priorities have really changed very much at all. I think what changed is we hit coronavirus all of a sudden, which has the risk of generating some difficult economic waves over the next however long, hard to say. It also has the opportunity of generating faster transitions in our direction. And so when you're sitting there and you're looking at opportunity and risk and you have to decide how do you manage that, capital is painful because you take an understood amount of dilution upfront, but it puts you in a position to be able to continue to play into that opportunity without fear of what could happen as a result of the risk. And so I don't think that there's super material changes. It's -- I think it enables us to be more aggressive on the margins, and it puts us in a spot where we can just confidently continue to march forward and not worry about what the world may bring us over the coming 6 months, a year, 18 months.

I guess another corollary question online is, "Given that you have the capital and you can play more offense at this point, are you still committed to reducing SG&A per unit sequentially from the first quarter?" I think that was something that you alluded to or Mark alluded on the last earnings call.

I would say in general, as I said, our plans have not changed. We think that we can be more aggressive on the margin. We're going to look to take advantage of opportunities as they show up. But at high levels, our plans have not changed.

"And then in April and May, as you were seeing sales rebound or at least in April, which you talked about on the last call, were you seeing stronger sales growth in markets where physical dealerships were forced to shut down?" That's one of the questions coming online. And trying to understand as those markets have opened back up, whether that's been impeding your growth.

We -- it's hard to disentangle all of that. We definitely saw relative outperformance in the couple of markets that had extended periods of dealer shutdowns. Now that was really only New York for a short period of time, Pennsylvania for a little bit, Michigan for a little bit. But that wasn't super long lived. And so during that period, I think relative to the rest of the company, we did see some outperformance, but it wasn't super material. And I think the geographic changes that we've seen have not been -- I don't think that there's any interesting-enough drivers underneath them to point to as being super meaningful.

So in November of '18, which seems like so long ago, and it's only a little over 1.5 years ago, you all had an Analyst Day and you outlined those long-term targets that you referenced earlier. Just what areas have you kind of surpassed your expectations on achieving or making progress on in the last 1.5 years? And what has really been more challenging or a more difficult nut to crack?

I think -- let's start with what we believe now. We believe the exact same thing that we believed back then, and I'm proud of that. It hasn't been a long time. It's been, as you said, 1.5 years, but we were a business that was, I don't know, on the order of 1/3 of the size of the business that we are today when we gave that presentation. I think our long-term views are the exact same today as they were then. And I think that's because we knew this business and we had thoughtfully designed the business, and we thought that we understood where the different pockets of money and opportunity and scale were. And I think that we've executed to that plan. I think what I would say has gone better than we expected is buying cars from customers. I think that clearly happened much more quickly than we had anticipated. I think we kind of knew what was possible, and we felt good about our goals. But that ramped up very, very quickly. And I think that -- I'll speak for myself. I'm an optimist by nature, and I think -- I don't remember a lot of times where we've out-achieved my own expectations, and that is definitely one of them. I think what's been harder, I don't think that anything -- I don't think anything looks like it cannot be achieved that we believed then. I think if anything, the signs have suddenly migrated positively. What's harder is everything. I mean I think something that I've gained respect for business in general over the last 7 years is just every single thing that you do is going to be harder than you think, and I think that's just kind of part of the reality of the ride that we're all on. But I think the team that we've got is an incredible team that works incredibly hard, is incredibly resilient and has made an unbelievable amount of progress so quickly. And so yes, I'm feeling very optimistic about our ability to achieve our long-term targets.

Another question from the audience, whether or not you're seeing any kind of surprises with respect to your long-term operating cost structure related to changes you might have made here during the pandemic.

I don't think so. I think there have been -- there are little line items that move around. All of a sudden, when you change your strategy, you stop hiring and you kind of move your focus around a little bit because of the uncertainty associated with coronavirus. And I think some of that has like buttressed our view that we can achieve our goals. But I also think nothing super material has happened. Like that's me looking for a way to answer it in a slightly interesting way, but I don't think anything super material has happened.

A question here on international growth. Obviously, there's a lot of opportunity domestically. But a question as to whether or not international is something of interest at some point in your future and what country might be first, what kind of incremental capital would be necessary and so on.

Sure. So, I mean, let me start with we were about 0.5% -- a little less than 0.5% of the car sales in the U.S. last year. And the business model that we have here works really, really well, and rolling it out is probably in order of magnitude easier than trying to roll something out in a new country. So would I take those opportunities off the table? No. But I would also say that another thing that I've gained respect for over time is the value of focus and prioritization. And so I think we've got a huge opportunity here, and we'll work hard to try to take advantage of that first, and we'll see where the future takes us.

And I think we have time for one last question. So I like this question. It builds on something you mentioned earlier, which relates to brand and how few national brands there are, if any, in the U.S. And a question on how your brand awareness is developing and what are the biggest levers you can pull to improve brand awareness.

Sure. Well, I mean, I think our brand awareness is developing all the time, and I think that we're constantly trying to make sure that we're measuring it in the appropriate ways. I think what's often measured is unaided awareness, right? And I think that the purchase journey looks like I have to know that you exist, one; I have to understand what you do; I have to trust that you're going to do it, and now I'm kind of in a position to evaluate your value prop. So I'm looking for a car dealer with the car that I want. Is the price good, whatever else. But that's kind of the waterfall a customer has to go through before they choose to transact with you. And I think you kind of have to get to the bottom of that. You have to explain all of that before they're ready to transact. I think in many businesses, just measuring awareness works because oftentimes, the business is very well understood. And there may not be the requirement for trust, right? If you're selling gum, I understand what gum is, and I don't have like a high trust hurdle to buy gum. So just awareness, I think, is a very good measure. For us, we're trying to measure that entire funnel and trying to think about how our messaging is supposed to change as we traverse that funnel and where we are in that funnel. And I think at very high levels, when we measure the unaided awareness, it's still very, very low. And I think that, that's actually exciting because I think that means we have so many steps left. I think there's a chance that the unaided awareness maybe understates things a little bit because people do -- automotive purchase is a -- it's a research purchase, right? It's something you do a lot of work, right, before you transact. Going back to gum, and I don't know why that's my analogy, but you don't think too much about gum, right? You just kind of -- you're checking out of the supermarket and you grab gum and you're out. When you're buying a car, you do a lot of research, right, before you buy. And so this concept of unaided awareness is a little bit different because a lot of work happens immediately prior to purchase. And so I think it's still clearly early days. And I think even knowing how to measure that and think about it, if you're trying to extrapolate to what's possible, is hard. But the takeaway from the sum of our research is we've got a lot of opportunity left.

Great. Well, I want to thank everyone for joining us from home or wherever you're working remotely, and I hope everyone has a great rest of their day.

Thanks, everyone.

Thanks.