Carvana - Q1 2023

Transcript

Operator (participant)

Hello, and welcome to the Carvana Q1 2023 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 0. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press * then 1 on your telephone keypad. To withdraw from the question queue, please press * then 2. Please note this event is being recorded. I would now like to turn the conference over to Meg Kehan, Investor Relations. Please go ahead.

Meg Kehan (Head of Investor Relations)

Thank you, MJ. Good afternoon, ladies and gentlemen, thank you for joining us on Carvana's Q1 2023 earnings conference call. Please note that this call will be simultaneously webcast on the investor relations section of the company's corporate website at investors.carvana.com. The Q1 shareholder letter is also posted to the IR website. Additionally, we posted a set of supplemental financial tables for Q1 which can be found on the Events and Presentations page of our IR website. Joining me on the call today are Ernie Garcia, Chief Executive Officer, and Mark Jenkins, Chief Financial Officer.

Before we start, I would like to remind you that the following discussion contains forward-looking statements within the meaning of the federal securities laws, including but not limited to Carvana's market opportunities and future financial results that involve risks and uncertainties that may cause actual results to differ materially from those disclosed here. A detailed discussion of the material factors that cause actual results to differ from forward-looking statements can be found in the Risk Factors section of Carvana's most recent Form 10-K. The forward-looking statements and risks in this conference call are based on current expectations as of today, and Carvana assumes no obligation to update or revise them, whether as a result of new developments or otherwise. Our commentary today will include non-GAAP financial metrics.

Unless otherwise specified, all references to GPU and SG&A will be to the non-GAAP metrics, and all references to EBITDA will be to adjusted EBITDA. Reconciliations between GAAP and non-GAAP metrics for all reported results can be found in our shareholder letter issued today, a copy of which can be found on our IR website. Now with that said, I'd like to turn the call over to Ernie Garcia. Ernie.

Ernie Garcia (CEO)

Thanks, Meg. Thank you, everyone, for joining the call. The Q1 was a quarter of significant progress for Carvana. A year ago, the automotive industry as well as the macroeconomic and market environment changed pretty dramatically, resulting in us significantly shifting our near-term priorities away from growth and toward profitability. This shift has impacted everything we do. It's impacted what we are focused on, it has impacted how much we are focused on, and it has impacted the way we are managing the business day-to-day. All these adjustments take time. First, we made a narrow set of operating goals inside the company that we knew would be necessary to hit our financial targets. Second, we tightened the connections between our technology and operating teams through shared goals, shared meetings, and even shared office spaces.

These changes first have to show up in the projects the teams are undertaking. They move to operating metrics, and finally, they show up in financial results. That is exactly how progress has been unfolding. In the Q2 of 2022, we outlined our plan and discussed how we were organizing internally to tackle our goals. In the Q3, we shared a number of operating metrics that were beginning to rapidly move in the right direction. In the Q4, we began to see some of the earliest signs of meaningful financial progress. Now in the Q1 of 2023, the direction speed of the financial progress is undeniable. We reduced SG&A by over $100 million quarter-over-quarter and completed our year-long effort to cut $1 billion of annualized costs out of the business.

In addition, in the Q1, we returned to our historical GPU and adjusted EBITDA margin trend lines and reported company best results for a Q1 in both metrics. We still have a long way to go to achieve our broader goals, but we are on the right path, and we are moving quickly. As we've discussed before, there are 3 steps in our plan to achieve positive cash flow and get Carvana back on track to becoming the largest and most profitable automotive retailer. Number 1, drive the business to positive adjusted EBITDA. Number 2, drive the business to significantly positive unit economics. Number 3, after achieving objective number 1 and 2, return to growth. As outlined in the letter, we expect to complete the 1st step in this plan in the Q2. The completion of this step is a milestone, not a change of direction.

We'll be using the same processes and focus we have benefited from over the last year to continue to see the plan through. We remain firmly on the path to fulfilling our mission of changing the way people buy cars and to becoming the largest and most profitable automotive retailer. The march continues. Mark.

Mark Jenkins (CFO)

Thank you, Ernie. Thank you all for joining us today. Our Q1 results demonstrated significant progress on our path to profitability. We exceeded our goal of driving $100 million of non-GAAP SG&A reductions 1 quarter early. We surpassed our previously communicated goal of greater than 4,000 GPU. In the Q1, retail units sold totaled 79,240, a decrease of 25% year-over-year and 9% sequentially. Our decline in retail units sold, which we expected, was driven by 4 primary factors. 1, reduced inventory size, 2, reduced advertising, 3, increased benchmark interest rates and credit spreads, and 4, a continued focus on executing our profitability initiatives. Total revenue was $2.6 billion, a decrease of 25% year-over-year and 8% sequentially.

Due to the dynamic nature of the current environment, we will focus our remaining remarks on sequential changes. As we previously discussed, our long-term financial goal is to generate significant GAAP net income and free cash flow. In service of that goal, in the near term, our management team is focused on driving progress on a set of key non-GAAP financial metrics that are inputs into this long-term goal, including non-GAAP gross profit, non-GAAP SG&A expense, and adjusted EBITDA. In the Q1, non-GAAP total GPU was $4,796, a sequential increase of $2,129, driven by increases across all components. Non-GAAP Retail GPU was $1,591 versus $632 in Q4. Retail GPU included a $593 benefit due to an adjustment to our retail inventory allowance.

In addition, sequential changes in Retail GPU were primarily driven by higher average days of sale, partially offset by wider spreads between wholesale and retail market prices, higher shipping revenue, and lower reconditioning and inbound transport costs. Notably, we achieved our Q1 Retail GPU despite selling vehicles that were on average more than 120 days old. Vehicles sold in Q1 that were less than 90 days old had Retail GPU over $2,000, in illustrating the benefit of normalizing inventory size and turning vehicles more quickly. non-GAAP Wholesale GPU was $1,236 versus $551 in Q4. Wholesale GPU included a $50 benefit due to an adjustment to our wholesale inventory allowance. In addition, we estimate that Wholesale GPU benefited by $150 due to abnormal wholesale market appreciation in the quarter.

Beyond those factors, sequential changes in Wholesale GPU were primarily driven by higher wholesale marketplace volume. Non-GAAP Other GPU was 1,969 versus 1,483 in Q4. Sequential improvement in Other GPU was primarily driven by a greater volume of loans sold in the quarter compared to Q4. In Q1, we sold slightly less than a normalized volume of loans as a result of uncertainty in the securitization market in March. The GPU impact of this less than normalized sales volume was largely offset by higher interest income and other improvements, leading to an approximately normalized Other GPU in Q1. In Q1, we made significant progress reducing SG&A expenses for the 3rd consecutive quarter, reducing non-GAAP SG&A expense by $119 million sequentially, following a $60 million sequential reduction in Q4.

These expense reductions were broad-based, including advertising, compensation and benefits, logistics and other SG&A. Non-GAAP SG&A expense per retail unit sold decreased by more than $900 sequentially in Q1, demonstrating significant operating leverage. Adjusted EBITDA loss was $24 million in Q1 or 0.9% of revenue. We expect to achieve positive adjusted EBITDA in Q2. After a strong quarter in Q1, we expect to drive greater than $5,000 of non-GAAP total GPU in Q2, as long as the macroeconomic and industry environment remains similar to Q1. Our strong GPU performance is powered by 3 fundamental drivers. Driver number 1, a more robust retail GPU model. We expect greater than $2,000 of non-GAAP retail GPU in Q2, driven primarily by our efforts to normalize inventory size, accelerate turn times, and generate additional revenue from additional services.

In FY 2021, we generated approximately $1,700 of non-GAAP Retail GPU. Since then, we've made fundamental improvements that we believe will drive higher Retail GPU on a sustainable basis. First, we have continued to improve our customer vehicle sourcing with a higher share of retail units sourced from customers in Q1 2023 than in FY 2021. Second, we are generating more revenue from the unique services we offer our customers, including nationwide shipping and home delivery. Third, over time, we expect per unit reconditioning and inbound transport costs, excluding depreciation and amortization, to be below FY 2021 due to our continued focus on operating efficiency. Moving on to driver number 2, expanded wholesale platform. We expect greater than $1,000 of non-GAAP Wholesale GPU in Q2, split between Carvana's first-party wholesale vehicle sales and ADESA's third-party wholesale marketplace.

In FY 2021, we generated approximately $450 of non-GAAP Wholesale GPU. Since then, we've made several fundamental improvements that we believe will drive higher Wholesale GPU on a sustainable basis. First, in May 2022, we acquired ADESA, the 2nd largest U.S. wholesale used vehicle auction marketplace. ADESA's wholesale marketplace generated significant gross profit in Q1 and will be a long-term addition to our total gross profit. Second, our acquisition of ADESA has improved the efficiency of our offering of buying cars from customers and selling them in the wholesale market. For example, since Q1 2022, we have reduced inbound transport costs on wholesale vehicles by approximately $200 per wholesale unit sold or approximately $90 per retail unit sold, supported by ADESA locations.

Third, we continue to invest in our wholesale platform through product and process improvements with a continued goal of growing these businesses over time. Moving on to driver number 3, strong finance and ancillary product execution. We expect greater than 2,000 non-GAAP Other GPU in Q2, primarily driven by a normalization of loan sales volume. Since the beginning of Q2, we have sold or securitized approximately $1.3 billion of loan principal, an increase compared to Q1. In FY 2021, we generated approximately 2,450 of non-GAAP Other GPU. While we have not yet regained this level, in the medium term, we see a significant opportunity to increase Other GPU by improving our cost of funds spread relative to mature securitization market participants and by continuing to expand our ancillary product platform.

To summarize, our Q1 results and Q2 outlook reflect a return to our multi-track, multi-year track record of driving GPU improvements.

We believe the gains we are demonstrating in 2023 are sustainable and reflect the significant fundamental improvements we have made in the last 12 months. We also see further opportunities for more improvements in GPU in the future. Moving on to our Q2 outlook. While the macroeconomic and industry environment continues to be uncertain, looking toward Q2 2023 more broadly, we expect the following as long as the environment remains stable. On retail units, we currently expect a sequential reduction in retail units sold in Q2 compared to Q1 as we continue to normalize our inventory size, optimize marketing spend, make progress on our profitability initiatives. On SG&A, we expect similar non-GAAP SG&A expense in Q2 compared to Q1. We continue to see significant opportunities to further reduce non-GAAP SG&A expenses over time.

We expect to generate positive adjusted EBITDA in Q2, achieving the 1st step in our 3-step plan to generate positive free cash flow. On March 31st, we had approximately $3.5 billion in total liquidity resources, including $1.5 billion in cash and revolving availability and $2 billion in unpledged real estate and other assets, including more than $1 billion of real estate acquired with ADESA. Our strong liquidity position, significant production capacity runway, and our clear and focused operating plan positions us well on our path to achieve our goal of driving positive free cash flow and becoming the largest and most profitable auto retailer in the future. Thank you for your attention. We'll now take questions.

Operator (participant)

Thank you very much. We will now begin the question and answer session. To ask a question, you may press * then 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw from the question queue, please press * then 2. At this time, we will pause momentarily to assemble our roster. Today's 1st question comes from Sharon Zackfia with William Blair. Please go ahead.

Sharon Zackfia (Head of Consumer Equity Research)

Hi, good afternoon. I guess, 2 maybe pretty quick questions. It sounded as if from the press release you might have made really significant progress on the kind of % of inventory that's under 90 days. I was hoping you could maybe talk to us about what % of the inventory today is under 90 days versus what you had in the Q1. Secondarily, ad spend was really low. I'm wondering if that's a low watermark for the year, if we should expect that to start to go higher. Thank you.

Ernie Garcia (CEO)

I think on inventory, we've definitely made a lot of progress. We rapidly moved through a pretty significant portion of our aged inventory in Q1. You know, we started with a much larger inventory than was sized to sales, and we made a lot of progress throughout the quarter. Our inventory's down year-over-year about 55%, and was down 20% in just Q1 alone. I think a useful metric for thinking about our inventory size and what that means for profitability is just thinking about how large our inventory is compared to the cars that we're selling on any given day. If you kind of do that simple math and take inventory size divided by daily sales, in the quarter, we had about 65 days of implied turn time.

That contrasts with the actual turn time of 120 days that Mark talked about in his prepared remarks. That's obviously a really big difference. That leads to a pretty significant impact to Retail GPU. In the letter, we provided a number where for the cars that were less than 90 days aged, which for that subset of cars, the average turn time is approximately 65 days. It's a useful number to compare to our implied turn time. We had Retail GPU of over $2,000. So I think, you know, we're heading into Q2 in a much better spot from an inventory perspective. I think that's been a year-long effort to kind of get sales to catch up to our relative size and inventory.

I think we're really pleased with the progress. We still have probably a quarter and a half to go, maybe 2 quarters to go to get that all the way into alignment, but the size of the inventory relative to sales is now in alignment. I think we're excited about that. On ad spend, that's another area where there has been a tremendous amount of pressure on units in the business. You know, we're down approximately 64% year-over-year in ad spend. Quarter-over-quarter, we are down approximately 35%. That was a big move as well. I think what we found is, you know, in this environment, cars are expensive and consumers are a little bit less responsive to advertising.

We've been retesting all of our various advertising channels, and I think the optimals that we are finding today are different from the optimals that we found in a more normalized environment, and that's led us to pull back pretty dramatically on marketing. That's exciting, because I think, you know, we were able to show a customer acquisition cost of approximately $700 in the quarter, which is the lowest we've ever shown as a company by a pretty long way. I think if you look in deeper, you know, we had our oldest cohort, we were in the low 300s. I think there's just a lot of progress that we're seeing there, and I think we're learning a lot about what the business model is capable of achieving.

I think, you know, we continue to learn as we shrink our inventory and reduce our marketing spend, and I think we'll continue to make adjustments over the next couple quarters as we learn more. I think it is more likely than not that there will not be large reductions in marketing spend from here. I think it's also unlikely that it will shoot back up super dramatically, but we will continue to test it and evaluate what we learn from those tests, and then we'll go from there.

Sharon Zackfia (Head of Consumer Equity Research)

Thank you.

Ernie Garcia (CEO)

Thank you.

Operator (participant)

The next question is from Ron Josey with Citi. Please go ahead.

Ron Josey (U.S. Internet Analyst)

Great. Thanks for taking the question. I wanted to maybe do a quick follow-up, Mark and Ernie, on just the inventory question from Sharon. Specifically, Mark, you mentioned a higher an increase in vehicle sourcing from customers. You know, I think, last quarter we talked about perhaps or maybe 2 quarters ago, overpaying for that. Talk to us a little bit more just about the sourcing of vehicles from customers. We are seeing more ads actually on social sites for Carvana on that, I wanted to hear just the sourcing of vehicles as overall inventory, call it, normalizes. Thank you.

Ernie Garcia (CEO)

Sure. Yeah, happy to answer that. Yeah, the comparison that we talked about in prepared remarks was Q1 2023, compared to, 2021. You know, we certainly have continued to make progress on sourcing cars directly from customers over that time period. I think we feel great about that. I think we've talked about it before, but, you know, sourcing cars from customers is a great source of inventory, because it's a great selection of cars, very, you know, broad, you know, array of different makes, models, years, mileages. Then also, you know, those cars tend to be more profitable than cars that you acquire at auction. I think that's an area of the business where we've had great success over the years.

I think we feel like we've got access to a lot of cars, and we have a lot of customers coming to the site, appraising vehicles with us. Yeah, I think that's obviously been a success story in the business over the last couple of years, and we'll, you know, we'll be looking to continue that success as we move forward.

Operator (participant)

The next question comes from Adam Jonas with Morgan Stanley. Please go ahead.

Adam Jonas (Head of Global Autos and Shared Mobility Research)

Hey, Ernie Garcia. Hey, Mark Jenkins. Hey, guys. The company is getting more profitable the smaller it gets. At some point, this will need to change. I hear you on the guidance that I was gonna ask, is 80,000 units a quarter the right size for the company? You're telling us, it's gonna get, continue to get a little smaller, I would imagine, with the lower levels of merchandising and then the lower ad spend too remaining there. I guess I'm wondering, are we there yet? What is the right size for the company? I have a follow-up.

Ernie Garcia (CEO)

Sure. I mean, to jump to the end, I think the right size for the company is much, much larger eventually. I think the path there through profitability has just included some of these moves that we've made to shrink inventory and shrink marketing and get back in balance. I think, you know, where we found ourselves after 2021 was expecting another similar year and just being pretty dramatically out of balance with where sales actually were. I think, you know, as we were, you know, growing from when we launched in 2013 all the way through 2021, we benefited a lot from the positive feedback in the business. As we got bigger, we got better. As we grew our inventory, conversion rates went up.

As we spent more on marketing, it was easier to open new markets. I think, you know, when we kinda found ourselves out of balance and we needed to rebalance the business, we knew that we were gonna face the other side of that feedback. We knew that as we shrunk, we'd see conversion rates go down, and we knew that was gonna be a difficult transition. In light of the environment, we also thought it was the fastest path to meaningful positive cash flow. We took that path, and I think we remain on it. I think, you know, we believe that we are probably pretty close to where sales will bottom out. I think, you know, we'll learn more on that over the coming quarters. You know, we've obviously made dramatic moves.

I gave the numbers to Sharon a moment ago about how quickly we've lowered advertising and inventory just in the last quarter. I think some of those things can have some lagged effects that'll show up over the next couple quarters, so I don't wanna act overconfident that we know exactly what will happen there. I think the major headwinds that have faced the business over the year are largely subsiding. There's clearly been, you know, some industry and macroeconomic headwinds in the form of cost. There's been macroeconomic headwinds in the form of interest rates. There's been a lot of Carvana-imposed headwinds in the form of inventory reduction and marketing reduction and focusing on profitability and pulling away from sales that were less profitable and implementing different product changes that we think make the business more efficient.

I think that's undoubtedly been a difficult transition. You know, it's hard to know exactly what the impacts of all of those things are on volume, but doing the best job that we can and trying to control for all those, we do believe that the business is performing better than we might have imagined, you know, once we've made those moves. You know, we have estimates for the elasticity of sales to inventory size and to marketing dollars and to many of our different product changes. I think based on what we're seeing, we're actually pretty happy with where volumes are. I think, you know, the 3rd step of our plan when we get there is gonna be to turn back to growth, and that's something that we clearly know how to do.

It's something we're clearly incredibly well positioned for. I think we'll be better positioned for it than ever before. When we're a more efficient business, it means that growth comes easier. When we're, you know, when we've got the infrastructure that we've been able to acquire over the last year and a half, we're gonna be in a better position to grow. I think that's step 3 in our plan. You know, we're looking forward to Q2, where we plan to hit step 1. We'll stay focused in that same direction. We've already got our plans for the next, you know, 9-12 months, to keep the pedal down and keep making a lot of progress in unit economics. We plan to do that at somewhat similar volumes to where we are today.

Then when we get there and hit that goal, we're gonna definitely turn our attention back to growth, because we're still incredibly small compared to this huge opportunity. It is still a 40 million unit market. We still have an incredibly unique offering, and it's still an offering that customers love.

Adam Jonas (Head of Global Autos and Shared Mobility Research)

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

Ernie Garcia (CEO)

Let me start with, I think where we've made the most progress in costs over the last year, you know, we've made a lot of progress. You know, I apologize for throwing these numbers around over and over again, but we're proud of them. You know, we've cut $1 billion of cost out of the business and, you know, over $100 million quarter-over-quarter. I think, you know, there are many areas of cost. There's kind of fixed costs, there's variable costs. I think there's semi-fixed costs, then there's, you know, customer acquisition costs. In the variable costs, I think we are currently operating across virtually all of our operating groups at all-time best efficiencies.

In the variable costs themselves, I think we're generally at or near all-time lows across all groups. I think that's happening despite input costs being higher. Generally, the efficiency for all of our groups is better than it's ever been. In some groups, the costs are still in similar place where they've been in the past because the input costs are higher, whether that's, you know, gas or, you know, there's been inflation just across the economy. There's some areas where they're somewhat similar, but I think we've made a tremendous amount of progress, and I think there's more progress to be made in those variable costs. In kind of the semi-fixed costs, I think that's actually been the biggest bucket over the last year.

That's where we were just built for a different level of volume than we saw. I think we've made a ton of progress there, and that's been extremely helpful. I think there's still some room for us to make progress and get all the way in balance there, but I think most of that has been achieved. In customer acquisition costs, you know, we're at all-time lows. You know, I gave the stat. At the company level, it's about $700. In our oldest cohort, you know, it's in the low 300s. We have 4 cohorts that are better than company average. You know, those are pretty great numbers.

Those are numbers that are in alignment, the below 300 numbers in alignment with best in class peers in the industry. It's in line with our long-term financial model. I think over time, there's room there. I think that we've clearly proven that we can do much better there than we ever have in the past. I think that that's exciting. Fixed costs today per unit are probably higher than they've ever been or at least near all-time highs. That's because volumes are lower. We've got a fixed cost business. We feel like we're getting returns on those investments. I think that's, you know, once you've got costs, you'd rather them be fixed than anything else. I think that's, you know, good news.

Certainly our fixed costs are high relative to our sales today. We do think we're getting return on that investment. We plan to reduce those costs over time. We plan to reduce the dollars of those fixed costs. We've been making progress on that, but we can make more progress. The remainder of them on a per unit basis, you know, go away with scale. Some of them go away just with the passage of time. You know, today we still have many facilities that we're massively underutilizing. In the case of some of our office space, that's office space that will probably go away over time. In the case of our inspection centers, for example, that's something that we expect to lever with scale.

I think we've clearly got a path to significant additional gains in expenses across all types of expenses. I think the biggest gains are behind us, and they took the form of that kind of semi-variable form where just getting the business back in balance was really valuable. And then you also asked a question about delivery fees.

Adam Jonas (Head of Global Autos and Shared Mobility Research)

[cross talk]

Ernie Garcia (CEO)

Something that we have done over the last year is we've changed our offering such that when customers elect to buy a car that is further away from them, especially in case when there's a car that's closer to them, we will charge a delivery fee. That is flowing through our gross profit. I think Mark spoke about that as being something that's different from the gross profit that we've had in years past. You know, for our customers, we still have thousands and thousands of options available to them that are free.

If there's, you know, some specific feature or option, or unique component of a car that they're interested in, that's further away, they can still buy those cars that are further away and we will charge a delivery fee. I think, you know, when we go back to our previous best GPU year, which was 2021, we were at $4,500 for that year. You know, that was a year where we didn't have that approximately $500 line item. That was a year where we didn't have ADESA. I think that's where Mark was talking about, you know, GPU being in a place where we think the future looks very bright relative to the past, and we're pretty excited about that as well.

Adam Jonas (Head of Global Autos and Shared Mobility Research)

Thanks, guys.

Operator (participant)

The next question comes from Michael Montani with Evercore ISI. Please go ahead.

Michael Montani (Research Analyst)

Hey. Thanks for taking the question. Had 1 on the cost side and then, a separate one on the customer base. Just on the cost side, if I could, just wanted to dig into a few of the buckets, in particular, you know, the compensation and benefit, other SG&A and then market occupancy, and just kinda get a handle around, you know, if you think of comp and ben right now, do you basically have the right team in place, the right size team, and any further improvements from here are basically gonna be about process and efficiencies that you might gain, or is there still some work to do there? Just kind of the same question then for other SG&A as well as, market occupancy.

Mark Jenkins (CFO)

Sure. Let me start with market occupancy. That's the shortest answer. Market occupancy, you can think of more or less a fixed expense. I think we, you know, it's largely facilities out in our, yeah, out in our markets, and including vending machines. You know, that's an expense where we think we have significant opportunities to scale into the fixed cost base that we have, but that is more or less fixed expense that we think we can lever meaningfully with volume over time. Moving on to comp and benefits, we certainly see opportunity to continue to drive down compensation and benefits. You know, I think we've made tremendous progress there. Ernie talked a lot about that progress.

you know, I do think the, I think the future gains are spread across different areas. Definitely see an opportunity to continue to become more efficient in operations. We see opportunities to, you know, continue to

You know, get leverage through our logistics network. We see opportunities to continue to identify, you know, I'd say savings in, you know, in our corporate expenses as well. I think, I think we see opportunities across the board in compensation and benefits. We've obviously made a lot of gains there recently. In other SG&A, you know, other SG&A we've talked about before. It's really, you know, it's kind of 3 major categories of expenses in there. There's transaction expenses, there's corporate expenses, and there's technology expenses. I think as Ernie sort of alluded to, we see opportunities in all 3 of those areas. We see an opportunity to bring down per unit transaction expenses over time with further efficiency initiatives.

You know, we've made some gains in limited warranty, bringing that down on a per unit basis recently, and see opportunities, you know, in some of the other expenses like title and registration. In corporate technology, definitely, I think Ernie covered a lot of this ground, but see a lot of opportunity for leverage with increased volume, but also see an opportunity to bring down dollar expenses, over time, you know, as we continue to focus on efficiency. That's touching on a lot of the same points that Ernie touched on. We clearly see opportunity throughout the cost structure, from where we sit today.

Michael Montani (Research Analyst)

Thanks for the color. That's helpful. Just to follow up on the consumer side for a second. I don't know if there's any color that you could share in terms of the 25% decline that you saw. You know, how would that shake out, you know, based on household income levels? Then also, I know you all have been working to, you know, improve profitability, and there was some metering involved. Can you give us a sense for how, you know, maybe the coastal markets were able to perform relative to those in the central part of the country?

Mark Jenkins (CFO)

Sure. I don't think we have anything particularly interesting to say there. I think the trends that we've seen over the last year or so have remained. I think, you know, as it relates to Carvana-specific trends, I think we continue to see the middle of the country performing a little bit better than the coast for the same reasons discussed. I think as affordability has continued to kind of move away from most consumers, I think we've seen the trends that you'd expect where I think across the entire auto industry, there's generally been a shift toward higher incomes and higher FICOs.

I think that's really just more of a distribution shift that, you know, we would expect and hope, will revert, you know, when either interest rates, you know, start to back up or car prices start to back up or both. I think, you know, we saw through most of 2022, we saw, you know, car prices depreciate, but it was offset by increasing interest rates. I think early this year, we saw volatility in interest rates, but we saw car prices start going back up. I think more recently we've seen, you know, wholesale price going down for the last several weeks. Retail prices still been barely appreciating but look like they will probably start to depreciate shortly.

You know, hopefully we're headed down a more sustainable path of sort of orderly depreciation, that will bring more customers back into the market.

Michael Montani (Research Analyst)

Thank you.

Mark Jenkins (CFO)

Thank you.

Operator (participant)

The next question comes from Seth Basham with Wedbush Securities. Please go ahead.

Seth Basham (Managing Director and Director of Research)

Thanks a lot and good afternoon. My 1st question is just on your Q1 results that were meaningfully higher than the updated guidance provided on March 22nd, driven by gross profit. Can you give us some more insight as to what drove the major improvement in the last days of the quarter?

Mark Jenkins (CFO)

Sure, yeah. So, you know, with respect to our outlook for Q1, I think, you know, we're very close to the top end of the range on units, revenue, SG&A, expense, loan originations, all of those metrics. We beat on GPU. In our outlook, we called out a couple of major points of uncertainty that wouldn't be known until after quarter end. Those being, P&L from our loan hedging, as well as our retail inventory allowance, which in part depends on, you know, what we see in the market, you know, kind of around the time of quarter end or shortly thereafter. Both of those uncertain items resolved favorably. That was the big driver on GPU.

We had a couple other beats, small beats on GPU across other areas of the business in the last couple weeks of the quarter, but those are the big 2.

Seth Basham (Managing Director and Director of Research)

Got it. That's helpful. You've indicated that the retail inventory allowance is likely not sustainable. You've also talked to Other GPU likely being over $2,000 in the Q2, primarily driven by a normalization of loan sale volumes. What do you consider normalized volumes? You've already sold $1.3 billion this quarter. I'd presume that's in line to above what I consider normal based on historical trend.

Mark Jenkins (CFO)

I think the easiest way to think about normalized loan sale volume is you approximately, you know, sell what you originate. You know, that's what we've done over the 1st many years of our life as a company. I think normalized is you sell what you originate. Obviously, there can be some timing shifts from quarter-to-quarter, depending on market and other dynamics. You know, as we mentioned, we, you know, for example, sold less than we originated in Q4, as 1 example of that. I think that's the easiest way to think about normalized loan sale volume. Some quarters will be below normalized, some will be above, but on average, that's the right way to think about normalized.

I think so far this quarter, obviously, you know, had success selling and securitizing loans. I think feel good about that. I think, you know, other GPUs we view as one of the areas of strength in the business, along with some of the other areas that we've pointed out on the rest of this call. I think we're feeling pretty good about where we're at.

Seth Basham (Managing Director and Director of Research)

Thank you.

Operator (participant)

The next question comes from Nick Jones with JMP Securities. Please go ahead.

Nick Jones (Director and Senior Equity Research Analyst)

Great. Thanks for taking the questions. maybe just a follow-up on the cost reductions and maybe the impact on the logistics network. As you start to turn the corner on maybe starting to build inventory and ramping volume, have kind of the cost reduction efforts you've made potentially impacted, you know, your ability to kind of scale volume and logistics? how should we think about maybe incremental investment out the other side, as you do start to build inventory down the road and maybe what changes you've made in logistics today? Thanks.

Ernie Garcia (CEO)

Sure. I'm gonna answer that with respect to most of the operating groups, and I think logistics will fit in this in this framework as well. I think there's efficiency and focus that are maybe 2 different things. I think, you know, we've clearly increased efficiency. You know, just because you asked about the logistics network. In the case of the logistics network, you know, we've recently increased utilization of our logistics network, meaning the trucks are driving around with more cars on their back. You know, we've decreased the miles they're traveling, you know, over time by something like 40%. I think, even quarter-over-quarter it was down by 12%. That's, you know, taking many different forms that are driving those miles down.

It is just more efficient and therefore there is kind of less work done per sale and therefore when it is time to grow, it'll be less work to achieve the same level of growth. I think that's true across all our different operating groups. I also think that a huge part of that efficiency has been gained because we've sort of removed a variable from the equation. We've aimed for lower volumes that we are confident we could hit. By doing that, we were able to just really focus on costs and expenses and keep everyone focused on all the projects that were necessary to complete to drive down those costs and expenses. I think as a result, you know, we are not focused on growth.

Growth is its own focus, and it has a lot of associated projects, and it requires time and effort and attention. And, you know, we're not currently positioned to grow as quickly. I think if we decided to press the button and turn around tomorrow, we certainly know how, but there would be a lag time associated with that, to be able to really grow the way that we have in the past. That is not our plan. Our plan is to hit, you know, the 1st step of our plan, next quarter to then, you know, move through that to significantly positive unit economics and then to move to growth.

I think between here and there, we hope to make more gains in efficiency across all of our operating groups and then to shift our focus to growth when it's time. That's something that we clearly feel like we know how to do, and we clearly feel like we've got consumer demand for our offering that we'll be able to go satisfy when it's time.

Nick Jones (Director and Senior Equity Research Analyst)

Great. Thanks, Ernie.

Ernie Garcia (CEO)

Thank you.

Operator (participant)

The next question is from Rajat Gupta with JPMorgan. Please go ahead.

Rajat Gupta (Research Analyst)

Great. Thanks for taking the questions. Just wanted to follow up on the, on the receivables question from Seth earlier. So, you know, if I look at, you know, the reported financials, I mean, I think in the Q1, you know, in the Q4, you sell roughly $800 million lower than what you originated. In the Q1, looks like it was close to $300 million-$400 million versus what's originated. So, there's like $1.2 billion of backlogged receivables that need to be sold before you can go back to like an origination to a similar origination versus say, a run rate or a normalized run rate. How long should we expect for that $1.2 billion backlog to get clear?

Like, is it gonna be as soon as 2Q or will it take multiple quarters? I have a follow-up. Thanks.

Ernie Garcia (CEO)

Sure. I think you're approximately right in the size of the backlog. I think that, you know, the way that that works in the business is we've got, you know, a couple billion dollars of warehouses where we can kind of house those loans prior to selling them. You know, that does tie up capital. That extra, you know, on the order of, you know, $1.2 billion loans is tying up a pretty meaningful, you know, portion of liquidity. When we relieve that will unlock quite a bit of cash. You know, we probably have about a $0.15 discount on average in our warehouses.

That means, you know, with using your number of $1.2 billion, you know, that would unlock about $180 million of cash by selling those receivables down. I think we plan to sell those down in the coming quarters in an orderly way. You know, the benefit of carrying them is we actually do earn additional finance GPU because those are very yield-y assets. Prior to sale, we are the ones benefiting from that yield. As Mark called out in Q1, we had some benefits there in finance GPU. We do plan to catch up and sell them. I think, you know, the financial markets at least recently have been in a better spot.

You know, at the end of the Q1, we had, you know, some elements of the regional banking crisis that caused the securitization market to be a bit choppy. That caused us to push the securitization back that had been planned. We recently completed that securitization. It was our largest subprime securitization that we've done to date. That actually went extremely well. We were many times oversubscribed across all classes. And we're extremely pleased with the way that went. I think a big part of what has driven that is I think we do attract the customer and we give them an experience that ends up leading to very high-quality loan performance. I think the securitization market has recognized that.

I think that's something that has, you know, we've been able to take advantage of as we've gone through this period. I think over the coming quarters, assuming that the financial markets remain open the way they have been over the last several weeks, we will likely sell down those excess receivables. That would be a, you know, one-time tailwind to Other GPU when we do complete those sales.

Rajat Gupta (Research Analyst)

Understood. That's, that's helpful. Then maybe, you know, just a broader question on the liquidity profile. You've mentioned in the past that, you know, your next avenue to shore up liquidity would be to leverage the ADESA real estate. I'm curious, like, if that view has changed at all over the last, you know, couple months.

Would you be open to considering alternate options, you know, outside of the exchange offer which is ongoing, to reduce the current level of interest burden, you know, versus taking on more debt, you know, maybe restructuring the existing unsecured bonds or perhaps even considering a debt for equity swap? Yep, that's it. Thanks.

Ernie Garcia (CEO)

Sure. I can take that one. No changes to the way that we've historically thought about that. I think, you know, typically when we think about financing sources, you know, generally speaking, we favor asset-based or you know, sort of, you know, asset-based or secured financing, of which I think, you know, the biggest asset that we have today is real estate. You know, have nearly $2 billion of total unpledged real estate assets. A little more than half of that is the ADESA real estate locations and no change to our overall thought process there. I think we generally, you know, generally prefer asset-based or secured financing.

Rajat Gupta (Research Analyst)

Got it. Thank you.

Operator (participant)

The next question comes from Alex Potter with Piper Sandler. Please go ahead.

Alex Potter (Managing Director and Senior Research Analyst)

Great. Just 1 question from me, and it's about the competitive landscape in auto loans. I know that historically you had mentioned you were a little bit quicker to hike interest rates than some of your peers who had bigger balance sheets. Wondering if there's been any rationalization in that regard or any other comments you'd be willing to make on the competitive landscape in auto lending would be helpful. Thanks.

Ernie Garcia (CEO)

Sure. Well, I think it's been a dynamic environment. I think, you know, the primary dynamic that we probably have spoken most about as it relates to our loans over the last year or so, was kind of the spread between the 2-year Treasury and Fed funds, which the 2-year Treasury is a good proxy for, you know, our cost of funds when we, when we sell our receivables because they have approximately a 2-year duration. And they're generally sold into capital markets that use, you know, those sorts of rates as a reference point. You know, approximately half of the, of the market for auto loans is provided by banks that oftentimes are, you know, using some combination of that and the Fed funds as their frame of reference.

I think, you know, since the end of the Q1 when kind of the regional banking crisis hit or started, I think there's also been some dramatic moves in spreads that I think are other impacts that are somewhat unique right now and I think are a little bit harder to forecast over the medium term. I think, you know, probably there's been some spread widening in different areas. I think undoubtedly Carvana itself has seen spread widening over the last year. I think that's, you know, that's too bad, but it shows up in our results. Once you've got the results, you know what they are. I think that's actually good news for the future.

I think there's room for our spreads to come down over time as we approach the cost of funds of more mature issuers. I think that that's a dynamic that will play out. I just think that, you know, from here to the next couple years from now when things are normal again, I think, you know, there will probably at some point be a normalization in 2-year Treasury versus Fed funds. That should normalize. There will probably be something of a normalization in spreads. Then, you know, there should be a normalization in Carvana spreads relative to other issuers. I think that all of those things leave room, I think to be optimistic, but the timing on all of them is also uncertain.

Alex Potter (Managing Director and Senior Research Analyst)

Great. Thanks very much.

Ernie Garcia (CEO)

Thank you.

Operator (participant)

The next question is from Winnie Dong with Deutsche Bank. Please go ahead.

Winnie Dong (Director in Equity Research)

Hi, thanks for taking my question. I just have 1. On the commentary that you expect similar SG&A expense on a quarter-over-quarter basis, can you maybe clarify whether this is on a per unit basis or absolute dollar? I know you've, you know, discussed all of the various buckets to sort of go after on a longer-term basis, but near term, what's sort of driving that pause? When might that longer-term sort of, you know, reduction come back? Thanks.

Ernie Garcia (CEO)

Sure. Yeah, absolutely. On the first part of the question, we were talking about SG&A expense on a dollar basis. To put that in context a little bit, you know, I think last quarter we outlined a goal to achieve approximately $420 million of non-GAAP SG&A expenses by Q2. We obviously did that a quarter early, not only did we do it a quarter early, we also, you know, beat that goal by more than $15 million. I think we're obviously feeling really great about the overall progress in removing SG&A expenses from the business and becoming more operationally efficient. I think that context is helpful.

You know, in Q2, our expectation is similar SG&A expense to Q1. I think that in part reflects just the, you know, very, very significant gains that we were able to make in Q1. Looking forward beyond that, you know, we certainly, we've made tremendous progress. We certainly do not believe we're done. I think we have significant opportunities across the business, as I alluded to earlier, to continue to become more efficient in our operations.

You know, that happens through all of the technology projects that we have going on throughout the operational efficiency groups to, you know, automate manual tasks, to make our routing and scheduling more efficient, to, you know, as we alluded to earlier, you know, incentivize customers to choose the, you know, cars that are close to them or to, you know, incentivizing them to do VM pickups versus delivery. All kinds of things to help, you know, that we, you know, still have in progress to help drive operational efficiencies we're working on. They're not. We've made great progress, but they're not done yet. I think, that's a little bit more color on the opportunities that we see ahead.

Winnie Dong (Director in Equity Research)

Great. Thank you so much.

Operator (participant)

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

Chris Bottiglieri (Equity Research Analyst in Hardlines, Broadlines, and Internet Retail)

Hey, guys. Thanks for taking the question. Yeah, wanted to ask about I guess first about the, you know, the financing market. You said a non-prime deal, which is pretty impressive to get that price in this liquidity environment. Like conceptually, how do you think about owning that residual versus selling it off, just given where discount rates and risk spreads are and all that. Like, is it still like capital efficient to do get on sale for these non-prime type deals, or would you ultimately look to sell the residual?

Ernie Garcia (CEO)

I think you know, in general, we've looked to sell the residual. I think you point to something that is correct, which is, the yields that residual buyers today are getting are very high compared to the past. Those yield profiles are very robust. They can take very large multiples of expected losses, and still do quite well. I think that dynamic is correct, and that makes those desirable assets. I think, in this environment with our current goals, we still intend to sell those residuals over time.

Chris Bottiglieri (Equity Research Analyst in Hardlines, Broadlines, and Internet Retail)

Gotcha. Okay. You know, 1, I guess, conceptual question as well on inventory. It sounds like you just make more money on Retail GPU when you sell the cars under 90 days. I get the world just shifted dramatically on a dime, like no one could see that move that quickly. Have you rethought how you price cars with your algorithms? Like, is there a way to get more proactive with taking markdowns and setting stuff through wholesale just to, like, put a rule in place you don't sell cars above a certain number of days? Like, how do you learn from this experience and realizing how much better the model runs with quicker inventory days and kind of prevent this from happening in the future?

Ernie Garcia (CEO)

Sure.

Chris Bottiglieri (Equity Research Analyst in Hardlines, Broadlines, and Internet Retail)

Go ahead.

Ernie Garcia (CEO)

I can take that one. You know, I think we had a multi-year period, I would say honestly, 2018, 2019, I think late 2020 and 2021, where we operated pretty tight inventory. You know, average age of sale, call it as low as the high 50s up through, you know, the mid to high 60s. We're, you know, and that's on average. We're pretty consistently operating in that range.

I think that we've probably experienced a little blip with COVID in early 2020, and then certainly moved materially off of that normalized range in 2022, because we just overbuilt inventory for the interest rate environment that ultimately, you know, came about and the sales that we ultimately ended up executing in 2022, we meaningfully overbuilt inventory for that. I think the... You know, what we're seeing with these cars above 90 days, I do think is really a function of us overbuilding inventory relative to sales, you know, and sort of maintaining that for most of 2022. We've clearly adjusted, clearly marked down inventory. You know, the cars that we hold relative to the cars that we're selling are in a much more normalized range.

As everything sort of works through, we, you know, we think that'll lead to a much more normalized average age of sale and a much more normalized share of cars sold in less than 90 days. I think really the name of the game is returning to our historical norms after a pretty significant outlier year in 2020 that really culminated in Q1.

Chris Bottiglieri (Equity Research Analyst in Hardlines, Broadlines, and Internet Retail)

Gotcha. Thanks, guys. Appreciate it.

Ernie Garcia (CEO)

Thank you.

Operator (participant)

The next question is from Zachary Fadem with Wells Fargo. Please go ahead.

Sam Reid (Equity Analyst)

Thanks so much, guys, for taking my question. This is Sam pitch hitting in. Sam Reid pitch hitting for Zach. Wanted to bucket advertising savings in a bit more detail. Can you break out how much you might be saving from shifting to different ad spend channels, like more digital versus just absolute reductions in ad spend? Separately, a more broader one on market share. As you right-size the business, who do you think is picking up some of the market share you might be giving up? Thanks.

Ernie Garcia (CEO)

I think at a very high level, I think what we've tried to do in marketing is kind of manage our uncertainty as best we can. What that basically meant was pulling more away from digital channels than brand channels. What I mean by managing our uncertainty is I think brand channels tend to have a long and difficult to measure payoff. We think that payoff is significant. You know, building a brand is an incredibly difficult thing to do. It's an incredibly valuable thing to do. Direct channels and, you know, various advertising channels vary in their level of directness, direct channels, you know, tend to have a shorter, faster payoff that is much more measurable.

As we've gone through this environment, we've tested many different channels. Some of those tests, you know, take kind of a global form, where we do, you know, large A/B tests of using a channel or not using a channel. Many of those tests take kind of a market level form where we pick a subset of markets that look similar to another subset of markets, and we run 1 marketing channel in 1 set of markets and a different marketing channel in a different subset of markets, and we try to get a sense for how those are going. Those sorts of tests are a little bit less susceptible to errors in attribution. I think we've just tried to kind of continually learn because this environment has been different.

It's been an environment where car prices are higher. It's been an environment where our inventory is smaller. Both those things mean lower conversion. It's been an environment where there's been less competition for various marketing channels, which means clicks are less expensive. That varies by the marketing channel, even by the kind of sub-channel inside of any given channel. If we think about SEM, for example, there are many sub-keywords and sub kind of campaigns that you can run. We try to be thoughtful about running many different tests and learning. I think that we feel like we've been pretty successful in cutting a lot of expense out, and I think we're excited by that.

I think, we're also starting to see that with GPU climbing up pretty significantly and our variable costs dropping pretty significantly, our contribution margins are starting to look better. I think some of those trades could change a little bit in terms of what marketing channels we're supposed to be utilizing. We'll keep learning. I think over time we will most likely grow marketing spend from here. I think there's a reasonable chance that it could even go up at the per unit level, just given what's most efficient, given our higher levels of GPU and our lower levels of variable costs.

Then as it relates to, to kinda market share, what I would say there is I really think the most important point here is this market is enormous. You know, we're probably right now, you know, on the order of about 1% market share. You know, we're down from where we were, let's say, 2 years ago, but we're down a similar amount to the market overall. I think quarter-to-quarter and kind of year to year there can be some variability in those numbers. If you look back kind of to a more normalized environment, we're probably down a similar level to where the market was overall. So we're probably about 1%.

If you look at it over, you know, the last, you know, 6 months, 9 months, 12 months, we've certainly given up some. We were probably a little higher than 1%. We're probably back down to 1% now. Where that is going is, you know, to a mix of the other 99%. And I think the most important dynamic there is just that this is a very, very large market. You know, now is not a time when everyone is focused on growth here, and we think it's appropriate not to be focused on growth. But I do think that, you know, if we allow ourselves the indulgence, it's worth thinking about what that'll feel like again, because we do have a differentiated customer offering the customers love. Our NPS is high.

As we get more efficient, we're seeing benefits to NPS there. you know, there will be a time when it's time to grow inventory again, and it's time to turn up marketing 'cause our GPU is high and our variable costs are low. It will be very difficult to replicate the machine that we've built, and we're incredibly well positioned for that time. I think when that time comes, we'll look to kinda take that volume from the entirety of that market again, that very, very large market. you know, the great news of being in a market that big is very few players will be able to identify exactly where it's coming from 'cause it is just such an enormous pool that we are drawing from.

I think, yeah, it's hard for us to say, where the very small amount of market share that we've given up has gone, but I think we're very well positioned to take it back when it's time.

Sam Reid (Equity Analyst)

That's super helpful. Thanks so much, guys.

Ernie Garcia (CEO)

Thank you.

Operator (participant)

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

Ernie Garcia (CEO)

Thank you. Listen, everyone on the Carvana team, I cannot thank you enough. I think, I hope you're proud looking at this quarter. I hope you feel that. I hope, you know, I know the last year has been a tough year. I know it is not a year that we anticipated walking into. I know that everyone's put in a ton of work. I know there were times when it felt, like the payoff in that work was slow and it was hard. I hope you see this quarter as evidence that it is paying off and it's paying off pretty quickly.

I hope you also know that we've still got a ton of work left to do, and all the focus that we've put in over the last year is paying off, but we've got a lot more effort to put in from here. I think, you know, heads up, be proud, but also, you know, let's keep the pedal down and let's keep going. Thanks, everyone, for joining the call.

Operator (participant)

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