Carvana Co.

Good day and welcome to the Carvana Third Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. In the interest of time, 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.

Thank you, Matt. Good afternoon, ladies and gentlemen, and thank you for joining us on Carvana's third 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 third quarter shareholder letter is also posted on the IR website. Additionally, we posted a set of supplemental financial tables for Q3 to assist investors in understanding the moving pieces with our first full quarter with the consolidation of ADESA, which can be found on the events and presentations page of our IR website. Please note that with the full consolidation of ADESA now complete, we do not intend to provide these supplementary tables going forward. Joining me on the call today are Ernie Garcia, Chief Executive Officer, and Mark Jenkins, Chief Financial Officer. Before we start, I would like to remind you that the following discussion contains forward-looking statements within the meaning of the federal securities laws, including, but not limited to, Carvana's market opportunities and future financial results that involve risks and uncertainties that may cause actual results to differ materially from those 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 our quarterly report on 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? Thanks, Mike, and thanks, everyone, for joining the call.

The third quarter was a quarter of strong operational progress against a difficult industry and economic backdrop. We are on track with our goals from an expense and operational efficiency standpoint, but industry demand, interest rate, and depreciation headwinds are slowing our progress on overall profitability. We made gains here, but they were slower than we would have liked, and these headwinds are likely to persist over the near term, making precise forecasting of that progress more difficult. To organize these remarks, I plan to provide our thoughts on five important questions. One, what is driving our expense and operational gains? Two, what are the key headwinds we face and how do changes in those dynamics impact us? Three, how do we believe we are doing relative to the industry? Four, what does all this mean for the near term? And five, what does it all mean for the long term? First, what is driving our expense and operational gains? In the letter, we provide a number of data points, including that we reduce expenses by about $90 million in the quarter, $360 million on an annualized basis, as well as many underlying operational metrics that are making those expense reductions possible. We're extremely proud of this progress. It is the result of an intense focus on efficiency throughout the company in the way that we manage the business, the way that we organize and set our priorities, and the way that we execute day to day. As we have faced the change in the economy, our industry, and in markets over the last several quarters, the people of Carvana have come together and are doing great work. We have a lot of work left to do, but we know it, and we know how we're going to go about doing it. Thanks to everyone inside the company for all the hard work you're putting in. We still have a long way to go, and there will probably be additional unexpected difficulties between here and the end of all this. We've got to keep our heads down and keep marching. Next, what are the key headwinds we face and how do changes in those dynamics impact us? There are three key headwinds that we are facing right now, industry-level demand, interest rate increases, and vehicle price depreciation. Let's take these one at a time. First, industry-level demand. There are many data sources available to assess industry-level demand, but regardless of the source, demand is slow. Industry data sources estimate used sales down approximately 10% to 15% year-over-year in the third quarter, and many of the forward-looking indicators that we use internally, including web searches and activity on Carvana.com, indicate further slowing recently. Cars are an expensive discretionary, often financed purchase that inflated much more than other goods in the economy over the last couple of years and is clearly having an impact on people's purchasing decisions. The good news is that historically used cars have been a relatively resilient category and that a press level of sales that we see today are similar to periods of fairly severe economic difficulty in the past, potentially suggesting that there is less medium-term downside than there may be for other categories. This possibility is also supported by higher depreciation rates that should, over time, make cars more affordable again and a forward interest rate curve that suggests that the majority of the interest rate increases are behind us. Regardless, we are building our plans around assumptions that the next year is a difficult one in our industry and in the economy as a whole. Next, interest rate increases. Interest rates have risen rapidly with the two-year treasury, a good benchmark for automotive loans, rising 3.9% over the last year and 2.6% since 2019. In addition, credit spreads have risen about 1% in the last year. To put this in perspective, for a customer utilizing financing, the moves in two-year treasury yields plus credit spreads over the last year are equivalent in their impact to the customer's monthly payment of about a $3,000 price increase. As a result, for customers using financing, cars ended the quarter at their most unaffordable point ever, despite the fact that retail prices have dropped roughly 10% this year. As benchmark interest rates, risk spreads, and market expectations for future credit performance evolve over time, we do expect those changes to impact our other GPU and sales volumes before the market fully adjusts, which is built into our expectation that other GPU will move down in the fourth quarter relative to the third. Lastly, vehicle depreciation. Over the medium term, we believe vehicle depreciation is good as it is necessary to bring cars back into alignment with other goods in terms of cost and affordability and therefore is healthy for volume. In the near term, it is less clear. Two key dynamics that have a big impact on retail GPU is the average spread between acquisition prices and retail prices and the rate of daily depreciation. Historically, on average, the wholesale retail spread roughly captures the depreciation dealers expect to see prior to selling a car, which creates stability in industry retail margins that can be seen over time. We've seen this in action recently as depreciation rates have increased over the last two quarters, and in both quarters, we saw acquisition spreads widen in a way that was approximately offsetting. Looking forward, we expect this to continue to be the case on average, but we don't know exactly what will play out quarter to quarter. We have recently seen wholesale retail spreads widen further and have also seen daily depreciation rates move up meaningfully. Given these moves, our expectation for the fourth quarter is that retail GPU will decrease relative to the third quarter. Over time, we expect this to normalize as it historically has, but the recent volatility is making a tougher call than it usually is. Moving on to how do we believe we are doing relative to the industry? This is a much more difficult question to answer simply with our results than it normally is, given the dynamics discussed above, as well as the volume impacts of our focus on profitability. We discuss much of this in the shareholder letter in a way that we hope provides some clarity and understanding, but to summarize our beliefs, they are this. For realized sales volumes year over year, we are clearly taking market share relative to the industry. Quarter over quarter, we are most likely not taking realized sales market share relative to the industry as a whole, but it depends on which data sources we compare to. If we use our best understandings of the differential impacts to conversion for our customers versus the average customer in our industry due to the choices we are making in setting interest rates, as well as the impacts driven by our focus on profitability, it is likely we are seeing somewhat meaningful gains in top funnel demand market share. We expect this to begin to show up in realized sales when the interest rate and general industry environment approaches more stability and when we stop further decreasing conversion through our profitability initiatives. Now heading to what does this mean in the near term? In the near term, our goal is clear, to march toward profitability as quickly as we can, regardless of industry-level sales volumes. To achieve this, we plan to continue to rapidly reduce expenses, to continue to put our focus on efficiency gains throughout every area of the company, and to continue to evaluate and test what levers we should pull to maximize the number of our more profitable sales and to minimize the number of less profitable sales. Lastly, I want to hit the question of what does this mean for the long term? This is an easy question to skip in a difficult environment, but in the end, it is the most important question. Our belief is this. If we manage through the current environment as we intend to, the long term will be even brighter. All the things that defined our opportunity when we started to carve on in were true a year ago when the environment felt very different are still true today. Nothing focuses us like difficulty, and the last several quarters have undoubtedly been difficult. The next couple may be as well. While it's never fun while we're in the middle of a difficult time, if we use the clarity and focus it provides, we'll be better on the side of it. This is our intention. The march continues. Mark.