CVNA - NYSE

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

Thank you, MJ. Good afternoon, ladies and gentlemen, and thank you for joining us on Carvana's First Quarter 2024 Earnings Conference Call. Please note that this call will be simultaneously webcast on the Investor Relations section of the company's corporate website at investors.carvana.com. The first quarter shareholder letter is also posted to the IR website. Additionally, we posted a set of supplemental financial tables for Q1, which can be found on the Events & Presentations page of our IR website. Joining me on the call today are Ernie Garcia, Chief Executive Officer; and Mark Jenkins, Chief Financial Officer. Before we start, I would like to remind you that the following discussion contains forward-looking statements within the meaning of federal securities laws, including, but not limited to, Carvana's market opportunities and future financial results that involve risks and uncertainties that may cause actual results to differ materially from those discussed here. A detailed discussion of the material factors that cause actual results to differ from forward-looking statements can be found in the Risk Factors section of Carvana's most recent Form 10-K and Forms 10-Q. The forward-looking statements and risks in this conference call are based on current expectations as of today, and Carvana assumes no obligation to update or revise them, 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 our GAAP and non-GAAP financial metrics for our reported results can be found in our shareholder letter issued today, a copy of which can be found on our IR website. And with that said, I'd like to turn the call over to Ernie Garcia. Ernie?

Thanks, Meg, and thanks, everyone, for joining the call. Q1 was an incredible quarter for Carvana and one that is worthy of reflection. My plan is to first share some of the highlights from the quarter and then to discuss the long-term implications of our recent performance. First, the highlights in the quarter. In the quarter, we achieved adjusted EBITDA margin of 7.7%. By this measure, in Q1, we not only set new all-time company records, but we also became the most profitable public automotive retailer in the U.S. for the first time. We returned to growth, growing retail units 16% year-over-year despite decreasing marketing dollars by 4% and having constrained inventory. We completed our first quarter with adjusted EBITDA exceeding CapEx and interest expense, achieving this milestone by a significant margin. We achieved GPU that exceeds our previous record from Q2 2023 after normalizing for last Q2's excess loan sale volume, achieving a GAAP gross profit margin of 19.3% above the high end of our long-term financial model. We significantly levered marketing spend, operations expenses and overhead expenses, the last of which were held flat in absolute dollars despite 21% sequential growth. In combining our GPU and expense leverage, we also validated our long-term financial model that we put out 6 years ago and clearly lit a path to significant additional financial gains from here. These gains will be driven by both leverage on our fixed overhead costs and additional fundamental gains in both operational expenses and GPU. We see opportunity for large improvements in our adjusted EBITDA margin from here. We achieved all of this in a difficult automotive environment at a time when most in the industry are moving backward on both unit economics and volume. The long-term implications of this quarter are significant. We continue to deliver experiences that our customers love. The strength of our customer offering has always been apparent in our growth, which even with the last 2-year hiatus, has earned us the honor of being the fastest-growing automotive retailer in U.S. history. As we get bigger and more efficient, the experiences we deliver get even better and simpler. Constantly improving customer experiences has always been centrally important to us, and it will remain centrally important to us in the future. It is one of our most important feedback loops. We are positioned to grow significantly from here. The part of our business that is most difficult to scale is reconditioning because it requires significant physical space, construction and zoning approvals. Across our current inspection and reconditioning center infrastructure, we have capacity for 1.3 million units per year, over 3x our current volume. Beyond that, our ADESA locations, we have the ability to increase our production capacity to a total of approximately 3 million units annually. To unlock this opportunity, we are developing a playbook to bring our full suite of retail reconditioning and logistics technology and processes to ADESA locations. We recently completed our first conversion of an ADESA site in Buffalo, New York to a Carvana Reconditioning Center, and now this site is leveraging Carli, our proprietary reconditioning software and our proprietary processes to recondition retail units. We believe we have a model that gets better as it gets bigger, and ADESA is a key part of that story. Reconditioning cars at more ADESA locations over time reduces inbound transportation, which positively impacts cost of sales and retail GPU and decreases outbound transportation, reducing SG&A per unit and decreasing delivery times for our customers, increasing conversion and decreasing marketing costs. This is also a good feedback loop. Competitively, we sit in a better position than we have at any point in our history. Through our own experiences and those of the various companies who have sought to do something similar to us, the last few years have resoundingly proven just how difficult it is to build a business this complex to drive it to scale, to achieve strong unit economics and to deliver high-quality customer experiences. Building a business like Carvana is very hard and hard is the ultimate competitive moat. Our addressable market remains an enormous opportunity. 40 million used cars are bought and sold on average each year. There are tens of thousands of car dealers offering customers similar experiences to one another with similar business models. Carvana offers a differentiated experience, supported by a differentiated cost structure and driving a differentiated business model. That differentiated model just delivered approximately $1 billion in annualized adjusted EBITDA, and we are still a long way from the full financial potential of our business model and its scale. With just 1% market share in this enormous, fragmented market, we are extremely well positioned. Today is an exciting day for Carvana. The size of our opportunity and the strength of our positioning are clear. Now it's our job to make sure we make the most of it. Our team is ready, the march continues. Mark?

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

[Operator Instructions] Today's first question comes from Rajat Gupta with JPMorgan.

Congrats on a great quarter and improving a lot of [indiscernible] so kudos on that. So I had one question, just looking at the first quarter results and comparing it to the fourth quarter. Unit, almost like 15% sequential growth -- or 20% sequential growth. I'm curious, was that all primarily driven by just better selection, faster deliveries? Was there anything that you saw changing in the used car market itself that supported that greater-than-seasonal pickup? I mean, just curious if you can characterize that growth in the first quarter a little more relative to what you're seeing in industry trends. And I have a quick follow-up.

Sure. So let me start with this. I mean, I think we're still moving down in marketing dollars. Our inventory is clearly constrained. We put a stat in our shareholder letter that for cars to make it up on our website, they're being picked up by a customer in 13 days on average right now. So we're definitely constrained. And so I don't believe the best explanation of growth is one of these levers that's being pulled. I think potentially, a better explanation of growth is that it's a return back to the kinds of things that drove our growth for many years prior. We grew extremely fast from 2013 to 2021. There were probably many things going on there, but I think the 2 most important because they're most sustainable were, one, we deliver to customers the experience they love. It's highly differentiated and hard to replicate and one for which I think consumer preferences are constantly migrating toward. And I think, two, there's positive feedback in our business inherently. And I think over the last 2 years, through '22 and '23, that positive feedback was going the wrong way on us because we were shrinking inventory, and we were shrinking marketing dollars, and we are pulling in, and we are really focusing on profitability. And I think over the last several quarters, that's -- at least kind of the wins have gotten still. And so I think that's probably our best explanation. In addition to that, there have been countless improvements across the business. You're seeing many of those in the financial numbers. You can see our operating expenses going down, you can see our GPU going up. That's the result of a lot of work from a lot of teams where they focus on customer experiences and efficiency gains and just made little improvements over and over again for the last several years. And I think that drives better customer experience, it drives higher conversion and it drives better economics. And we think all of that is playing into what we're seeing today.

Got it. Got it. That's clear. And then I think in your prepared remarks, you mentioned that you plan to grow EBITDA margins from here. So is it fair to assume the 7.7% is the whole point even on a quarterly basis? Or was that more of like an annualized comment? I mean, just curious how should we think about -- you've obviously given us like some guidance in the second quarter. But curious, does that also mean margins are also naturally up sequentially, and it's just not EBITDA that's up.

Sure. Well, so I think we're going to stick with the guidance we provided. The guidance we provided for Q2 is in EBITDA dollars, and we expect it to go up. But then I think we can also provide some color. We provided a table in the shareholder letter that we hope is useful that quantifies 3 relatively straightforward extrapolations, we believe, relatively straightforward extrapolations, from our Q1 results to give kind of some visibility into where we think things can go. And so those 3 changes were, one, we started with 7.7% adjusted EBITDA margin. We did actually undersell loans in the quarter versus what we originated. And if we assume that we would have sold those loans at a similar premium, which would be our expectation to loans we sold in the quarter that would have gotten us up to 8%. And then number two, we kind of provided a data point where our average marketing dollars divided by revenue was 1.8% in the quarter. That's -- that already compares pretty great to our long-term model that we put out 6 years ago where we expected to be between 1% and 1.5%. But if we look at our 4 oldest cohorts where we tend to have higher market shares and lower marketing spend, it was down to 1%. And we think that clearly lights the way to getting down to the low end of our financial model over time. And so that's 0.8%. And then you also saw in the quarter that we held our overhead expenses flat in dollar terms at approximately $150 million. And that led to significant leverage on a per unit basis, given the 21% sequential growth. And so if we assume that we grow into the infrastructure that we have across the business, we have inspection centers that we're ready to grow into. We have excess multicar haulers as a result of our path over the last couple of years. We've got the market operations hubs to support significantly more growth. We think there's over 3 points of possible leverage there. And then that also leaves out the fundamental gains that we're continuing to work very hard on across the business in driving down operations expenses and driving up GPU where all the teams that have done all this incredible work over the last 2 years to make all these gains have exciting projects that they're still working on today. So I think we look at all that, and we're extremely optimistic and extremely excited, frankly, about the medium term. I think we got a lot of work to do to make sure that we unlock all that value, but we're working hard to do it.

The next question is from Chris Bottiglieri with BNP Paribas.

So obviously, really impressive unit economics, I think amongst the highest in retail that we've ever seen. Curious how you think about sustaining this versus reinvestment. Is there a level -- like when you have this 3,000-plus retail GPU, why is that the right level versus, say, taking it lower? And have you looked at elasticity and what it could mean if you sacrifice some of the GPU to drive higher units? Curious how you think of that balance.

Sure. Well, first, this is our 29th call that we've done as a company after being public. And I think now after Rajat, we've got 5 great quarters. Your first comment was ambiguous. So would we qualify that as a great quarter or no?

You could add me on that list.

Thank you. Appreciate it. Okay. I think is -- what I would say, I think we're very excited. We're in a great spot. I do think that today, we are a bit constrained, most notably in inventory, but also as we've spoken about for the last several quarters, we have not been positioning for growth just yet, right? We've been focused on driving the economic gains that we're seeing today. And that's been part of a plan that kind of has an annual cycle that is up in June. So most of our operating teams really have not been focused on growth at all. They've been focused on kind of staying in a similar spot and then basically responding to the demand that has kind of been -- has just been showing up kind of absent us pulling it forward from customers. And so I think where we are today is we have to start to position the business for growth over time. We've been working on trying to catch up on inventory. I think an interesting somewhat hidden stat in the business is because we were shrinking inventory so much a year ago, even though our inventory is roughly flat and our sales were up year-over-year 16%, the cars that we have reconditioned year-over-year are up closer to 50%, and that's because last year, we were really pulling down on that capability because we were trying to shrink our inventory and get back in line. So that part of the business has begun to flex that muscle and you're seeing the results in retail GPU that you see today, that's happening while they're working hard to grow and support that 50% growth year-over-year. The rest of the business has a little bit of work to do, and we're also behind on inventory. I think until we catch up, I think it's pretty clear what our move is supposed to be. We're supposed to work hard to catch up, and we're supposed to kind of make normal adjustments with the market as we go. I think once we catch up, there may be other moves that we can make, but we'll have to make that call at that time. We clearly think we're constrained, and we clearly think that if we had more cars to sell and we're -- build more capacity, we would be selling more cars than it would be leading to additional EBITDA.

The next question comes from Sharon

I'm not going to keep showering you with complements, so that's going to just end here. So I guess, 2 questions. On the GPU, it's obviously very, very good. And I know you've done a lot of work on reconditioning, you mentioned Carli, in your prepared comments. Can you give us kind of any insight on where recon per car is all in today relative to maybe several years ago and how much more you think you can harvest in terms of efficiencies there? And then I have a follow-up.

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

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

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

The next question comes from Chris Pierce with Needham.

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

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

Okay. And then just as a follow-up, what does growth look like from here? I know you're talking about increasing production, which means you're buying more cars from customers to get more cars on the site. But like do you need more technicians? Do you need more -- like, is there anything you need more of? Or like what kind of -- or you're just literally just using excess capacity that you already have or adding a second shift? Like what does growth really look like from here?

Well, I think growth -- so I think maybe it's helpful to make that as concrete as possible, let's kind of overlay it with the growth that we have from 2013 to 2021. during that period, we were growing very, very quickly, even in kind of like the last normal year, we grew at 100% in units year-over-year in 2019. Obviously, as you get to a large and larger scale, that gets very hard but we were able to grow very quickly. And what we were doing that entire time is, we were building each of our operational capabilities and scaling them out. And so at that time, that meant that we were going out and we were finding reconditioning centers, we are purchasing the land, we were getting it zoned, we are doing construction on the land, we're getting all the improvements done. And then we were going out and we were hiring teams. We were training teams, and we're doing the reconditioning. We're doing the same logistics and customer care to answer customer questions and verifications and registration. All these different operating groups, we had to do all this work, and we were able to grow at pretty fast rates doing all that. I think where we sit today, to first speak kind of medium and long term, and then we'll speak in the near term. I think there's reasons to be pretty optimistic about what's possible. I think from an effort per sale perspective, the business is just materially more efficient than it was when we were driving that growth back through 2021. A couple of stats that are useful. And this also speaks to the fundamental gains we made as a business. In market operations, we now have 50% roughly of our activities are paired, which means when a customer advocate loads up a car to drive to a customer, before they come back, they stop somewhere else, they pick up a car that we bought from a customer and drive it back. That's a relatively complicated capability to build out that requires a bunch of different teams, but it's a valuable capability. And even a year ago, that was less than 30%. So that gives you a sense of each of these people in market ops are more efficient than they've been in the past. If we look at total miles driven in our logistics network for a number of reasons, we're down about 30% versus a year ago. So that's less logistics work to drive a transaction. Our sales per advocate are up 61% year-over-year. That's a big number. That means that we're more efficient there as a business. In title registration, we're more than twice as efficient as we were per person a year ago. So I think from just a work required to grow perspective, we're in the best place we've ever been. From an infrastructure perspective, we're clearly in the best place we've ever been. In the past, we had to build infrastructure as we went. Today, we have infrastructure sitting on the shelf. So that's great. I think the financial impacts of growth are better than they've ever been. We're sitting here with more overhead expense per unit than we had back in the growth years by a significant margin. And with larger GPUs and very low variable costs, that means contribution margins are high and leverage into fixed cost is also high. So I think from a finance perspective, it's good. And then I think risk is sort of a combination of all of those things. I think we all together saw very clearly the risk of growth at fast rates at large scale when 2022 showed up and car prices went up and interest rates went up, and we were not well positioned and that was tough. That put us in a tough spot, but I think when all is said and done is going to end up being a great part of our story, and it's going to be a positive part of our story. And so I think we're extremely proud of the team for making the most of it, but we saw what risk looks like there. Given where we are in the kind of financial position of the business and our unit economics, it's likely the risk is less. So I think growth from here, like I said, there's reasons to be optimistic. We also kind of coined this term of a transition period. I think we've had a lot of success over the last 2 years, focusing on driving efficiency. And when we go through each part of the business with every operating group and talk about what can we do in the next year, there are still meaningful gains to be had in every group, and they're still exciting projects to work on. And so we want to make sure that we continue to take advantage of that and make progress there because we think in the long run, that's going to serve our purpose by making this even more efficient. But we also see the very obvious payoff in growth. And so we want to start to lean into that. And so we're going to have to start balancing those considerations. And the transition period, I think, is about us finding that right balance. So we've always been an ambitious group of people. We remain an ambitious group people. We're going to push that. But we also recognize that moving through this transition period purposefully and observing different levels of growth as we move will enable us to make the highest quality decision we can about exactly what the right speed is. So I think we had to figure that out over the next several quarters, but we're excited about what it can look like.

The next question is from Seth Basham with Wedbush Securities.

Congrats on the outstanding results. The conversion is just popping here. Is there 1 or 2 things that you can point to that's really driving this increased conversion over the last quarter or so?

I think the simplest explanation for that, and I think that this is kind of the first of the feedback loops that we tried to point to in the prepared remarks is just that as we get better, our customer experiences get simpler and faster. One way to say it from a cost perspective is we have 60% more sales per advocate than we had a year ago. What also means is the customer has fewer touch points, right? When they call in -- well, they're less likely to call in. If they call in, they get a better experience where they get more information faster and things in the background are moving more quickly so that we don't need as many back and forth. And so I think that is just the business getting simpler. And so I think a lot of these expense improvements that we've had over the last 2 years have also driven simplicity in customer experience. We've seen NPS go up pretty linearly for the last 18 months, which is pretty exciting. And so we're going to continue to push on that. But I think it's that. And then again, going back to the answer we gave in the first question, I do think that we were dealing with some negative feedback for a 2-year period as we were shrinking inventory and shrinking marketing. And I think even just that stabilizing has been helpful.

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

Sure, I'll take that one. So in the shareholder letter, we lay out a number of places where we see opportunities for fundamental gains in gross profit per unit or gross margin. I think those gains take a number of different forms. One is, we definitely don't think we're done on costs. So I -- in response to Sharon's question earlier, see meaningful opportunities for reductions in reconditioning costs from here, both due to technology and process driven efficiency gains as well as due to some scale components. I think in addition to that, we see opportunities to make further gains on inbound transport costs over time. Ernie touched on this with some of his commentary about adding more reconditioning centers, including at ADESA. That gives you more production locations, which reduces your inbound shipping miles and therefore, your inbound shipping costs. So those are on the cost side. In some of the other areas, we absolutely see opportunities to continue to drive our wholesale vehicle business. We have teams that are working on fundamental gains there. We see opportunities in finance and ancillary products as well that are outlined in the shareholder letter. I won't talk through every single one of them here. But those have been areas where we've had success over the years, with teams really focused on just grinding out fundamental gains in those areas. And those same teams see more and more opportunities as we look forward from where we are today. So even though we're experiencing exceptional results, we still see opportunities for fundamental gains across all of those different areas that the teams are going to be working to pursue.

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

So it's been almost 6 years since we had the Analyst Day, obviously, we're making great progress toward the long-term model we laid out at that time with our 7.7% adjusted EBITDA margin in Q1. We haven't given any plans for an Analyst Day in the future, but I think that's something that we could pursue at some point in time in the future.

The next question comes from Michael Montani with Evercore ISI.

Just wanted to ask, if I could, around 2 things. One was just around the capital stack. If we should be surprised if there's an equity raise here coming down the pipe? Or if you think at this stage, it's more about improving EBITDA and delevering the balance sheet gradually in that way? And then I had a separate question on the vehicle pricing.

Sure. Yes. So I'd say for the last couple of years, in response to questions about capital structure, we've been focused on operating results. And talking about how first driving the positive adjusted EBITDA and then driving significant adjusted EBITDA from there was our key focus. That focus has obviously paid very significant dividends here with record adjusted EBITDA in Q1 and a very big adjusted EBITDA number in Q1 that meaningfully exceeds our capital expenditures and interest expense. And so absolutely a goal for the business will be to continue to drive adjusted EBITDA. And as you drive more and more adjusted EBITDA, your -- all of your capital structure metrics look better and better over time as you continue to drive those operating results. So that's certainly going to be our #1 focus. In terms of more financial aspects of the capital structure, we did call out in my prepared remarks that we do plan to pay cash interest on our 2028 and 2030 senior secured notes. Those are the 2 sets of notes that are eligible for cash interest in 2025. So we plan to pay cash interest on both of those notes in 2025. That reduces overall debt outstanding and also reduces long-term cash interest expense. And so we did call that out earlier in this call.

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

Sure. What I would -- let's start with this. I think we keep track of millions of cars that are listed across many different websites all the time to make sure that we have a good sense of the pricing of our vehicles and how it compares. And I think over the last several years, our offering versus both some of our larger competitors. And then also just across -- against the market generally have been very stable over time. So we've generally held that pretty consistent. I think that's the right first order assumption from here as well, especially given the constraints. Over time, I think as we continue to make gains, there's no question that there's opportunities there. But that's not something that we're planning on right now.

The next question comes from Adam Jonas with Morgan Stanley.

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

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

Never, never for a minute. I mean your margins are like twice CarMax and you're doing like 1/3 their volume. So it's a good start. It's a good start. So I'm going to ask Michael Montani's question a little different way. There's still a lot of economic uncertainty. It seems like the Fed might have overplayed their hand and talk of stagflation and just an uncertain time. So I'm just wondering, do you feel that you have enough equity in the business right now? And remind us maybe how you think about longer-term leverage targets for the business.

Sure. I can take that one. So I think the simple answer to the first part of that question is, I think we have ample liquidity and the business is generating very strong EBITDA and cash flow today. So I think we feel great about that structure. As I talked about earlier, we do intend to delever over time. I think a component of that, that we talked about on the call earlier is we do plan to pay cash interest expense on both eligible sets of notes in 2025. And that reduces overall debt outstanding relative to paying in kind and also reduces long-term cash interest expense. So I think there's been so many questions about our capital structure over the past couple of years, including pretty serious ones that people were asking at earlier points in time. But I think this quarter resoundingly repositions us as it relates to those questions. I mean, $235 million of adjusted EBITDA, an outlook for an increase in that adjusted EBITDA dollars looking towards Q2. And as we talked about meaningfully exceeding CapEx and interest. And then as we've talked about throughout the call, we see big opportunities ahead now that where we're positioned from an excess capacity perspective, from a customer offering and customer demand for our product perspective, I think we see a lot of opportunity ahead. And so I think that we feel really great about where we are today.

And then as a follow-up, they say, what doesn't kill you makes you stronger. And I think this quarter seems to be -- goes a long way of some evidence of that. But what also doesn't kill you maybe makes you wiser. And now that you're returning to growth, tell us, Ernie, what are you -- now that you're in a more humble after that near-death experience, but growing and stable and things are looking good, what are you keeping an eye out for? What does keep you up at night in terms of things that you don't want to get complacent on, whether it's things that you can control or the things that you can't?

Well, first of all, you made an assumption in that question, which is not obviously true, but we'll assume that it is. I would say, listen, we're extremely excited, right? If we go back to the very beginning, what do we want to do? We wanted to build a business that we thought was going to require a ton of work, to deliver great customer experiences, give them a better, simpler experience and drive industry-leading economics. And I think it feels really good to be in a spot where we feel like there's a very strong argument to be made that those boxes are checked, and now our job is to get from here to the promise land and build this thing to be as big as we possibly can. And I do think, going back to the growth answer, we are incredibly well positioned to do that. I think it's -- the last couple of years have been absolutely brutal, but they have really cleared the competitive field quite a bit and also as a result of us getting it wrong in terms of what was going to happen in '22 and '23, we're very well positioned from an infrastructure perspective, and so forward growth looks good. I think that transition period is about us figuring out the balance between that enormous opportunity and making sure that we continue to execute extremely well. And I think that will be something that we'll be debating internally over the next several quarters. I think it's something that we'll figure out. And I think it will be different voices in the room trying to make sure that we get that right. But I think that we're picking between I think different versions of pretty good outcomes as long as we execute. And so I think we're excited about that. In terms of fear, I think -- I do think -- I would like to give our team credit for being a team that places a lot of internal pressure on ourselves. I think that hopefully, that's apparent in the sum of the work that we've done together over the last 11 years. But I think that there's no question that there is no substitute for a bunch of external pressure. It is -- it can put pressure on you in a way that you just cannot pressure yourself. And I think something that we're working on internally is just trying to make sure that we remember the value of that pressure we were under and that we try to keep as much of that on ourselves as we possibly can, even if the world decides that we're maybe a little less dumb than the world might have thought we were a couple of years ago. And I think that's not an easy thing to do. That's a very easy thing to say. But to come in every day and put your head down and grind over and over again, even when things feel pretty good, is much easier said than done. So I think internally, we're working hard to try to cement that culture as best we can. I think we have the right people to do it. I think we're on a good path. I think acknowledging that, that's important is the first step. But I think that to me is the biggest fear because it made us better, and we want to stay in the position we're in right now.

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

Ernie, you sort of answered this in a lot of different ways, but you guys guided to units being slightly up in the quarter. Your marketing expense was very well contained. So what drove -- you talked about better conversion, but what sort of drove the upside in units, which were a big upside surprise? And I've got a follow-up.

So I think there's a series of things. I do think that the units came in stronger than we anticipated. And I think that, that starts with demand moving in our direction. And then I think it's completed with the team executing very well despite not anticipating it. And so that -- there's no getting around inventory shrinking when demand comes in a little hotter than expected because there's long lead time there to kind of the number of cars you're buying and you're reconditioning. And so we saw inventory shrink a bit, but we saw even that team made quick adjustments and started to kind of get in a better position relatively quickly. And then I think the rest of the operating teams also handle the volume very, very well. And so I think that, that enabled us, despite not being super well positioned for growth to handle growth pretty well anyway. And so I think -- we're excited about that. We think that, that bodes well. But we think we have work to do to really get the business into a position for sustained growth at high levels, and that's what the transition period is all about.

Excellent. And then, Mark, just to be super clear here in terms of your guidance, you're seeing a sequential increase in our year-over-year growth rate in the retail units. So I mean seasonally, I don't know, you generally have flat to slightly down units Q2 over Q1. I mean it's jumped around a lot over time. But -- so you're saying the growth rate will be up from the first quarter.

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

The next question is from Ron Josey with Citi.

Ernie, I wanted to ask a little bit more about sources of leverage and advertising specifically because I thought the commentary in the letter around the 4 oldest cohorts achieving 1% of advertising expense as a percentage of revenue was pretty telling, especially as you're just seeing pretty good growth come back here. So I just wanted to get your thoughts as you think about sort of go forward and sort of the brand recognition and awareness of Carvana, just how do you think about advertising spend going forward strategically? That's question one. I've got another one, which might be a little bit easier, I might have missed earlier. But I think I heard capacity for 1.3 million units per year across the IRCs and ADESA about 3 million units annually. Mark, I go back to the Analyst Day, however many years ago about that 5% share goal. We have enough capacity now. Or did I hear that maybe more IRCs might be on their way or just more efficient ones?

Sure. So let's start with marketing spend. I think from here, there are 2 forces on marketing spend that point in different directions. I think as we continue to make fundamental gains, we think there's reasons why we can continue to drive that down as our newer cohorts of markets age and act more like older cohorts of markets, we think that, that can be driven down. And then we also do believe that in inventory specifically we're constrained today. And if we were not constrained, we'd likely see higher conversion of the customers we already see on the website, and that would likely drive marketing dollars down as well. So I think that there's a number of forces that we're going to be actively working on to push advertising spend down. I also think it is clearly true that we believe we could acquire incremental customers today at incremental customer acquisition costs that would be much lower than the gross profit minus variable costs and therefore, would be additive. And it is also likely that much of those incremental customers that would be positive EBITDA additive would come at higher CAC than our average CAC today. And so as we kind of march up that incremental customer acquisition cost curve, that would be a force that would push it up. I think going forward is a balancing of those 2 forces, and I don't think that we want to call our shot just yet. I think that's also something that we'll be figuring out as we go through the transition period. On the footprint side, just to make sure that's clear. At our existing inspection centers, we have capacity for 1.3 million units, and then we add the ADESA sites, you get to approximately $3 million in sum total. Those ADESA sites do still need CapEx on top of the land to unlock that potential. We size that CapEx at the time of the acquisition at approximately $1.2 billion, which is probably still a good way to think about it. But that would be on the order of what would be required to unlock that additional reconditioning capacity.

The next question is from Nick Jones with Citizens JMP.

Sorry if I missed this. But in the past, and you were kind of growing really rapidly. On occasion, you might hit some choke points that you would need to work through, which you tend to always be able to do that. As growth accelerates here, and Ernie, I think you mentioned you're kind of feel good about where the infrastructure is. I mean are those choke points potentially still out there as growth accelerates? Or how should we think about some things that may be out there that still need to get worked through that we have kind of seen in the past?

I think the short answer is yes. I think growing is always hard. We tried to give an outline for why we think we're very well positioned for growth in the future from here and in many ways, better position than we were in the past. So hopefully, that's somewhat helpful. But of course, there will be difficulty as we head back into growth, and there will be growing pains. There always are. And then hopefully, we execute well and we push through those pains. And we have a lot of fundamental gains to offset them. But I think that's the work that we have in front of us. And I think in terms of real-world opportunity in front of us, we feel extremely good about it. But of course, there's going to be work to do. And of course, over the years, there will be a version of these calls where we'll be explaining what we're dealing with at any point in time because running a business is hard.

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

Great. Well, thank you, everyone, for joining the call. We really appreciate it. And to the Carvana team, we say this at the end of every 1 of these calls, but thank you guys so much. You've done an absolutely incredible job. This was virtually impossible to foresee. And I think really this quarter is probably the hardest one to foresee from the perspective a couple of years ago. I think we've been through tough times together, and I think there will undoubtedly be a lot of good days in front of us and a couple of bad days. I think if we keep grinding the way that we have grinded over the last couple of years, there's going to be a lot more good days and bad days. And when we see those bad days, we know how to face them. And I just cannot thank you guys enough. You've done an incredible job. Please be proud and then please put your head down and keep fighting like it's 2022 because that's what got us here. Thanks, everyone.