Hello and welcome to the Carvana First Quarter 2023 Earnings Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Meg Kehan, Investor Relations. Please go ahead.

Thank you, MJ. Good afternoon, ladies and gentlemen, and thank you for joining us on Carvana's First Quarter 2023 Earnings Conference Call. Please note that this call will be simultaneously webcast on the Investor Relations section of the company's corporate website at investors.carvana.com. The first quarter Shareholder Letter is also posted to the IR website. Additionally, we posted a set of supplemental financial tables for Q1, which can be found on the Events and Presentations page of our IR website. Joining me on the call today are Ernie Garcia, Chief Executive Officer; and Mark Jenkins, Chief Financial Officer. Before we start, I would like to remind you that the following discussion contains forward-looking statements within the meaning of the federal securities laws, including, but not limited to, Carvana's market opportunities and future financial results that involve risks and uncertainties that may cause actual results to differ materially from those disclosed here. A detailed discussion of the material factors that cause actual results to differ from forward-looking statements can be found in the Risk Factors section of Carvana's most recent Form 10-K. The forward-looking statements and risks in this conference call are based on current expectations as of today, and Carvana assumes no obligation to update or revise them, whether as a result of new developments or otherwise. Our commentary today will include non-GAAP financial metrics. Unless otherwise specified, all references to GPU and SG&A will be to the non-GAAP metrics, and all references to EBITDA will be to adjusted EBITDA. Reconciliations between GAAP and non-GAAP metrics for all reported results can be found in our Shareholder Letter issued today, a copy of which can be found on our IR website. And now with that said, I'd like to turn the call over to Ernie Garcia. Ernie?

Thanks, Meg, and thanks, everyone, for joining the call. The first quarter was a quarter of significant progress for Carvana. A year ago, the automotive industry as well as the macroeconomic and market environment changed pretty dramatically, resulting in us significantly shifting our near-term priorities away from growth and toward profitability. This shift has impacted everything we do. It has impacted what we are focused on, it has impacted how much we are focused on, and it impacted the way we are managing the business day to day. All these adjustments take time. First, we made a narrow set of operating goals inside the company that we knew would be necessary to hit our financial targets. Second, we tightened the connections between our technology and operating teams through shared goals, shared meetings and even shared office spaces. These changes first have to show up in the projects the teams are undertaking. They move to operating metrics, and finally, they show up in financial results. That is exactly how the progress has been unfolding. In the second quarter of 2022, we outlined our plan and discussed how we are organizing internally to tackle our goals. In the third quarter, we shared a number of operating metrics that were beginning to rapidly move in the right direction. In the fourth quarter, we began to see some of the earliest signs of meaningful financial progress. And now in the first quarter of 2023, the direction and speed of the financial progress are undeniable. We reduced SG&A by over $100 million quarter-over-quarter and completed our year-long effort to cut $1 billion of annualized costs out of the business. In addition, in the first quarter, we returned to our historical GPU and adjusted EBITDA margin trend lines and reported company-best results for the first quarter in both metrics. We still have a long way to go to achieve our broader goals, but we are on the right path, and we are moving quickly. As we've discussed before, there are three steps in our plan to achieve positive cash flow and get Carvana back on track to becoming the largest and most profitable automotive retailer. Number one, drive the business to positive adjusted EBITDA; number two, drive the business to significantly positive unit economics; number three, after achieving objectives one and two, return to growth. As outlined in the letter, we expect to complete the first step in this plan in the second quarter. The completion of this step is a milestone, not a change of direction. We'll be using the same processes and focus we have benefited from over the last year to continue seeing the plan through. We remain firmly on the path to fulfilling our mission of changing the way people buy cars and to becoming the largest and most profitable automotive retailer. The march continues.

Thank you, Ernie, and thank you all for joining us today. Our first quarter results demonstrated significant progress on our path to profitability. We exceeded our goal of driving $100 million of non-GAAP SG&A reductions one quarter early, and we surpassed our previously communicated goal of greater than 4,000 GPU. In the first quarter, retail units sold totaled 79,240, a decrease of 25% year-over-year and 9% sequentially. Our decline in retail units sold, which we expected, was driven by four primary factors: one, reduced inventory size; two, reduced advertising; three, increased benchmark interest rates and credit spreads; and four, a continued focus on executing our profitability initiatives. Total revenue was $2.6 billion, a decrease of 25% year-over-year and 8% sequentially. Due to the dynamic nature of the current environment, we will focus our remaining remarks on sequential changes. As we've previously discussed, our long-term financial goal is to generate significant GAAP net income and free cash flow. In service of that goal, in the near term, our management team is focused on driving progress on a set of key non-GAAP financial metrics that are inputs into this long-term goal, including non-GAAP gross profit, non-GAAP SG&A expense and adjusted EBITDA. In the first quarter, non-GAAP total GPU was $4,796, a sequential increase of $2,129 driven by increases across all components. Non-GAAP retail GPU was $1,591 versus $632 in Q4. Retail GPU included a $593 benefit due to an adjustment to our retail inventory allowance. In addition, sequential changes in retail GPU were primarily driven by higher average days of sale, partially offset by wider spreads between wholesale and retail market prices, higher shipping revenue and lower reconditioning and inbound transport costs. Notably, we achieved our Q1 retail GPU despite selling vehicles that were, on average, more than 120 days old. Vehicles sold in Q1 that were less than 90 days old had retail GPU over 2,000, illustrating the benefit of normalizing inventory size and turning vehicles more quickly. Non-GAAP wholesale GPU was $1,236 versus $551 in Q4. Wholesale GPU included a $50 benefit due to an adjustment to our wholesale inventory allowance. In addition, we estimate that wholesale GPU benefited by $150 due to abnormal wholesale market appreciation in the quarter. Beyond those factors, sequential changes in wholesale GPU were primarily driven by higher wholesale marketplace volume. Non-GAAP other GPU was $1,969 versus $1,483 in Q4. Sequential improvement in other GPU was primarily driven by a greater volume of loans sold in the quarter compared to Q4. In Q1, we sold slightly less than a normalized volume of loans as a result of uncertainty in the securitization market in March. The GPU impact of this less-than-normalized sales volume was largely offset by higher interest income and other improvements, leading to an approximately normalized other GPU in Q1. In Q1, we made significant progress reducing SG&A expenses for the third consecutive quarter, reducing non-GAAP SG&A expense by $119 million sequentially, following a $60 million sequential reduction in Q4. These expense reductions were broad-based, including advertising, compensation and benefits, logistics and other SG&A. Non-GAAP SG&A expense per retail unit sold decreased by more than $900 sequentially in Q1, demonstrating significant operating leverage. Adjusted EBITDA loss was $24 million in Q1 or 0.9% of revenue. We expect to achieve positive adjusted EBITDA in Q2. After a strong quarter in Q1, we expect to drive greater than $5,000 of non-GAAP total GPU in Q2 as long as the macroeconomic and industry environment remains similar to Q1. Our strong GPU performance is powered by three fundamental drivers: driver number one, a more robust retail GPU model. We expect greater than $2,000 of non-GAAP retail GPU in Q2 driven primarily by our efforts to normalize inventory size, accelerate turn times and generate additional revenue from additional services. In FY '21, we generated approximately $1,700 of non-GAAP retail GPU. Since then, we've made fundamental improvements that we believe will drive higher retail GPU on a sustainable basis. First, we have continued to improve our customer vehicle sourcing with a higher share of retail units sourced from customers in Q1 2023 than in FY 2021. Second, we are generating more revenue from the unique services we offer our customers, including nationwide shipping and home delivery. Third, over time, we expect per unit reconditioning and inbound transport costs, excluding depreciation and amortization, to be below FY 2021 due to our continued focus on operating efficiency. Moving on to driver number two, expanded wholesale platform. We expect greater than $1,000 of non-GAAP wholesale GPU in Q2, split between Carvana's first-party wholesale vehicle sales and ADESA's third-party wholesale marketplace. In FY '21, we generated approximately $450 of non-GAAP wholesale GPU. Since then, we've made several fundamental improvements that we believe will drive higher wholesale GPU on a sustainable basis. First, in May 2022, we acquired ADESA, the second largest U.S. wholesale used vehicle auction marketplace. ADESA's wholesale marketplace generated significant gross profit in Q1 and will be a long-term addition to our total gross profit. Second, our acquisition of ADESA has improved the efficiency of our offering of buying cars from customers and selling them in the wholesale market. For example, since Q1 2022, we have reduced inbound transport costs on wholesale vehicles by approximately $200 per wholesale unit sold or approximately $90 per retail unit sold, supported by ADESA locations. Third, we continue to invest in our wholesale platform through product and process improvements with a continued goal of growing these businesses over time. Moving on to driver number three, strong finance and ancillary product execution. We expect greater than $2,000 non-GAAP other GPU in Q2, primarily driven by a normalization of loan sales volume. Since the beginning of Q2, we have sold or securitized approximately $1.3 billion of loan principal, an increase compared to Q1. In FY '21, we generated approximately $2,450 of non-GAAP other GPU. While we have not yet regained this level, in the medium term, we see a significant opportunity to increase other GPU by improving our cost of fund spread relative to mature securitization market participants and by continuing to expand our ancillary product platform. To summarize, our first quarter results and second quarter outlook reflect the return to our multiyear track record of driving GPU improvements. We believe the gains we are demonstrating in 2023 are sustainable and reflect the significant fundamental improvements we have made in the last 12 months. We also see further opportunities for more improvements in GPU in the future. Moving on to our second-quarter outlook. While the macroeconomic and industry environment continues to be uncertain, looking toward Q2 '23 more broadly, we expect the following as long as the environment remains stable. On retail units, we currently expect a sequential reduction in retail units sold in Q2 compared to Q1 as we continue to normalize our inventory size, optimize marketing spend, and make progress on our profitability initiatives. On SG&A, we expect similar non-GAAP SG&A expense in Q2 compared to Q1. We continue to see significant opportunities to further reduce non-GAAP SG&A expenses over time. Finally, we expect to generate positive adjusted EBITDA in Q2, achieving the first step in our three-step plan to generate positive free cash flow. On March 31, we had approximately $3.5 billion in total liquidity resources, including $1.5 billion in cash and revolving availability and $2 billion in unpledged real estate and other assets, including more than $1 billion of real estate acquired with ADESA. Our strong liquidity position, significant production capacity runway, and our clear and focused operating plan position us well on our path to achieve our goal of driving positive free cash flow and becoming the largest and most profitable auto retailer in the future. Thank you for your attention. We'll now take questions.

Today's first question comes from Sharon Zackfia with William Blair.

I guess two maybe pretty quick questions. It sounded as if from the press release, you might have made really significant progress on the kind of percent of inventory that's under 90 days. So hoping you can maybe talk to us about what percent of the inventory today is under 90 days versus what you had in the first quarter. And then secondarily, ad spend was really low. I'm wondering if that's a low watermark for the year, if we should expect that to start to go higher?

Thanks for the question. So I think on inventory, we've definitely made a lot of progress. We rapidly moved through a pretty significant portion of our aged inventory in Q1. We started with a much larger inventory than was sized to sales, and we made a lot of progress in the quarter. Our inventory is down year-over-year about 55% and was down 20% in just Q1 alone. A useful metric for thinking about our inventory size and what that means for profitability is just thinking about how large our inventory is compared to the cars that we're selling on any given day. If you kind of do that simple math and take inventory size divided by daily sales, in the quarter, we had about 65 days of implied turn time. That contrasts with the actual turn time of 120 days that Mark talked about in his prepared remarks. That's obviously a really big difference, and that leads to a pretty significant impact on retail GPU. In the letter, we provided a number where for the cars that were less than 90 days aged, for that subset of cars, the average turn time is approximately 65 days. We had retail GPU of over $2,000. I think we're heading into Q2 in a much better position from an inventory perspective. That has been a year-long effort to get sales to catch up to our relative size in inventory, and I think we're really pleased with the progress. We still have probably 1.5 quarters to go, maybe two quarters to go to get that all the way into alignment, but the size of the inventory relative to sales is now in alignment. I think we're excited about that. On ad spend, that's another area where there has been a tremendous amount of pressure on units in the business. We're down approximately 64% year-over-year in ad spend. Quarter-over-quarter, we were down approximately 35%. That was a big move as well. In this environment, cars are expensive, and consumers are a little bit less responsive to advertising. We've been retesting all of our various advertising channels. The optimal that we are finding today is different from the optimal that we found in a more normalized environment, leading us to pull back dramatically on marketing. We're able to show a customer acquisition cost of approximately $700 in the quarter, which is the lowest we've ever shown as a company by a long way.

The next question is from Ron Josey with Citi.

I want to maybe do a quick follow-up, Mark and Ernie, on just the inventory question from Sharon. But specifically, Mark, you mentioned higher incurred an increase in vehicle sourcing from customers. I wanted to hear just the sourcing of vehicles as overall inventory normalizes.

Sure. Yes, happy to answer that. The comparison that we talked about in prepared remarks was Q1 2023 compared to 2021. We've continued to make progress on sourcing cars directly from customers over that time period. Sourcing cars from customers remains a great source of inventory because they tend to be more profitable than cars acquired at auction. We feel great about our access to a lot of cars, and we have a lot of customers who are coming to the site to appraise vehicles with us. This has been a success story in the business over the last couple of years, and we're looking to continue that success moving forward.

The next question comes from Adam Jonas with Morgan Stanley.

The company is becoming more profitable as it gets smaller, but this trend will need to change eventually. I understand your guidance; I wanted to ask if 80,000 units per quarter is the right size for the company. You're indicating that it's going to decrease, particularly with lower merchandising and advertising expenditures. So, I’m curious if we’ve reached that point yet. What is the optimal size for the company? I also have a follow-up question.

Sure. So I mean to jump to the end, I think the right size for the company is much, much larger eventually. The path to profitability has just included some of these moves that we've made to shrink inventory and shrink marketing. I think where we found ourselves after 2021 was expecting another similar year and just being dramatically out of balance with where sales actually were. I think as we grew from when we launched in 2013 all the way through 2021, we benefited a lot from the positive feedback in the business. However, as we got bigger, we got better. When we grew our inventory, conversion rates went up. When we spent more on marketing, it was easier to open new markets. We found ourselves out of balance and needed to rebalance the business, expecting to face the other side of that feedback. As we shrunk, we saw conversion rates go down during the transition. However, we believed it was the fastest path to positive cash flow and ultimately profitability. We're likely close to where sales will bottom out.

Just a follow-up. I'm curious where your team sees the lowest-hanging fruit from here on the SG&A. And has your team given consideration to charging a delivery fee or somehow incentivizing the customer either paying or avoiding a delivery cost to you?

Sure. Yes. As for the progress we’ve made, we're proud of cutting $1 billion of costs out of the business and over $100 million quarter-over-quarter. I think there are many areas of costs. We currently see opportunities in compensation and benefits, logistics, and customer acquisition costs. In variable costs, we’re generally hitting all-time best efficiencies across all groups despite input costs being higher, and there is room for us to make more progress. In customer acquisition costs, we are at all-time lows. We think there’s room there to improve. Regarding delivery fees, we've changed our offerings such that when customers elect to buy a car that is further away, we will charge a delivery fee.

Next question comes from Michael Montani with Evercore ISI.

I had one on the cost side and then a separate one on the customer base. But just on the cost side, if I could, I wanted to get a handle around if you think of comp and ben right now, do you have the right team in place, the right size team? Are further improvements from here about process and efficiencies or is there still some work to do?

Yes. Moving on to compensation and benefits, we see opportunities to drive down compensation and benefits. We’ve made tremendous progress there. The future gains are spread across different areas, especially in logistics and corporate expenses. So we see opportunities across the board in compensation and benefits, and we have made a lot of gains there recently.

That's helpful. And just to follow up on the consumer side for a second, can you share insights on the 25% decline based on household income levels?

Sure. The trends we've seen over the last year have remained. As for Carvana-specific trends, the middle of the country is performing a bit better than the coasts for similar reasons discussed. There has been a shift toward higher incomes and higher FICOs across the entire auto industry. This distribution shift is expected to revert when interest rates and car prices stabilize. Retail prices have been barely appreciating, but wholesale prices are starting to decline again. We hope for a more sustainable depreciation path moving forward.

Next question comes from Seth Basham with Wedbush Securities.

My first question is just on your first-quarter results that were meaningfully higher than the updated guidance you provided on March 22nd. Can you give us more insight into what drove the major improvement in the last days of the quarter?

With respect to our outlook for Q1, we were very close to the top end of the range on units, revenue, SG&A expenses, and loan originations, all those metrics. We beat on GPU, and in our outlook, we called out a couple of major points of uncertainty: the P&L from our loan hedging and our retail inventory allowance. Both of these items resolved favorably, driving the GPU increase. We had a couple of other small beats across other business areas in the last couple of weeks of the quarter, but those are the two major drivers.

You've indicated that the retail inventory allowance is likely not sustainable. You've talked about other GPU likely being over 2,000 in Q2, primarily driven by normalization of loan sale volumes. What do you consider normalized volumes?

The easiest way to think about normalized loan sale volume is to sell what you originate. That's how we've operated for many years. Some quarters will be below normalized, and some will be above, but over time that’s the right benchmark.

The next question comes from Nick Jones with JMP Securities.

As you start to turn the corner and ramp up volume, have the cost reduction efforts impacted your ability to scale volume in logistics? What changes have you made in logistics?

There's efficiency and focus. We've increased the efficiency of our logistics network, meaning that our trucks are traveling with more cars on their backs. We've decreased the miles traveled by about 40%, and quarter-over-quarter, it was down by 12%. This has driven down costs. When it’s time to grow, it will require less work to achieve the same level of growth. Our plan is to hit the first step of our plan next quarter to move to significantly positive unit economics, and then focus on growth after that.

The next question is from Rajat Gupta with JPMorgan.

If I look at the reported financials, in the fourth quarter, you sold roughly $800 million lower than what you originated. In the first quarter, it looks like it was close to $300 million to $400 million versus what's originated. How long should we expect for that backlog to clear?

You are approximately right on the size of the backlog. We plan to sell those down in the coming quarters in an orderly way, assuming that financial markets remain favorable. The average discount in our warehouses is about 0.15, which means selling that backlog would free up significant cash and trigger a onetime tailwind to GPU when completed.

Curious if your view on leveraging ADESA real estate has changed. Would you be open to considering options outside of the exchange offer, such as restructuring existing unsecured bonds?

No changes to the way we have historically thought about that. Typically, we favor asset-based or secured financing, and our biggest asset is the real estate.

The next question comes from Alex Potter with Piper Sandler.

Wondering if there's been any rationalization in the competitive landscape in auto loans?

I think it's been a dynamic environment with significant shifts. The primary dynamic we've spoken about relates to spreads. Carvana itself has seen spread widening over the last year, but there is room for our spreads to come down as we approach the cost of funds for more mature issuers.

The next question comes from Winnie Dong with Deutsche Bank.

On the commentary that you expect similar SG&A expense on a quarter-over-quarter basis, can you clarify whether this is on a per unit basis or absolute dollar? What’s driving that pause?

We were talking about SG&A expense on a dollar basis. Our expectation is similar SG&A expense to Q1 reflects the significant gains we made in that quarter. We've made tremendous progress, but we still have significant opportunities to drive efficiencies in our operations moving forward.

The next question comes from Chris Bottiglieri with Exane BNP Paribas.

How do you think about owning residuals versus selling them off given current conditions?

In general, we prefer to sell the residuals. The yields that residual buyers are getting are very high compared to the past, making those desirable assets. However, we still intend to sell those residuals over time.

Have you rethought how you priced cars to sell them faster? How do you learn from this experience?

We have a historical period where we operated our inventory in a much tighter range. We saw a blip with COVID and then moved away from those norms considerably in 2022. We are now working through the process and have adjusted our inventory appropriately to normalize the average sales. That should lead to a more normalized share of cars sold in less than 90 days.

The next question comes from Zachary Fadem with Wells Fargo.

Wanted to bucket advertising savings in a bit more detail. Can you break out how much you might be saving from shifting to different ad spend channels versus absolute reductions in ad spend? And who do you think is picking up the market share you might be giving up?

We’ve focused more on direct channels with measurable payoffs and pulled back on brand channels. We are testing various marketing approaches. We feel successful in cutting a lot of expenses and are starting to see improvements in GPU and variable costs. As we become more efficient, we might grow marketing spend going forward. The market is enormous, and we’ve given up some share, but we are prepared to reclaim it when the time is right.

This concludes the question-and-answer session. I would now like to turn the call back over to CEO, Ernie Garcia, for any closing remarks.

Thank you. Everyone on the Carvana team, I cannot thank you enough. I hope you're proud looking at this quarter. I know the last year has been tough and not what we anticipated walking into. Everyone's put in a ton of work. I know there were times when it felt like the payoff was slow and hard. I hope you see this quarter as evidence that it is paying off. I also want you to know we have a ton of work left to do. The focus we've put in over the last year is paying off, but we have more efforts to put in from here. So heads up, be proud, but let's keep the pedal down and keep going. Thanks, everyone, for joining the call.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.