Carvana Co. (CVNA) Earnings Call Transcript & Summary

All right. So take 2, and I'm losing my voice, so hopefully, this will hold out. So thank you for joining us this morning. I'm Sharon Zackfia with William Blair. Really happy to have with us from Carvana today, Ernie Garcia, Founder and CEO. As many of you are aware, Carvana was started in 2012, grew very rapidly, features a very user-friendly, transparent way to buy used cars online with a nationally pooled inventory of over 30,000 cars. The company has pivoted over the last probably 15 months now to focus on improving the path to profitability. There was some interesting news on that front this morning, which I'll let Ernie go over. But we're really excited about the path the company is on, and I think the future remains very bright. So Ernie is going to go through the presentation. And then if we have time, we'll do a little bit of fireside chat. And there's a complete list of research disclosures and potential conflicts of interest at williamblair.com. Thanks.

We also have a list of disclosures that you can please check out when you're looking for something interesting to read. So thanks everyone for coming. I think the goal that we've got today is over the last several months, we've definitely noticed that we're talking to a lot of new investors that are getting up to speed on the story. So I think, this is going to be a bit of a summary of our path so far, as well as kind of what we're focused on today with the goal of bringing those investors more up to speed. I think for those of you that have been closer to the story, a lot of this will probably be understood, but hopefully it will be a helpful summary and then we're going to touch on updated views of the quarter. Safe harbor always exciting. So first, I want to start with the history of Carvana. I think that there's many ways to break down our history, but I think 3 kind of key phases is probably important. I think we launched in 2013, we opened for business in Atlanta. And from that period through 2021, we are growing incredibly quickly. And I think that, that was probably what characterized the company. We enjoyed a lot of success during that period. There were certainly a lot of bumps during that period. When you look back over it, it looks like a pretty straightforward period where it was just nothing, but up into the right. But there were definitely a lot of things that we're working on. I'll provide some color about what that period looked like and felt like as we were going through it. But I think that, that was one relatively straightforward phase of the company. I think we then headed into 2022. We are expecting growth like we saw in 2021. We made a big acquisition which we think is going to be incredibly helpful for us over the next 5 to 10 years. We finance that with debt. I think that some of those things was definitely out of step with where the market was at the time as the market kind of shifted toward a real focus on profitability, I think expecting a lot of growth that didn't show up for industry reasons, as well as taking out a bunch of debt at that moment, led to a difficult time in the company's history. We then shifted our focus pretty heavily to profitability, and we've been there for approximately over the last year. We're making a ton of progress. And I think those are kind of the 3 key phases. So first, if I hit on the growth phase, which is a fun period to look back on now, but I think it's an important period because I think it points to the underlying capabilities that the company has, the people inside the company have and the opportunity. We grew unbelievably quickly from when we launched until 2021, even in 2021 after all that growth, which was a CAGR of 170% over that entire period, we are still only 1% market share. This is a truly enormous market. It's a $1 trillion market. And I think our opportunity to be much bigger was very clear. We had much larger market shares in our older markets. The path was very straightforward. I'll skip over revenue as that's basically just a projection of units sold, but that obviously had grown very quickly as well. And despite being just 1% of the market, we got up to almost $13 billion in revenue, which again, I think speaks to the size of the market. Gross profit per unit, this looks almost perfectly linear. I think if you were there for the ride, there were a lot of discussions along the way. We were adding financing capabilities. We are building out our first securitization. We are selling loans in all kinds of different ways. We were decreasing turn time of our inventory by shrinking our inventory relative to sales, which really took the form of growing inventory and growing sales even faster. That was a major dynamic early on that allowed us to grow gross profit very quickly. We are adding additional ancillary products. There was all kinds of seasonality. There were hurricane effects. There were 1 million conversations across every quarter that we had. But when you look back on it now, it was pretty steady progress. And I think the reason for that very steady progress that looks almost linear in hindsight, but created so many questions along the way is just that monetizing these transactions is pretty straightforward because it's a mature industry. The path to monetization are very well understood. And so we were able to kind of continually build that out. During that period, we were also -- for most of that period, we're also levering our SG&A per unit, and that led to constantly improving adjusted EBITDA. When we went public in 2017, we were coming off a year where our adjusted EBITDA was negative 23%. We improved that by about 500 basis points a year on average to get to our first year that was actually positive in 2021. And that was despite making all kinds of investments in growth, kind of our seasonal pattern prior to that period was -- in Q2, you tend to see the most growth every year because immediately after tax season in Q3 and 4, we would see less growth. We'd make a ton of investments preparing for the next year's growth. And then that growth would show up, and we would continually grow and move along this path. So that was a pretty clear story. Like I said, when you look at it now, it's very straightforward when you were there for the whole ride, there were many bumps along the way. But I think it was a great time in the company's life. And I think it demonstrated that we have a huge market. We have a team that's capable of building a large company quickly. We have a customer offering that resonates and enable us to grow really quickly. And I think very importantly, we also benefited from positive feedback. Ours is a business where there is a lot more positive feedback in the business than the traditional automotive retail business. As we grow inventory, that means that customers in all of our markets have more selection, that means they're likely to convert is higher. That means that you're selling more cars everywhere, which means you can open up more logistics routes, which means you can deliver cars faster, which means conversion rates go up again, which means you can spend more on marketing. And there was all this positive feedback that enabled that wheel to continually turn. I think as we head into 2022, I'll start on the bottom right. The bottom right is meant to be illustrative of what the consumer kind of faced going through this period. So in 2019, for Nissan Altima with roughly 30,000 to 40,000 miles, the average payment was around $300. We started to see prices go up quite a bit in early '21, and they basically continually rose. We saw interest rates start to move up in early 2022. The sum of those things mean that today, a customer buying that same car is paying about $450 a month. That's really -- the monthly payment, I think, is the right way to think about consumer affordability because in our business, the vast majority of customers finance with us of the remainder, the majority financed with someone else and then the minority are paying cash. So the monthly payment is really what matters the most. I think in early '21 as prices were rising, there was a lot of money sloshing around the economy and consumers were still spending a lot of money on physical things. And so I think we were able to handle a lot of that price appreciation without huge impacts to our sales. As we move through time, that got compounded by interest rates and then also consumers started spending a lot more on services. And I think that provided pressure on the industry overall. Over the last several years, the industry in some total is down, and that's more pronounced in the independent space than in the franchise space. I think there's a number of relative advantages that franchise dealers have enjoyed over the last couple of years that have made it a bit harder to be an independent and a bit easier, all else constant, to be a franchise dealer. And so I think that's kind of the industry backdrop. I think we also went into 2022 after experiencing all the growth that you saw in the previous slide and you're feeling a lot of growth heading into the end of 2021 and kind of seeing that we were able to continue to grow despite the increase in price that consumers are facing on cars. We came in expecting another very large growth year, and I think we miscalculated a bit there. And so we were carrying kind of expense load that expected a lot more growth. That growth ultimately didn't show up. In addition, we made a large acquisition of ADESA U.S. That's the second largest auction house in the U.S. of 56 locations across the country that puts us very close to 80% of the U.S. population. We think it's a tremendously valuable asset, both because it allows us to further vertically integrate and provide more value to our customers and monetize our wholesale purchase better and because it puts us closer to our customers with infrastructure that would be very, very, very, very difficult to replicate. So we are extremely excited about that acquisition. It was expected to kind of pay us back over the next 5 to 10 years as we grew into it. You can largely think about that as kind of prepaid CapEx. But doing that at a time when growth was slowing and taking out debt to pay for it, put us in a spot where when the market shifted to a focus on profitability. We were overbuilt. We had too much SG&A. That obviously hurt profitability, and we had a much larger debt load and a much less forgiving market that was much less willing to finance all of that. The sum of those things caused us to shift to a heavy focus on profitability. And I think importantly that shift to profitability, we knew was the right thing to do and was basically the only option that we had at that time, but it also shifted a business that had always benefited from the positive feedback we discussed earlier into a business that now is going to face some negative feedback in order to focus on profitability at a time when there were affordability challenges and there was a shrinking industry, we knew that we're going to have to shrink inventory. We knew we're going to have to pull back on our marketing spend. We knew that, that would lead to fewer logistics legs. We knew we're going to have to focus on transactions that were more profitable, which meant cutting out some of the less profitable transactions that we're investing in, in the past. And we knew that, that would create a negative feedback loop that would be the opposite of what had kind of powered our growth prior. And that obviously was going to be a difficult thing to deal with. But when we kind of ran all the different options, it felt like it was clearly the right choice. Since then, we've been making a ton of progress. And I think the team has had to learn a skill set that is similar, but a little bit different. I think when you have an operationally intensive business, I think, growing rapidly is not that dissimilar in the underlying skill set to cutting costs. It's about understanding what are all the things that you have to do? What are all the operational process you have to build to enable your growth? How do you break those down? How do you prioritize them? And then how do you just make sure you continually turn the wheel and get better? And I think that, again, in an operationally intensive business that skill set is not crazily different from cutting costs. But I do think cutting costs requires focusing on smaller things. It requires a little bit more discipline. It requires more ruthless prioritization. And our team had to kind of figure our way through that because that wasn't something that was kind of key to what we had done over the previous 8 years. But we've made a lot of progress there. And so I think the graph on the left here, which is gross profit per unit is emblematic of that progress that we've made. We were going up into the right, linearly through 2021. 2022, we faced a lot of challenges. A lot of our costs do flow through COGS as well. And then there are some things that sort of indirectly lead to GPU challenges as you're shrinking, things like an inventory that is oversized relative to sales, which means that it takes you longer to sell any even car, and cars are depreciating assets. So your realized gross margin is less. So we took a step backwards for the full year 2022. In Q1 of 2023 after making a bunch of dramatic actions to move in the right direction, we actually had our best Q1 ever from a GPU perspective. And so I feel like we're getting to a spot we're starting to catch that negative feedback is real, but we made a lot of aggressive moves in the last year, even more aggressive moves in the fourth quarter of last year. And I think we're beginning to catch and starting to show up in the results. That also flowed over to EBITDA margin, we've cut $1 billion of expense out of the business in the last 12 months. That's taken a ton of work in many, many projects to achieve. It's made us a better business and a more efficient business. And as a result, we also had our best Q1 ever from an EBITDA margin perspective. You can see it's not as good as our best year of 2021, which was 0.5% positive. In Q1, it was 1% negative. But because of the seasonality in the business, that's our best ever Q1. So I think we're extremely excited by that. The graph that's not appears volume. Volume has not turned around in the same way. Volume is still decreasing year-over-year. We will outline our 3-step plan to get back to growing that in the future. That's certainly something that we feel like we know how to do, and it's certainly something that we have sufficient demand for, but in this period of focusing on profitability, it has not been our focus. And so these are the 2 graphs that represent what has been our focus. So we've outlined this kind of 3-step plan to manage through this period. The first step was to get to positive EBITDA. Last year, we had a tough year. As I said, we were overbuilt. We are carrying way too much SG&A relative to the volumes that we were seeing in anticipation of growth that didn't show up. And that led to very large negative EBITDA. So goal one was to get to breakeven EBITDA. We expect that to happen in this quarter, which we announced last quarter. So we're extremely excited about that. Step two is to stay focused in the same area, kind of maintain similar levels of volume and aim for significantly positive unit economics. We get a lot of questions around, what exactly does that mean? What is the dollar figure? It is left intentionally vague. I think as we continue to make progress in monetizing our transactions and driving GPU up in COGS expenses, which drives GPU up through expense reduction and an SG&A reduction. I think as long as we're making rapid progress and that progress is being aided by the simplicity of maintaining volume at similar levels, we will stay here for a little bit because the progress we're making is very quick. I think if that progress slows, we are already getting to a place where the kind of gross profit relative to variable costs is such that growth probably already makes economic sense, but probably not as much sense as just making rapid progress with a more simplified operating model for the time being. So I think that, that's one thing. If our progress slows in those 2 areas, that could push us toward growth faster. And then I think if we find ourselves in a capital markets environment that is kind of more positively inclined toward growth. I think that all else comps get push us toward that more quickly. But for the time being, we plan to stay here and drive to significant positive economics. And then once we've achieved that, and we've gotten to a place of stability, we expect to return to growth. And again, I think that's something that we really feel like we know how to do. We're in an enormous market. We're still 1% roughly market share. So there's a lot of room to grow from here and consumers do love our offering. So we feel that we'll be able to do that. We're updating our Q2 outlook. I think one of the questions that we've gotten a lot from investors who are in the weeds on our stories. At the end of Q4, we are preparing for our seventh year update in our Ally relationship, which is one of the 2 major ways that our receivables and so we pushed off some sales of receivables to Q1. At the end of Q1, the regional banking issue showed up. So we didn't do a securitization of as planned at the end of the quarter. So for the last 2 quarters, we've accumulated receivables on our balance sheet, we've undersold receivables relative to those that we've originated, which needed a little harder to interpret our results. And then we kind of gave the market color that we expected to sell more this quarter, which would obviously aid our results and aid cash, but there was uncertainty of the speed at which that would occur. And I think many investors wondered with our outlook of positive adjusted EBITDA, how much of that was reliant on selling more receivables and how many more receivables will we need to sell to achieve that? So at the time of our announcement of our earnings, which is in early May, we have sold $1.3 billion in receivables quarter-to-date. That's just shy of what we've been originating over the last several quarters. As of today, we sold approximately $2 billion in receivables. And so we're -- as a result of that and that flowing through our statements were updating our guidance from above 5,000 GPU to above 6,000 GPU, and we're updating our EBITDA outlook from approximately -- or from positive to over $50 million. And so obviously, really excited about that. We're keeping our other line items the same as the biggest change. There's just been visibility uncertainty into selling receivables. So we wanted to make that clear to have one out there. And I think really importantly, this is just more evidence of the comeback that we're on. I think the team has done an incredible job the last 18 months if you've been following, Carvana has not been the easiest 18 months. I think it's been really tough on the entire team. But it's been a period where we felt the pressure that I think has made us better, and the trajectory that we're improving at is incredibly fast. I think if you put these results on any graph, you'll see that it's moving quickly. And that's only possible because we've got a business model that customers love. It's a business model that has clear monetization. We know how to monetize it. We've got a team that's very effective. And that team has been able to take the difficulty of the last 18 months and turn it to something positive. And I think what will emerge as is a better, more efficient company. So I think we still have a ton of work to do. We're nowhere near done. We definitely found ourselves in a bit of a whole 18 months ago, but the fundamentals are good. The fundamentals are the same as they always were. It's a huge market. It's an offering customers love, and it's a team that cares at is fighting. And so we're making it come back pretty quickly. So with that, we also have some reconciliations. I'll click through just to make sure that I'm checking all the boxes. I'm sure you're excited about that, but please feel free to go check that out. It's available online as well.

Yes. So I guess a quick clarifying question then on the second quarter. It sounds like SG&A, was this planned? You had better finance income. Did you see anything surprising in the realized GPU for the vehicles themselves quarter-to-date?

So I think we're going to have to stick with our guidance, so I apologize for being immediately evasive. But we'll stick with what we put up there. I think the major crux of this update was, there was uncertainty around how much we were relying on additional receivable sales, and there was uncertainty about how much we would sell in receivables. That's the biggest change that is leading to this and flowing that through speaks to the majority of the change in our GPU line item. So that's what this is relating to.

I guess, secondarily in the 3-step plan. So slowing growth just generally helps margins innately in any business, although you've done a lot of cost cutting as well. So I'm not taking away from that. But as you think about the 3 steps and step 2 being getting to these very attractive unit economics and then positive free cash flow and then growing again, it just seems to me, intuitively, there's going to be a cost to growth when you start to go that step 3. But is the thought process to get to a level in step 2, where you can then embark on the growth and not see some degradation in the metrics, whether it's unit economics or CAC or operating margin or EBITDA margin, however, you want to look at it?

Yes. There's a lot going on in that question. So what I would say is, I think the point that gross profit is higher as we are not growing, I think, is practically speaking correct today in light of the fact that we have chosen to -- one of the ways in which we are making gains is focusing on more profitable transactions. So an example we've given a lot in the past, but there really are many, many, I mean, probably dozens of versions of the same story. We used to sell cars in the Pacific Northwest, even though we didn't have an inspection center there. And we basically sell them at the prices that we expected to be good unit economics when we did have an inspections that are there. So we would just kind of incur all the cost associated with shipping the cars out there because that was part of our long-term plan, and we didn't want the customer offering to change. Going through this period, we're focused on cash flows and profitability, that sort of choice is unwound. And so that means that your margins are going to get better, especially as it relates to EBITDA, but then to a degree also as it relates to gross profit. And so I think there are choices like that, that have impacted growth negatively that have benefited GPU, and I think that's true. I also think that there are components of our business where shrinking actually hurts gross profit per unit, most notably in COGS costs and in our recon centers, for example. We've built out our recon centers to be able to support -- the existing centers are built to support over 1 million sales per year. And then we went out and we acquired ADESA as well. So we have a lot of capacity that then flows through our COGS cost, which negatively impacts gross profit. So I think that, that's the dynamic as well. I think when we go back to SG&A for this third point, I think it is true there are investments that are required to grow. It will require more focus on recruiting and training than we have today. It will require focus from some of our most talented operators who are going to handle the recruiting and training and kind of bringing up to speed all the various lines as we grow. So there will be extra expense, but there's also a lot of fixed cost in the business. Today, from an SG&A perspective, we're roughly as high as we've ever been from a fixed cost perspective. So I think growth is more likely from here to -- well, it's definitely going to help us significantly in SG&A. And I think at least in the medium term, is more likely to help us in overall margins than it is to hurt us. I think it's -- sentiment changes and perspectives change. But 2 years ago, the general idea out there was that we needed to grow to be able margins. And I think today, when you're in a place where you're not growing, I think the fear is only start to grow that will hurt margins. I think that the fundamentals have been the same the whole time. We are a business that has a large opportunity that has a significant amount of fixed cost relative to our peers. There are undoubtedly investments that are necessary to enable us to grow. But overall, I think growth helps the financial model.

Can you talk about -- so obviously, goal free cash flow positive, but investors are very focused on your interest burden as well. Can you talk about the time line to kind of self-funding and liquidity and how you feel about the company's position right now or need to raise capital?

Yes. So as of the end of last quarter, we had about $1.5 billion of cash and liquidity on the balance sheet. We had pretty significant interest plus CapEx burden that is meaningful, and we've outlined in kind of the $700 million per year of ballpark. And so that's a meaningful number. You're obviously getting to breakeven and to positive adjusted EBITDA is helpful because it starts to move against that number. I think for context, CarMax, which is the largest independent dealer in the space, largest dealer in the space, but also the largest independent dealer, when they were at approximately our scale, given their monetization of the transaction, they were monetizing at a level that was pretty similar to what we would need to cover our CapEx and our interest expense. And we're currently monetizing on the gross profit side better than they were at the time. So I think even at this scale, we certainly think that, that's possible. I don't know that, that will be the path forward. But I think that we can really bite into that kind of negative cash burn at this scale very significantly and get to a place where we're not consuming too much cash. And then I think as we turn to growth and start multiplying kind of those positive unit economics times larger numbers, I think that there's room to generate a lot of cash.

All right. So we're out of time, so we'll see you in the breakout.

Thanks, everyone.