Earnings Call Transcript - CVNA Q1 2024

Operator, Operator

Hello, and welcome to the Carvana First Quarter 2024 Earnings Call. As a reminder, this conference is being recorded. I would now like to hand the call to Meg Kehan, Investor Relations. Please go ahead.

Meg Kehan, Investor Relations

Thank you, MJ. Good afternoon, ladies and gentlemen, and thank you for joining us on Carvana's First Quarter 2024 Earnings Conference Call. Please note that this call will be simultaneously webcast on the Investor Relations section of the company's 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 & 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 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 discussed 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 and Forms 10-Q. 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 due to 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 our GAAP and non-GAAP financial metrics for our reported results can be found in our shareholder letter issued today, a copy of which can be found on our IR website. And with that said, I'd like to turn the call over to Ernie Garcia. Ernie?

Ernie Garcia, CEO

Thanks, Meg, and thank you everyone for joining the call. Q1 was an incredible quarter for Carvana and one that is worthy of reflection. My plan is to share some of the highlights from the quarter and then to discuss the long-term implications of our recent performance. In the quarter, we achieved an adjusted EBITDA margin of 7.7%. By this measure, in Q1, we not only set new all-time company records, but we also became the most profitable public automotive retailer in the U.S. for the first time. We returned to growth, growing retail units 16% year-over-year despite decreasing marketing dollars by 4% and having constrained inventory. We completed our first quarter with adjusted EBITDA exceeding CapEx and interest expense, achieving this milestone by a significant margin. We achieved GPU that exceeds our previous record from Q2 2023 after normalizing for last Q2's excess loan sale volume, achieving a GAAP gross profit margin of 19.3%, above the high end of our long-term financial model. We significantly leveraged marketing spend, operations expenses, and overhead expenses, the last of which were held flat in absolute dollars despite 21% sequential growth. In combining our GPU and expense leverage, we also validated our long-term financial model that we put out six years ago and clearly lit a path to significant additional financial gains from here. These gains will be driven by both leverage on our fixed overhead costs and additional fundamental gains in operational expenses and GPU. We see opportunities for large improvements in our adjusted EBITDA margin from here. We achieved all of this in a difficult automotive environment at a time when most in the industry are moving backward on both unit economics and volume. The long-term implications of this quarter are significant. We continue to deliver experiences that our customers love. The strength of our customer offering has always been apparent in our growth, which even with the last two-year hiatus, has earned us the honor of being the fastest-growing automotive retailer in U.S. history. As we get bigger and more efficient, the experiences we deliver get even better and simpler. Constantly improving customer experiences has always been centrally important to us, and it will remain centrally important to us in the future. It is one of our most important feedback loops. We are positioned to grow significantly from here. The part of our business that is most difficult to scale is reconditioning because it requires significant physical space, construction, and zoning approvals. Across our current inspection and reconditioning center infrastructure, we have the capacity for 1.3 million units per year, over three times our current volume. Beyond that, at our ADESA locations, we have the ability to increase our production capacity to a total of approximately 3 million units annually. To unlock this opportunity, we are developing a playbook to bring our full suite of retail reconditioning and logistics technology and processes to ADESA locations. We recently completed our first conversion of an ADESA site in Buffalo, New York, to a Carvana Reconditioning Center, and now this site is leveraging Carli, our proprietary reconditioning software, and our proprietary processes to recondition retail units. We believe we have a model that gets better as it gets bigger, and ADESA is a key part of that story. Reconditioning cars at more ADESA locations over time reduces inbound transportation, which positively impacts cost of sales and retail GPU and decreases outbound transportation, reducing SG&A per unit and decreasing delivery times for our customers, increasing conversion and decreasing marketing costs. This is also a good feedback loop. Competitively, we sit in a better position than we have at any point in our history. Through our own experiences and those of various companies who have sought to do something similar to us, the last few years have proven just how difficult it is to build a business this complex, drive it to scale, achieve strong unit economics, and deliver high-quality customer experiences. Building a business like Carvana is very hard, and hard is the ultimate competitive moat. Our addressable market remains an enormous opportunity. 40 million used cars are bought and sold on average each year. There are tens of thousands of car dealers offering customers similar experiences to one another with similar business models. Carvana offers a differentiated experience, supported by a differentiated cost structure and driving a differentiated business model. That differentiated model just delivered approximately $1 billion in annualized adjusted EBITDA, and we are still a long way from the full financial potential of our business model and its scale. With just 1% market share in this enormous, fragmented market, we are extremely well positioned. Today is an exciting day for Carvana. The size of our opportunity and the strength of our positioning are clear. Now it's our job to make sure we make the most of it. Our team is ready, and the march continues. Mark?

Mark Jenkins, CFO

Thank you, Ernie, and thank you all for joining us today. The first quarter was a milestone quarter for proving the long-term earnings power of our online retail model. We set company records on adjusted EBITDA and adjusted EBITDA margin. We achieved industry-leading adjusted EBITDA margin for the first time. We drove significant GAAP operating income, and we generated adjusted EBITDA that significantly exceeded capital expenditures and interest expense. Our results in Q1 were exceptional, but we also see significant opportunities to improve margins with scale and continued efficiency gains over time. We provide additional details on these opportunities in our shareholder letter. Turning to our first quarter results. We entered Q1 squarely focused on unit economics and profitability initiatives. Despite this focus, we saw strong customer demand, partly due to several fundamental gains in conversion and customer experience that we made over the preceding quarters. Retail units sold increased by 16% year-over-year and 21% sequentially, reflecting significant market share gains on both year-over-year and sequential basis. Revenue increased by 17% year-over-year and 26% sequentially. This unit and revenue growth was more than we targeted, given our continued focus on profitability initiatives entering the year. That said, our teams have handled it well and responded to increased sales while also demonstrating leverage on operations expenses. We are excited by this and believe there is more to come. Our growth in Q1 has had multiple impacts on our inventory. First, our results in Q1 demonstrated how efficient our nationally pooled inventory can be. In March, the average car we sold was only visible to customers on our website for 13 days before being purchased, nearing our all-time monthly low on this metric. Second, our inventory is currently smaller than we would like, resulting in less selection available to our customers. All else constant, we believe this is negatively impacting our sales volumes today. To respond, our teams have begun increasing production across the country. In the near term, our focus will remain on growing production to increase selection to more optimal levels for our customers. Our strong profitability results in Q1 were driven by meaningful fundamental improvements in GPU and SG&A expenses. In the first quarter, non-GAAP total GPU was $6,802, a sequential increase of $1,072 and a new first quarter record. Non-GAAP retail GPU was $3,211 versus $2,970 in Q4, a new company record. Our strength in retail GPU continues to be driven by fundamental gains and consistent performance in several areas, including non-vehicle cost of sales, customer sourcing, inventory turn times, and revenues from additional services. Non-GAAP wholesale GPU was $1,153 versus $881 in Q4. Sequential changes in wholesale GPU were primarily driven by more favorable depreciation rates and first quarter seasonality. Non-GAAP other GPU was $2,438 versus $1,879 in Q4. Sequential changes in other GPU were primarily driven by more normalized loan sale volume relative to originations, lower securitization credit spreads, and credit scoring and pricing optimizations, including credit tightening in Q4. Non-GAAP SG&A expense was $390 million versus $376 million in Q4. Q1 was an exceptional quarter for demonstrating the power of our model to leverage SG&A expenses. Retail units sold increased by 21% sequentially while non-GAAP SG&A expenses increased by less than 4%, leading to a nearly $700 reduction in SG&A expenses per retail unit sold. We continue to see opportunities for significant SG&A expense leverage over time as we scale. Adjusted EBITDA was $235 million in Q1, a new company record. This result included small, one-time headwinds that were larger than any one-time tailwinds. It is important to note that the change in fair value of our Root Warrants does not impact adjusted EBITDA. Demonstrating the quality of our adjusted EBITDA, we also generated $134 million of GAAP operating income in Q1, a new company record. As mentioned previously, in Q1, we generated adjusted EBITDA that significantly exceeded capital expenditures and interest expense. This milestone means that in Q1, we officially achieved the goal we set out in May 2022 to drive significant positive cash flow after interest expense. Moreover, we achieved this goal at 360,000 units of annualized volume, in line with our expectations. Given our strong liquidity position and operating results, we currently plan to pay cash interest on our 2028 and 2030 senior secured notes on both semiannual payment dates in 2025, reducing long-term cash interest expense and supporting our plan to deleverage over time. Turning now to our second quarter outlook. We expect the following, as long as the environment remains stable: a sequential increase in our year-over-year growth rate of retail units sold, and a sequential increase in adjusted EBITDA. This outlook does not anticipate any material one-time benefits or costs. With our strong results in Q1 and outlook for Q2, we expect to comfortably deliver on our outlook of year-over-year growth in retail units sold and adjusted EBITDA for full year 2024. To conclude, our team's strong execution has positioned us well to pursue our financial goals. When we focused our growth, we joined Amazon, Google, and Meta as one of the four fastest companies to join the Fortune 500. When we focused on profitability, we increased quarterly adjusted EBITDA by more than $500 million in under two years and catapulted to industry-leading margins. We are now focused on our long-term phase of driving profitable growth and pursuing our goal of becoming the largest and most profitable auto retailer and selling and buying millions of cars. We are excited about what's ahead. Thank you for your attention. We'll now take questions.

Operator, Operator

Today's first question comes from Rajat Gupta with JPMorgan.

Rajat Gupta, Analyst

Congratulations on an impressive quarter and significant improvement. I have a question regarding the first quarter results compared to the fourth quarter. I noticed unit growth was nearly 15% or even 20% sequentially. Was this increase mainly due to better selection and quicker deliveries, or did you observe any changes in the used car market that contributed to this stronger-than-usual pick-up? I'm interested in how you would characterize the first quarter's growth in relation to current industry trends. I have a quick follow-up as well.

Ernie Garcia, CEO

Sure. So let me start with this. I mean, I think we're still moving down in marketing dollars. Our inventory is clearly constrained. We put a stat in our shareholder letter that for cars to make it up on our website, they're being picked up by a customer in 13 days on average right now. So we're definitely constrained. And so I don't believe the best explanation of growth is one of these levers that's being pulled. I think potentially, a better explanation of growth is that it's a return back to the kinds of things that drove our growth for many years prior. We grew extremely fast from 2013 to 2021. There were probably many things going on there, but I think the two most important because they're most sustainable were, one, we deliver to customers the experience they love. It's highly differentiated and hard to replicate and one for which I think consumer preferences are constantly migrating toward. And I think, two, there's positive feedback in our business inherently. And I think over the last two years, through '22 and '23, that positive feedback was going the wrong way on us because we were shrinking inventory, shrinking marketing dollars, and really focusing on profitability. And I think over the last several quarters, that at least kind of the wins have gotten still. And so I think that's probably our best explanation. In addition to that, there have been countless improvements across the business. You're seeing many of those in the financial numbers. You can see our operating expenses going down; you can see our GPU going up. That's the result of a lot of work from a lot of teams where they focus on customer experiences and efficiency gains, just made little improvements over and over again for the last several years. And I think that drives better customer experience, it drives higher conversion, and it drives better economics. We think all of that is playing into what we're seeing today.

Rajat Gupta, Analyst

Got it. That's clear. In your prepared remarks, you mentioned plans to grow EBITDA margins from here. Is it fair to assume that the 7.7% is the target, even on a quarterly basis, or was that more of an annualized comment? I'm curious about how we should interpret this. You've provided guidance for the second quarter, but does that also indicate that margins are increasing sequentially and that EBITDA isn't the only metric seeing an uptick?

Ernie Garcia, CEO

Sure. Well, so I think we're going to stick with the guidance we provided. The guidance we provided for Q2 is in EBITDA dollars, and we expect it to go up. But then I think we can also provide some color. We provided a table in the shareholder letter that we hope is useful that quantifies three relatively straightforward extrapolations from our Q1 results to give some visibility into where we think things can go. And so those three changes were, one, we started with 7.7% adjusted EBITDA margin. We did actually undersell loans in the quarter versus what we originated. If we assume that we would have sold those loans at a similar premium, which would be our expectation to loans we sold in the quarter, that would have gotten us up to 8%. And then number two, we provided a data point where our average marketing dollars divided by revenue was 1.8% in the quarter. That's already close to our long-term model that we put out six years ago, where we expected to be between 1% and 1.5%. But if we look at our four oldest cohorts where we tend to have higher market shares and lower marketing spend, it was down to 1%. And we think that clearly lights the way to getting down to the low end of our financial model over time. And so that's 0.8%. And then you also saw in the quarter that we held our overhead expenses flat in dollar terms at approximately $150 million. That led to significant leverage on a per-unit basis, given the 21% sequential growth. If we assume that we grow into the excess infrastructure that we have across the business, we have inspection centers that we're ready to grow into; we have excess multi-car haulers as a result of our path over the last couple of years. We've got the market operations hubs to support significantly more growth. We think there's over three points of possible leverage there. That also leaves out the fundamental gains that we're continuing to work very hard on across the business in driving down operations expenses and driving up GPU, where all the teams that have done all this incredible work over the last two years have exciting projects that they're still working on today. So I think we look at all that, and we're extremely optimistic and excited about the medium term. We’ve got a lot of work to unlock all that value, but we’re working hard to do it.

Operator, Operator

The next question is from Chris Bottiglieri with BNP Paribas.

Christopher Bottiglieri, Analyst

It’s clear that you have impressive unit economics. I’m interested in how you plan to maintain this compared to reinvesting. Is there a specific level you aim for with over 3,000 retail GPU? Why is that the optimal level instead of going lower? Additionally, have you considered elasticity and what it might entail if you reduce some of the GPU to increase unit sales? I’m curious about how you view that trade-off.

Ernie Garcia, CEO

Sure. Well, first, this is our 29th call that we've done as a company after being public. And I think now after Rajat, we've got five great quarters. Your first comment was ambiguous. So would we qualify that as a great quarter or no?

Christopher Bottiglieri, Analyst

You could add me to that list.

Ernie Garcia, CEO

Thank you, I appreciate it. We're very excited and in a strong position. However, I acknowledge that we are currently a bit limited, especially in terms of inventory. As we've discussed over the last few quarters, we haven't been focusing on growth at this moment. Instead, we've concentrated on achieving the economic gains we're experiencing today. This has been part of a yearly plan that peaks in June. Most of our operational teams haven't prioritized growth; they've been maintaining a steady course and responding to the existing demand without actively pushing it from our customers. Moving forward, we need to start positioning the business for growth. We've been working to replenish our inventory, and an interesting statistic is that although our inventory is roughly flat and our sales have increased by 16% year-over-year, the cars we have reconditioned have risen by nearly 50%. This increase occurred because last year we were focused on reducing our inventory. Now, that part of the business has begun to ramp up, which is reflected in our current retail gross profit per unit, while also working diligently to support that 50% growth year-over-year. The rest of the business still has some catching up to do, particularly regarding inventory. Until we reach that point, our strategy is clear: we need to work hard to catch up and make appropriate adjustments as needed. Once we do catch up, we may have more options to consider, but we'll assess that when the time comes. We recognize that we're constrained, and if we had more cars available and increased capacity, we would be selling more, resulting in higher EBITDA.

Operator, Operator

The next question comes from Sharon Zackfia with William Blair.

Sharon Zackfia, Analyst

I'm not going to keep showering you with complements, so that's going to just end here. So I guess, two questions. On the GPU, it's obviously very, very good. And I know you've done a lot of work on reconditioning, you mentioned Carli in your prepared comments. Can you give us kind of any insight on where recon per car is all in today relative to maybe several years ago and how much more you think you can harvest in terms of efficiencies there? And then I have a follow-up.

Mark Jenkins, CFO

Yes. I can hit that. So I think recon is one of the places where we've made very significant gains. I think we've talked a bit before about some of the gains relative to 2021. And there, we are down hundreds of dollars relative to where we were in full year 2021. So there's been some meaningful gains there. That is a significant reduction in per unit cost, while overall cost inflation and wage inflation around the industry and economy has generally led to higher costs. And so that's really just technology-driven efficiency gains, process-driven efficiency gains, and the result of a lot of the efforts that we've made over the last couple of years. So I think we feel really great about that, and that's absolutely part of the strength in retail GPU. Ernie also hit on, I think, a stat that we’re feeling really good about, which is we are ramping production now to respond to demand. And we're not seeing those costs tick up. And so I think that’s something that also speaks to the quality of the technology, the quality of management, and the teams out in those inspection and reconditioning centers. I think that some commentary on where we are and where we've been. In terms of where we can go, we absolutely see opportunities to further drive down per unit reconditioning costs. I think that takes a couple of forms. One is simply continue to pursue further efficiencies through technology and process improvements, and I think we see opportunities there. I think we also see some opportunities as we start to scale into this infrastructure to get some fixed cost leverage on the cost of sales side as well. That's not nearly as large as the fixed cost leverage that we hope to achieve in the SG&A part of the business, but we see some opportunities there as well as it relates to recon.

Sharon Zackfia, Analyst

I guess the follow-up is in the shareholder letter. There was a lot of commentary around ADESA and your original vision there, which obviously was maybe deferred a bit just given the cash reality that you faced for the last 18 to 24 months. So how do we think about that vision coming to fruition in terms of timing? I mean, when will we start to see ADESA sites start to convert to something more meaningful where you can harvest efficiencies from them?

Ernie Garcia, CEO

Sure. Well, let me take that one. I want to start with this. I think something that's very important to the success of the business today and to us achieving kind of best-in-industry EBITDA margins this quarter is that we do have a large network kind of underneath all the things that we do. That's the network of reconditioning centers, it's a network of long-haul logistics, it's a network of last mile logistics to deliver cars to customers and pick them up. And so ADESA is already playing a very important role there. We've got 30 of the 56 ADESA locations where we have last-mile logistics, including buying cars from customers, picking them up, and sometimes customers dropping them off, delivering cars to customers. And then we've got 9 of these locations where we have multi-car haulers that are able to kind of run their logistics routes through those locations, making us more efficient across the country as a business. And then we've also now begun to develop this playbook of adding Carvana reconditioning at the Buffalo site, which we're very excited about because that's something that we think unlocks approximately 2 million units of reconditioning capacity across those ADESA sites as we roll that out nationwide. And so I think that's very foundational, right? It is very difficult to get many sites that are large enough to run our business at scale and to get them zoned and appropriately located across the country. That may not sound hard from a distance, but it takes a lot of time. So I think it's already showing up in the Carvana results. And then I think the ADESA team is also doing a great job, and that core business of ADESA, the wholesale business is also going very well. And then I think we're also mutually benefiting from kind of the vertical integration of us being able to buy more cars from customers and then sell them at their locations, which has positive feedback for the auction business and removes auction fees for us. So I think there's a lot of great stuff that's happening there. And I do think it’s a big part of our story as we move forward in time because it is very hard to build a business like this without a very large network underneath it that powers it.

Operator, Operator

The next question comes from Chris Pierce with Needham.

Christopher Pierce, Analyst

Just following up on that. Is there anything specific about the ADESA Buffalo site that allowed you to pick that one first? Like how repeatable is that playbook with the other 56 sites that are out there? How many of these mini IRCs could you pop up to kind of strengthen the network that you spoke to?

Ernie Garcia, CEO

There are a number of reasons we picked that site. I don't know if we want to dive into all those in detail, but I think the absolute belief is that it is repeatable across the majority of ADESA sites. We felt like that was a good place to start for a number of reasons relating to both ADESA and Carvana's needs.

Christopher Pierce, Analyst

Okay. As a follow-up, can you explain what growth looks like moving forward? I understand you're planning to increase production by acquiring more cars from customers to have more vehicles available. Do you need to hire more technicians, or are you simply utilizing the excess capacity you currently have, or perhaps adding a second shift? What does growth truly entail from this point onward?

Ernie Garcia, CEO

I believe it's important to clarify what growth looks like. Let's examine the growth we experienced from 2013 to 2021. During that time, we grew rapidly, especially in 2019, where we achieved a 100% year-over-year increase in units. As a company scales, achieving such growth becomes more challenging, but we managed to expand significantly. Throughout this period, we focused on enhancing our operational capabilities. This included establishing reconditioning centers, purchasing and zoning land, managing construction, and training teams for reconditioning. We also improved logistics and customer care, which required collaboration from various operational teams. Today, I feel optimistic about our medium and long-term prospects. The business has become much more efficient compared to our growth period up to 2021. For instance, in market operations, about 50% of our activities are paired, allowing customer advocates to pick up cars while delivering others. This capability, which was below 30% a year ago, is complex but adds significant value. Additionally, we've reduced total miles driven in our logistics network by about 30% compared to a year ago, resulting in less logistical work for each transaction. Our sales per advocate have increased by 61% year-over-year, indicating greater efficiency. In title registration, we've more than doubled our efficiency per person compared to the previous year. From a growth perspective, we're in the best position we've ever been. Our infrastructure is fully developed now, unlike in the past when we had to build it as we grew. Currently, we have excess infrastructure ready to use. Financially, we have higher overhead expenses per unit than during our previous growth phase, but with larger gross profit margins and low variable costs, our contribution margins are high, and we are effectively leveraging fixed costs. Given our current financial situation and unit economics, the risks appear to be lower. We've termed this time a transition period, during which we've focused on enhancing efficiency over the past two years. Each segment of the business is engaged in exciting projects with significant potential for gains, and we're aiming to balance these efforts. This transition period is about finding the right balance. While we are ambitious, we understand that moving through this transition thoughtfully will allow us to make the best decisions about the pace of our growth. We are enthusiastic about the future.

Operator, Operator

The next question comes from Seth Basham with Wedbush Securities.

Seth Basham, Analyst

Congrats on the outstanding results. The conversion is just popping here. Are there one or two things that you can point to that are really driving this increased conversion over the last quarter or so?

Ernie Garcia, CEO

The simplest explanation for this is that as we improve, our customer experiences become simpler and faster. From a cost perspective, we have 60% more sales per advocate than we did a year ago, which also means customers have fewer touch points. They are less likely to call in, and when they do, they receive better, quicker information, allowing us to avoid unnecessary back and forth. This indicates that our business is becoming simpler. Many of the expense improvements we have made in the last two years have also contributed to simplifying the customer experience. Our Net Promoter Score has steadily increased over the past 18 months, which is encouraging, and we will keep striving for further improvements. Additionally, during a two-year period of reducing inventory and marketing, we encountered some negative feedback, so stabilizing that situation has also been beneficial.

Seth Basham, Analyst

That's helpful perspective. And then my follow-up, just on gross margins. You talked about them being at 19.1% about the long-term range. Obviously, there's some seasonality, but do you think that you can sustain or even drive gross margins higher than that long-term goal over time?

Mark Jenkins, CFO

Sure, I'll take that one. In the shareholder letter, we lay out several places where we see opportunities for fundamental gains in gross profit per unit or gross margin. Those gains take a number of different forms. One is we definitely don't think we're done on costs. So in response to Sharon's question earlier, we see meaningful opportunities for reductions in reconditioning costs from here, both due to technology and process-driven efficiency gains as well as scale components. Additionally, we see opportunities to make further gains on inbound transport costs over time. Ernie touched on this with some of his comments about adding more reconditioning centers, including at ADESA. That gives you more production locations, which reduces your inbound shipping miles, and therefore, your inbound shipping costs. On the sales side, we see opportunities to continue to drive our wholesale vehicle business. Our teams are working on fundamental gains in these areas, and those same teams see more opportunities looking forward from where we are today. So even though we're experiencing exceptional results, we still see opportunities for fundamental gains across all those different areas that the teams will pursue.

Seth Basham, Analyst

With that response, does that mean you'll address your long-term margin expectations at a later point in time?

Ernie Garcia, CEO

It’s been almost six years since we had the Analyst Day. Obviously, we're making great progress toward the long-term model we laid out at that time with our 7.7% adjusted EBITDA margin in Q1. We haven't given any plans for an Analyst Day in the future, but that’s something we could pursue at some point in the future.

Operator, Operator

The next question comes from Michael Montani with Evercore ISI.

Michael Montani, Analyst

Just wanted to ask, if I could, around two things. One was just around the capital stack. If we should be surprised if there's an equity raise coming down the pipe? Or if you think at this stage, it's more about improving EBITDA and delevering the balance sheet gradually in that way? And then I had a separate question on vehicle pricing.

Mark Jenkins, CFO

Sure. Yes. So I'd say for the last couple of years, in response to questions about capital structure, we've focused on operating results. Talking about how driving positive adjusted EBITDA first and then driving significant adjusted EBITDA from there was our key focus. That focus has paid significant dividends here with record adjusted EBITDA in Q1 and a very big adjusted EBITDA number in Q1 that exceeds our capital expenditures and interest expense. Continuing to drive adjusted EBITDA means all of your capital structure metrics look better and better over time as you continue to improve operating results. That's certainly going to be our #1 focus. As for financial aspects of the capital structure, we plan to pay cash interest on our 2028 and 2030 senior secured notes. Those notes are eligible for cash interest in 2025. So our plan is also to pay cash interest on both of those notes in 2025, which reduces overall debt outstanding and also long-term cash interest expense. We've heard many questions about our capital structure over the past couple of years, including serious inquiries at earlier points in time. But I think this quarter resoundingly repositions us as it relates to those questions. I mean, $235 million of adjusted EBITDA, an outlook for an increase in adjusted EBITDA dollars looking towards Q2, and we see opportunity ahead based on our excess capacity, customer offering, and customer demand for our product.

Michael Montani, Analyst

Okay. Got you. And then just on the pricing front. I just want to see how you think about the potential opportunity with respect to unit growth in the sense that when I look at the website and do my own pricing surveys, at times, I'm noticing you guys above KBB fair pricing. I'm just wondering, with GPUs above your target, if you would consider flexing a little bit on GPU, either with more aggressive offers to bid up cars when you're buying or potentially to push more units to get to 2 million-plus units more quickly?

Ernie Garcia, CEO

Sure. Let’s start with this. I think we keep track of millions of cars that are listed across many different websites all the time to ensure that we have a good sense of our vehicle pricing and how it compares. And I think over the last few years, our offering versus both larger competitors and just against the market has been very stable over time. So we've generally held that pretty consistent. I think that’s the right first order assumption from here, especially given the constraints. Over time, as we continue to improve, there’s no question that there are opportunities there, but that's not something we're planning on right now.

Operator, Operator

The next question comes from Adam Jonas with Morgan Stanley.

Adam Jonas, Analyst

We see Ernie, I told you everything would work out.

Ernie Garcia, CEO

You did. From the very beginning, you never doubted us and we appreciate it.

Adam Jonas, Analyst

Never, never for a minute. I mean your margins are like twice CarMax, and you're doing like a third of their volume, so it's a good start. It's a good start. So I'm going to ask Michael Montani's question a little differently. There's still a lot of economic uncertainty. It seems like the Fed might have overplayed their hand and talk of stagflation and just an uncertain time. So I'm wondering, do you feel that you have enough equity in the business right now? And remind us how you think about longer-term leverage targets for the business.

Mark Jenkins, CFO

Sure. I think the simple answer to the first part of that question is, I think we have ample liquidity, and the business is generating strong EBITDA and cash flow today. I think we feel great about that structure. As I talked about earlier, we do intend to deleverage over time. A component of that, which we mentioned on the call earlier, is we plan to pay cash interest expense on both eligible sets of notes in 2025. That reduces overall debt outstanding relative to paying in kind and reduces long-term cash interest expense. So there have been many questions about our capital structure over the past couple of years, including serious inquiries at earlier points in time, but I think this quarter has positioned us as it relates to those questions. With $235 million of adjusted EBITDA and an outlook for an increase in adjusted EBITDA dollars heading into Q2, we see big opportunities ahead.

Adam Jonas, Analyst

As a follow-up, there's a saying that what doesn't kill you makes you stronger, and this quarter seems to support that idea. Additionally, what doesn't kill you makes you wiser. Now that you're returning to growth, Ernie, in this more modest phase after your challenging experience, what are you paying attention to? What concerns you at night regarding potential complacency, whether it's things within your control or those beyond it?

Ernie Garcia, CEO

Well, first of all, you made an assumption in that question, which is not obviously true, but we'll assume that it is. I would say, listen, we're extremely excited. If we go back to the very beginning, what do we want to do? We wanted to build a business that we thought was going to require a ton of work to deliver great customer experiences, give them a better, simpler experience, and drive industry-leading economics. It feels good to be in a spot where we feel like there's a strong argument to be made that those boxes are checked, and now our job is to build this thing to be as big as we possibly can. The last couple of years have been brutal, but they have cleared the competitive field significantly. We’re positioned from an infrastructure perspective, and so forward growth looks good. The transition period is about finding the balance between that enormous opportunity and making sure we continue to execute very well. We will be debating internally over the next several quarters, but we’re excited about growth prospects.

Operator, Operator

The next question comes from Doug Arthur with Huber Research Partners.

Douglas Arthur, Analyst

Ernie, you covered this in several ways, but you indicated that unit sales are expected to be slightly higher in the quarter. Your marketing expenses were well managed. So what led to the unexpected increase in units? I've got a follow-up question.

Ernie Garcia, CEO

I think there’s a series of things. I think the units came in stronger than we anticipated. It starts with demand moving in our direction, and then the team executing very well despite not anticipating it. There’s no getting around inventory shrinking when demand comes in a little hotter than expected. However, the team made quick adjustments. So I think that enables us to handle growth pretty well, and that excites us. We believe that bodes well, but we know we have work to do to get the business into a position for sustained growth at high levels, and that what the transition period is all about.

Douglas Arthur, Analyst

Excellent. And then, Mark, just to be super clear here in terms of your guidance, you're seeing a sequential increase in the year-over-year growth rate in retail units. I mean seasonally, generally, you have flat to slightly down units Q2 over Q1. So you're saying the growth rate will be up from the first quarter.

Mark Jenkins, CFO

That's correct. The year-over-year growth rate will be up in the second quarter compared to the first, and we'll also do more adjusted EBITDA sequentially.

Operator, Operator

The next question comes from Ron Josey with Citi.

Ronald Josey, Analyst

Ernie, I wanted to ask a little bit more about sources of leverage and advertising specifically. I thought the commentary in the letter around the four oldest cohorts achieving 1% of advertising expense as a percentage of revenue was pretty telling, especially as you're just seeing pretty good growth come back here. So I just wanted to get your thoughts as you think about go-forward and sort of the brand recognition and awareness of Carvana, just how do you think about advertising spend going forward strategically? That's question one. I've got another one, which might be a little bit easier, I might have missed earlier. But I think I heard capacity for 1.3 million units per year across the IRCs and ADESA about 3 million units annually. Mark, I go back to the Analyst Day, however many years ago about that 5% share goal. Do we have enough capacity now? Or did I hear that maybe more IRCs might be on their way or just more efficient ones?

Ernie Garcia, CEO

Sure. So let's start with marketing spend. I think from here, there are two forces on marketing spend that point in different directions. I think as we continue to make fundamental gains, we believe there's reasons to drive that down as our newer cohorts of markets age and act more like older cohorts. And then we also believe that if we were not constrained, we’d see higher conversion from existing customers, likely making marketing dollars more manageable. I think there are several forces that we'll be actively working on. On the footprint side, just to clarify, at our existing inspection centers, we have a capacity for 1.3 million units, and when you add the ADESA sites, you get to approximately 3 million in total. However, these ADESA sites still need CapEx to unlock their potential capacity. We sized that at the time of the acquisition at about $1.2 billion, which we still think is a good way to think about it.

Operator, Operator

The next question comes from Nick Jones with Citizens JMP.

Nicholas Jones, Analyst

Sorry if I missed this. But in the past, and you were growing rapidly, you might hit some choke points that you would need to work through. As growth accelerates here, are those choke points potentially still out there as growth accelerates? Or how should we think about some things that may need to get worked through?

Ernie Garcia, CEO

I think the short answer is yes. Growing is always hard. We tried to give an outline for why we think we’re very well positioned for growth in the future from here and in many ways, better positioned than we were in the past. That said, of course, there will be difficulties as we head back into growth and growing pains. However, I believe we’ll execute well and push through those pains, and we have a lot of fundamental gains to offset them. We feel extremely good about the real-world opportunities in front of us.

Operator, Operator

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

Ernie Garcia, CEO

Great. Well, thank you, everyone, for joining the call. We really appreciate it. To the Carvana team, we say this at the end of every one of these calls, but thank you guys so much. You've done an absolutely incredible job. This was virtually impossible to foresee. This quarter is probably the hardest one to foresee from the perspective of a couple of years ago. We've been through tough times together, and I think there will undoubtedly be a lot of good days in front of us and a couple of bad days. I believe if we keep grinding as we have in the last couple of years, there will be a lot more good days than bad days. When we see those bad days, we know how to face them. I cannot thank you all enough. You've done an incredible job. Please be proud and keep fighting like it’s 2022 because that is what got us here. Thanks, everyone.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your line, and have a great evening.