Earnings Call: Q4 2018

Feb 27, 2019

Good afternoon, and welcome to the Carvana 4th Quarter 2018 Earnings Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. 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, Andrea, and good afternoon, ladies and gentlemen. Thank you for joining us on Carvana's Q4 2018 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 4th quarter shareholder letter is also posted on the website. Joining me on the call today are Ernie Garcia, Chief Executive Officer and Mark Jenkins, Chief Financial Officer. Before we start, I would like to remind you that the following discussion contains forward looking statements within the meaning of the federal securities laws, including, but not limited to, Carvana's market opportunities and future financial results that involve risks and uncertainties and 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 section of Carvana's most recent Form 10 ks. 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. We will be discussing some non GAAP financial measures, including gross profit ex Gift, SG and A ex Gift and EBITDA ex Gift. All gross profit, SG and A and EBITDA metrics mentioned by us on this call are on an ex gift basis unless otherwise noted. You can find reconciliations of those measures to the most directly comparable GAAP measure in the shareholder letter we published today posted on our website investors. Carvana.com. And now with that said, I'd like to turn over the call to Ernie Garcia. Ernie? Thanks, Mike, and thanks everyone for joining the call. Completion of another year is always fun because it provides an opportunity to take a quick break from all the things we're doing to continue our progression forward and to instead pause and reflect on what we've built so far. We're excited to be reporting results on another incredible year of building the company. We closed the year with our 20th straight quarter of triple digit growth. This is an accomplishment that clearly demonstrates the power of our customer offering and the quality of our execution and is a feat that we are extremely proud of. We grew units by nearly 50,000 for the year. This growth makes us the fastest growing automotive retailer in the country. We grew revenue by 128%. This makes us the fastest organically growing U. S. Listed public company at anywhere near our scale in either retail, consumer or technology. We grew our GPU from $15.39 to $2,133 an increase of nearly $600 for the year and an increase of over $1100 since going public in April of 2017, cementing our path to our midterm goal of $3,000 and beyond. We continued our march toward profitability, showing 700 basis points of leverage for 2018 and over 1300 basis points since going public. All of this progress is the result of 2 powerful long term forces. We're building a product our customers love and we have incredible people who love building and delivering it. If we do our jobs from here, those same two forces will drive us to our goal of selling 2,000,000 plus units per year. That number may sound daunting to some, but looking backwards provides some helpful context. Getting to $2,000,000 requires that we grow roughly 20x from here. Few companies scale like that. That said, we are 120 at the size we are today just 3.5 short years ago. The next 20X will undoubtedly be harder than the last, but that is a pretty interesting statistic that speaks to the power of our customer offering and to the power of the growth it has generated. In the shareholder letter we published this afternoon, we included our market penetration and customer acquisition charts by cohort. These charts continue to get us very excited and show continued impressive penetration into this $1,000,000,000,000 market. Our growth in customer acquisition cost leverage in each of our cohorts continues to progress very quickly and clearly lights the path to our long term unit and financial model goals. Led by Atlanta, our first market, which achieved a nearly 2% market penetration in the 4th quarter and $462 CAC for the year. The trends underlying the cohort's progress have persisted in a consistent and encouraging way as well. Newer markets are on average growing faster than older markets. In fact, 72 of 84 non Atlanta markets are ramping faster than Atlanta at the same time in its way. And Phoenix, our home market, made it to the 1% market penetration milestone in 16 months versus the 42 months it took Atlanta. Smaller markets continue to ramp faster than larger markets. An example of this is that Montgomery, Alabama and Charleston, South Carolina became our fastest markets to 0.5% of market penetration, both hitting that landmark in only their 2nd quarters after launch. We continue to see markets that are nearby pre existing markets ramp faster than those that aren't, which we think is an exciting indication of the value of the brand we are building. As of today, we're in 100 markets that span different geographies, demographics and market sizes. The results we are seeing are consistent and compelling, cementing our belief that we have built a better way to buy a car that has mass appeal. Part of the materials we published today, we included a deeper dive in our finance platform, which we hope you will find helpful. There are many takeaways from that information, but the most important in general I would like to make today is this, fundamental improvements in our model, namely lower variable costs, incredible customer experiences and thoughtful vertical integration are powerful and have many expressions. One such expression is in our finance platform, which enjoys many advantages when compared to traditional finance businesses. In the case of traditional automotive finance companies, they are part of a vertical chain that sits on top of brick and mortar dealers. Effectively, brick and mortar dealers are suppliers to automotive finance companies and all the attributes of the brick and mortar dealers, including their cost and pricing structure, their vehicles and the customer experiences they generate are embedded in the loans originated by their finance company partners. In our case, the innovation that exists in our retail platform flows into our finance platform, allowing us to generate higher quality loans and to customers' finance experiences that are as simple as the retail experiences we are known for. There's a lot more detail on our platform and on the performance of the loans we have generated over time in the 101 materials we posted today, which we request you review. Our strategy has always been to build an industry changing business through a combination of great technology, world class operations and a culture of delivering great customer experiences. I'll now touch on the progress we made in each of these areas in 2018. First, technology. There are 2 areas inside of technology I'd like to briefly hit, customer facing and internal facing improvements. We made a ton of progress on customer facing initiatives. This included redesigning each of our main pages, improving content, usability and speed, developing and launching our first mobile app that has all core functionality available on carvana.com and laying the foundations for what we hope will be an exciting SEO progress over time. We also continue to work integrating, iterating on and improving the technology we've acquired from Carliptso, Car360 and Propel, each of which have exciting releases coming out in the first half of this year and broader product roadmaps in front of them stretching as far as the mind's eye can currently see. We also made a lot of less visible progress in our internal facing initiatives that are aimed at further improving efficiency and scalability through proprietary software. This progress including building applications and the supporting analytical improvements to enable our buyers to buy cars our customers will love even more intelligently, enhancements to our logistics software and scheduler that enable us to support more activity types, including buying cars from our customers and a more efficiently and intelligently scheduled deliveries, an application used by our advocates that puts vehicle and transaction knowledge into a scalable tool that allows our advocates to spend more time doing what they do best, delivering exceptional customer experiences a dynamic underwriting tool that enables us to complete underwriting tasks more quickly and with less effort, and many other internal tools that we expect to enable us to deliver better customer experiences over time even more efficiently. Now heading to ops. As we've said before, given the customer response we are seeing as well as the size of our market, we believe execution is the biggest single risk stand between us and our goals. Accordingly, evaluating our execution to date gives an important and positive indication of our team's ability to execute. 2018, we opened more markets than we ever had before and more vending machines than we did in our entire cumulative operating history prior. Our purchasing, inspection center, logistics and advocate teams have all done an amazing job keeping up with 20 straight quarters of triple digit growth, while simultaneously investing in better, more efficient and more scalable processes. Achieving that growth and improvement in any company is difficult and extremely rare. But doing so in a company as operationally complex as ours that has reinvented the entire automotive retail supply and fulfillment chain is even more impressive. Our teams have done an outstanding job and they deserve a tremendous amount of credit for our success today. Finally, I want to touch on building a culture of delivering great customer experiences. We believe a great company culture has 2 fundamental ingredients, a better business model and great people. These two ingredients are very closely intertwined and we believe we are a positive outlier in both. Great people want to work with other great people and they want to work on problems they find interesting and meaningful. Foundations are what enable our culture, all the progress we are reporting and all the potential we see in front of us. I don't think I'll be able to adequately convey the comfort, confidence and pride I get whenever I walk into a meeting or into one of our locations in the field and see the quality of people, the focus and dedication and the belief in what we are building together. But I believe it is unique and it is something that I'm personally very grateful for and excited about. We are positioned to achieve our mission of change the way fuel by cars. We are positioned to change the industry. We have a lot of work in front of us and there will inevitably be bumps along the way. We are more confident than we have ever been in where we are headed and firmly believe we're in control of our destiny. If our team executes, we will achieve our goals. Mark? Thank you, Ernie, and thank you all for joining us today. Unless otherwise noted, all comparisons are on a year over year basis. We are pleased to report another quarter of triple digit growth in both retail units and revenue. Retail units totaled $27,750 in Q4, an increase of 105%. Total revenue was $584,800,000 in Q4, an increase of 121%. In 2018, we also completed our 2nd year of triple digit growth as a public company. Retail units sold totaled 94,108 in 2018, an increase of 113 percent and revenue totaled $1,960,000,000 an increase of 128%. Underlying this company growth was another year of strong growth within our cohorts. Atlanta grew 30% in 2018, reaching a quarterly market penetration in Q4 of 1.94%, up from 1.54% the previous year. 2014 cohort growth accelerated in Q4, reaching a market penetration of 1.11%. The 2015 cohort faced a harder comparison this year than last year with replacement demand in Houston in 2017, but it remained on a strong trajectory and the 2016 cohort saw its 2nd year of nearly triple digit growth. Finally, the 2018 cohort launched with the fastest start in our history, exceeding the 2017 cohort, which ramped faster than any previous ones. We believe the strong and consistent growth in our cohorts demonstrates the significant consumer demand for our product and the replicability and scalability of our model. Total gross profit per unit in Q4 was 2,131. Dollars For the year, total gross profit per unit was $21.33 an increase of $5.94 Our growth in GPU in 2018 was broad based, including gains in average days of sale, financing and ancillary products. EBITDA margin was negative 10.8 percent in Q4, an improvement of 4.7%, reflecting significant gains in the quarter. We made substantial progress on operating leverage this year, while also increasing our investment in scalability and expanding our logistics and delivery network. Since becoming a public company nearly 2 years ago, we have made significant progress on our 3 main financial objectives. Since 2016, we have grown units in revenue more than 5 times while increasing gross profit per unit by more than $1100 and reducing SG and A per unit by more than $13.50 This represents more than $2,450 of progress toward our goal of becoming the largest and most profitable auto retailer. We ended the year with $410,000,000 in total liquidity resources, which includes cash and equivalents, available capacity in our floor plan line and available capacity under existing sale leaseback agreements. We plan to report on liquidity resources going forward to provide investors with a holistic picture of the resources that underlie our financial strategy. As of December 31, we had $253,600,000 of borrowing capacity on our floor plan line. Over time, we plan to borrow on the line to increase financial flexibility, while also paying it down selectively to optimize interest expense. This means we will maintain cash and equivalents that may be lower than in past periods, while simultaneously maintaining higher availability on the line than in past periods. Combining the 2 along with our real estate liquidity resources gives a more complete view of our financial picture. On December 6, 2018, we converted the outstanding balance of convertible preferred stock that we had issued in December 2017 into Class A common shares. You should use approximately 150,000,000 shares on a fully exchanged basis in the first half of twenty nineteen. This year, we have made the decision to move to annual guidance that we will update quarterly. This decision was primarily made because our management team evaluates and runs the business with a long term perspective, focusing on providing the best customer experience while driving toward the goals outlined in our long term financial model. The goal of our guidance is to give the market the information necessary to evaluate our business, while more closely aligning our shareholders' perspective with our own. As we look toward 2019, we expect significant growth in retail units and revenue, increased GPU and improved EBITDA margin. Our outlook for retail units sold is 160,000 to 165,000, up from 94,108 in 2018. Our outlook for total revenue is 3.4 $1,000,000,000 to $3,500,000,000 an increase from $1,960,000,000 in 20 18. We expect GPU to increase to $2,450 to $2,650 reflecting gains across all parts of the transaction as we move to our $3,000 mid term goal and beyond. We expect OpEx to increase in dollar terms as we expand, but to decrease as a percent of revenue. Combined with our GPU growth, we expect EBITDA margin to improve to negative 5.5 percent to negative 3.5 percent, representing meaningful progress on the path to profitability. In addition, we expect to open 50 to 60 markets in 2019, reflecting an acceleration of market openings relative to the 41 we opened in 2018. In our 2nd year as a public company, we made significant progress toward achieving our financial goals. As we look toward 2019, we intend to continue to expand our footprint, rapidly grow sales, increase GPU and demonstrate operating leverage, all while continuing to improve our customer experience. Thank you for your attention. We'll now take questions. Our first question will come from Zack Fadem of Wells Fargo. Please go ahead. Hey, good morning guys. Sorry about that. When thinking about the drivers of the GPU improvement in 2019, could you walk us through some of the near term buckets of improvement that you're expecting to contribute? And how much do you expect the improvement to come from financing and other items? Sure. So we've talked a lot about the different sources of GPU opportunity for us. And I'll start with some of the big buckets that we talked about at Analyst Day and then I'll touch on some other items. So 2 of the big opportunities that we see are in buying more cars from customers and expanding our finance monetization program. I think buying more cars from customers is something where we obviously started to see more traction in 2018 as we devoted more resources to that business line. It's an area where we feel like we provide customers with a great experience and have some really nice aspects of our offering and we'll be looking to grow that business over time. Of course, buying cars from customers is a contributor to GPU for two reasons. First, cars that you buy from customers and wholesale, you earn wholesale gross profit that way and then cars that you source from customers are typically more profitable when you turn them into a retail transaction than cars that you source from auctions or other sources. So that's one place where we see opportunity. Obviously, that's a new business and we expect to be doing lots of testing and we're still we feel at a very early stage, but that's opportunity number 1. Opportunity number 2 that we see is expanding our finance program. I think we presented a little bit of data today on the quality of our program to date. And I think that's something that we're very excited about. We have a special model. Our loans have performed very well over time and as a result are very valuable. We'll look to continue to monetize those loans over time by expanding our number of partners and bringing down our cost of funds. In terms of other areas, I do think we see opportunities across the other parts of the transaction as well. We've talked over time about continuing to leverage our existing infrastructure that we use to transport and recondition cars. We've talked over time about continuing to expand attachment on existing ancillary products as well as potentially over time adding new ancillary products to the checkout flow. There are many places where we see opportunity, but I walked you through a couple of the big ones. Yes. If I could just jump in too, Zach. I think most of the attention most recently on the finance platform has been on how we're going to monetize that platform. So I hope the data we presented today is helpful. We showed that our loss experience has been great there relative to other public issuers that have data out there and that has been consistent improving over time. But I think there's a story lost there that's really important that we want to make sure we make the point on as well, which is as long as we're originating high quality loans, we're selling cars at lower price to customers, we're putting them in a better position to succeed in their loan. They're also defaulting less, which aside from creating more valuable loans that we can monetize better is a better customer experience with customers that are less likely to default, who are more likely to become repeat customers. And so we think that that's a really important area where our vertical integration is paying off in a way that is probably not yet totally understood, but we think it pays serious dividends over time. Got it. That's super helpful. And just taking this bigger picture, could you comment on just overall consumer adoption in the category? Any color on how online penetration has been trending in the used car industry in 2018? And how do you expect this adoption to continue in 2019 and over the next 3 to 5 years? So I think that's a hard question to answer precisely specifically because I think most consumers in the U. S. Still don't even know exactly what is meant when you say you buy a car online. So I think if you even if you ask them the question, I'm not sure they have enough exposure to what our model looks like to know if that's something that's appealing to them. We continue to see very steady progress across all of our cohorts. Atlanta continues to grow very quickly. I think something that gets us really excited is that we don't feel like we necessarily even need significant additional gains in the number of customers who would be willing to buy cars online in order to continue to see a lot of gains in actual transactions in the market of Atlanta, for example. And the reason that can happen is because as we grow inventory or as we add more inspection centers and shrink delivery time, we should get a higher conversion rate on the customers that we're already seeing today. And then I think there's kind of this completely separate dimension of customers becoming aware of what we do and getting more comfortable with what we do. We haven't made public data on research that we do to try to understand which customers or what percentage of customers are really even aware of us. But the awareness levels nationwide and in Atlanta remain pretty low. And so we think there's a lot of opportunity there. And so we think our job is to keep delivering great customer experiences 1 at a time. And those customer experiences will tell the story and get more and more customers comfortable. And if we execute all the positive feedback and the model is going to show up and we should be in a really good spot. So if I were to ask that question slightly differently, I mean CarMax just launched an omni channel platform in Atlanta. Just curious if you're seeing any impact there and could you see that as a positive for driving brand consumer awareness in the category? Yes. So I think we would start that with just kind of reiterating our general view on competition, which is that this is an enormous market that's enormously fragmented. The large player has 1.8% market share, the largest 100 players have about 7% market share. So I think those dynamics are fairly unique across different retail verticals. It's also a business that is somewhat operationally intensive making rapid scaling So we think that all those things mean the competition is relatively less important than it might be in other verticals. I think your point is a good one though. I think even when you start to look at competition, it's a little bit unclear which direction that even pushes because effectively 2 brands are being pushed when one of our competitors out there advertising selling cars online. They're pushing their own brand out there, right, which all is constant is negative for us. They're also pushing out the brand of buying cars in a new way. And we would like to think that we're kind of cemented in consumers' minds as the number one brand to go out and buy a car online. And so we think that there's a chance that that will ultimately be positive. I think we haven't seen any material impacts in any of our markets where any of the different competitors out there are doing any different things. In Atlanta, in particular, we're very pleased with the growth we saw in the Q4. It's extremely early in 2019, but we continue to see really good trends there. We've seen a slight acceleration of growth in the 1st couple of months in Atlanta. So, so far, we just don't see anything that concerns us too much on that front and we continue to believe that we're the leader and as long as we keep building, we're in a great spot. Our next question comes from Sharon Zackfia of William Blair. Please go ahead. Hi, good afternoon. A couple of questions. I guess it was really encouraging to hear about Phoenix and the ramp you saw there. I'm wondering if correspondingly you saw a similar decrease in customer acquisition costs as you reach that 1%? So we don't break out kind of our reporting at the individual market level, but I think in general, it's a very good first order assumption that there's an inextricable link between customer acquisition cost and market share. So in general, that would be a good assumption, but we're going to continue to report at the cohort level. Can you talk about anything you did specifically in Phoenix or anything unique there other than you being headquartered there that you think drove the massive quick increase? So I do think we had an advantage of ever to have being headquartered here, which I think made the early awareness easier to gain. So I think that probably benefited us. I also think the other advantage of Phoenix is it's very nearby an inspection center. And so there's on the order of 25% of our cars in the Q4 at least were parked just down the street from those customers in Phoenix and that meant that delivery times were fast and I think that probably aided in conversion as well. Okay, great. And then on wholesale, I mean that was probably the only area where maybe it was a little bit weaker than we would have expected. Can you give some commentary around wholesale just given that that was part of the longer term thought process on GPU? Sure. Yes. So I'm going to break that into units and then margins. Let me start with units. I think we're very pleased with the progress we made across the year. I think we grew by something in the order of 220% or 230% in total units that we bought from customers. Some of those flow through wholesale, some of those flow through to retail sales and kind of in either case, there's a profit opportunity there, but it just depends kind of which line item is going to flow through. I think like I said, the progress we made in last year was exceptional. And I think our expectations that we'll make continued very significant progress through 2019. I think when you look at the Q4 or the Q1, there are some dynamics that are worth kind of keeping in mind there. We have some different customer selection effects in the Q4 due to the promotion. We have some different customer selection effects in the Q1 due to tax season. The Q4 and the Q1 tend to be the quarters where we're growing inventory the most. And in general, kind of the easiest inventory to go out and grow is coming from non direct and consumer channels. So we're going to we tend to grow more in those channels, which means it puts downward pressure on the percentage of cars that we're selling that were acquired from customers. But the underlying trends in cars that we're buying from customers and the margin that we expect to be able to make over time are all very, very positive. And then on the margin front, in wholesale in particular, I think that probably moves around by $100 maybe $200 something like that, not a super material number. We're still as we've tried to set expectations, we're growing this business very, very fast and we're learning very, very fast. We're changing the ways that we're going out and acquiring these customers, which has selection effects and changes the way customers go through the funnel. We're constantly evolving the funnel and learning and changing conversion there. We're changing the way that we nurture these customers. We're working on pricing at the aggregate level and at individual car levels. So there are constantly lots and lots of tests going on. And I think that that business today is optimized for growth and learning, not for steady progress. And so I think if we look at it over longer time frames, I think we'll be very pleased with the progress there. If we look at it quarter to quarter with all these different dynamics, I think it could be a little bit choppier. And so I would build that into your expectations. And one last question, I didn't see this in the shareholder letter. What was the 2018 national market share for Carvana? I think so it was the way that we calculate that is the 94,000 units divided by 40,000,000. So that would put you just shy of about a quarter percent. Our next question comes from Ron Josey of JMP Securities. Please go ahead. Great. Thanks for taking the question. Maybe a quick follow on and then a broader one on just the IRC strategy. On the follow-up, Ernie, you were just talking about wholesale and buying cars from consumers or users. Can you tell us what percentage of those cars were sold to retail? I think you said 16% in the past, I think in 3Q. And then maybe a broader question, just the IRC strategy. You talked about adding a production line in Phoenix and Indianapolis, launching newer IRCs though with only 2 production lines, some with 4. So if you just tell us about maybe how you're thinking about IRCs and the build out as you reach to 2,000,000 units over time and then here in the near term, just the location of these IRCs being potentially close to your markets, the importance of being closer to consumer with the IRCs and maybe the impact on shipping times as you launch, call it, 4 production lines and 2 production line IRCs? Thank you. And then of course CapEx. Thanks. Oh, man, you really got that last third one there. In one word, that was the first one. Well, it's all the same right with IRCs. Very good. Yes. So retail, so cars that we're selling to customers that were purchased from customers, that went to 17% in the quarter versus 16%. That's the statistic that kind of the headwind of growing inventory, right? If we're growing inventory, it's generally coming from non direct and consumer channels. That means that a smaller percentage of your inventory is on the site at any point in time was purchased directly from consumers and that creates a headwind for the likelihood that any given customer chooses a car that was bought from a customer. So I think we're pleased with that progress, especially in light of that headwind. From inspection center perspective, I think we're really focused on making sure that we stay in front of all of the growth that we see over the next several years that we basically try to calculate by extrapolating out the cohort curves. And then we're trying to make sure that we're building in flexibility. So I think we're excited to be building in this efficiency that enables us to add additional lines in Phoenix and in Indy. We're excited to be adding additional locations in different parts of the country to kind of shorten delivery times overall. We expect this to be a constant push where we'll be continually either acquiring new inspection centers or adding to existing inspection centers and in many cases probably both. I think something that we're really excited about Phoenix was the first inspection center that we built from scratch and kind of laid out and set up specifically for Carvana processes. And in just about every metric, that's already our most efficient inspection center. Many of the learnings that we kind of got there, we're taking into the next several inspection centers that we're setting up. And that's driving some of the subtle changes in CapEx, which I think we now estimate at $10,000,000 to $12,000,000 per line. And we think that thinking about CapEx on a per line basis is probably the right way to think about it. And then we'll size individual inspection centers based on the needs that we see in any given geography at any point in time. Great. Thank you. Our next question comes from Chris Bottiglieri of Wolfe Research. Please go ahead. Hey guys, thanks for taking the question. A couple of financing questions. So the financing gain on a retail unit really pop this quarter even if you back out the refinancing transaction. So was there any noise on timing of receivables or maybe you could talk about what drove that significant improvement year over year or even relative to last quarter early pops? Sure. So one factor that influenced Q4 gain on loan sale, looking at it on a per retail unit sold basis is our Q4 refinancing transaction. And so the Q4 refinancing transaction had one major difference from the Q3 refinancing transaction and that is in Q4 we sold some loans directly from our balance sheet into the transaction along with loans that were refinanced. And so because those loans were sold directly with much better financing than our typical forward flow financing, we earned a higher premium on those loans. And so part of the increase that you're seeing quarter over quarter and also year over year is due to that direct to sale to purchasers with much better financing. Got you. Okay. And then, sort of getting through this financing primer while on the call, it's not written fully yet. But I guess my first question is, it's obviously very impressive improvement in CNLs. So my first question is, has this improvement in the CNL been pretty consistent across your 3 scoring buckets? Are you seeing like 1 bucket versus the other drive a more significant outperformance? And then the follow-up to that would be for the 10% of loans that are in the riskiest bucket, are you still receiving a positive fee on these gain on sale type transactions or are you like a net payer on that 10%? Thank you. Yes. So first, what I'd say is, I think you can kind of look at the outperformance of any given band of loans based on the data we provided. You can look at kind of how the credit score or excuse me, the loss curves look over time and then you can compare that to other issuers in the market. We try to provide that data in there. So I think that'll help you to try to size the relative outperformance by credit band. I think if you're asking about the improvements over time, which credit bands those came from, in general, they've come from several credit bands, but the kind of higher loss credit bands are always the places that have the biggest impact on your overall losses just because the way the math works out. So in general, improvements there are always kind of most powerful to your entire curve. And then we haven't really broke out the premiums that we get on any given credit band. But I think in general, we have very high quality loans originating and you can kind of look at the loss differences by credit band and then you can do a little math to figure out how much more valuable those loans may be. And I think across credit bands, we're originating very high quality loans. And then we're also obviously functionally doing something different where we're kind of like the combination of a retailer and a finance company in the sense that we're doing the credit scoring, pricing, structuring, all of that work that's associated with verifications work, all the work associated with originating those loans and that also puts us in a good spot to monetize. So in general, we're monetizing well across the spectrum, but we haven't broken out exactly how we're doing it in each bucket. Okay, great. And then just one quick one very quickly on, wanted to talk about the transportation bucket. Is because you're growing so exponentially with market growth and I guess you opened another RC, is any of that like having a quantifiable impact on your inbound transportation cost and maybe temporarily depressing the retail GPU? Just wasn't sure if there's anything kind of drove some of that Q4 step down. Anything you can quantify there would be helpful. Thank you. Sure. So let me first hit the, guess, sequential change in retail GPU because I think that will help the thinking on that. So there's a couple of things that happened in the Q4 that impact retail GPU. The first is our Cyber Monday promotion, which is $1,000 off for customers that take advantage of the promotion. That obviously impacts retail GPU. Secondly, Q4 is the period in the year where used car depreciation rates are highest. So while you're holding inventory between acquisition and sale, those cars depreciate faster and that also has an impact on retail GPU. In terms of the in terms of inbound logistics costs, there's nothing that I would call out there in particular. I think it's mainly the 2 big factors that I listed upfront. Yes. I'd add to that. I think the effect you're talking about is probably present to some degree, but probably just isn't a huge number inbound. I think that that effect is meaningful outbound as we build out the network and kind of spread out across the country with fewer IRCs supporting an entire nationwide network. That definitely does provide pressure because we're moving cars longer distances on average. And then as we fill in the IRC network, you're starting to ship cars lower distances on average. So I think the bigger effect there over time will be on outbound, which shows up in SG and A. But there probably will be something of an effect inbound as well to your point. Our next question comes from Nat Schindler of Bank of America Merrill Lynch. Please go ahead. Yes. Hi, guys. A couple of things. 1, if I look at just some basic math on the marketing per unit in Atlanta, Atlanta. It looks like you're running, call it, 2.5% right now with a target on your advertising spend being somewhere on the order of 1%, 1.5%. What gets you there? Is it from here to get way beyond where you are even in Atlanta when you're hitting roughly 2% market share? And what do you need to do from here to get there? Secondly, just a weird thing, I just was wondering if you could help me out understand why do you seem to have, particularly in Atlanta, I can't really tell on the other charts, why do you have a downturn in share in Q3 sequentially in the last several years? Is there something that occurs seasonally that makes offline guys do better? And finally, just one final question, and I know these aren't related, so you're going to have to remember them all. But there was a competitor made commentary in the last couple of days that you guys were doing great, but selling 100,000 units is one thing. When you start selling 400,000 units or something to that effect, similar to what you're suggesting your IRCs will be able to handle after you do this next round that you added in, it doesn't scale as well. Do you need to buy retail units, consumer units? Do you need to buy from consumers in order to be able to get enough cars to meet to handle 400,000 units in the year? Okay. There's a lot in there. So let's start with the customer acquisition costs. So I think there's many, many ways that we can drive down customer acquisition costs. We talked a little bit earlier about kind of being in the early innings of awareness generation, and I think that's true. We think that when we're advertising today, we're not only acquiring customers in real time, we're also building a brand. We think there's a lot of evidence of that you can see in the cohort CAC curve, right? They're downward sloping for a reason. It's that we're building brand over time. And so we think there's some natural momentum that will probably continue to show up there. I think the most compelling and kind of simplest way to understand how that you should be able to push that down over time is just simply to think about conversion. So if we take that market share of approximately 2% in Atlanta and we extrapolate that out nationwide, that suggests around 800,000 car sales. If we had on the order of 800,000 car sales and we had about a 30 day on-site turn time, we'd have about 70,000 cars on the site at any point in time. That's a very significant increase where we are today, and we think that alone with the exact same marketing dollars would lead to higher conversion and therefore would push down our customer acquisition cost quite a bit. If you had 800,000 car sales per year, you'd also have on the order of 16 inspection centers. And so we'd see on average across the network faster delivery times, which I think would also push that down. So I think those to me are the simplest ways to extrapolate out to kind of much lower customer acquisition costs. And so we feel really, really good about our path there. We're not going to rush it. We don't think that that's a particularly important target right now, right? We're already at a level where the variable economics make a ton of sense. And so if we can keep building brand and growing share, that's still a pretty interesting prospect. But we think it's pretty clear the evidence is there that they will be able to push it down over time. The downturn in Q3, that's a little bit of a quirk. And so I think the way that we've kind of defined our market penetration is we look at historical data. We use our historical seasonality to try to figure out what we think. We use historical data basically to understand the total units sold in any given market. And then we've historically used our seasonality to spread those units across months or quarters. In this case, we're reporting in quarters. And that's because many of the public databases that we can look at for registration, etcetera, are either lagged or a little bit difficult to rely on. And so we basically have embedded in our market share shape our historical seasonality at the time that we locked it from the IPO. We talked last year about in August the lack of an August bump. We saw in previous years a really big increase in sales in August and that was kind of locked into our expectations in our curve going forward. And so we think it's probably somewhat likely that, that seasonality isn't right now that we have kind of more data. And so we may continue to see Q3 in Atlanta look like it's going down and popping back up. I think if you look at any of the other cohorts, there's many, many markets in those cohorts. And so all of those different seasonality assumptions are basically blended together and it's a much, much simpler curve to look at. But that's what you're seeing in Q3. And I think that's more what's driving it than any interesting nuance with us versus brick and mortar dealers in the Q3. And then do we need to buy cars, more cars from customers to get to bigger scale? I think the answer is no. There's many, many cars go through auction. I think it's something on the order of 14,000,000 cars, something like that go through auction every year. So there's a lot of volume that goes through auction. Now do we want to buy more cars from customers? The answer to that is absolutely. I think the way that we try to think about this entire market is basically that used car transactions are just consumers switching cars with each other. And that switch happens through this extremely complex mechanism of a trade in at a dealer and then transport to an auction and then an auction fee and then transport to another dealer and then sales to a customer. And if you look at all that, there's a lot of cost in that chain. And I think the way that we try to think about the whole model is how do we remove as much cost from the chain as we possibly can so we can keep giving customers very simple experiences, very fair prices and then as a result having that roll into the loans that they ultimately use to finance their FERCs with us. So they've got great performance and are less likely to default, more likely to become repeat customers. So I think we definitely are going to continue to invest in buying more cars from our customers, but we would not agree that it is accurate that, that is necessarily a necessity. Okay. If you look at the auction of the 14,000,000 cars, roughly what percentage are in your kind of sweet spot of the 3 to 5 year old vehicle with the pretty prime used car? I don't know the exact answer for you there. I believe and so I want to caveat this with I believe. I believe about 50% of car sales in the U. S. Are less than 5 year old cars. And so my guess is the cars going through auction would at least be somewhat proportionate to that distribution, but I'm not certain on that. Our next question comes from Steve Dyer of Craig Hallum. Please go ahead. Thanks. Thanks for taking my question. As it relates to your GPU guidance for this year, is there any assumption around another receivable sale in there? Or would that all be sort of incremental and additional towards your guidance? Yes, sure. So I can hit that. I think when we first announced the 1st refinancing transaction, we provided some commentary that we expected to do an additional fixed pool financing in Q4 and that we would endeavor to make it part of our ongoing finance monetization program. And so I think that still holds true today. Obviously, I think the with the loan performance that we've seen and the quality of our platform, we think we'll have an ability to continue to use those types of transactions. We think those types of transactions make a lot of sense for everyone involved and we'll look to continue to do them going forward. So in that $400 or so per unit GPU improvement this year, I guess, what is your general thinking as to what role these transactions may play in that? Sure. So consistent with past years, I think the way that we're looking at GPU and particularly our guidance on GPU is in terms of total GPU. We don't plan to break down specific line items. But we did do we've done 2 of these refinancing transactions so far. Those give you a sense of the additional economics available when you transition from forward flow financing, which is less efficient to fixed pool financing, which is more efficient. And like I said, we will look to do continued fixed pool financings over time to realize better effective cost of funds, which has a positive impact on finance gross profit. Okay. So presumably there's something in it for this year. Just a question on inventory. I noticed your inventory was up 22% sequentially. Floorplan debt was down 44% sequentially. Is that sort of as you had alluded to where you're using your Floorplan line almost more like a revolver now? I mean, are you taking equity in your vehicles or help me think about that? Sure. So let me hit the inventory growth first and then talk the floor plan line. So we typically grow inventory in Q4 in preparation for the first half of the next year. This year was no different. We started building inventory in advance of the positive demand seasonality in the first half of twenty nineteen. As it relates to the Floor Plan line, we expect looking forward to maintain more availability on the Floor Plan line than we have in the past. We think that's smart from a financial management strategy. The floor plan line is available to us to draw upon using our inventory as assets when we would like to. But from an interest expense management perspective, it makes sense to keep that line available as much as possible to minimize interest expense. Okay. And then just one more for me. As it relates to CAC or more specifically advertising, how do you allocate those expenses by cohort when a lot of them are national? I guess I was always of the impression that it was really difficult to give any kind of profitability per cohort metric just because so many of the costs are national or corporate level. Thanks. Sure. Yes. So on the order of half of our advertising is national and on the order of half is local. We've talked about that before. That's because TV is our main national channel. And then in terms of allocating, so all the local channels are obviously very straightforward. For national cable, the way we allocate is based on population within a cohort. And so, we take our national TV spend and allocate it out to the cohorts based on their population. Our next question will come from Armintas Sinkevicius of Morgan Stanley. Please go ahead. Great. Thank you for taking the question. When I look at the free cash flow burn this quarter and the anticipation for further free cash flow burn in the quarters ahead, how do you think about financing? I know you have $400,000,000 plus of availability, but at some point, presumably, you would need to raise either equity or debt and what's your thought process there? Sure. Yes. So we don't plan to raise equity or debt other than our standard asset based financing, which we've accessed many times over the past few years. I think a couple of key points there. 1, our inventory is financeable with our floor plan line And we haven't fully drawn to that floor plan line at this time as I was mentioning with respect to the earlier question, but obviously have availability there. The second key point I would make about sort of use of cash is the a very large portion of our CapEx is hard assets that we've historically financed. Those include real estate assets as well as hauler assets, which we financed with sale leaseback financing or other types of leases or equipment financing in the case of haulers. And so we'll endeavor to do that on a go forward basis. At the end of Q4, we had approximately $130,000,000 of unpledged real estate sitting on our balance sheet. We had a $75,000,000 master sale leaseback agreement in place as well as some other smaller sale leaseback commitments. And so I think the combination of floorplan line when you're looking at working capital for inventory and then our historical access to capital for the hard assets on our balance sheet, I think we feel good about our liquidity position. Okay. Thank you for taking the question. Thank you. Our next question will come from Rick Nelson of Stephens. Please go ahead. Thanks for taking my question as well. So there is mention in the shareholder letter about the delay in tax refunds. To the extent you can, Ernie, can you comment on the Q1 and how confident are you that these are delays in refunds as opposed some of the data suggesting refunds are coming in lower on a per person basis, how that might affect the business? Sure. So I think there's a lot going on probably with this tax season. I think there's probably more uncertainty about all the specifics today than there normally would be at this time of year. So let me try to walk through that. I think based on the best research that we have seen, it seems like probably aggregate refund dollars overall will be lower. And our understanding is that that's going to be primarily driven by, especially 10.99 filers and some higher income people who have kind of the ability to change their withholdings more easily. And as a result of the tax law change, the recent tax law change, they increased their withholdings and therefore they will get lower refunds. As part of the tax law changes well though, there was an increase something called the child tax credit. Historically, if you look at kind of tax dollars that are released and then the kind of relationship that those tax dollars have to ultimate purchase of vehicles, The tax credits that kind of correlate best are the child tax credit and the earned income tax credit. Our belief today and based on research that we've seen from a number of is that those will be similar and potentially even higher. So we kind of think that the overall refunds will probably be lower with low certainty. We think that probably the refunds that are most highly correlated with the taxing response will be higher. We also feel that with relatively low certainty. And then it is undoubtedly been delayed to some degree. The government puts data out there, so we can kind of like watch when the drops are happening and we can see what year over year total dollars look like. So it's undoubtedly been delayed a bit. There was actually a somewhat sizable at least drop today. So we're still kind of learning exactly how much it's going to be delayed and I don't think we know. But our guess would be with reasonably high confidence it's delayed. With low confidence it's probably going to be similar to maybe even a little bit better overall. But I think there's more uncertainty than there usually is in tax refund season this year. Got it. And do you think this affects the subprime car buyer more so than the prime buyer? I think historically the tax refunds that have correlated most with kind of 1st quarter car purchases are the earned income tax credit, the child tax credit, which on average are associated with lower incomes. So I think it does probably impact the lower income population more than the higher income population in terms of the immediate response to the tax refund. Our next question comes from Nick Jones of Citi. Please go ahead. Hi, thanks for taking my question. I want to focus back on IRCs. Can you dive in a little deeper on kind of the shift work? Is it 2 shifts a day, 5 days a week or 7 days a week? And, is it possible to add a 3rd shift? So I guess, I'm asking is there kind of like a 33% upside to what your footprint is going to be even at 400,000 unit capacity? Sure. Yes. So the way we're planning today is based on 2 shifts per line and those shifts running 5 days per week. We do believe over time that there's an opportunity to expand beyond that and that could include weekend production, as you mentioned. So transitioning from 5 days per week to 6 or even 7. And then it also can include expanding shifts within any given day to 2.5 or 3. Those aren't in our immediate plans, but we do think given the infrastructure that we're building, that option is on the table at some point in the future and which I think is great, but we don't have any immediate plans for that today. We're focused on 2 ships per line, 5 days per week. Okay. And one quick follow-up. How did the Black Friday, Cyber Monday weekend go this year? I would say it went fine. It went a little bit better than 2017 and it didn't go as well as '15 and 'sixteen. I think when we guided for Q4, that guidance was basically the largest probably driver of range was uncertainty around exactly how the promotion would play out. And I think it went a little bit better than 'seventeen, but not nearly as well as 'fifteen and 'sixteen. Our kind of guidance range was basically for it to go somewhere between 'fifteen and 'sixteen or 'seventeen. So I think it went fine. I don't think any of our major thoughts about running that promotion have changed. We think about that promotion as much more of a brand building effort than kind of a real time sales driver. And the reason we like it is because it associates us with online buying. And so we think that that's valuable. And so I think we'll continue to evaluate it to that long lens and through kind of the shorter lens of how many sales it drove this year. It was fine, but it wasn't great. Our next question comes from Colin Sebastian of Robert W. Baird. Please go ahead. Hey, it's Ben on for Colin. Just two questions. First, given the advertising leverage you're seeing across your cohorts, does that imply that your older cohorts are profitable on a market contribution basis or have some of the logistics investments kind of offset those? And then secondly, as it relates to the 2019 guide, how are you guys prioritizing unit growth versus improvement? Is there a bias toward 1 versus the other? Sure. So I would say, I mean, in general, I think our priorities are to drive unit growth and deliver great customer experiences and then GPU and then to reduce SG and A. So I think in general, that's how we think about it. I think that it's probably a fair way to kind of think about the business that our expenses to complete a transaction are somewhat similar across markets. So when you look at our Atlanta CAC for example and compare that nationwide, it's probably fair to then say, okay, well, if the rest of the country gets down to where Atlanta is, how does that improve your economics? And the answer there is very, very significant. And then the question about profitability is always a question about how you're allocating expenses because obviously at the company level we are not profitable. But with many reasonable allocations, our older markets are and have been profitable. And that has us feeling very confident about where we're Thanks. Our next question comes from Seth Basham of Wedbush Securities. Please go ahead. Thanks a lot and good evening. My question first is on the quarter, trying to understand a little bit better the bridge to your results relative to your expectations. It seems like Black Friday wasn't quite as good as you expected, but those are relatively low incremental margin units since they're highly discounted. What else drove the miss in EBITDA relative to your expectation? Can you please give a little more color around investments, etcetera? Sure. Yes. So the primary driver of our EBITDA margin relative to expectations was the lower units and also the lower revenue that was associated with those lower units. In addition, we made some incremental investments similar to ones that we've talked about on previous calls and that includes investing additionally in our technology team here at home office as well as our logistics network. Got it. And when you think about the rate of investments going forward, do you expect a much slower growth rate in 2019 relative to 2018? Sure. So all of our expectations about future investments are incorporated into our 2019 guidance. I think overall, I think we're very excited about the leverage that we've shown. I think Ernie alluded to, we made 700 basis points of EBITDA margin improvement year over year. A significant portion of that was driven by expense leverage year over year in 2018, which actually accelerated relative to 2017. I think as we look forward to 2019, we expect obviously further GPU gains, but also further operating leverage gains as we march toward profitability. Our next question comes from Sameet Sinha of B. Riley FBR. Please go ahead. Yes. Thank you very much. So, Ernie, you've previously spoken about as you look at network expansion, part of it is sometimes it's increasing density, part of it is expansion. Seems like this year it's going to be about increasing your density and that will be your capital efficiency is going to be higher. Now if you start to think about next year, are you kind of would you say that next year you'll probably look to do more of the expansion part and we just need to just to kind of have our expectations adjusted accordingly. That's one question. Secondly, the question is, if I'm just looking on a year over year basis on your retail business, units increased by about 14,000 year over year, gross profit by about 15 1,000. So incremental unit gross profit was about 1,000 let's say, maybe a little more, but that's down year over year, that's down like 20%. Is there anything specific in the composition or maybe to Cyber Monday, anything that you can point to? Okay. Let's start with the first question. So I think you're right, most of the markets that we're going to open or many of the markets that we're going to open this year are going to be added basically on top of the existing logistics network, which will be a little bit more capital efficient. Now I think that the CapEx required to open markets in general is pretty low. So I don't know that that's a super material difference when we're kind of zooming out and looking at the company. But I do think that directionally, we will have lower CapEx per market that we're opening this year. I think looking forward, our logistics network is getting pretty expansive now and it's covering most of the country. There's still some room for us to go up to the Pacific Northwest and a little bit more room for us to go up kind of farther north in the middle of the country. But we don't have a lot to add there. So I do think that after these 60 markets probably in 2020, we'll be opening more markets that are that kind of are a little bit heavier in CapEx, but I don't know that that will be even a necessarily noticeable change, but I think directionally that probably is going to happen. I think the most important kind of density that we can build into the system over time is basically just having all of these markets continue to ramp up their market penetration and then that drives up sales. Driving up sales allows us to carry more inventory that increases conversion and then driving up sales also allows us to build more inspection centers or requires us to build more inspection centers, which decreases shipping times. And so I think those are the most important things over the next several years as we look for the positive feedback in the model. And just to reiterate, we feel really good about that. We feel like we have a repeatable playbook across the board there in terms of the way that we're opening up markets, in terms of the way that we're building out the logistics network, in terms of the way that we're opening up IRCs. We're constantly improving in all those different dimensions. It's highly scalable and obviously very difficult to replicate as well. So we're feeling really good about all that. And then I apologize, but I'm not sure I totally followed the second question and what we're trying to get at. Do you mind restating that? Yes, sure. Actually, you know what, I'll just take that offline. Maybe I'll just replace it with another question. Now you've had 2 quarters of kind of middling experience with Cyber Monday. And is that something that you're going to evaluate whether to have it or not because most of your competitors usually do not have such promotions. So if you can talk about that, that would be helpful. Sure. Yes. So let's start at a really high level. So at a high level, I think we generally don't want to be a super promotional company, right. I think that the notion of price in automotive retail is something that's been beaten up pretty bad over a very long period of time. And so we don't want to participate in that. We want to maintain the integrity of price. And so we think that it's important for us not to be super promotional. Cyber Monday has always been an exception to that because we think the benefits of being associated with other online retailers and telling our story that way outweigh the cost of running a single promotion. And so that's how we thought about it. We thought about it as a brand building effort. It's more something that we measure over a longer period of time and something that we measure in real time. I think we are absolutely consistently learning about how to do these promotions, right. Given that we do 1 a year and we're now a 6 year old company and the promotion is a several day event, we now have on the order of 20 days of experience of running these promotions. And so we're continuing to learn and kind of get more efficient at that very quickly. I think we're going to keep a value on whether or not this makes sense through a long term lens and we will always keep our options open there. We're trying to think about as we become a better known brand, does that mean that promotions are less important? Or does it mean that we're in a better position to take advantage of promotions because many very large well known brands have their own promotions? And I think we don't quite know the answer to those questions yet. So in terms of what your expectation should be for next year, we're likely to run the promotion again. We wouldn't want to put that in stone. But I think it's more likely than not. And again, we'll just keep evaluating it through a longer term lens and make the best decisions we can. We're not our mind is not going to be changed by a promotion that goes 10% better or worse in any given year. That's just not the scale at which we're making that decision. The last question will come from Derek Glynn of Consumer Edge Research. Please go ahead. Thanks for taking my question. As you grow the number of vehicles acquired from customers, would it make sense at some point to operate your own on-site wholesale auctions? How do you think about that opportunity long term? So I think we've got a lot of building to do and a lot of really clear opportunities in front of us. And so we're trying to stay as focused as we can, while also taking advantage of all of the huge opportunities in front of us. I think that particular opportunity is unlikely to be an exciting opportunity for us anytime in the immediate future, just given the operational complexity of it. I think we feel like we can grow very, very fast and it's not clear that we want to be taking on more operational complexity that will slow us down over time. I also think there's a lot of interesting data out there about I believe Manheim and Adesto both put out data that suggests that on the order of 50% of wholesale buyers through their auctions now are buying online, which I think is suggested that there may be opportunities that are kind of much more scalable and much less intensive over time. But again, that's not on the immediate horizon. And we've got great relationships with our auction partners and we plan to continue to work with them. So that's kind of where we are today. Got it. Makes sense. And then just lastly, looking back in 2018, you had mid single digit growth in used retail pricing. Do you think that growth rate is sustainable as we look out to 2019 or should we expect that to decelerate? I think you first of all, I think it's probably best to think about the model as being unit driven of dollar driven. We're buying our product to the wholesale market and then we're selling them in a retail market. And so what really matters is the spread more so than the price. And so I think it's probably best to think about kind of units and then GPU as opposed to like price going up and what impacts that may have flows through our income statement. There are some impacts, but I don't think that they're super material. I think we saw some subtle changes in vehicle mix throughout 2018 that drove some of that. Depending on if you're looking at kind of average retail price or ARPU, we also had progress in other parts of transaction that drove ARPU up. And then I think over time we expect to be able to make more progress selling both lower cost cars and more expensive cars. And the balance of how that will play out over time, I don't think is crystal clear yet. So I think first order, we're just going to keep trying to put cars in front of our customers that they love, and we're going to try to do that at the biggest scale that we possibly can, and we think that that's what we should be focused on. This concludes our question and answer session. The conference has now also concluded. Thank you for attending our presentation. You may now disconnect.