Carvana Co. (CVNA) Earnings Call Transcript & Summary

Great. Good morning, everybody. Thanks for being here with us today. I'm Nick Jones, an Internet analyst here at Citi. If you need my disclosures, e-mail me directly, our corporate active team, and we can send those to you. And if you have questions, you can submit them through a text box in the window you are looking at, and I will receive them in e-mail. I'm happy to ask them on your behalf. Before we get into it, I'm going to hand it over to Mike Levin to run through the safe harbor.

Thanks, Nick. 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 10-Q filed with the SEC. 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. Thanks.

Great. Thanks, Mike. We're really excited to have Carvana here and Mark Jenkins, the CFO. Mark, thanks for joining us today.

Well, thank you very much for having me.

So maybe to just kind of kick things off, we can start with kind of macro/COVID backdrop today. The last 18 months has been pretty interesting, specifically within the auto segment. Things kind of came to a screeching halt in 2Q last year and then rapidly came back as people were kind of clamoring to buy cars. I guess could you kind of talk about what you've learned over the last 18 months and large consumers rolling up as they transact online and really how resilient you see these trends doing as things begin to normalize?

Sure. Yes. Well, I mean, I think we certainly think that COVID has been an accelerant. And really, this applies to all verticals, not just the auto vertical. In terms of customers' willingness to buy online, I think a lot of customers came online for types of transactions that they maybe wouldn't have in the past or they weren't familiar with in the past. And I think what they're finding when they shop online is more selection, better value and significantly more convenience than the old way of buying cars and indeed buying goods across multiple retail verticals. And so I think the acceleration of online adoption is something that we think COVID did bring and is something that will be long lasting. And I think that's a very positive for our business model over the long run. I think in terms of some of the more narrow industry dynamics, I think there's -- COVID certainly brought some unique dynamics of the industry. The chip shortages have led to a very tight supply of new cars, which has significantly limited selection for customers who were shopping for new cars. Some of those effects have spilled over into the used car market, where there's more selection, but prices are much higher than they have been in past years, just due to the lack of total vehicles available for sale in the system. And so those are some dynamics that actually put pressure on demand, other things equal, in the near term. But I think those types of things, shorter-term effects will normalize over time.

Great. So you talked about the chip shortage impacting new cars. I think there's kind of trend of de-urbanization, commuters shying away from public transit. How are you thinking about maybe some of these other trends beyond just the chip shortage and the impacts kind of just of broader auto demand?

Sure. Yes. So we do think demand -- sort of fundamental demand is strong, and I do think there are other trends that COVID has brought on. You mentioned a movement away from public transit, people moving out of larger cities where they might have historically not owned a car, into markets where they're much more likely to own a car. We think those trends are certainly happening. And other things equal, are -- create a benefit to both used and new car demand.

Great. And maybe kind of the last question on kind of the pandemic impact. I guess how are you thinking about the impact of variants from here? A lot has happened over the last 18 months and the kind of auto ecosystem reacted and Carvana's probably built to be able to kind of navigate those types of shutdowns. But I guess how are you thinking about potential future shutdowns from here? And do you think the ecosystem is kind of better prepared, having kind of gone through it once now?

Sure Yes. So I mean, we've seen this latest wave of COVID cases pick up. I think there's a possibility that there will be more waves in the future. I do think the system is getting better at adapting and sort of knowing how to deal with waves. Fortunately, the latest wave was not as large as some of the waves that we've seen in the past, which I think is beneficial for the entire system as well. But I do think there -- the system has learnings, becomes more prepared over time and is better able to deal with waves as they come one by one, if they come one by one in the future.

Great. Great. And then maybe putting a finer point on supply constraints. There's a lot of demand. Cars are turning quickly. How much of the supply constraints for Carvana is industry-wide challenges versus things that are idiosyncratic to Carvana like bringing employees on who can process cars faster and having flatbed to get the cars places? I mean -- so I guess what's the balance of industry-wide constraints versus improving hiring pace and being able to kind of scale internal operations?

Sure. Yes. So for us, it's just the latter. It's -- I don't think we feel like we're facing sort of meaningful industry-wide constraints. I think our constraints that we're constantly seeking to alleviate are really in our own operational chain. And that starts in our inspection conditioning centers, where having production capacity to be able to take the cars that we're buying from customers or in the wholesale market and inspect them, recondition them to our standards, photograph them, so they're ready to put up on the site for retail customers, that's a critically important part of our model in an area where we have experienced constraints in the past, and we'll always be working to relieve those constraints. We relieve those constraints through 2 primary steps. First, making sure that we have enough building capacity or infrastructure capacity in these inspection and reconditioning centers. There, we've got about 750,000 units of building capacity up and expect that to be about 1.25 million units by the end of 2022. And then the second step is really the hiring, training, the staffing of these centers, which is one of our top priorities to make sure that we're constantly growing production to meet the demand that we're seeing on the site.

Great. And now maybe taking a step back and just looking at the broader market Carvana is addressing, I think some investors do struggle with the TAM for Carvana, mostly maybe on the pricing and how old the cars are and the mileage that's on there. Some 40 million units sell kind of annually. Why is it the right number? Or is the right number something that's a bit smaller and then may be more difficult to get some of the P2P volume and that ends up maybe not being quite 40 million? How should we be thinking about the TAM?

Sure. So the simplest way to think about it is there's 40 million transactions out there every year where one customer has a used car, and that used car transfers over to another customer who wants that version of the used car that the first customer is trying to move on from. And we believe our online platform can play a role in the vast majority of those transactions. I think the -- you mentioned peer to peer. I think in the peer-to-peer, why is there a market for peer-to-peer used car transactions? Well, it's really just a reflection of the fact that many people don't want to deal with dealership and the overhead costs and the more complicated, time-consuming transaction that happens with the dealership. We, of course, take away those significant costs of a brick-and-mortar dealership transaction, which we think allows us to attract customers that are using peer-to-peer channels today. And so I think we view our TAM as very large and very complete and believe that most of the used cars that are driving around on the road today can be transacted on carvana.com.

Great. And then as Carvana builds this great logistics network and there's a massive opportunity of used cars in front of you, are there additional opportunities to expand this TAM into other categories? Are you like servicing used cars or using logistics for other areas within the auto ecosystem beyond used cars?

So we certainly think there are opportunities to generate ancillary revenue streams and expand our TAM. I think we're building fundamental assets that are very valuable. Those include a nationwide reconditioning and logistics network, a state-of-the-art transaction platform that allows customers to easily transact, attach ancillary products related to their vehicle ownership, finance their car, trade in existing cars. And we're also building a very strong brand that we hope customers associate with the online vehicle experience. And so we think the combination of those fundamental assets do open up multiple opportunities for us that may be smaller or not necessarily part of our model today.

Great. Maybe switching gears to geographic expansion. You've kind of relatively recently hit the Pacific Northwest. Your goal is to cover around 95% of the population. How should we think about the cadence for the remaining? Is it largely just adjacent markets that can kind of tuck in to the large existing markets you're in today?

Yes. So as it's been for some time, I do think it will be a combination of -- as we march toward 95% filling in markets within our existing logistics footprint, combined with stretching out to new regions or subregions that extend the network. Now with our launch of Portland and Seattle and the Pacific Northwest earlier this year, that really covered the last large population center that we had not reached thus far. And so you can expect our move from 80% population coverage, which is where we are today, to 95% to largely be reaching out to medium and smaller markets, either within our existing footprint or around the edges of our network.

Great. And I think this is a question you probably get a lot, but how do the new markets compare to the older existing markets? Are they ramping similarly, better as you kind of learn more about how to roll out markets more efficiently?

Sure. Yes. So we've continued to see consistent patterns in market penetration growth in the markets that we've launched. We provided lots of data on that over time. But one of the consistent patterns that we've seen is that new markets have tended to ramp faster than older markets, and there's a number of reasons for that. I think the product gets better all the time. Our awareness -- I think it's still in an early stage but accumulates over time. Generally speaking, we have better selection over time for newer cohorts relative to some of our earliest cohorts. And so I think all of those provide tailwinds to the newest cohorts.

And given the size of the opportunity, I guess, there's no surprise that the competition continues to pick up. How do you view the competitive dynamic today between D2C players that are somewhat similar to Carvana and then maybe the traditional brick-and-mortar dealers who are trying to launch omnichannel offerings to provide a somewhat similar experience for consumers?

Sure. Yes. So I mean, we are far and away most focused on our own execution versus being focused on competition. I think we have a model that we believe ultimately can win on selection, convenience and value. And we think that's a very, very powerful thing. And so what we're really focused on is scaling our operational capacity to be able to meet all the demand that we're seeing and continuing to march down our path becoming the biggest company and most profitable company that we can be. And so I think that's our focus, first and foremost. I think one of the, I think, key facts of our industry is it's incredibly fragmented. There are no large players in the industry. I think the largest player has a roughly 2% market share, which leaves a very fragmented competitive landscape, which also supports our focus on just marching forward and executing our plan.

And given how fragmented it is today, is this a category that structurally will be more challenging to consolidate over time? Or do you see this as a category that over a long period of time can consolidate around maybe the top 10 or 20 players in the ecosystem?

Sure. So you noted, but the auto industry is pretty unique among large retail verticals in its level of fragmentation. If you look out across other retail verticals, general merchandise, home goods, where you have Home Depot and Lowe's, pharmacy where you have Walgreens and CVS, grocery where you have a few large players, electronics where you have a huge player in Best Buy, for example, every other large retail vertical has significantly larger players than anything we've ever seen in automotive. And we think that, that can change over time. We think by centralizing the transaction experience, centralizing and vertically integrating the used vehicle supply chain, there's really an opportunity to have the automotive industry look a lot more like these other large retail verticals, all of which have significant players that have relied on, in many cases, big box technology, but big box technology and sophisticated supply chains to take significant share and become much larger players than we've seen in auto. So we definitely think, in our view, the auto industry will head the direction of these other large retail verticals over time.

Great. Switching focus now to kind of Carvana's really sourced vehicles from customers. Carvana has done a great job from kind of when you initially announced that this was kind of an objective kind of growing that channel. As you continue to see traction within this offering, how has your views changed, if at all, and where this can go over time? And then I guess on top of that, in time, is the goal kind of to sell every car you take in? Or does the wholesale market really kind of remain a powerful channel for Carvana?

Sure. Yes. So I think this has been a really sort of explosive growth area for the business is buying more cars from customers. I think we much more quickly than we even expected exceeded our long-term targets for the number of cars we're buying from customers relative to retail units sold. We set a record on that metric in Q2. We also exceeded our long-term targets on a fraction of cars that we retail that we originally sourced from customers as opposed to from other wholesale channels. And so that's been a fantastic success for the business. I think that fantastic success is driven by the customer experience we provide, where it truly is a unique and incredibly convenient customer experience where you can go on your phone and with a few clicks get an official value for your car, schedule a pickup and we'll come take a look at your car and take it away and hands you a check. It's really truly an amazing experience. And so we [Technical Difficulty] still see opportunities to improve that business over time, but we're very pleased with the progress we've made so far. In terms of the matching between the number of cars we buy from customers and the number of cars we retail, we actually -- we don't think there's necessarily -- there has to be a one-to-one link there because you can always wholesale cars that you may not have capacity to recondition or retail at any point in time.

Great. And as you take in more cars from consumers, what are you learning about how they prefer to transact? Are consumers maybe doing discrete transactions where they will sell Carvana the car and then look to buy the car separately, either at Carvana or somewhere else? Or are people still kind of generally preferring to kind of bundle their next purchase with the trade-in?

Sure. Yes. So both types of transactions happen. In many cases, a customer who wants to sell a car is also looking at that same time to buy a new car retail, to replace their old car. And so those types of transactions often end up as trade-ins. There are also customers who just are looking to sell a car and may not be looking to buy a car at this particular time. And then there are customers that also may be looking to sell a used car and buy a new car, for example. And so they might split the sale and purchase transaction. So all of those types of dynamics happen. Obviously, over time, we want to be serving as many cars as customers, both buying and selling cars.

Got it. And I'm going to switch gears a little bit towards the IRCs. This past quarter, you opened your 13th IRC, bringing total annual production capacity to 750,000 units. The goal is to bring total capacity at full utilization to 1.25 million by the end of 2022. Getting to 2 million unit capacity, which is kind of a mid to long-term target, that was laid out at the Analyst Day, what are the puts and takes to getting the capacity to be able to do that and then also kind of getting the staffing requirements internally required to do that as well?

Sure. Yes. So the first step in the process is to identify sites and then go through the various regulatory processes to get the sites properly zoned for construction and vehicle storage and things like that. And so we have a team that has developed and is now executing a playbook. We have sort of standard footprint IRC. Internally, we call it our McDonald's. The IRCs are sort of our McDonald's blueprint where we can go in and now we know exactly what we're looking for and have a set structure that the teams can go in and build. And so we really developed that process over time. As I mentioned, we expect that process to allow us to print 8 IRCs in 2022, taking our capacity up to 1.25 million units by the end of the year from an infrastructure perspective. And then the second phase, as you alluded to, is staffing and training. And there, that's been a big area of focus for the business. We have a number of initiatives to source employees for the IRCs, quickly onboard them, train them, make sure they have long-lasting and attractive career paths to be able to make progress, develop skills over time. And so we're doing all those things to make sure that we're meeting our staffing goals as best as possible.

Great. Now maybe switching kind of the more -- the recent results. We had some questions coming in kind of on the financial results. You had a record 2Q across the board, first ever quarter of positive net income, making Fortune 500 list. Can you walk through how much of these results were kind of due to temporary benefits of increasing car prices to outperformance in financing and warranty? Just can you expand on that a little?

Sure. Yes. So if we're looking at Q2, we obviously had a tremendous quarter, set records across the board, had our first quarter positive net income, sold more than 100,000 units, which is a great milestone. I think in terms of some of the near-term sort of industry effects that impacted Q2 performance, I'd point to a couple. So one, through Q2, the wholesale market was appreciating. That has a positive impact on wholesale GPU because when you buy a car from a customer and then you're paring it to wholesale, if it appreciates, that's beneficial for wholesale GPU, other things being equal. I think in retail GPU, there were some offsetting effects, but probably the largest was when used car prices are very high. Some customers are more likely to want to sell their car when they see a very high price in the market for it versus if they saw a more normalized price. And so that can lead to more customers selling their cars, which we think was a benefit to buying cars from customers that complemented all the sort of structural progress that we've made in that business line. So that impacted Q2. And then the last thing I would point to is in other GPU we do think we saw a benefit from higher car prices, leading to just larger loans, which impacts other GPU, other things being equal. So those are a few of the factors that I would call out related to the environment in our Q2 results.

What -- I guess, what are your views of what the kind of long-term opportunities that are left within the other bucket or the financing bucket? Is there still room to kind of drive GPU there? Or are we getting to the point where that's reaching kind of the peak contribution?

Sure. Well, I think we clearly see opportunities to expand the set of ancillary revenue and profit opportunities that are attached to the used vehicle transactions that we're executing on the site. We offer 2 products today, vehicle service contracts and GAP waiver coverage. We certainly think there's an opportunity to expand that selection of ancillary products and more deeply sort of impact the customers' vehicle ownership experience. One example there where we just announced a partnership is in auto insurance, which is a very natural product for customers to be looking for at the same time that they're shopping for a car. And so I think we're excited about that as an opportunity to really differentiate the customer experience and drive additional revenue.

Great. And we got a question I think is along the same vein here, so I'm going to slip it in here. Could you talk about your latest thoughts on the kind of mid- to long-term margins? And I guess, why they should or shouldn't differ from comparative dealers that are brick and mortar?

Sure. Yes. So we laid out a pretty detailed long-term model in late 2018, which is also available in our shareholder letters. And our progress so far towards that long-term model has been great. And I think we're still marching toward that long-term model that we laid out in 2018. I think relative to other dealers, I think we have some meaningful long-term benefits. I think, one, vertical integration and a seamless online transaction experience we think generates meaningful revenue opportunities over time. And we also think the centralization and automation of so much of the transaction leads to meaningful cost differentiation opportunities over time as well.

Great. And maybe going back to the $2 million (sic) [ 2 million ] unit per year target that was laid out back at the Analyst Day, and we talked about briefly here. Given the record quarter, given kind of the pull forward of the digitization or online transactions within auto, the 2 million number still the right way to think about this? Or can that be a bit higher given that, that target was laid out prior to kind of this rapid pull forward of this type of mode of transaction?

Sure. I would say the simplest way to say it is our goal is to retail more than 2 million units per year.

Okay. Then as we think about profitability and as more and more people are transacting things online, not just autos, how do you think about kind of customer acquisition cost and brand awareness? And what kind of investments will need to be made for Carvana to remain competitive in winning new customers and maintaining the brand building that you've been working out for several years now?

Sure. Yes. So we think brand is really important. And having a strong brand and high awareness and significant awareness and trust from customers is very valuable for building a long-term business, and we will continue to invest in brand advertising. I think we still see lots of opportunity to continue to raise awareness, to continue to communicate to customers the various strengths of our offerings and the different aspects of our offering. I think we're still in relatively early days, for example, and even raising awareness of our product buying cars from customers. We're a couple of years into that now. But I think, there, we still see meaningful opportunity to communicate to customers all of the many amazing things that Carvana brings to their shopping experience.

Great. And something unique to Carvana is the construction of the vending machines across the country, and there's obviously a benefit since you keep building them. So can you touch on kind of what the marketing type branding benefit is of these vending machines? And then also, can you remind us what logistical benefits there are by having these locations across the country as well?

Sure. Yes. Yes. So the vending machines have been a big part of our brand. They definitely have been very helpful in building up our brand over time, and we expect that to continue to be the case. I think when you zoom into the individual market putting aside the national brand effect, I think the vending machines are great marketing, right? They're a really unique, almost billboard that we place in high-traffic areas and allow customers to just gain that additional level of familiarity with Carvana, which we think is beneficial. And we have historically seen upticks in market penetration when we launch vending machines in markets. That's on the sort of marketing benefit side. On the logistics side, they also ease some last mile logistics, sort of, workloads by having many customers just come to you to pick up the car. The customer when they come to the vending machine gets a memorable experience, in which they drop a coin into a slot and then a mechanical arm will go up, grab the car out of the tower, bring it down to the customer for them to walk around or take a quick drive. And so we think that there are some logistical benefits in addition and customer experience benefits actually in addition to the marketing benefits.

And do you find those who do use the vending machines -- do you see kind of increased engagement with the vending machines once they enter a market? Or do they kind of stabilize and kind of seem pretty consistent engagement?

So I would say pretty consistent. There's not sort of like a notable like initial surge in engagement with the vending machine, for example. I think it's pretty consistent over time within a market.

And then I do want to just double-click again back on ad rates and maybe really just about traffic volumes. Carvana has been able to generate quite a bit of traffic volumes throughout COVID and it persisted today. The ad rates go up. Are you seeing ad rates going up and impacting the ability to generate the traffic volumes that then obviously generate conversions? And then how do you kind of size the ad investment required to maintain those volumes and conversions with some of the struggles to kind of generate the supply that you need to have conversion?

Sure. Yes. So at a high level, we seek to match our marketing spend to our ability to fulfill sales. In some cases, where we're particularly constrained, we won't necessarily pull back on marketing as much as we could because we're taking a long-term view and want to make sure that we're steady and raising consistent awareness of our brand, even in times when we get a little bit constrained. And so our goal in marketing is sort of to stably and consistently make sure we're building awareness for the brand. In terms of marketing performance, I mean, you can see in our results, it's been fairly consistent. We've added new markets, added a new large region recently, but our marketing performance has been relatively stable.

Great. We do have a question that came as we're getting towards the end here. The question is whether Carvana has any intent over time to expand outside of North America? I guess, if so, where? And I guess, if not, why not?

Sure. Yes. So that certainly falls under the list of opportunities that are available to us. I think from our perspective, international expansion is a question of prioritization. We're certainly prioritizing building the largest, most profitable retailer in the U.S. and making sure that we're investing in all the areas that we want to invest in to achieve that goal. But we -- I think the Carvana model will work in many parts of the world, and that could be an opportunity down the road, but it's not our priority today.

Great. And I think this would be our last question here. It's around M&A and partnerships. You recently partnered with Root to provide a unique insurance experience for car buyers. You've acquired companies in the past for technology. How should we be thinking about the opportunity for additional M&A or just partnerships to bolster Carvana's offering?

Sure. So yes, as you mentioned, we just entered into a partnership with an entrepreneurial auto insurance disruptor called Root. I think we're very excited about what opportunities there are to bring a really differentiated customer experience embedded in the retail purchase experience to customers. I think we're excited about those opportunities. In terms of other partnerships or M&A, certainly, there will be -- continue to be opportunities over time. And so I think we're always looking and always thinking about what's the next step for Carvana. So there may be opportunities over time, although nothing to report today.

Great. Well, I think, that takes us to the end of the session here. And Mark, thanks for joining us today. We really appreciate the time.

Thank you, Nick. Really appreciate the time as well and enjoy the conversation.

Thanks, too, Mike.