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spk05: Hello, and welcome to the Caravana Second Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then 1 on a touch-tone phone. To withdraw your question, please press star, then two. Please limit yourself to one question and one follow-up. Please note, this event is being recorded. I would now like to turn the conference over to Mike Levin, Vice President of Investor Relations. Please go ahead.
spk08: Thank you, MJ. Good afternoon, ladies and gentlemen, and thank you for joining us on Carvana's second quarter 2022 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 second quarter shareholder letter is also posted on the IR website. Also, we posted a set of supplemental financial tables for Q2 to assist investors in understanding the moving pieces this quarter with the consolidation of ADESA, and we've updated our operating plan deck to reflect the addition of ADESA. Both 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, and they cause actual results to differ materially from those discussed here. A detailed discussion of the material factors that cause actual results that differ from forward-looking statements can be found in the risk factor section of Carvana's most recent Form 10-K and Form 10-Q for the first quarter of 2022. 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. Unless otherwise noted on today's call, all comparisons are on a year-over-year basis. Our commentary today will include non-GAAP financial measures. Reconciliations between GAAP and non-GAAP metrics for our reported results can be found in our shareholder letter issued today, a copy of which can be found on our investor relations website. And now with that said, I'd like to turn the call over to Ernie Garcia. Ernie?
spk12: Thanks, Mike, and thanks a lot for joining the call. The second quarter was probably the most dynamic quarter we've had at Carvana. We shifted our priorities for the first time in company history to favor efficiency and cash flow in recognition of the changes to the market and the economic landscape, as well as to enable us to quickly adjust to changes in our industry that had caused our expenses to be out of balance with sales volumes. We also complete our acquisition of Adessa in a transaction that we believe will be transformative over time. First, I want to hit our change in priorities to favor efficiency and cash flow. We began to make the biggest changes inside the company in May. These changes have been significant. They've resulted in prioritization shifts across every group in the business. They've resulted in the creation of new processes to increase focus and drive progress on these priorities. While it is early in the execution of our plan, this is going very well so far. At Carvana, we've always set high standards for ourselves, and I think it's one of the reasons we've been pretty successful so far. In the long run, the ability to keep pressure on ourselves is probably one of the greatest differentiators in how groups of people perform. But there's no substitute for the focus and motivation provided by market and economic disruption. Everyone feels it. And difficulty reveals people. What is revealing about the people of Carvana is something I already knew and something I can't thank them all enough for. The people of Carvana care, and they don't shy away from a challenge. They're fighters. The people of Carvana are focused in making faster progress than we have made at any point in our history. They're working hard, but they're finding the fun in it, and they're making change they're proud of. And as a result, we are rolling out new capabilities, products, and processes at an incredible rate. Our plan is to continue until we reach our goals. This drove a lot of progress in the quarter in a short period of time. We grew units sequentially by over 10% and reduced total SG&A by 5% at the same time, causing us to drive cash SG&A down per unit by $850 in the quarter to $5,400. We set a stretch goal to hit 4,000 cash SG&A per unit in the fourth quarter, excluding impacts from EDESA. This is going to be a hard mark to hit, but so far we're on the path. From there, we will continue to our midterm goal of 3,000 per unit. We will keep pushing. We also drove up GPU by $500 in the quarter to $3,400. We provided some bridges back to $4,500 and beyond in our shareholder letter. The biggest thing separating us from climbing back to that level is execution. We'll be pushing here as well. Now turning to the ADESA acquisition. We were excited about joining forces with ADESA when we completed the deal. Now that we've begun working with the team, we are more excited. First, I want to give credit to the Odessa team. They've embraced us in a way that we couldn't have reasonably expected. They are a fun group of warm people who are enthusiastic about doing right by their customers and about finding ways to do even better. On a personal level, it has been fun to meet so many people inside the company to learn from them and to see how interested they are in learning from us. Our alignment is leading to extremely fast progress in our integration. We already have over half the cars we buy from our customers that we plan to sell through the wholesale channel landing at 46 Odessa locations nationwide. We've already embedded market operations hubs at 18 Odessa sites. Odessa is already reconditioning over 500 cars a week in locations that complement our existing IRC footprint, primarily on the coast. In addition, we have also already deepened our relationship with Hertz in ways we couldn't have without ADESA. Over time, we expect ADESA to dramatically increase the scale and customer proximity of our inspection center network. We expect it to strengthen and simplify our logistics capabilities, and we expect to find cost savings and revenue opportunities that wouldn't be possible without our combined capabilities. We still have a long way to go to complete our integration, and this is another area where we will continue to push. Now I'd like to turn to what we're thinking about the near term. We are going to maintain our current priorities for the foreseeable future to drive efficiencies that we believe serve our short- and long-term goals best in this environment. While we continue to expect to rapidly gain market share, our shift in focus means growth in units and revenue will be slower than it otherwise would be in the short term. We also don't know exactly what to expect from industry-level sales in the near term in light of everything going on in the economy. In July, for example, there was another industry-wide reduction in demand levels, which has impacted us as well. We have meaningful latent demand and several levers to drive growth, which we will begin to pull over time, but the speed that we pull those levers will be driven by the progress we are making in our higher priorities. In more difficult times, people tend to get more nearsighted. There are good reasons for this. There is value in dialing into important cost fundamentals to get less attention in easier times. And as you can see from our priorities, we are focusing more on fundamentals in this environment as well. That said, it is still important to maintain awareness of the mountain we are climbing. Through a long-term lens, Q2 has the potential to be one of our greatest quarters. It serves as a catalyst to put more focus on driving efficiency. This was something we were going to do at some point anyway, and the environment has provided pressure that we will use to make progress faster than we likely would have otherwise. Our visibility to much higher volumes means high. On the demand side of the equation, we continue to take market share in this environment, and the market shares we have in our most mature cohorts provide a clear map to growing volume dramatically. In addition, previous periods of economic strain have accelerated consolidation in our industry. On the supply side, the acquisition of ADESA is a game changer. Simply put, execution is all that separates us from millions of sales per year. From a GPU perspective, our bridge back to 2021 levels is straightforward. And from there, opportunity remains. SG&A has been and remains our biggest opportunity. We have a clear plan. That plan is being aggressively executed against with concrete goals in every group of the company. And we have the historical performance we have seen in our more mature cohorts as proof points. We remain firmly on the path to achieving our mission of changing the way people buy cars and of becoming the largest and most profitable automotive retailer. The march continues. Mark. Thank you.
spk11: Thank you, Ernie, and thank you all for joining us today. We made significant progress in Q2 on many fronts. We closed our acquisition of Odessa. We set clear operating priorities focused on reducing SG&A expense and driving toward positive free cash flow. And we made significant sequential progress on our key metrics, despite facing continued macro-related pressures and working through internal constraints. In Q2, retail units sold totaled $117,564, an increase of 9%. We gained significant market share in Q2 despite the impact of high used vehicle prices, rising interest rates, and other economy-wide factors on our industry. Total revenue in Q2 was $3.884 billion, an increase of 16%. Total revenue included $108 million from our acquisition of Adesys Wholesale Marketplace, which closed on May 9th. Total gross profit per unit in Q2 was $33.68, a decrease of $17.52 year-over-year, and an increase of $535 sequentially. Due to the dynamic nature of the current environment, we will focus our more detailed commentary on sequential changes. Retail GPU was $11.31, in Q2 compared to 808 in Q1, a sequential increase of $323. Retail gross profit included a $51 per unit impact from Ernie's 1 million unit milestone gift to Carvana employees and a $34 per unit impact from our May reduction in force. Excluding these impacts, retail GPU in Q2 was 1216 compared to 884 in Q1. Sequential changes in retail GPU were primarily driven by higher spreads between retail sales prices and acquisition prices. Retail reconditioning and inbound transport costs were similar in Q2 and Q1 as we primarily sold vehicles in Q2 that were reconditioned prior to our cost efficiency initiatives. Wholesale GPU was $383 in Q2 compared to $219 in Q1, a sequential increase of $164. Sequential changes in wholesale GPU were primarily driven by a $43 impact from the Odessa wholesale marketplace, net of $128 of depreciation and amortization expense, as well as increased spreads between wholesale sales prices and acquisition prices. Other GPU was 1854 in Q2 compared to 1806 in Q1. Sequential changes in other GPU were primarily driven by higher customer rates relative to benchmark interest rates, partially offset by wider credit spreads and a change in loan sales channel mix. Looking toward Q3, we expect to sell loans in the whole loan sales format, but will maintain flexibility to optimize our channel mix as the quarter progresses. We made significant progress reducing SG&A per retail unit sold in Q2, with SG&A per unit excluding depreciation and amortization, share-based compensation, and ADESA declining by $942 compared to Q1. We expect to make continued progress on reducing SG&A expense in the coming quarters as we continue to focus on operating efficiency across all areas of the business. Adjusted EBITDA margin in Q2 was minus 6.2% compared to minus 10.2% in Q1, an improvement of four percentage points. Adjusted EBITDA excludes impacts from earnings gift of personal stock to Carvana employees, as well as other income and expense, which primarily includes changes in the fair value of securities. But it includes non-gift share-based compensation and expenses related to our May reduction in force. Adjusted EBITDA also included a minus $2 million impact from the acquisition of ADESA, inclusive of $3 million of one-time expenses and the reallocation of $2 million of gross profit generated from Carvana Business that was internalized following the acquisition. Following quarter end, we began implementing changes that we expect to positively impact EBITDA contribution from ADESA by approximately $7 million per quarter by later this year. As a result of the way the teams have come together, all we have continued to learn about the Odessa business, the rapid progress we are making in integration, and the long-term opportunity that exists between our two companies, we are as excited as ever about our acquisition of Odessa. On June 30th, we had approximately $4.7 billion in total liquidity resources, including $2.7 billion in cash and revolving availability, and $2.1 billion of unpledged real estate and other assets, including approximately $1 billion of real estate acquired with Edessa. We also ended the quarter with approximately 1.2 million annual units of inspection and reconditioning center capacity at full utilization, giving us substantial infrastructure for future growth. This strong liquidity position, our significant production capacity runway, and our clear and focused operating plan positions us well on our path to achieve our goal of driving positive cash flow and becoming the largest and most profitable auto retailer. Thank you for your attention. We'll now take questions.
spk05: We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then 2. Again, please limit yourself to one question and one follow-up. You may always return to the queue. At this time, we will pause momentarily to assemble our roster. Our first question. comes from Zach Fatum of Wells Fargo. Please go ahead.
spk02: Hey, good afternoon. Ernie, at the current level of 8,000 to 9,000 cars per week, should we view this as a fair characterization of demand for your business today or more so a level that you're intentionally managing to as you shift the focus to profitability? And assuming it's the latter, Can you talk about the level that units need to re-step up to in order to achieve the stretch SG&A per unit goal in Q4?
spk12: Sure. So let's start with where units are. I think in the second quarter, we grew units by 9% at a time when the market was probably shrinking by around 15%, give or take. So when you look at that, I think we did continue to take market share. It's certainly at a slower rate than we historically have, but but still at a pretty fast rate when you kind of really stop and take in. So I think that that's something to be happy with in light of the circumstances. We have obviously changed our focus quite a bit, and that has real impacts. When we think about year-over-year growth rates, a year ago, everyone across every group inside Carvana had their number one priority, just driving growth. Today, their one priority is driving efficiency, and that has all kinds of impacts. We talked about the logistics network, for example, in the shareholder letter that gives some examples, but there are examples like that everywhere else. And so I think there's certainly some impacts that are happening when you think about it from a year-over-year basis. I think when you look at it sequentially... I think there's some impact there as well that take the same form in terms of the shift of focus. We decrease our marketing budget by about 15% quarter over quarter. That was certainly from elevated levels in Q1 that we're not interested in sustaining. But nonetheless, it's a 15% reduction in marketing spend quarter over quarter. That's going to have something of an impact all of a sudden. We've also been purposeful about managing our inventory down. So from peak to more recent, we probably have around 20% fewer cars that are visible for our customers today than we had recently. Again, all else constant, that would put a bit of a headwind on growth. So I think we're making the choice today that we think enable us to drive efficiency as quickly as we possibly can, and we think that's the right thing to do for the business, and we're making a lot of progress as a result, and that's the way that we're prioritizing things. i think when we think about kind of what the opportunity is long term i think you know honestly it's the exact same way we would have thought about it six months ago or 12 months ago i don't think there's really anything different you know we have years and years of history across hundreds of markets of continually gaining market penetration and i think extrapolating off that's not super hard and then even in this environment with a focus change we continue to take market share so i think from a long-term perspective we don't really look at it differently and i think you know we're certainly um you're reducing the speed at which we're growing today given the shift in focus But our hope and belief is that by getting more efficient, it makes it easier to grow faster in the future because you have kind of less work to do per sale. And so, you know, we'll hope to get that back over time at some point. I think when we look to our goals, you know, there's kind of two ways that we can make progress toward, you know, 4,000 cash SG&A ex-ADESA. I think one is just general progress in the business and driving more efficiency, and one is certainly getting more units so we can have more units to have our fixed cost flow over. And I think both are very powerful. The first is probably sufficient to get to that goal. It's probably insufficient to get to that goal in the fourth quarter. So without growth, you'd probably expect that to push out further in time. We don't want to, I think, specifically give thoughts on exactly what we expect growth to be as we head through the next couple quarters, but I think our expectation of stretching to get that $4,000 goal, it does have gains in both areas, but the primary focus is efficiency throughout the business.
spk02: Got it. That all makes sense. And in terms of your SG&A run rate in dollars, it looks like the primary step down sequentially was was pretty much all advertising. And as you look to Q3 and Q4, can you walk through how the reduction in force impacts the comp and benefits line, and maybe pinpoint specifically how the SG&A dollar decline should trend from here, and then what the synergies from ADESA, you know, for the logistics or market occupancy lines, how those flow in as well?
spk11: Sure. So I'll hit that one. So I think our, you know, just as a starting point, we did see pretty meaningful SG&A dollar savings in Q2 relative to Q1. I do think those came across multiple buckets, including, you know, I think, you know, total payroll declined by, you know, on the order of $20 million. Advertising came down by on the order of, $25 million, slightly less. Other SG&A also declined. So we did see declines across multiple buckets looking from Q1 to Q2. And I think that's due to all the things that we've talked about around looking to drive efficiencies. Certainly the reduction in force impacted the payroll number. But I do think we're seeing gains across multiple areas of the business. One number that stepped up from an SG&A spend perspective was logistics in Q2 relative to Q1. I think a big portion of that step up was related to logistics. third-party transport services that we used in q2 to work to clear certain backlogs out of out of the logistics network in areas that were particularly constrained and so you know that's something that's an expense that we bore in q2 but don't expect the bear to nearly the same degree in q3 and So that's one particular example. You know, as we're looking out over the rest of the year, we really do see opportunities across all areas of the business that continue to drive SG&A efficiency. And so, you know, we will be looking to do that across the business. Some of the bigger buckets, I do think, you know, continuing to match staffing levels to volume, I think, you know, would be one of the bigger ones there. But we do see many opportunities. Overall, I would say, you know, obviously we're very pleased with our progress on SG&A per unit in Q2, bringing it down by on the order of $1,000 quarter over quarter. We're excited about the progress that we hope to make from here.
spk05: The next question comes from Sharon Zaxia of William Blair. Please go ahead.
spk04: Hi. Good afternoon. A question on reconditioning and inbound transport. I know it was kind of similar earlier. and the second quarter, the first quarter, and there's obviously a timing lag here. But, you know, given the work you've done, where is that running now in terms of improvement? I'm assuming on cars reconditioned today and transported today, it's no longer a $600 delta. And then secondarily, I just wanted to, as you shifted focus as a company to cost, how have you changed, like, the incentive structure within the organization?
spk12: Sure, I'll try to take those and then feel free to jump in if you'd like, Mark. So I think first with kind of COGS expenses, we really started to make a lot of these changes in the middle of May. And so that's obviously going to take some time to then flow all the way through to sales, which is when we'll see that in June. in retail GPU. We're making a lot of progress in those underlying expenses, just like we are in SG&A. And so those will show up over time. We expect to continue to make progress there. And then the SG&A kind of flows through immediately as you get the progress, whereas the COGS benefit, you make the progress, and then you have kind of a time lag until you sell the car, and then it flows through. So there kind of is a delay there. And again, those kind of cost reductions really just started over the last month and a half. In terms of focus inside the organization and incentive structure, I would say in many ways it's similar. It's just the projects that we're pulling off the wall are different and they're cost-focused instead of being growth-focused. I think we have implemented a number of different processes that we're finding really efficient inside the company. Not to dive into too much detail, but across every group in the company, we've got very clear projects. We're doing, I think, a better job than we have in the past, narrowing our focus on those that are most likely to make the biggest impact the fastest. We've got every group meeting together on Monday and reporting the progress against expectations every single week. On Tuesday, we're getting all of our operational groups together, and we go through how each group is performing relative to other groups internally so we make sure that we can take full advantage of internal benchmarking. And then, obviously, a lot of work is happening the rest of the week as well. And so I think, you know, really it's more about the projects that we're pulling off the board. We've always had a lot of areas that we wanted to work on. It was just a question of what we prioritized. And so I think our priorities have changed, but I think we've also implemented some processes that have driven additional focus on and attention and accountability and speed. And I really do think the results of that so far have been pretty great. Yeah, I think just it's hard to put this in a model, but we have a project that we rolled out, for example, the last couple of days. and just kind of sitting in the room with the team as that was rolled out. And there were people across many different offices on a Zoom call with 50 people going back and forth talking about the statistics in real time of how this new product was working. It was really cool to see. And you could see on everyone's faces there was just a lot of pride in what they had built and that they had built it fast and rolled it out quickly. And like I said, that's a hard thing to put in a model, but it's probably the most valuable thing over time because that just compounds over and over again. And I do think that You know, as we've gone through this change of focus, the people inside Carvana have done an unbelievable job embracing that, getting excited about it, and then pushing very hard. And I think that the enthusiasm and speed at which we're getting things done is something that I'm extremely excited about and grateful to the team for.
spk05: The next question comes from Michael Montani of Evercore ISI. Please go ahead.
spk01: Hey, thanks for taking the question. So first I was just hoping if you could give some incremental color around the consumer in terms of maybe what you're seeing in demand trends for high income versus lower income, and then also if there's any impact in terms of credit availability and or, you know, ASPs of the vehicles that you're selling, if there's kind of a noteworthy divergence in trend there for high versus low price tag units.
spk12: Sure. I don't know if we have anything too interesting to share here versus what we've shared in the past or what you might expect. But I think in general, the trends are as you'd expect. I think we're seeing higher incomes in general kind of fare a little bit better in this environment. Higher FICOs in general fare a little bit better in this environment. All is constant. That's leading to higher purchase prices. It's leading to You know, differences in, you know, mix and attach rates for finance and products like that. So, I mean, I think the impacts that we're seeing are probably those that you'd expect. I think, you know, from a credit perspective across, you know, automotive, I think in general, most finance companies continue to see pretty strong performance. I think there's, you know, been a slow drift back to more normalized 2019 levels off of kind of what was absolutely exceptional performance in 2020 and 2021. So I don't think there's anything too notable happening there just yet. And so, yeah, I think, you know, the only other notable thing is this is a large ticket purchase. It's a purchase that is financed. It's discretionary. I think historically it has oftentimes been a purchase that leads the economy. And then it also kind of uniquely in this environment, you know, it's driven by kind of the complexity of OEM's global supply chains. This is probably one of the products that has inflated the most in terms of price relative to all other products in the economy. And so it's probably an area that has felt relatively more stress so far broadly. That's That's not great when you're looking at it in hindsight, but I think when you look at it from a forward lens, it's debatably good news because it's hard to say exactly what's going to come from the economy here, but if we start from a place of believing that the auto industry has already taken a deeper stress than the rest of the economy, I think it means any additional stressors from here and expectations should probably be less than any uh recovery from here and expectations should probably be more so i think you will see how that all unfolds over time uh we're certainly in a unique time where it's obviously impacting customers in lots of ways but as i said i don't think that it's anything unexpected for our customer uh versus other customers out there and then just in terms of pricing just curious if you all have a view that we may see uh flat or even decreasing retail pricing from here and if we do see retail prices decrease into the back half of the year
spk01: Does that make it harder to reach the GPU goals that you've set out, or have you already kind of planned for that?
spk12: so i i think that's hard to say but i i do think let me give you first just a fact i i think we have seen uh depreciation kind of return to the market um so far this year so so that is something that that is occurring uh next is something of a mental model it's not totally dissimilar from what we just discussed but i think you know given that car prices have inflated more than other um you know goods and services it is probably likely that on average they will depreciate faster uh in the future to kind of you know get back into alignment with their relationship with other goods and services. So I think that's a reasonable expectation. I think whether or not that has an impact on retail GPU is a little bit less clear than you might think because it's largely a function of what are dealer expectations. Historically, when there's more depreciation, you see a bigger spread between wholesale prices and retail prices because dealers are in effect kind of building in the expected depreciation to the price they pay for a car at the wholesale market. To the extent that occurs, you could see decreasing prices without noticeably decreasing retail GPUs. To the extent that depreciation is unexpected, I think you could see decreasing GPUs as you go through that period. On average, you have seen kind of the former. You've seen basically flattish retail GPUs as car prices have decreased. And I do think that in the early depreciation we've seen so far, there's evidence that that relationship remains. Even in our results from this quarter, you can see that we began to see higher spreads between the price that we paid for cars and the price we were able to receive for cars. And so I do think there's some evidence of that spread widening again. Obviously, we don't know exactly how that will play out, but that's how it's historically played out, and there is some evidence it's playing out that way now as well.
spk05: The next question is from Chris Battiglieri of Exxon B&P Paribas. Please go ahead.
spk06: Hey, guys. I think you got to beat me to my first question a little bit there, but can you give us a sense, like obviously the $600 didn't float through from the logistics and reconditioning, but you did see, like, frankly, pretty good improvements sequentially in a retail GPU, and you seemed to highlight market improvements there. Is that all just kind of, which you cited a second ago on kind of movements in wholesale pricing. Were there other factors that led you to kind of expand that retail GPU $400 sequentially?
spk11: Sure. So I'll take that one. I think we were very pleased with our retail GPU progress in the quarter, frankly. I think it was a nice step up, you know, once adjusting for our reduction in force and underneath gift, you know, 1216 in the quarter, meaningful step up from Q1. And so I think we feel really good about that number in light of the fact that we still have, you know, I think that number includes very elevated reconditioning and inbound transport costs. And so I think we, you know, we view that as a real positive. I think what were some of the sequential drivers? So one simple one is about $100 of the sequential gain. We had lost about $100 of shipping revenue per unit in Q1 due to refunds driven by significant logistics network delays. We basically got that back in the second quarter. So that was part of the sequential bridge. A second part of the sequential bridge is You know, Q4 2021 was a really high price time to be purchasing cars. And so as we moved away from Q4 21, I think, you know, that had a positive impact on retail GPU where, you know, in Q1, we were just selling more cars that were purchased in Q4 than we sold in Q2. And, you know, Q4 was a very high price time to be purchasing. So that was a favorable impact going from Q1 to Q2 as well. And so I think those are the big impacts. You know, I think, yeah, I think those were the primary impacts, yeah, in Q2, and I think leaves us feeling in a pretty strong position in light of the opportunities that we still see on the cost side of GPU.
spk06: Gotcha. That's really helpful. And then just an unrelated question, if I look at the ADESA financials, Like, best I can tell, it looks like if I take kind of, like, the $7 million improvement and kind of, like, double the quarter to date ADESA financials, it seems like you're probably running $13 million a quarter on ADESA profitability, which is maybe a tad below the $100 million you were targeting. And I know volumes decline sequentially, but so I guess my question is, with that long preamble, is, like, is this a good run rate for profitability until volumes improve, or is there other reasons to be more positive on kind of profitability ramping ADESA near term?
spk12: Sure. So I think, you know, we try to provide some guidance in our deck, our operating plan deck, of kind of around $100 million as being a good kind of ballpark estimate for where Odessa would be. I think, you know, we're clearly at a trough of... for kind of the auction business today, or I don't want to say necessarily precisely the drop. We're at a low point relative to recent history for the auction business. Before a death in 2019, they were at approximately 1.8 million units per year, which is obviously a very large number. They're on the order of a million shy of that today. I think there's plenty of room for the business to continue to improve from here. I think a reasonable way to think about how it might improve from here is to kind of look back to 2008 and what occurred back then. In 2008, the units dropped by actually a lesser amount because it wasn't really kind of a perfect storm for auctions like the last couple of years has been. And then it took about five years for all the volume to come back as the OEMs got their production back up after bankruptcy and everything else. I think the fundamentals were not as severe. The technicals were more severe in the auction business this time around. I think there's potential that the recovery could be faster, but I think it's hard to know exactly how quickly that will occur. I think a good heuristic for thinking about What flow through looks like in that business is probably something on the order of $250 of kind of incremental EBITDA per unit is probably a reasonable way to think about it. And so I think when we look forward, we don't quite know if we're exactly at the trough for auctions, but I think there's lots of reasons to be. I'm somewhat optimistic. There's some indications that OEMs are starting to increase their production. Car prices are starting to dip a little bit, which makes it a little bit less likely than any given franchise dealer is going to keep every kind of off-lease car like they have been. OEMs are starting to sell more cars to rental car companies, which rental car companies are normally big sellers. I think there's room for finance companies to start selling more cars as well. So I don't think we know exactly how that will play out, but I think over time there's certainly room for volume to continue to come back. And Adeph has built a great business with a lot of great customers, so they're well-positioned when it does. And so I think there's room for it to certainly move materially beyond what our medium-term average expectation of $100 million that we put in that deck is. So we still think that kind of on average, that's probably a reasonable way to think about what the earnings power of the business is. And then obviously, there's a ton of things that we're extremely excited about in terms of the way that we're working together. Our integration really is going very well. I know I said it in my prepared remarks, but we closed that transaction two and a half months ago, and we have cars on the ground in 46 locations. We have people that are actively working, dropping off retail cars, picking up cars we're buying from customers out of 18 locations. Those numbers are growing quickly. We've already started to ramp up production in coastal locations. There's a lot of cost savings there as well. When we buy a car from a customer and we're able to drop it off at a nearby Adessa instead of running it through our logistics network, We can save pretty material dollars per transaction there, and it also dramatically simplifies our logistics network. There's a ton of gains there. You know, I talked about some benefits we've had with some partners where we've been able to do things that we couldn't have otherwise done. So I do think that just the deeper we get into the ADESA transaction, the more excited we get, you know, not just about the extremely exciting long-term opportunities around reconditioning and logistics, but also around the near-term opportunities there. of just ways that we can be more efficient together. And again, I do want to give the team credit there. You never know exactly how integration is going to go. I think when you do an acquisition, then you kind of walk over to the other side when the deal closes, and you get to go meet all the people and have your first couple conversations. You don't quite know what the reception is going to be, and I really will say the ADESA team has just greeted us with completely open arms, and it has been really great. And I think the integration has gone a lot better than it might have otherwise because of how open-minded they've been and how much they've already been able to teach us. So we remain extremely excited about it. We think it's a huge deal in the long term, and we also think that there's very big gains that we can make in the near term as well, but it's going to require work, and we're hard at it.
spk05: The next question comes from Adam Jonas of Morgan Stanley. Please go ahead.
spk07: Hey, everybody. I just had a question about working capital, specifically inventory, which, of course, just declined very substantially, about $466 million. I believe that number includes a death end there, so correct me if I'm wrong. So is that a level that you feel is kind of normal to finish the year with? Do you see it as kind of more correcting from what was the last couple quarters of just the issues between COVID and IRC bottlenecks and now you're at a normal level? Or is there some kind of making up to do and you need to have like a flow out again in order to achieve the volume that you want? My first question.
spk11: I'll take that one. So we did reduce inventory meaningfully quarter per quarter. As a note, that doesn't include any impacts from Adesu who doesn't have material inventory. So that's just related to Carvana. I think the main way to think about that is we talked a bit about this on the Q1 call, but, you know, we did meaningfully overbuild in various areas of the business. You know, kind of moving into Q1 of this year, that included infrastructure, that included staffing, that also included inventory. So, you know, we definitely have been at an above normalized level. level of inventory. And so we've been sort of steadily marching it down like over the course of Q2 and also so far in Q3. I think we do expect to continue to lower inventory balance here in the third quarter, you know, just as we sort of normalize the size of inventory to get to our target level and sort of think of our target level as somewhere in the 2 billion to $2.5 billion range. Um, and I think, um, you know, I think we'll continue, we were above that at the end of Q2. And so I do think we'll continue to lower that just to get a inventory size in line with, um, in line with our targets aligned with the rest of the business. So I think that's one point. I do think we've got lots of opportunities to get more out of our inventory as we move away from third-party reconditioning. Third-party reconditioning typically has much longer cycle times than first-party reconditioning, and so as we move away from third-party reconditioning, that will have a positive impact on you know recon cycle time many of our cost initiatives are also speed initiatives that you know have the the goals of speeding up the you know number of days between when we acquire a car and get at the IRC speeding up the number of days between when we start you know inspect a car and get it fully reconditioned and so we do think we've got a number of levels to get more out of our inventory as it normalizes
spk07: That's very clear. Just a follow-up then, housekeeping. How many cars did you have in inventory at the end of 2Q in terms of units and have that compared to 1Q? Thanks.
spk11: Sure. So, we don't report that number specifically. But we did see a unit decline in inventory as well that was, you know, think of it as approximately in line with the balance decline.
spk05: The next question comes from Nick Jones with JMP Securities. Please go ahead.
spk09: Hi, thanks for taking the questions. I guess two if I could. On the time buffers in certain states related to title and registrations, Is that a structural hurdle that's going to persist? Can you drive more efficiency there and kind of get rid of that over time? And how do you expect that to impact, I guess, conversion in the states? And the second question, you know, there was a bullet about not passing through the cost of fund increases. How should we think about, I guess, you know, when you might start passing this through? Thanks. Thanks.
spk12: Sure. Those are two big questions that lend themselves to long answers, so we'll try to be as concise as we can. So first, on the time buffers, I do think that's been associated with just ensuring that we're delivering the cleanest and fastest experience to our customers on the registration front that we possibly can. I'm going to kind of jump into just an explanation on that as well for a moment, because I can imagine that's a question people on the call may have. We've definitely, unfortunately, gotten a lot of attention for registration over the last maybe three to six months. And I think, unfortunately, that narrative is probably both pretty exaggerated and then also lagging where reality is. I think I want to talk a little bit about kind of the progress we've made there. So today we probably have about kind of one-third the rate of customers that are getting delayed plates that we had even a year ago. That puts us at kind of the best levels we've ever been in our company history. And, you know, while it's unfortunately kind of hard to get really clear data around how other dealers perform in registration, that is an imperfect process, you know, across the entire industry. Unfortunately, I think over time it's something that many states want to improve, but it is a complicated process. And so we do our best to try to pull down what data we can to look at various parts of the flow, whether it's title processes or registration processes. And it is the case that in the majority of states, we're performing better than the majority of dealers. And so I think that's something that we're generally pretty proud of. We think we're especially proud of that in light of the fact that in order to give our customers a seven-day return policy and a nationwide inventory, we oftentimes take on more complicated underlying registration tasks. And when you control for the complexity of that, we're sort of better, again, than most dealers out there. So I think, again, the team has done a great job. I think the way that we're executing today, is better than we've ever executed in the past, and it's a level that we're proud of, but certainly not satisfied with. We're going to continue to push, and we've got A lot of improvements in process, a lot of additional improvements in product that we're rolling out to make sure that we're getting all the paperwork that we need to from customers, that it's clear to customers what to upload and what to have ready at the time of delivery, et cetera. And so we're working on all those processes and I think continually getting better all the time. We're also working to improve the system. We're working with several states as partners. We view the states as partners and many states view us as partners as well. Many of these states have registration modernization initiatives underway, and so we proactively work with them on those. We've been part of legislative change in a number of states. We've seen policy changes in a number of other states as a result of our involvement. And so I do think this is something that's actually continually changing. improving. And I do think it's something where we do expect those buffers to go away over time. So we think it's hard to predict exactly when we'll be pulling those back, but the expectation is absolutely that we will pull those back over time. And then certainly that does impact sales conversion. There's no question that faster delivery times impact sales conversion. And when we add these time buffers, the form it takes to a customer is just they see a longer delivery time. And so that does impact conversion. And we expect to continue to make progress there over time. On the interest rate changes, what I would say is we have passed through some interest rate changes over the last many months. If we go back to when interest rates started to increase in the back half of last year. But in general, when interest rates start to increase, we tend to see finance companies, ourselves included, pass through those increases in benchmarks or risk spreads a little more slowly than they show up. And I think that's where kind of the term interest rates are sticky comes from. And so the sum of interest rates, interest rate increases, both benchmarks and risk spreads, has not yet been passed all the way to consumers. I think it's hard to say exactly what will be the smart rate for that to be passed through over time. In many ways, it's a function of what other finance companies are doing. We obviously don't have perfect data on what other finance companies are doing, but we do have pretty good data there. And so when we kind of monitor many different kind of larger banks and financial institutions, We've seen a lot of those institutions start to raise interest rates really starting in March and April, kind of a couple months after we did. And we tend to see them, you know, over the last several months raising interest rates by, you know, something between 25 and 50 base points, give or take, a month, which actually, you know, can make a pretty big difference pretty fast. So we don't know exactly how other finance companies are going to react. You know, we'll continue to monitor elasticities and try to make smart decisions about how we're handling these interest rates on our side, but certainly we've seen an increase in benchmarks and spreads that have not been passed all the way through, and then we try to provide some math to make it straightforward for investors to understand what the impact of that is, holding all else constant, and we're obviously hopeful that over time that comes back.
spk05: The next question is from Seth Basham of Wedbush Securities. Please go ahead.
spk03: Thanks a lot, and good evening, and thanks for all the great information. I have a follow-up question after the last question that was asked. First, as it relates to the titling registration challenges, are there any states where you are not able to currently sell vehicles because of those challenges? And then secondly, are there any issues currently with selling vehicles that don't have clean titles?
spk12: Sure. So there are no states where we're not able to sell vehicles today and no issues with the clean title issue as well. I do think over time these things can periodically pop up. We recently had Illinois pop up. We were excited to have a judge kind of give us time to make sure that we were able to work with the state and make sure that we could resolve some of the maybe miscommunication disagreements that we've had. So we look forward to working with them. We kind of share the same goals that they've got. The regulators in all these states just want to make sure the customers get the best registration process they possibly can. And that's the goal that we share. So we look forward to working with them. And our hope is that we can partner with them in the same way that we've partnered with many other regulators in many other states. I also say that as part of that, something that Sometimes good things can come out of a more difficult situation, but something that's great that came out of Illinois is when we were shut down for a period of time there, as we were working to resolve some of these misunderstandings with the state, we did reach out to customers and ask for support. In 48 hours, we had 6,000 customers sign a petition of support. We had thousands of comments that came in supporting Carvana. Since then, we've had thousands more come in as well. And so I think, you know, that was a powerful, you know, kind of message from our customers that certainly customers across the country and in the state of Illinois and all other states as well are really, you know, loving the Carbon experience. Those are people that are intimately familiar with our process that kind of instantly came to our aid there, which I think was a great sign. And so I think periodically over time there's certainly risk that we'll run into these, you know, with a state here or there. But in general, we've got a great relationship across states, and we view the states as partners. And our goal is to make sure that we continue to evolve all those relationships so that we can view all the states as partners and they can view us the same way.
spk03: Great. As a follow-up on the financing business, can you talk about the channel mix shift for selling your finance receivables in the second quarter? How much did you sell to Ally? What's the remaining availability with that agreement? And then your decision to potentially sell whole loans in the third quarter, what's driving that?
spk12: Sure. So what I would say is I think, you know, whenever we've thought about – Where we're going to sell our receivables, we're trying to balance maximizing proceeds and minimizing kind of cross-time volatility. I think that's always been our goal. That's been the reason we've set up kind of a platform that enables us to move in both directions. And obviously, there's been a lot more noise, I think, across financial markets over the last many months than there has been in quite some time. And so I think – and a form that basically takes is that increases volatility in – in a process like a securitization. And so what we elected to do is kind of in this environment, I think we're kind of leaning more in the direction of reduced volatility than we are in the direction of maximized proceeds. And we elected to work with Ally to purchase more of our loans, which is something that we did in COVID as well with very similar motivations. And I think that that's a relationship that we feel has worked out great for us and that we hope and believe that they believe has worked out great for them as well. So I think that's the way that we generally think about it. We make sure that we always have access to all the different channels and we're monitoring what our expectations would be in each channel, again, in both of those dimensions, both expectation and um kind of volatility around that expectation i think as we head through the rest of the year it's hard to know exactly um you know where things are going to go uh it is a pretty dynamic kind of macroeconomic backdrop and these markets can be sensitive to You know, the way the data flows in across that backdrop. I think several weeks ago the ABS markets were in rougher shape. I think the last couple weeks have actually been very good in the ABS markets. So we'll continue to monitor those markets and try to make the best decisions that we possibly can. But our baseline expectation today is to continue to lean more in the direction of pooled loan sales. But, again, we want to make sure that we have flexibility to exercise, you know, whatever freedom we think is the right choice to make as we move through the rest of the year.
spk11: And then on the question about capacity, so our agreement with Ally was most recently upsized in March and has 3.2 billion of capacity remaining.
spk05: The next question comes from Rajat Gupta with JP Morgan. Please go ahead.
spk00: Great. Thanks for taking the questions and for all the color provided on the call so far. I just had a follow-up on one of the earlier questions on SG&A. Um, so what happens when you get to the $4,000 target? Um, you know, one of the, one of the questions we get a lot and trying to address is, you know, once you get to the 4,000 and you continue to reduce that even further, you know, how should we think about growth, uh, in particularly in the context of, you know, some reduced ad spending recently, you know, some of the other growth initiatives that you've had that you're, you know, tempering recently. What kind of like, what's the growth algorithm for the company once you get to that lower SG&L level?
spk12: Sure. So I think the short answer on what do we do when we get to $4,000 is we keep going, I think is kind of the plan. So first, let's talk about the walk from where we are to $4,000. That's a level that we've hit many times before in the company's history. And so I don't think in our minds, at least, there's a big question about whether or not we can get to $4,000. I think the question is, how quickly can we responsibly get to $4,000? We do have hundreds of locations and many functions across those locations, so there's many hundreds of groups that we have to manage across the business. And we have to make sure that we're managing our expenses down at a rate that is both fast, because we want to get it down as quickly as we can, but also that doesn't derail these different groups and different locations and different functional areas, because that's costly as well. And so I think The stretch goal of 4,000 at the end of this year is basically more a function of the pace at which we think we can responsibly get there than a question about whether or not we believe that we can get there. I think as we look from 4,000 down to kind of the midterm goal of 3,000 and beyond that to our long-term model, I think it's just about driving additional efficiencies. We have many ways to look at where those efficiencies are. I think probably the easiest is to just look at our cohorts. We've provided some data in the past about, you know, what our SG&A expenses are and some of our more mature cohorts. And so I think that, you know, provides visibility into what we've been able to do. And we were able to do that before we really put focus on, you know, prioritizing processes and products that make us more efficient. So, you know, as we kind of move through this period where we've prioritized those process improvements and product enhancements, We think that we're positioning ourselves better to outperform that than ever before. We think across every group inside the company, we now have concrete goals that build up to our midterm goal of $3,000 per unit. I think we've always had bottoms-up models to inform our long-term financial model, but now that's converting into actual kind of products and projects that we have across all these different teams to get us there. And then in terms of what it means for growth, I think the biggest impact to growth are probably based on the kind of shift in focus and just a question of which projects we prioritize and where we put our effort across the business. And so I think as we get to lower and lower SG&A levels, I think the impact there to growth, in our expectation at least, are probably positive. And, again, I think the simplest way to think about that, or at least the way that we think about that, is that the amount of work it takes to increase sales by any given amount is in many ways kind of proportionate to your expenses per unit because they kind of represent the work that's being done inside the company to sell a unit. And as we drive those expenses down, it means there's less work to do per unit, and it means with the same amount of work we can grow units by more. So I think we're excited about that. what kind of, you know, these efficiency goals are going to mean for our growth in kind of the medium term. But I think, as I said, you know, we're really focused on gaining efficiency today, and I think we're making a lot of progress. We undoubtedly have a lot more progress to make, and the team recognizes that and, you know, is extremely focused. But we're on a very good path, and we're excited about it.
spk00: Got it. And maybe just a follow-up on the S&A. you know, within the comp and benefits line, is there a way, you know, that you can help dissect for us, you know, what the corporate employee costs are versus, you know, some of the more personnel related expenses in terms of employees who are involved in, you know, the actual buy, sell, you know, financing part of the transaction. You know, any metric you can share around efficiency there, you know, you know, transaction time per sale or, you know, employee hours per sale or something of that sort. And where are we today and where do you expect to, you know, get to, you know, as you get to your, you know, 4,000 or, you know, the 3,500 target next year?
spk11: Sure, I can hit that one in a couple different ways. So, you know, I do think we've, I think, you know, on comp, for example, you can see what we've achieved in the past on sort of compensation and benefits for retail units sold. I think that's a useful benchmark for where it can go. I think, you know, we've laid out midterm goals that are available on the, you know, investor relations website that also give a sense of where it can go. sort of beyond what we've already achieved in the past. And so I think those are hopefully helpful resources for you on that question. I think in terms of what we're seeing from an efficiency perspective, we're absolutely seeing efficiency gains throughout the business. Our teams are working every day on those efficiency gains, and I think we're seeing things like hours per delivery is coming down, and the customer care phone time per sale is coming down. Those are a few examples. utilization of the logistics network is going up. And there are many, many more. That's just a few. But I do think we're seeing very positive trends in some of these efficiency metrics that we've been focused on over the last several weeks or slightly longer. And so I think some of those internal metrics that all the teams are focused on, we're feeling really good about the way those are trending.
spk05: The next question comes from Colin Sebastian of Baird. Please go ahead.
spk10: Thanks. Good afternoon, guys. Thanks for squeezing me in. I guess I was going to ask about sort of the whole process of managing the process improvements, but I think that maybe takes a little too long to answer here. So instead, as follow-ups, I guess first off, What, in terms of not using the ABS market, is that factored into the GPU or what's the impact on other GPU if you do not access the ABS market? And then secondly, in terms of widening the scope of inventory to capture more value-priced cars, you know, if you are doing that, are you seeing more demand through the mass market part of the funnel? Is that something that you're marketing against, or does that sort of – that traffic sort of naturally come to the website and the app? How does that work? Thank you.
spk11: Sure. So I think on the first question, so, you know, the way we've always – thought about this is, you know, we have a two-channel strategy for monetizing our loans. You know, we use the securitization market, and then we sell loans through whole loan sales or a forward flow agreement. And I think the way we think about that two-channel strategy is that it balances economics and stability. And what I mean by that is typically in the securitization market, you see better monetization, but the securitization market involves more variability. And so the forward flow and hold on sales typically have lower monetization, but add a degree of stability. So that's basically the way we thought about it. In terms of our forward looking expectations, I think we plan around expectations you know, for ABS or for floor or whole loan sales. As we laid out in Q3, you know, our current expectation is we'll be selling loans in a whole loan sale format, but we'll continue to evaluate as the quarter progresses.
spk12: And then I think there's certainly demand for lower-priced cars. I think that's definitely something that's true. There's basically just a dearth of lower-priced cars out there industry-wide today. It is also true that those that are seeking higher-priced cars are probably less impacted by the economy, at least so far, in the form that this thing has taken so far. In terms of like demand across cars, I would say it's shifted to cheaper cars less than you might expect in light of kind of the desirability of those inexpensive cars, but then also kind of the relative strength of the higher income consumer, which offsets that to a degree. But I think we're continuing to push in that direction. We've got a number of initiatives to make sure that we're able to provide our customers with a diverse set of cars that fit their needs across all industries. different dimensions that matter, including price, and working on different product enhancements to make it easier for customers to afford cars in this difficult environment when prices are high. So I think that's an area that will continue to get focus from us, and it's an area where we've made progress so far and plan to make more progress going forward.
spk05: The last question will come from Brian Nagel of Oppenheimer. Please go ahead.
spk13: Hi, good afternoon. So I know we're trying to write down. So that's one when one guy gets one question with two parts. But with regard to a desk, there's a lot of there's been chatter out there about now that Carvana owns a desk, maybe some historic customers or partners with the desk. So we don't want to do business with us because they're now competitors to Carvana. So the question I have is, are you seeing that dynamic? If so, is that factored into the parameters you've given us for the Adessa business. And then secondly, just as we think about Adessa and its enhancement to the overall Carvana model, at what point would there kind of be that breakout moment where we really start to see the true benefits Adessa is bringing to Carvana?
spk12: Sure, I'm going to try to answer this concisely because, as you said, we are tight on time. Let me start with this. I think, for sure, we saw some customers of Odessa initially react negatively to the news, and we do feel like we lost some volume as a result of that immediately as the transaction was announced. I do think since then, the news is actually pretty good. Obviously, we don't know how this will play out over time, but we've seen a number of those customers already come back. We've seen some big commercial accounts start to shift more business back to Odessa. And so I think that, you know, so far at least it feels like the team at Adessa has done a good job, you know, weathering the turbulence of that transaction, which obviously caused everyone to kind of stop and reevaluate for a moment. But it feels like we're in a pretty good spot. And then I do think Looking forward, it's hard to know how that's going to unfold. Again, Odessa is approximately a million units back of where it was in 2019, so there's a lot of room for volume increases from here, regardless of the number of customers that come back, but we'll be We'll be fighting and shooting to provide great experiences to all the historical customers of Odessa and trying to explain why we think that Odessa is still a great option for them. And as I said, I think so far the news there is pretty good. I think in terms of when you should expect to see the benefits of Odessa, I think, you know, hopefully it's relatively quick. We're already seeing operationally some benefits today that are pretty material. And hopefully it's kind of continual over time and continually increasing. And hopefully it's continually increasing for a long time. I think that there are many areas to reduce costs. There are many areas to drive revenue. There are many areas to collaborate on. solutions for our shared customers that kind of benefit from our shared capabilities. And then there's obviously a lot of room to recondition more cars closer to our customers and to enhance our logistics network to get cars to customers faster. And I think unlocking all of that is a many, many year plan that we're excited about running at as quickly as we can. And we're excited to do it with the team at Adessa.
spk05: This concludes our question and answer session. I would like to turn the conference back over to management for any closing remarks.
spk12: Perfect. All right. Well, thank you everyone for joining the call. To everyone inside Carvana and Edessa, you know, thank you so much for everything that you guys have done. The last several months have been dynamic, I believe was the word that we used in the prepared remarks. You all have, you know, felt that and seen that. And I think that, you know, people always have to decide how they respond to questions any kind of adversity. And I think the way that people inside Carvana have responded has been unbelievable. I think we could not ask for more. We couldn't be prouder to be working side by side with you guys. The progress that we're making is exceptional. I hope you're proud of what you're doing. If we keep our heads down, we're going to continue to make a lot of progress really quickly. And that has been awesome to see and is exciting for the future. And then For the ADESA team, we've done this a couple times now, but I really do just feel extremely grateful that you have embraced us in the way that you have, and I think that, you know, hopefully we're both seeing the gains from that. I think it's showing up in the results already, and we're excited about where we can go from here. So we look forward to continuing to work with you. Thanks, everyone. We'll talk to you next time.
spk05: The conference has now concluded. Thank you for attending today's presentation. You may now
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