Carvana Co. (CVNA) Q2 2022 Earnings Report, Transcript and Summary

Hello and welcome to the Carvana Second Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] 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 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 & 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 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 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 all 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 completed our acquisition of ADESA in a transaction that we believe will be transformative over time. First, I want to hit our change in priorities to favor efficiency in 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 said 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 are 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've set a stretch goal to hit $4,000 cash SG&A per unit in the fourth quarter excluding impacts from ADESA. 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 mid-term 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 are 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 ADESA team. They've embraced us in a way that we couldn't have reasonably expected. They're 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 on 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 ADESA locations nationwide. We've already embedded market operations hubs at 18 ADESA sites. ADESA 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. Overtime, 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 overtime, 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's value in dialing into important cost fundamentals to get less attention at easier times. And as you can see from our priorities, we are focusing more on fundamentals in this environment as well. That said, it's 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 in 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 level 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 are becoming the largest and most profitable automotive retailer. The Mark continues. Mark?

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 ADESA. 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 ADESA's wholesale marketplace, which closed on May 9. Total gross profit per unit in Q2 was $3,368 a decrease of $1,752 a 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 $1,131 in Q2 compared to $808 in Q1, a sequential increase of $323. Retail gross profit included a $51 per unit impact from Ernie's one 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 $1,216 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 ADESA 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 units 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 Ernie's gift to 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 ADESA 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 ADESA. On June 30, we had approximately $4.7 billion in total liquidity resources including $2.7 billion in cash and revolving availability and $2.1 billion of real estate and other assets including approximately $1 billion of real estate acquired with ADESA. 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 goals of driving positive cash flow and becoming the largest and most profitable auto retailer. Thank you for your attention. We'll now take questions.

We will now begin the question-and-answer session [Operator Instructions] Our first question comes from Zach Fadem of Wells Fargo. Please go ahead.

Hey, good afternoon. Ernie at the current level of 8000 to 9000 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 restep up to in order to achieve the stretch SG&A per unit goal in Q4?

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 still at a pretty fast rate when you kind of really stop and take in. So I think that 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 you 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 the number 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 to focus. We decreased 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 impact all else constant. We've also been purpose about managing our inventory down. So from peaks and 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 with 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 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. 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 we're certainly 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 we'll hope to get that back over time at some point. I think when we look to our goals we -- there's kind of two ways that we can make progress toward $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 kind of 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 the growth to be as we head through the next couple of quarters. But I think our expectation of stretching to get that $4000 goal, it does have gains in both areas, but the primary focus is efficiency throughout the business.

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 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 for the logistics or market occupancy lines how those flow in as well?

Sure. So I'll hit that one. So I think our -- 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 I think total payroll declined by -- 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. And so -- 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 third-party transport services that we used in Q2 to work to clear certain backlogs out of the logistics network in areas that were particularly constrained. And so that's something -- that's an expense that we bore in Q2 but don't expect to bear to nearly the same degree in Q3. So, that's one particular example. As we're looking out over the rest of the year we really do see opportunities across all areas of the business. They continue to drive SG&A efficiency. And so we will be looking to do that across the business. Some of the bigger buckets I do think continuing to match staffing levels to volume I think would be one of the bigger ones there but we do see many opportunities. Overall, I would say 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 be prepared.

The next question comes from Sharon Zackfia of William Blair. Please go ahead.

Hi, good afternoon. A question on reconditioning and inbound transport. I know it was kind of similar in the second quarter to the first quarter. And there's obviously a timing lag here. But 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 is 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?

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 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 immediately as you get the progress whereas the COGS benefit you make the progress and then you have kind of the time lag until you sell the car and then it flows through. So, there's 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 kind of, incentive structure, I would say in many ways it's similar. It's just the projects that we're kind of 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 in the rest of the week as well. And so I think 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 and attention and accountability and speed. And I really do think the results of that so far has been pretty great. Yes, I think just it's hard to put this in a model but we have a project that we rolled out for example in the last couple of days. And just kind of sitting in the room with the team is 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 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 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 of which we're getting things done is something that I'm extremely excited about and grateful to the team for.

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

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 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.

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 that 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 else constant, that's leading to higher purchase prices. It's leading to differences in 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 from a credit perspective, across automotive I think in general, most finance companies continue to see pretty strong performance. I think there's 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 yes, I think 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, it's driven by kind of the complexity of OEMs 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 is felt relatively more stressed so far broadly. 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 to believing that the kind of industry has already taken a deeper stress than the rest of the economy, I think it means kind of any additional stresses from here and expectations should probably be less than any recovery from here and expectations should probably be more. So, I think we'll see how that all unfolds over time. 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 versus other customers out there.

And then just in terms of pricing, just curious if you all have a view that we may see a flat or even decreasing retail pricing from here. And if we do see retail prices decrease into the back half of the year, does that make it harder to reach the GPU goals that you've set out, or have you already kind of planned for that?

So, I think that's hard to say, but I do think -- let me give you first just a fact. I think we have seen depreciation kind of return to the market so far this year. So that is something that is occurring. Next is something of a mental model. It's not totally dissimilar to what we just discussed. But I think given that car prices have inflated more than other goods and services, it is probably likely that on average they will depreciate faster in the future to kind of 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, 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 into 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 the depreciation is unexpected I think, you could see decrease in 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, that's -- we don't know exactly how that will play out, but that's how it's historically played out and there is some evidence that's playing out that way now as well.

The next question is from Chris Bottiglieri of Exane BNP Paribas. Please go ahead.

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 flow the room from the logistics and reconditioning. But you did see like frankly, pretty good improvement sequentially in a retail GPU. And you seem to highlight market improvements there. Is that all just kind of would you cited a second ago on kind of move in to wholesale pricing, or are there other factors that led you to kind of expand that retail GPU $400 sequentially?

Sure. 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 once adjusting for our reduction in force in Ernie's gift $1,216 in the quarter a 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 -- I think that number includes very elevated reconditioning and inbound transport costs. And so, I think, 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 Q4, 2021, was a really high time to be purchasing cars. And so, as we moved away from Q4, 2021, I think, that had a positive impact on retail GPU where in Q1 we were just selling more cars that were purchased in Q4 than we sold in Q2. And 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. I think -- yes, I think those were the primary impacts, yes, 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.

Got you. That's really helpful. And then, just an unrelated question. If I look at the ADESA financials like, the best I can tell, it looks like 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 may be a tad below the $100 million you were targeting. And I know volumes declined 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?

Sure. So, I think, 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 ADESA would be. I think we're clearly at a trough for kind of the auction business today. It's -- or I don't want to say necessarily, precisely the trough. We're at a low point relative to recent history for the auction business. For ADESA, 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 1 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, kind of, this time around. And so, 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 touristic 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 somewhat optimistic. There are 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 that 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 ran with our 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 ADESA's 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 kind of what our kind of 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 2.5 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 ADESA instead of running 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. I talked about some benefits that 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 not just about the extremely exciting long-term opportunities around reconditioning and logistics, but also around the near-term opportunities 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 other side of the deal closes, and you get to go meet all the people and have your first couple of 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.

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

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 ADESA in 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? Was it -- do you see it as kind of more correcting from what was the last couple of quarters of just your the issues between COVID and IRC bottlenecks and now you're at a normal level, or is that -- 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.

Sure. So I'll take that one. So we did reduce inventory meaningfully quarter-over-quarter. As a note that doesn't include any impacts from ADESA 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 we did meaningfully overbuild in various areas of the business, kind of, moving into Q1 of this year. That included infrastructure. That included staffing. That also included inventory. So we definitely have been at an above normalized 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 just as we sort of normalize the size of inventory to get to our target level. I sort of think of our target level as somewhere in the $2 billion to $2.5 billion range. And 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 inventory size 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. The 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 recon cycle time. Many of our cost initiatives are also speed initiatives that have the goals of speeding up the number of days between when we acquire a car and get it the RC speeding up the number of days between when we start -- inspect the 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.

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 how that compared to 1Q? Thanks.

Sure. So the -- so we don't report that number specifically, but we did see a unit decline in inventory as well that was think of it as approximately in line with the balance decline.

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

Hi. Thanks for taking the question. I guess two if I could. On the time buffers in certain states related to title and registration, 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 then the second question, there was a bullet about not passing through the cost of fund increases. How should we think about, I guess, when you might start passing this through? Thanks.

Sure. Those are two big questions, they'll lend themselves to long answer. 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 moms, I can imagine that's a question people on the call may have. We 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 -- kind of lagging where reality is. So 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 the 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 while it's unfortunately kind of hard to get really clear data around how other dealers perform in registration that is an imperfect process across the entire industry. Unfortunately, I think, over time it's something that things 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 oft-times 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 is 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 process 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 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 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 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 the finance companies are doing, but we do have good data there. And so when we monitor many different larger banks and financial institutions, we've seen a lot of those institutions start to raise interest rates really starting in March and April a couple of months after we did. And we tend to see them over the last several months raising interest rates by something between 25 and 50 basis points give or take a month, which actually can make a pretty big difference pretty fast. So we don't know exactly how other finance companies are going to react. We'll continue to monitor elasticities and try to make smart decisions about how we're handling interest rates on our side. But certainly we've seen an increase in benchmarks and spreads that has 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.

The next question is from Seth Basham of Wedbush Securities. Please go ahead.

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?

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 give us time to make sure that we were able to work with the state and make sure we could resolve some of the maybe miscommunication disagreements that we've had. So we look forward to working with them. We 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 -- 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 asked for support. In 48 hours, we had 6,000 customers sign a petition of support. We have thousands of comments that came in supporting Carvana. Since then we've had thousands more come in as well. And so I think that was a powerful message from our customers that certainly customers across the country and in the state of Illinois all other states as well are really loving the Carvana experience. And those are people that are intimately familiar with our process that instantly came to our aid there, which I think was a great sign. And so I think periodically over time there is certainly risk that we'll run into these -- with the 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 safest partners and they can view us the same way.

Great. And as a follow-up on the financing business, can you talk about the channel mix shift for some your finance receivables in the second quarter? How much would 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?

Sure. So what I would say is I think whatever we thought about where we're going to sell our receivables, we're trying to balance maximizing proceeds and minimizing cross time volatility. I think that's always been our goal. That's been the reason we've set up a platform that enabled 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 a process like securitization. And so what we elected to do is 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 it 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 the expectation and kind of volatility around that expectation. I think as we head through the rest of the year, it's hard to know exactly where things are going to go. It is a pretty dynamic kind of macroeconomic backdrop, and these markets can be sensitive to 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 of weeks have actually been very good, in the ABS market. So we'll continue to monitor those markets and try to make the best decision 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 ensure that we have flexibility to exercise whatever freedom we think is the right choice to make as we move through the rest of the year.

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.

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

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. So what happens when you get to the $4,000 target? One of the questions we get a lot is trying to address is once you get to the $4,000 and you continue to reduce that even further, how should we think about growth particularly in the context of some reduced ad spending recently some of the other growth initiatives that you had that you're tempering recently? What kind of like -- what's the growth algorithm for the company will get to that lower SG&A level? And I have a follow-up. Thanks.

Sure. So I think the short answer on what do we do when we get to $4,000 as 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, in different locations, in different functional areas because that's costly as well. And so I think the goal -- 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. But then 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 provided some data in the past about, what our SG&A expenses are in some of our more mature cohorts. And so I think that provides visibility into what we've been able to do. And we were able to do that before we really put focus on prioritizing processes and products that make us more efficient. So 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. It means with the same amount of work we can grow units by more. So I think, we're excited about what kind of these efficiency goals are going to mean for our growth in kind of the medium term. But I think as I said 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 is extremely focused. But we're on a very good path and we're excited about it.

Got it. And maybe just a follow-up on the SG&A. Within the comp and benefits line, is there a way that you can help dissect for us what the corporate employee costs are versus some of the more personnel-related expenses in terms of employees who are involved in the actual buy-sell financing part of the transaction? Any metrics you can share around efficiency there, transaction time for sale or employee hours per sale or something of that sort? And so where are we today? And where do you expect to get to as you get to your $4,000 or the $3,500 target next year? Thank you.

Sure. I can hit that one in a couple of different ways. So I do think we've -- I think on comp for example, you can see what we've achieved in the past is on sort of compensation and benefits for retail units sold. I think that's a useful benchmark for where it can go. I think we've laid out midterm goals that are available on the Investor Relations website that also give a sense of where it can go sort of beyond what we've already achieved in the past. I think -- 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. I think, 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 sort of the customer care phone time per sale is coming down. Those are a few examples. Utilization in the logistics network is going up. There's -- 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 of the teams are focused on, we're feeling really good about the way they're -- those are trending.

The next question comes from Colin Sebastian of Baird. Please go ahead.

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 if that -- 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.

Sure. So, I think on the first question, so the way we've always thought about this is we have a two-channel strategy for monetizing our loans. We use the securitization market. And then we sell loans through whole loan sales or for 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 whole loan 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 for ABS or for whole loan sales. As we laid out in Q3, 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.

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 kind of the form that this thing has taken so far. So in terms of like demand across cars I would say it 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 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 focused from us and it's an area where we've made progress so far and plan to make more progress going forward.

The last question will come from Brian Nagel of Oppenheimer. Please go ahead.

Hi, good afternoon. So I know we're trying to rein down here. So I'll ask one – I guess one question with two parts. But with regard to ADESA, well there's a lot of – there's been chatter out there about now that Carvana owns ADESA maybe some historic customers or partners with ADESA would no longer want to do business with ADESA because they're now competitors to Carvana. So the question I have are you seeing that dynamic? If so is that factored into kind of the parameters you've given us for the ADESA business? And then secondly, just as we think about ADESA and its enhancement to the overall Carvana model, at what point or at what point would there kind of be that breakout moment where we really start to see the true benefits that ADESA is bringing to Carvana?

Sure. I try to go on site as you said we are tight on time. Let me start with I think for sure we saw some customers of ADESA 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 ADESA. And so I think that so far at least it feels like the team at ADESA has done a good job, weathering the turbulence of that transaction which obviously causes 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 that's going to unfold. Again, ADESA is approximately one million units back of where it was in 2019. So there's a lot of room for volume increases from here kind of regardless of the number of customers that come back. But we'll be fighting and shooting to provide great experiences to all the historical customers of ADESA and trying to explain why we think that ADESA 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 to see what you expect to see the benefits of ADESA I think 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 continue 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 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 ADESA.

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Perfect. All right. Well, thanks everyone for joining the call. To everyone inside Carvana and ADESA, thank you so much for everything that you guys have done. The last several months have been dynamic, I believe, it was the word that we used in the prepared remarks. You all have felt that and seen that. And I think that people always have to decide how they respond to 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 of 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 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.

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