Carvana Co. (CVNA) Earnings Call Transcript & Summary

Thanks, everybody. Okay. Really excited to have Ernie Garcia, CEO of Carvana, joining us today.

He says that about all the companies.

I'm particularly excited about -- not just because you are pulling off the no-sock thing better than I ever could. I don't have socks. That is one reason why, but also maybe, I always say this that when you're hearing, like when the first time you were here before you were public, I was so excited about this new model. This is like I had car dealers, some of that might remember my uncle Chuck, I used to write this like a monthly report, uncle Chuck, maybe I'm getting too old. Even Uncle Chuck said, "Wow, this Carvana stuff is -- it's going to change the industry, watch." I would watch this company very carefully. We had here and there was nobody in the room. Literally no people.

Invited us that we're so excited, first conference, sat here. [indiscernible] got like 3 analysts, then I had to awkwardly present to people I knew didn't care.

I think I took the mic off and we ended up just like, I don't know, we should crack a beer. But a lot's happened since then. I don't know how you continue to look this young and whatever you kind of seem like you're healthy and enjoying life. Well, okay. I know you are a workaholic and you're all in on this stuff. And your resilience seems to have been paying off, been through pretty tough last couple of years. But just some messages from the top that you want to kind of convey to the audience of kind of where you are in the journey right now, and then we'll go into it.

Yes, sure. So I don't know how much attention I see, different faces out there that maybe a lot of people have been paying attention, maybe there are some new faces. But the last 1.5 years has been a crazy time for Carvana, I think we basically went from, I think, darling to whatever is the exact opposite of that pretty quickly. And then I think the last 6 months or so, I think investors have been able to start to see the real progress that we've been making. I think our goal through all this, and I think we're on the path to do it, is that when this is all said and done, I think the pressure that we face in 2022 will end up being a really positive part of our story. I think undoubtedly, that kind of pressure is not something that's fun that anyone wants to face. It's a real bummer when you're in the media every day being told how stupid you are. But it also definitely makes you better. I think we are a group of people that I think has always worked really hard. But I think -- sometimes it takes a ton of pressure to make you also make tough decisions you didn't want to make. And I think we're forced to make a lot of those decisions that I think we're a better company for it. So I think what we've got to do now is just stay on the same path that we're on, keep executing. I think that's what actually matters over the medium term. I do think that the long-term path is the same as it always was and probably better for a number of reasons, but I do think if anything probably better. And I think from an investor perspective, I think investors have been through such a whirlwind in the last 18 months that I think there's been investor turnover, and I think there's maybe kind of like the frameworks that were used before to understand the business and understand what mattered into predict what was going to happen. I just think people are kind of throwing their hands up and don't exactly know how it works anymore. And so I think we've got to do a good job kind of providing those frameworks again. I think we've been trying to do that. Most importantly, through our results, I think we've made a ton of progress in GPU. We provided some detail in GPU. I think in unit economics, we still got some work to do to provide a deeper understanding in SG&A. But I think the performance that we posted and that we expect to continue to post, I think, is starting to get people a lot more comfortable there. I think people have no idea what to think about growth. Our views on growth are unchanged from what they were prior to all this. I think we've been through a crazy period over the last 1.5 years that is forced. A lot of different behavior than we probably would have otherwise expected, both on the part of consumers and in part of Carvana. So I think it's been harder to see. But we think that's -- all that growth is still out there. The opportunity is the exact same. And I think our job is just to keep executing and kind of tell that story and get people back to a place and comfort where they feel like they know what's going to happen ahead of time, which I think is not where most people are today.

Yes. We're going to talk about all those things. We're going to get into growth, too, but I just want to start out with progress and sustainability and unit economics, both on the fixed side and the variable side in the business right now?

So I mean, we have made -- the like concrete things that I feel like we can share right now. I think probably the best we were from a variable expense perspective was 2021. We're back now to those kind of levels today. From an actual efficiency perspective, with efficiency being defined as kind of the inputs to cost, things like labor hours and miles driven for sale, we're at a better place than we've ever been today. And I think in both of those metrics, we're trending positively. And I think if you view the automotive retail business as sort of a cost-plus business, I think the thing that actually matters is efficiency, because I think everyone in the automotive retail businesses had input costs have gone up. So I think by that measure, we're at all-time best. Fixed costs were certainly higher than we've been in a really long time. Outside of the very beginning in the last 12 months were as high as we've ever been and by meaningful amounts which I think is good when it's time to turn to growth, but today is certainly weighing on our financial performance. I think that's all still pretty hard for investors to see. So we do plan to give more visibility into that in the near term, probably with our Q3 earnings. We'll provide a little more visibility into fixed variable breakout, so people can start to get a better understanding of that. But I think that's all trending really, really well. So I think we're excited about the progress we're making there.

Yes. I mean it's an interesting journey, because you kind of demonstrated I guess the same thing, high customer acquisition costs when you were during 2021 and into 2022 or negative operating leverage every to look at it. And so we're kind of losing more money per unit, the bigger you've got there may have been some acceptance of that, but I'm just kind of painting broad brush. And then when you realize, all right, we need to move growth off to the off the agenda here and kind of shrink before we grow and get better and be smaller, which we're still in the phases of although we'll see where we are in that kind of journey, how much longer that lasts. You were -- wow, you were losing a lot less money and even made money per unit, the smaller you got. So obviously, that will have to change at some point. Where are we on that? How much more shrinkage do we need to have while you reinforce that? It feels like we're close, but I don't know if you had any color around that considering the market environment, too.

Sure. So I think we've tried to kind of break the plan down into 3 steps. And step one was all the things we had to do to get back to EBITDA positive and I think that included getting more efficient across the entire business. It included cutting out sales that weren't profitable, especially in a more difficult environment. It included a lot of just rightsizing of the business overall. We're now in, what we're calling Phase 2, we cross over positive EBITDA and materially so last quarter and expect to again this quarter. Phase 2 is just about taking all those same line items that we're working on. We've got a new kind of operations cadence where we're every different team across the business has a bunch of different goals, and they're targeting those and reporting back on them every week. So we're running the exact same playbook we ran for the last 12 months while holding sales approximately flat to get to a spot where unit economics are really good. Last quarter, we were at $1,100 of EBITDA per unit after adjusting for onetime items. We were higher than that prior. But when you adjust for onetime about $1,100. We plan to continue to make significant progress and move beyond that. In the not too distant future. And then I think we'll move to Phase 3, which is growth. I think a question that is definitely out there today is, a year ago, the story was, okay, Carvana has been this growth machine for so long. They're not going to be able to get better unit economics without growing, because they need growth to lever. And I think more recently, as people have seen kind of the results where we've gotten better as we shrink the story is kind of turns to, oh, okay, all that kind of money consumption must have been a function of growth. And when they go back to growth, they're going to consume a lot of money again. I think that, that's -- our view is definitely that's not the case. I think during that period of growth, we were investing in variable expenses. We are also building our fixed kind of apparatus at the exact same time. We were -- we started as a company in Phoenix that didn't have crazy funding early on, and so we didn't like build our full kind of fixed operations early on. We were building that over the last several years as we were growing and then we also were investing a lot in kind of the capital infrastructure necessary to be able to scale to a much larger size. Today, we have the infrastructure to scale to significant multiples of our current scale. So I think when it's time to turn to growth, there's going to be significant fixed cost leverage.

Turning to contribution margin, then where can this go?

Yes. So I think that's -- our internal focus right now is making sure that we get that to a sizable number. I think any investor trying to build a model, it's what's going to matter is what are unit economics and what is your volume? And then it's just a question of when and whatever valuation metrics you want to apply to that. But I think we just want to make sure that we get our unit economics to a place where they're very, very meaningfully positive for all the units that we add, and then it's easier to grow, because I think a relatively straightforward way to think about the difficulty of growth is, I think it's largely proportionate to your variable costs. I think like whatever your variable costs are, that's effectively the thing that you have to scale to grow. And as we keep pushing that down, I think we put ourselves in a better spot to where our unit economics are better, so growth is more valuable and growth is easier. And so that's kind of what Phase 2 is all about is just kind of continuing to power through that.

Anything you want to highlight on the progress for the third quarter at all. We don't need to go there, you don't want to, but anecdotally, just versus your outlook at the time?

Yes. I think nothing super concrete. Mark was recently at a conference and updated the view to over $75 million of EBITDA. That's exciting, that's a meaningful number versus units at least last quarter, which we guided this quarter to similar units. That would have been about $1,000 again. So I think we're on a very good path. And I think we just got to keep pedal down.

So maybe going back in time, 6, 9 months, I think it was around the time of the MidCap bank kind of wobble and First Republic. I'll tell my team and we had a lot of people doing some work. We were trying to put out primers on Carvana. And I told the team in all hands, Danielle was there. I said, look, I said I think the things we need to see is -- 2 things we need to see for Carvana to work. One, I want to see the company shrink like actually improve EBITDA with revenues being smaller. Because if that started at a small level, then I think you could keep doing that for a while, which could kind of slow the bleeding. Second thing is we need to get bankruptcy off the table. We can't have a company where it's just like it could be backup on paper kind of thing, right? We need to get that like out of the lexicography. And you've done those 2 things, and then you had the extra very -- pretty impressive moves on pushing out the maturities and negotiating with your big bondholders on that at a time when it was looking pretty damn acrimonious. So I don't know if you want to tell us to that journey here like -- anything we need to know that's relevant now as to kind of how important that was to give you that breathing room? And then because it's now kicking off, you do have investor turnover. I think I'd love to hear a bit more about what are -- what do people -- the new class of investors like about the story and what are they still on the fence for? Because I'm frankly on the fence here.

Yes, sure. I think I think the last 18 months was not expected by anyone ourselves included. I think that we had grown at triple-digit rates forever. We came out of 21 guns blazing, and it felt like we were just going to continue that. I do think -- I at least can't think of a time in automotive retail, certainly, but probably in the entire automotive kind of vertical where there's been more distortions in the market than sort of like mid-2020 to now. And I think that led to many of the decisions that hopefully were reasonable that we made at the time, ending up just very wrong, and then you pair that with capital market transition that was fairly severe. They just forced a lot of change for us and I think for a lot of investors, that was hard. I think it was hard financially, we think it was hard to keep track of even what was going on. I think the simplest argument that I could make, which investors have decided what they believe is that I think you have to kind of decide what is truth. Its truth the period from 2013 to pre-COVID where there was meaningful customer adoption and there was constant leverage every year. There was improvement of every single line item. And I think there was a view that we couldn't be stopped or is this period of distortion where car prices went up, payments went up by 50%. And production went down and all of a sudden the dynamics between franchise dealers and independent dealers changed dramatically. Is that at the moment that's truth? And capital markets changed. Is that the moment of truth. And I think that what we've got to do is just get people back to a spot where I hope that what we can do is we can just kind of keep delivering. And I think if we deliver a little bit, and I think as long as the world around us, meaning the economy and kind of the industry, as long as they even kind of stabilize. I don't know we need things to get a ton better, but just kind of stabilize and hang out for a second.

Table is good.

Yes. I think people can start to say they can start to get more comfortable with the previous world was truth, right? And then I think if they get a couple of that, they can say, and of the company is clearly in a better unit economic spot than it's ever been. And it's been slapped around, which is a bummer, but is good for you in the grand theme of things. And I think we're a better company for it. And so I think that we've had many investors that I feel terrible and grateful to that have stuck around the entire time. And so I think we owe them, and we hope that we get them back to where all their dreams were about where this could be before. And then I think we have some investors that left that are probably open-minded to coming back once they give us their faith back. And I think we have a lot of new investors that are trying to figure out, okay, how do I separate out the last 18 months from the 9 years that came before it. And I think most importantly, is our results will do that, and I think, hopefully, just clarity and disclosure will also help.

Ernie, when can the business start to grow again?

I think it could start to grow -- I think that is largely a choice. I think the -- what I would say is I think if -- for those that have done work, if we pulled people and said, what do you think the kind of realistic long-term Carvana unit economics are. I think the reasonable guess is high to low would be 2x, like it would be kind of like the variation that would exist there. I think what do you think units can be, I think the variation would be 10x and so I think in everyone's model, it's going to be all about growth pretty soon as long as we do what we're supposed to do and deliver on unit economics. And I think that, that's going to create -- that's just going to make that the focal point. I also think that there's no question that the last 18 months where we moved away from growth, we cut out or unprofitable sales, and we just focused on turn the wheel, get tighter, get better everywhere. Every operator was able to shut off the part of their brain that was focused on -- we've got to hire. We've got a train. We've got to ramp this up. We've got to figure out a way to buy more cars. We've got to get more cars to the [indiscernible] centers. And they get focused and said on just being more efficient everywhere in sustainable ways. We've seen tremendous gains. And I think that in a model and in kind of certainly my mind before all this, I would believe that you could do it all at once. But I think the reality is you can't do everything at once. But when you try to everything at once, I think just efficiency goes down and there's more mistakes and there's more kind of like exhaust. When you really focus on fewer things, you make way more progress in aggregate and wait -- doubling more progress in the places that you're focusing. And so I think we are going to hang out in Phase 2 for a little bit longer, because we have so much momentum, and we have so many different line items getting better by so much. And when we do that, when it's time to turn to growth, we're going to be able to grow more efficiently and what matters is that equation in 5 years from now, not that equation today. So I think we took this painful pivot to move away from the only thing that defined us for 10 or 8 years, which was growth toward let's just get way more efficient. Once you've pivoted everyone's mindset and you pivoted your operating cadence in the way that you run the business, I think that is a cost that we have incurred and now we want to get paid for that cost we incurred.

The message I'm hearing from your Ernie is you just do more work to do. And that is if you throw growth on too early, a lot of things get screwed up. So I don't know -- so amongst that to-do list of before we can grow, it's a choice, it could be next year, it could be this year or to 5-year, whatever, whenever that is, before you dial it up, we need to have these 2 or 3 things nailed and proven, which are easier to do as a smaller company or a not quickly growing company. What would those items still be on that to do?

I think the most important one is just going to be that we've made significant additional gains in unit economics. And then that we believe the remaining gains are still achievable at growth, but they're not so big and so easily achievable that we'd be dumb to turn away from them and just grab them, because I think our view is right now, there's still very significant gains to be had in the near term if we just stay focused, and that's what Phase 2 is about.

Ernie, you said you felt that the long-term growth opportunity was -- maybe I'm putting -- I think I'm quoting you, it's exactly the same as it was before COVID kind of thing. But surely, the way you get there, the opportunity might be there, but the execution, it can't be identical, like something changed. So how -- so when you do turn it on, -- how do you grow? What's different?

So I mean what I would say it is just you think the thing that's great about the automotive industry is it's a big mature industry that's pretty predictable. You kind of know what used sales are going to be every year and they're going to fluctuate by 10% or 15%. You know what new sales are going to be, you know what the economics are. So to me, like that's where I say the opportunity is the exact same. I just -- I don't think that there has been a change in consumer behavior, consumer desires, consumer preferences. I don't think there's been change in the competitive landscape. If there has been change, I think it's been more in the direction of financing. Something like what we've built would be harder, not easier. So I think the opportunity is the exact same. I think what is easier for us from here is we now have the capital investments to be a much, much larger company that are already made. They're not going to be a requirement that's being simultaneously built out as we build. The inspection centers that we've already built have over 1 million units of capacity, which would allow us to be over 3x as big as we are today by just staffing the physical buildings that are already built. In addition, we have ADESA with 56 other locations that has another 2 million units of capacity when it's time to go unlock that. So -- and then we've got real estate all over the country for last mile delivery that in our previous phase, we were building out as we went. So I think that we will be a more efficient company that spends less on variable costs and already has an infrastructure to plug into. I think it will be a lot different when it's time go again. I really do...

A lot of learning along the way. A lot of...

For sure. And you do learn a lot going through a period like we went through. I think it's important that you don't overlearn that lesson and become overly shy, but I think it's important that you learn the lesson, and I think we have.

Single biggest lesson learned. Like we thought this -- if you interviewed me 3 years ago, Adam and then put me next to Ernie today, I really wish I could go back in time and tell the Ernie then do it please. You got to learn this.

I think we are really wrong about where things were headed in 2022. And I think the lesson you should take from that is just to have a -- I don't think that was in fairness to us, this has been a wild circumstance, but we are really wrong, and I think just having wider kind of uncertainty is useful in planning. And then what I would say, I think is, by far and away, the most important lesson is I just think there's -- I'm sure there's many investors here to see many different types of management teams. I think a management team that is a founding management team, one thing that probably will define that team is that they will hustle, like it requires hustle to start from 0 and to go fast. And I don't think there was ever a moment 2021 included, where people inside Carvana were not hustling. We are hustling fast. But pressure was removed relative to what it was in 2013 to '19, because all of a sudden, we were blessed, right? We live the first 6 or 7 years of our life where people question whether we can make it. They questioned the business model, they didn't really believe what we could do. We're on the wrong city, it's just nothing worked about it. And then all of a sudden, we were blessed for a period and I think when you're blessed, I think it's easy to avoid hard choices, right? I think it's easier to take things that aren't working as well as you'd like and keep pouring resourcing into them. It's easy to add another thing to your list, because you think that everything you touch turns to gold, it's easy to not address other issues that emerge inside the company. And so to me, I think the discipline to make hard choices, I think was like a very valuable thing. And then I think the operating discipline, it's a different thing to build a business and to build a customer-facing product than it is to have an operating discipline where you make sure you're always tightening down all the time and I think learning how to do that. I think we would have thought -- 1.5 years ago, I would have thought we were better at that. And we weren't bad at it, honestly, like if you look at our numbers going all the way back, I really do think they were pretty good all the way through, but we weren't anywhere near as good at that as I thought we were. So I think pressure is good, is another big lesson.

That humility and self-awareness. I mean maybe the industry I look at it. I don't usually see that maybe folks you listen to this. I mean this is kind of unusual self-recognition. Folks any questions from the audience for Ernie here? We have microphone. Then I could be patient. Just kidding, I can't be patient for now.

And all the eyes go down. It's my favorite part of any...

Make eye contact -- Okay I'll let you think about it a little bit. How is the used car market?

Interesting. There's a lot happening there. I think -- so I guess like my very potentially wrong like macro model of like pricing, which I think is probably the most important variable in the used car market is that looking at payments relative to other goods is a reasonable way to predict where car prices are ultimately likely to go. And today, car prices are still -- or sorry, car payments are still kind of 40% or so higher relative to other goods than they were before all this. So I think some combination of rates and car prices like have to continue to go down. We saw some unexpected appreciation early in the year. We saw some pretty rapid depreciation even faster than 2022. 2022 was the fast depreciation period over a sustained period that I at least can remember. So we saw very fast appreciation kind of in the middle of this year. I think it's kind of jumping around right now. I think the UAW uncertainty is showing up there a little bit. We'll see kind of where that goes.

You might benefit a bit from that. Not that you're rooting for that? Or is that overhyped? If you'd rather just...

I think first order, it's probably not like -- I think what we care about the most is we would love for car prices to come down over time. I think that's better for the model set up. I think it's better for our customers. I think it's -- yes, we're set up better for that. I think it's better for franchise versus independent dynamics. So I think we would like car prices come down. I think a big strike probably does the opposite. I don't know that it's a huge impact, but I think it probably slows things out.

Okay. I'm going to throw just a couple of terms or topics your way. I just want you to see where your head is in this. ABS market?

Actually pretty solid right now. And I think we've had some great wins there. I think one of the tough parts of going through a period like the last 18 months is our capital markets brand got beat up pretty good. And so our cost of capital in the ABS market was significantly worsened, and that showed up in -- as another thing that was hurting GPU. Look, that's pretty mechanical. And I think as things have gotten better, we've kind of deal over deal over the last 6 months or so. We've been tightening that down. And so relative to other issuers that issue similar securities to us. I think that we're in a very good spot. We just priced the deal, I believe, yesterday, where we kind of ratcheted down relative to competitors again. So I think the ABS market is solid today.

Gain on sale?

So when you say gain on sale, I presume you mean -- what that effectively means when paired with the previous question is selling the residual so that kind of the entire receivable that we originated from a customer is sold.

Mainly the other GPUs.

Yes. All the profit kind of flows through. Yes, at that time. I think the residual market is, it's definitely the thinnest part of kind of ABS capital markets. But generally, it's been pretty supportive of us. And I think, yes, I don't think our plans there are materially different. I think over time, that's something we'll definitely pay attention to, because those residuals do have pretty high yields. And I think as we find ourselves in a better capital position, it's -- that's not a crazy place to potentially use some of our capital.

EVs?

Interesting. I think we're -- in new, EVs make up 7% of sales. It was probably 3 or 4 years ago that they were 1% or 2% of sales and used across the market, they're about 1% of sales. We're just shy of double that. So we have kind of a disproportionate share there.

Kind of skews towards the kind of customer that...

It aligns with our customers. I think the transition is interesting. I don't think there's a big operational impact to us. There are some operational impacts. The most important of which is probably just making sure that we have sufficient power coming into all of our facilities to handle all the charging. But otherwise, like relatively nominal changes, I think it's exciting. There's just so much -- I think the automotive world in general, there's more potential for significant change across the entire world of automotive than I feel like I have ever seen, which I think is interesting and exciting. And I think we like the position we're in.

Labor tightness?

As we've been more in Phase 2, I think our exposure to trying to rapidly hire is less. So I'm not sure that we're the Yes, as good of a mouthpiece to kind of find answer there, but nothing that I would say has been crazy notable from my perspective at least.

Hertz?

I think Hertz is going great. They've been a great partner for us. That was -- we had a broader products, which we call dealer marketplace, which is the ability to take someone else's unit and sell it for them effectively. And I think there are a lot of efficiency gains to the system, depending on who that partner is and how they run their business that are possible through that. That was the whole kind of product line that we were launching. Given our focus over the last 18 months, we chose to basically shut down our other kind of opportunities there and focus just on Hertz. I think that's treated us well. I think that partnership has gone extremely well. We've grown it. We've learned a lot about that product. I think we'll be well positioned when it's time to turn that product back on as a result of all that, but I think that's gone great, and they've been a great partner.

Ernie, I was talking with the CEO of a very large OEM and we were talking about the importance of car companies if they -- as cars become connected for them to have downstream infrastructure to kind of help service, particularly fleet clients with then -- if you're going to have a car that is a marketplace for other services and instead of just using a onetime episodic, someone buys a car and you never see it again, but really like the full life cycle there may be some assets that they need to have exposure to or relationship with, if not own, downstream. And they brought up -- Danielle, I think you were in the room, right? They brought up, wow, they use the words, there is a certain tech forward used car retailer that has some really interesting assets out there that could be helpful. And it was very obviously, they were talking about you. I've been kind of full -- I've been premature on this idea of you being able to help on the new side, even or new car companies, whether it's start ups or who knows going to be the Chinese come here one day or -- and they won't have those resources and maybe want to have a different physical network other than the franchise dealer model that you could be helpful with as a fulfillment partner. Is that a dream? Is that something that -- again, you have other ship on your plate right now, and I respect that. But if I'm thinking longer term, is that -- how you might grow differently, where would that kind of fit into your thinking without getting to 2021 on us? I mean I'm saying that for my own benefit.

Yes. What I would say is I think we're supposed to be focused, right? I think the focus is service very well. I think it is also in my very not objective opinion, undeniably true that we have a unique set of assets that are desirable in this world, and it's a world that's changing fast. And I think that, it makes it hard to bend on what the outcomes will be, but I think it's a good place to be on the board.

It's a good place to end. I promise not to throw any more good. How we do?

Awesome. All right.

Thank you. Right of time. We're done. Thanks so much.

Cheers. Appreciate it.