The following table presents a summary of our consolidated cash flows from operating, investing, and financing activities for the years ended December 31, 2017, 20162019, 2018, and 20152017 (in thousands):
The following table sets forth the amounts of our significant contractual obligations and commitments with definitive payment terms as of December 31, 20172019 (in thousands):
receivable originated in connection with the sale of the vehicle. In either case, the payment is expected to be within one year of December 31, 2017.2019.
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles (“GAAP”("GAAP"). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenue and expenses and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions, impacting our reported results of operations and financial condition.
Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of assets and liabilities and the recognition of income and expenses. Management considers these accounting policies to be critical accounting policies. The estimates and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. The significant accounting policies which we believe are the most critical to aid in fully understanding and evaluating our reported financial results are
described below. Refer to “NoteNote 2 — Summary of Significant Accounting Policies”Policies of the consolidated financial statements, appearing elsewhere in this document for more detailed information regarding our critical accounting policies.
We sell used vehicles directly to our customers through our website. Revenue is recognizedThe price of used vehicles are set forth in the customer contracts at stand-alone selling prices which are agreed upon prior to delivery. We satisfy our performance obligation for used vehicle sales upon delivery when the sales contract is signedtransfer of title, risks and rewards of ownership, and control pass to the agreed-uponcustomer. We recognize revenue at the agreed upon purchase price has been received or financing has been arranged. Used vehicle sales revenue is recognized net of a reservestated in the contract, including any delivery charges, less an estimate for returns. Our return policy allows customers to initiate a return during the first seven days after delivery. Estimates for returns are based on an analysis of historical experience, trends and sales data. Changes in these estimates are reflected as an adjustment to revenue in the period identified. The amount of consideration received for used vehicle sales includes noncash consideration representing the value of trade-in vehicles, if applicable, as stated in the contract. Prior to the delivery of the vehicle, the payment is received or financing has been arranged. Payments from customers that finance their purchases with third parties are typically due and collected within seven30 days from delivery. Our reserve is estimated using historical experience and trends and is dependent on a number of variables.delivery of the used vehicle. In future periods additional provisions may be necessary due to a variety of factors, including changing customer return patterns due to the maturation of the online vehicle buying market, macro- and micro- economicmicro-economic factors that could influence customer return behavior and future pricing environments. If these factors result in adjustments to sales returns, they could significantly
impact our future operating results. Revenues exclude any sales taxes, title and registration fees, and other government fees that are collected from customers.
We also sell vehicles to wholesalers. These vehicles sold to wholesalers are primarily acquired from customers who trade-in their existing vehicles that do not meet our quality standards to list and sell through itsour website. Revenue fromWe satisfy our performance obligation for wholesale vehicles sales when the wholesale purchaser obtains control of the underlying vehicle, which is upon delivery when the transfer of title, risks and rewards of ownership and control pass to the customer. We recognize revenue at the amount we expect to receive for the used vehicle, which is the fixed price determined at the auction. The purchase price of the wholesale vehicle sales is recognized whentypically due and collected within 30 days of delivery of the wholesale vehicle.
We account for income taxes pursuant to the asset and liability method, which requires the recognition of deferred income tax assets and liabilities related to the expected future tax consequences arising from temporary differences between the carrying amounts and tax bases of assets and liabilities based on enacted statutory tax rates applicable to the periods in which the temporary differences are expected to reverse. Any effects of changes in income tax rates or laws are included in income tax
expense in the period of enactment. We reduce the carrying amounts of deferred tax assets by a valuation allowance if, based on the evidence available, it is more likely than not that such assets will not be realized. In making the assessment under the more likely than not standard, appropriate consideration must be given to all positive and negative evidence related to the realization of the deferred tax assets. The assessment considers, among other matters, the nature, frequency, and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carry forward periods by jurisdiction, our experience with loss carryforwards not expiring unutilized, and all tax planningtax-planning alternatives that may be available. A valuation allowance is recognized if under applicable accounting standards we determine it is more likely than not that our deferred tax assets would not be realized.
Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of exposure due to potential changes in inflation or interest rates. We do not hold financial instruments for trading purposes.
Based on our analysis of the periods presented, we believe that inflation has not had a material effect on our operating results. There can be no assurance that future inflation will not have an adverse impact on our operating results and financial condition.
Carvana Co.
We have audited the accompanying consolidated balance sheets of Carvana Co. (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 20172019 and 2016,2018, the related consolidated statements of operations, changes in stockholders’ equity / members’ deficit, and cash flows for each of the three years in the period ended December 31, 2017,2019, and the related notes and financial statement schedules included under Item 15 (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 20172019 and 2016,2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017,2019, in conformity with accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”)PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
We have served as the Company’s auditor since 2015.
CARVANA CO. AND SUBSIDIARIES
See accompanying notes to consolidated financial statements.
CARVANA CO. AND SUBSIDIARIES
(1) Amounts for periods prior to the initial public offering have been retrospectively adjusted to give effect to 15.0 million shares of Class A common stock issued in the initial public offering and the Organizational Transactions described in Note 1.
(2) Weighted-average shares of Class A common stock outstanding have been adjusted for unvested restricted stock awards.
See accompanying notes to consolidated financial statements.
CARVANA CO. AND SUBSIDIARIES
See accompanying notes to consolidated financial statements.
CARVANA CO. AND SUBSIDIARIES
See accompanying notes to consolidated financial statements.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 — BUSINESS ORGANIZATION
Description of Business
Carvana Co. and its wholly ownedwholly-owned subsidiary Carvana Co. Sub (collectively, "Carvana Co.") together with its consolidated subsidiaries (the “Company”"Company") is a leading eCommercee-commerce platform for buying and selling used cars. The Company is transforming the used car buyingsales experience by giving consumers what they want —- a wide selection, great value and quality, transparent pricing, and a simple, no pressure transaction. Using the website, customers can complete all phases of a used vehicle purchase transaction including financing their purchase, trading in their current vehicle, and purchasing complementary products such as vehicle service contracts ("VSC") and GAP waiver coverage. Each element of the Company's business, from inventory procurement to fulfillment and overall ease of the online transaction, has been built for this singular purpose.
Organization and Initial Public Offering
Carvana Co. is a holding company that was formed as a Delaware corporation on November 29, 2016, for the purpose of completing an initial public offering ("IPO") and related transactions in order to operate the business of Carvana Group, LLC and its subsidiaries (collectively, "Carvana Group"). Substantially all of the Company’s assets and liabilities represent the assets and liabilities of Carvana Group. Group, except the Company's senior unsecured notes which were issued by Carvana Co. and guaranteed by its and Carvana Group's existing domestic restricted subsidiaries.
Carvana Group was formed as a limited liability company by DriveTime Automotive Group, Inc. (together with its subsidiaries and affiliates other than the Company, collectively “DriveTime”Carvana Group, "DriveTime") and commenced operations in 2012. Prior to November 1, 2014, Carvana Group was a wholly ownedwholly-owned subsidiary of DriveTime. On November 1, 2014 (the “Distribution Date”"Distribution Date"), DriveTime distributed its member units in Carvana Group to the unit holders of DriveTime on a pro rata basis (the “Distribution”"Distribution"). Carvana Group accounted for the Distribution as a spinoff transaction in accordance with ASC 505-60, Equity —- Spinoffs and Reverse Spinoffs and reflected assets and liabilities before and after the Distribution Date at their historical basis.
On May 3, 2017, Carvana Co. completed its IPO of 15.0 million shares of Class A common stock at a public offering price of $15.00 per share. Carvana Co. received approximately $205.8 million in proceeds, net of underwriting discounts and commissions and offering expenses, which it used to purchase approximately 18.8 million newly-issued membership interests of Carvana Group at a price per unit equal to 0.8 times the initial public offering price less underwriting discounts and commissions and offering expenses.
Also in connection with the IPO, the Company completed the following organizational transactions (the “Organizational Transactions”"Organizational Transactions"):
•Carvana Group amended and restated its limited liability company operating agreement (the "LLC Agreement") to, among other things, (i) eliminate a class of preferred membership interests, (ii) provide for two2 classes of common ownership interests in Carvana Group held by the then-existing holders of LLC units, (the "Existing"Original LLC Unitholders" and together with any holders of LLC units issued subsequent to the IPO, the "LLC Unitholders") consisting of Class B common units (the “Class"Class B Units”Units") and Class A common units (the “Class"Class A Units”Units"), and (iii) appoint Carvana Co. as the sole manager of Carvana Group;
•Carvana Co. amended and restated its certificate of incorporation to authorize (i) 50.0 million shares of Preferred Stock, par value $0.01 per share, (ii) 500.0 million shares of Class A common stock, par value $0.001 per share, and (iii) 125.0 million shares of Class B common stock, par value $0.001 per share. Each share of Class A common stock generally entitles its holder to one1 vote on all matters to be voted on by stockholders. Each share of Class B common stock held by Ernest Garcia II, ErnieErnest Garcia III and entities controlled by one or both of them (collectively, the "Garcia Parties") generally entitles its holder to ten10 votes on all matters to be voted on by stockholders. All other shares of Class B common stock generally entitle their holders to one1 vote per share on all matters to be voted on by stockholders;
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
•Carvana Group converted its outstanding Class C Redeemable Preferred Units as defined in Note 5 — Related Party Transactions, into approximately 43.1 million Class A Units;
•Carvana Co. issued approximately 117.2 million shares of Class B common stock to holders of Class A Units, on a four-to-five basis with the number of Class A Units they owned, for nominal consideration; and,
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
•Carvana Co. transferred approximately 0.2 million Class A Units to Ernest Garcia II in exchange for his 0.1% ownership interest in Carvana, LLC, a majority-owned subsidiary of Carvana Group.
In accordance with the LLC Agreement, Carvana Co. has all management powers over the business and affairs of Carvana Group and conducts, directs and exercises full control over the activities of Carvana Group. Class A Units and Class B Units (the "LLC Units") do not hold voting rights, which results in Carvana Group being considered a variable interest entity ("VIE"). Due to Carvana Co.'s power to control and its significant economic interest in Carvana Group, it is considered the primary beneficiary of the VIE and the Company consolidates the financial results of Carvana Group. As of December 31, 2017,2019, Carvana Co. owned approximately 12.9%32.3% of Carvana Group and the Existing LLC Unitholders owned the remaining 87.1%67.7%.
The Organizational Transactions described above are considered transactions between entities under common control. As a result, the financial statements for periods prior to the IPO and Organizational Transactions have been adjusted to combine the previously separate entities for presentation purposes.
Follow-On Public Offerings
On April 30, 2018, the Company completed a follow-on offering of 6.6 million shares of its Class A common stock at a public offering price of $27.50 per share and received net proceeds from the offering of approximately $172.3 million after underwriting discounts and commissions and offering expenses. The Company used the net proceeds to purchase approximately 8.3 million newly-issued LLC Units in Carvana Group, which used the net proceeds primarily for general corporate purposes.
A holder of Class A common stock (the "Selling Stockholder") and certain LLC Unitholders (the "Selling LLC Unitholders") sold a total of approximately 6.1 million shares of Class A common stock as part of the offering. The Selling LLC Unitholders exchanged approximately 6.9 million LLC Units for approximately 5.6 million shares of Class A common stock to be sold in the offering, and to the extent such Selling LLC Unitholder held Class B common stock, the corresponding shares of Class B common stock were immediately retired by the Company. The Company did not receive any proceeds from the sale of the approximately 6.1 million shares of Class A common stock by the Selling Stockholder and the Selling LLC Unitholders.
On May 24, 2019, the Company completed a follow-on offering of 4.2 million shares of the Company's Class A common stock at a public offering price of $65.00 per share and received net proceeds from the offering of approximately $258.8 million after underwriting discounts and commissions and offering expenses. As part of the offering, the Company granted the underwriters a 30-day option to purchase all or part of approximately 0.6 million additional shares of Class A common stock. On June 20, 2019, the underwriters exercised their option in full for an additional $38.9 million in proceeds after offering expenses.
Convertible Preferred Stock
On December 5, 2017, Carvana Co. amended and restated its certificate of incorporation to authorize 100,000 shares of Class A Convertible Preferred Stock, with an initial stated value of $1,000 per share and a par value of $0.01 per share (the "Convertible Preferred Stock") and, effective December 5, 2017, Carvana Group amended its LLC Agreement to, among other things, create a class of convertible preferred units. On December 5, 2017, Carvana Co. sold 100,000 shares of Convertible Preferred Stock for net proceeds of approximately $98.5 million, which it used to purchase 100,000 newly-issued convertible preferred units of Carvana Group (the "Convertible Preferred Units") at a price per unit equal to the initial stated value of the Convertible Preferred Stock less issuance costs. During the year ended December 31, 2018, all 100,000 shares of Convertible Preferred Stock were converted into approximately 5.1 million shares of Class A common stock. Simultaneously, and in connection with these conversions, Carvana Group converted Carvana Co.'s 100,000 Convertible Preferred Units into approximately 6.3 million Class A Units.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“("U.S. GAAP”GAAP"). All intercompany balances and transactions have been eliminated.
As discussed in Note 1 — Business Organization, Carvana Group is considered a VIE and Carvana Co. consolidates its financial results due to the determination that it is the primary beneficiary. All intercompany balances and transactions have been eliminated.
Revisions
In connection with the preparation of the Company's consolidated financial statements for the year ended December 31, 2019, the Company reviewed its historical accounting for payments from Carvana Group to Carvana Co. to fund interest on the senior unsecured notes and identified an error associated with the allocation of net loss between Carvana Co. and non-controlling interests. The periods affected by the error are the year ended December 31, 2018 and the first three quarters of 2019. There was no error in the historical accounting associated with determining net loss or net loss before income taxes for those periods. In accordance with SAB No. 99, "Materiality," and SAB No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements," the Company evaluated the errors and determined that the related impact was not material to its financial statements for any prior annual or interim period. Although the Company has determined such error to be immaterial to its prior financial statements, the cumulative effect of the error as of December 31, 2019 would be material if corrected in the fourth quarter of 2019. Therefore, the Company has revised its historical financial statements to properly reflect the allocation of net loss between Carvana Co. and non-controlling interests.
The revisions to its consolidated statements of operations for the year ended December 31, 2018 reflect an increase in net loss attributable to non-controlling interests of approximately $6.3 million, a decrease in net loss attributable to Carvana Co. and net loss attributable to Class A common stockholders of approximately $6.3 million, and a decrease in net loss per share of Class A common stock, basic and diluted of $0.21. The Company reviews subsidiariesalso revised its consolidated balance sheets and affiliates, as well as other entities,consolidated statements of stockholders’ equity / members' deficit to determine if they shoulddecrease the accumulated deficit and non-controlling interests by approximately $6.3 million and increase total stockholder’s equity attributable to Carvana Co. by approximately $6.3 million.
Additionally, the 2019 quarterly periods will also be considered a variable interest entity, and whether it should changerevised in connection with the consolidation determinations basedCompany's future 2020 unaudited interim condensed consolidated financial statement filings in Quarterly Reports on changes in its characteristics.Form 10-Q. The Company considers an entity a VIE ifwill revise its consolidated statements of operations, for the three month period ended March 31, 2019, the three and six month periods ended June 30, 2019 and the three and nine month periods ended September 30, 2019. The Company will also revise the consolidated balance sheets and consolidated statements of stockholders’ equity investors own an interest therein that lacks the characteristicsat March 31, 2019, June 30, 2019 and September 30, 2019. The amounts of a controlling financial interest or if such investorsthese revisions are included in Note 19 — Selected Quarterly Financial Data (Unaudited).
These revisions do not have sufficient equity at risk forimpact the entityconsolidated statements of cash flows. The Company has concluded that the effect of this revision is not material to financeany of its activities without additional subordinatedpreviously issued financial support or if the entity is structured with non-substantive voting interests. To determine whether or not the entity is consolidated with the Company’s results, the Company also evaluates which interests are variable interests in the VIE and which party is the primary beneficiary of the VIE.statements.
Liquidity
The accompanying consolidated financial statements of the Company have been prepared in conformity with U.S. GAAP, which contemplate continuation of the Company as a going concern. The Company has incurred losses each year from inception through December 31, 2017,2019, and expects to incur additional losses in the future. As the Company continues to rapidly fund growthgrow into new markets, fund construction ofbuild vending machines and inspection and reconditioning centers ("IRCs"), and enhance technology and software development efforts, it needsmay need access to substantialadditional capital. From inception,Historically, the Company has raised additional equity or debt instruments to fund the expansion; refer to Note 10 — Stockholders' Equity and Note 9 — Debt Instruments. The Company has also funded operationssome of its capital expenditures through long-term financing with lenders and other investors as described in further detail in Note 9 — Debt Instruments. At December 31, 2019, the saleCompany had $137.7 million of Class A Units, its IPO completed on May 3, 2017committed funds for net proceedsfuture construction costs of approximately $205.8 million, its issuance4 IRCs in process as of Class A Convertible Preferred Stock on December 5, 2017 for net proceeds of approximately $98.5 million, the sale of Class C Redeemable Preferred Units, capital contributions from DriveTime and short-term funding from the Company’s majority owner.31, 2019. The Company has historically funded vehicle inventory purchases through its Floor Plan Facility and had approximately $26.2$434.5 million available under theits $950.0 million Floor Plan Facility that the Company may draw against through October 2020 to fund future vehicle inventory purchases as of December 31, 2017. Beginning January 1, 2018, the Floor Plan Facility capacity will increase to $350.0 million to allow for more vehicle inventory purchases,2019, as described further in Note 79 — Debt Instruments. Further, the Company plans to increase the amount and maturity date of
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
financing available to purchase vehicle inventory within the next year by amending its existing Floor Plan Facility or by entering into a new agreement. TheIn the year ended December 31, 2019, the Company has also funded some commenced a quarterly securitization program for the finance receivables generated within its business. Prior to selling the finance receivables as part
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
of its capital expendituresa securitization transaction, the Company funds the finance receivables through long-term financing with third partiesFinance Receivable Facilities, as described in further detaildiscussed in Note 7 — Finance Receivable Sale Agreements and Note 9 — Debt Instruments. The Company has historically entered into various agreements under which it sells the finance receivables it originates to third parties. As of December 31, 2017, the Company sells finance receivables under multiple agreements, all of which expire in November 2018. The Company plans to extend or enter into new agreements to sellcontinue selling its finance receivables through the securitization program. Subsequent to third parties withinDecember 31, 2019, the next year.Company entered into 2 new finance receivable facilities, as mentioned in Note 20 — Subsequent Events, with a current capacity of $925.0 million, which the Company can contribute into through July 2021 and February 2022 and which may be increased to an aggregate $1.0 billion with the consent of certain lenders. Management believes that current working capital, results of operations, and expected continued inventory and capital expenditure financing is sufficient to fund operations for at least one year from the financial statement issuance date.
Use of Estimates
The preparation of these consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions. Certain accounting estimates involve significant judgments, assumptions and estimates by management that have a material impact on the carrying value of certain assets and liabilities, disclosures of contingent assets and liabilities and the reported amounts of revenues and expenses during the reporting period, which management considers to be critical accounting estimates. The judgments, assumptions and estimates used by management are based on historical experience, management’s experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ materially from these judgments and estimates, which could have a material impact on the carrying values of the Company’s assets and liabilities and the results of operations.
Comprehensive Loss
During the years ended December 31, 2017, 20162019, 2018, and 2015,2017, the Company did not0t have any other comprehensive income and, therefore, the net loss and comprehensive loss were the same for all periods presented.
Cash and Cash Equivalents
The Company has cash deposits and cash equivalents deposited in or managed by major financial institutions. Cash equivalents include highly liquid investment instruments with original maturities of three months or less, and consist primarily of money market funds. At times the related amounts are in excess of the amounts insured by the Federal Deposit Insurance Corporation. The Company has not experienced any losses with these financial institutions and does not believe it represents significant credit risk.
Restricted Cash
TheAmounts included in restricted cash includesrepresent the depositdeposits required under the Company's Floor Plan Facility, which is 5% of the outstanding floor plan facility principal balance,short-term revolving facilities as explained in Note 79 — Debt InstrumentsInstruments. During the years ended December 31, 2018 and 2017, amounts held as restricted cash asalso included amounts required under letter of credit agreements, as explained in Note 1316 — Commitments and Contingencies.
Accounts Receivable, Net
Accounts receivable, net of an allowance for doubtful accounts, includes certain amounts due from third partycustomers and their finance providers and customers.providers. The allowance for doubtful accounts is estimated based upon historical experience, current economic conditions, and other factors and is evaluated periodically. The allowance for doubtful accounts was approximately $0.4$3.2 million and $0.6$0.4 million as of December 31, 20172019 and 2016,2018, respectively.
Finance Receivables Held for Sale, Net
Finance receivables include vehicle loansinstallment contracts the Company originates to its customers to facilitate vehicle sales. The Company classifies these receivables as held for sale, as it does not intend to hold the finance receivables it originates to maturity. The Company typically sells the finance receivables it originates, as explained in Note 5 — Related Party Transactions and Note 67 — Finance Receivable Sale Agreements.Agreements and Note 8 — Securitizations and Variable Interest Entities. The Company records a valuation allowance to report finance receivables at the lower of unpaid principal balance or fair value. To determine the fair value of finance receivables the Company utilizes industry-standard modeling, such as discounted cash flow analysis, factoring in the Company’s historical experience, the credit quality of the underlying receivables, loss trends and recovery rates, as well as the overall economic environment. For purposes of determining the valuation allowance, finance receivables are evaluated collectively to determine
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
determining the valuation allowance, finance receivables are evaluated collectively to determine the allowance as they represent a large group of smaller-balance homogeneous loans. The allowance was approximately $0.9$7.3 million and $0.2$1.8 million as of December 31, 20172019 and 2016,2018, respectively. Principal balances of finance receivables are charged-off when the Company is unable to sell the finance receivable and the related vehicle has been repossessed and liquidated or the receivable has otherwise been deemed uncollectible.
The Company has made certain representations related to the sales of finance receivables. Any significant estimated post-sale obligations or contingent obligations to the purchaser of the loansreceivables would be accrued if probable and estimable in accordance with ASC 450, Contingencies. Any such obligations are considered in the Company's determination of the accounting for the transfers of the finance receivables under ASC Topic 860, Transfers and Servicing of Financial Assets.
Vehicle Inventory
Vehicle inventory consists of used vehicles, primarily acquired at auction.auction and directly from customers. Direct and indirect vehicle reconditioning costs including parts and labor, inbound transportation costs and other incremental overhead costs are capitalized as a component of inventory. Inventory is stated at the lower of cost or net realizable value. Vehicle inventory cost is determined by specific identification. Net realizable value is the estimated selling price less costs to complete, dispose and transport the vehicles. Selling prices are derived from historical data and trends, such as sales price and inventory turn times of similar vehicles, as well as independent market resources. Each reporting period the Company recognizes any necessary adjustments to reflect vehicle inventory at the lower of cost or net realizable value through cost of sales in the accompanying consolidated statements of operations.
Property and Equipment
Property and equipment consists of land, buildings and improvements, transportation fleet equipment, software and furniture, fixtures and equipment and is stated at cost less accumulated depreciation and amortization. Repairs and maintenance costs that extend the life or utility of an asset are also capitalized. Ordinary repairs and maintenance are charged to expense as incurred. Costs incurred during construction are capitalized as construction in progress and reclassified to the appropriate fixed asset categories when the project is completed. In addition, interest on borrowings during the active construction period of construction projects is capitalized and depreciated over the estimated useful lives of the related assets. Costs incurred during the preliminary project planning phase are charged to expense as incurred.
The Company capitalizes direct costs of materials and services consumed in developing or obtaining internal useinternal-use software. The Company also capitalizes payroll and payroll-related costs for employees who are directly associated with and who devote time to the development of software products for internal use, to the extent of the time spent directly on the project. Capitalization of costs begins during the application development stage and ends when the software is available for general use. Costs incurred during the preliminary project and post-implementation stages are charged to expense as incurred.
Depreciation and amortization are computed using the straight-line method over the lesser of the remaining lease term or the following estimated useful lives:
|
| | | | | | | |
Buildings and improvements | | 5-30 years |
Transportation fleet equipment | | 3-8 years |
Software | | 3 years |
Furniture, fixtures and equipment | | 3-5 years |
Management reviews long-lived assets for impairment when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. The Company compares the sum of estimated undiscounted future cash flows expected to result from the use of the asset to the carrying value of the asset. When the carrying value of the asset exceeds its estimated undiscounted future cash flows, the Company recognizes an impairment charge for the amount by the which the carrying value of the asset exceeds the fair value of the asset. The Company recorded no0 impairment charges during the years ended December 31, 2017, 20162019, 2018, and 2015.2017. See Note 3 — Property and Equipment, Net for additional information on property and equipment.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Goodwill and Intangible Assets
Intangible assets are recognized and recorded at their acquisition date fair values. Definite-lived intangible assets consist of developed technology, customer relationships, and non-compete agreements and are amortized on a straight-line basis over their estimated useful lives. The Company determined the useful lives of its definite-lived intangible assets based on multiple factors including technological obsolescence, the make-up of the acquired customer base and expected attrition, and the period over which expected cash flows are used to measure the fair value of the intangible asset at acquisition. The Company periodically reassesses the useful lives of its definite-lived intangible assets when events or circumstances indicate that useful lives have significantly changed from the previous estimate. Definite-lived intangible assets are tested at least annually or more frequently when events or changes in circumstances indicate that the carrying value may not be recoverable. NaN impairment charges related to intangible assets were recognized during the years ended December 31, 2019, 2018, or 2017.
Goodwill represents the excess purchase price over the fair value of the net assets acquired. Goodwill is not amortized but is tested at least annually or more frequently when events or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company has 1 operating segment, which is its reporting unit; therefore, management analyzes goodwill associated with all of its operations when analyzing for potential impairment. The Company first assesses qualitative factors to determine if it is not more likely than not that the fair value of its reporting unit is less than its carrying amount. NaN impairment charges related to goodwill were recognized during the years ended December 31, 2019, 2018, or 2017.
Leases
As discussed below, the Company adopted ASC 842 on January 1, 2019. Under ASC 842, the Company determines if an arrangement is a lease at inception by evaluating if the asset is explicitly or implicitly identified or distinct, if the Company will receive substantially all of the economic benefit or if the lessor has an economic benefit and the ability to substitute the asset. Right-of-use ("ROU") assets represent the Company's right to use an underlying asset for the lease term and lease liabilities represent the Company's obligation to make lease payments arising from the lease. The Company assesses whether the lease is an operating or finance lease at its inception. Operating lease liabilities are recognized at commencement date based on the present value of the lease payments over the lease term. To calculate the present value, the Company uses the implicit rate in the lease when readily determinable. However, most of the Company's leases do not provide an implicit rate and it uses its incremental borrowing rate. The incremental borrowing rate is based on collateralized borrowings of similar assets with terms that approximate the lease term when available and when collateralized rates are not available, it uses uncollateralized rates with similar terms adjusted for the fact that it is an unsecured rate. The operating lease ROU asset is the initial lease liability adjusted for any prepayments, initial indirect costs incurred by the Company, and lease incentives. The Company's operating leases are included in operating lease right-of-use assets, other current liabilities, and operating lease liabilities on the accompanying consolidated balance sheets. The Company's finance leases are included in property and equipment and long-term debt on the accompanying consolidated balance sheets.
Securitizations and Variable Interest Entities
The Company reviews subsidiaries and affiliates, as well as other entities, to determine if they should be considered VIEs, and whether it should change the consolidation determinations based on changes in their characteristics. The Company considers an entity a VIE if its equity investors own an interest therein that lacks the characteristics of a controlling financial interest or if such investors do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support or if the entity is structured with non-substantive voting interests. A VIE is consolidated by its primary beneficiary, the party that has both the power to direct the activities that most significantly impact the VIE’s economic performance and the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. The Company evaluates whether it has variable interests in the VIE and if so, if it is the primary beneficiary of the VIE on an ongoing basis. The Company consolidates VIEs when it is deemed to be the primary beneficiary.
The Company sponsors asset-backed securitization transactions. These transactions often result in the creation of securitization trusts, which are VIEs. To comply with Regulation RR of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Risk Retention Rules") the Company retains at least a 5% interest in the credit risk of the underlying finance receivables, which it accomplishes by retaining at least a 5% interest in each security issued by the securitization trusts. Typically, this includes notes and certificates, which are presented as beneficial interests in securitizations on the accompanying consolidated balance sheets.
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Other Assets
Other current assets consist of various items, including, among other items, software licenses and subscriptions, prepaid expenses, the estimated reserve for vehicle inventory returns, debt issuance costs on revolving debt instruments, and deposits. Other assets consist of various items, including, among other items, the purchase price adjustment receivable based on the performance of the Company's finance receivables, the receivable related to the excess cash reserves over realized claims of VSCs, deposits and debt issuance costs on revolving debt instruments.
Accrued Liabilities
Accrued liabilities consist of various items payable within one year, including, among other items, accruals for capital expenditures, sales tax, compensation and benefits, vehicle licenses and fees, interest expense, and advertising expenses.
Other Liabilities
As of December 31, 2019, other current liabilities primarily consist of the current portion of operating lease liabilities. Other liabilities consist of various items to be recognized beyond one year, including the deferred tax liability associated with acquisitions of intangible assets. As of December 31, 2018, other liabilities also included the long-term portion of deferred rent and the long-term portion of the tenant improvement allowance associated with the Company's corporate headquarters.
Revenue Recognition
The Company recognizes revenue in accordance with the five-step model prescribed by ASC 606 that includes: (1) identify the contract; (2) identify the performance obligations; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations; and (5) recognize revenue when (or as) performance obligations are satisfied.
Used Vehicle Sales
The Company sells used vehicles directly to its customers through its website. The prices of used vehicles are set forth in the customer contracts at stand-alone selling prices which are agreed upon prior to delivery. The Company satisfies its performance obligation for used vehicle sales upon delivery when the transfer of title, risks and rewards of ownership, and control pass to the customer. The Company recognizes revenue at the agreed upon purchase price stated in the contract, including any delivery charges, less an estimate for returns. Estimates for returns are based on an analysis of historical experience, trends and sales data. Changes in these estimates are reflected as an adjustment to revenue in the period identified. The amount of consideration received for used vehicle sales includes noncash consideration representing the value of trade-in vehicles, if applicable, as stated in the contract. Prior to the delivery of the vehicle, the payment is received or financing has been arranged. Payments from customers that finance their purchases with third parties are typically due and collected within 30 days of delivery of the used vehicle. Revenue excludes any sales taxes, title and registration fees, and other government fees that are collected from customers.
Wholesale Vehicle Sales
The Company sells vehicles to wholesalers. These vehicles sold to wholesalers are primarily acquired from customers that do not meet the Company’s quality standards to list and sell through its website. The Company satisfies its performance obligation for wholesale vehicle sales when the wholesale purchaser obtains control of the underlying vehicle, which is upon delivery when the transfer of title, risks and rewards of ownership, and control pass to the customer. The Company recognizes revenue at the amount it expects to receive for the used vehicle, which is the fixed price determined at the auction. The purchase price of the wholesale vehicle is typically due and collected within 30 days of delivery of the wholesale vehicle.
Other Sales and Revenues
Other sales and revenues include gains on the sales of finance receivables, commissions on vehicle service contracts ("VSCs"), GAP waiver coverage, commissions on GAP waiver coverage, and interest income received on finance receivables prior to selling them to investors.
Customers purchasing used vehicles from the Company may enter into contracts for VSCs and, if they finance with the Company, GAP waiver coverage. The prices of VSCs and GAP waiver coverage are set forth in each contract. The Company
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sells and receives a commission on VSCs under a master dealer agreement with DriveTime, pursuant to which the Company sells VSCs that DriveTime administers and is the obligor. The Company receives a commission on GAP waiver coverage contracts where the administrator of the contract is obligated to reimburse the holder of the underlying finance receivable for a balance that is in excess of the value of the financed vehicle in the event of a total loss. The Company recognizes commission revenue at the time of sale, net of a reserve for estimated contract cancellations. GAP waiver coverage contracts administered by DriveTime obligate whoever holds the underlying finance receivable to not attempt collection of a balance that is in excess of the value of the financed vehicle in the event of a total loss. DriveTime GAP waiver coverage is recognized as the performance obligation is satisfied over the period of coverage, generally on a straight-line basis over the expected period the outstanding balance of the related finance receivable will exceed the value of the financed vehicle, less a reserve for cancellations. Upon selling the corresponding finance receivable, the Company recognizes any remaining deferred revenue. The reserve for cancellations of VSCs and GAP waiver coverage contracts is estimated based upon historical experience and recent trends and is reflected as a reduction of other sales and revenues. Changes in these estimates are reflected as an adjustment to other sales and revenues in the period identified.
Under the master dealer agreement with DriveTime, the Company is also contractually entitled to receive profit-sharing revenues based on the performance of the VSCs once a required claims period has passed. This is a form of variable consideration the Company recognizes as revenue to the extent that it is probable that it will not result in a significant revenue reversal. The Company applies the expected value method, utilizing expected VSC performance based on historical claims and cancellation data from its customers, as well as other qualitative assumptions to estimate the amount it expects to receive. The Company reassesses the estimate each reporting period with any changes reflected as an adjustment to other sales and revenues in the period identified. Profit-sharing payments will begin when the underlying VSCs reach a specified level of claims history. As of December 31, 2019 and 2018, the Company had ending receivables of approximately $6.0 million and $1.9 million, respectively, related to cumulative profit-sharing payments recognized as revenue to which it expects to be entitled. The receivables are included in other assets on the accompanying consolidated balance sheets.
The Company accounts for sales of finance receivables in accordance with ASC Topic 860, Transfers and Servicing of Financial Assets ("ASC 860"). ASC 860 states that a transfer of an entire financial asset, a group of entire financial assets, or a participating interest in an entire financial asset in which the transferor surrenders control over those financial assets is accounted for as a sale only if all of the following conditions are met:
•The transferred financial assets have been isolated from the transferor - put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership.
•Each transferee has the right to pledge or exchange the assets (or beneficial interests) it received, and no condition both constrains the transferee (or third-party holder of its beneficial interests) from taking advantage of its right to pledge or exchange the asset and provides more than a trivial benefit to the transferor.
•The transferor, its consolidated affiliates included in the financial statements being presented or its agents do not maintain effective control over the transferred financial assets or third-party beneficial interests related to those transferred assets.
For the years ended December 31, 2019, 2018, and 2017, all transfers of finance receivables met the requirements for sale treatment. The Company records the gain on the sale of a finance receivable upon receipt of proceeds, in an amount equal to the fair value of the net proceeds received less the carrying amount of the finance receivable.
Cost of Sales
Cost of sales includes the cost to acquire used vehicles and direct and indirect vehicle reconditioning costs associated with preparing the vehicles for resale. Vehicle reconditioning costs include parts, labor, inbound transportation costs, and other incremental overhead costs, which are allocated to inventory via specific identification and standard costing. Occupancy and labor costs not related to vehicle acquisition or reconditioning, including those incurred in connection with expanding production capacity, are expensed as incurred as a component of selling, general and administrative expense. Cost of sales also includes any necessary adjustments to reflect vehicle inventory at the lower of cost or net realizable value.
Selling, General, and Administrative Expenses
Selling, general, and administrative ("SG&A") expenses primarily include compensation and benefits, advertising, depreciation expense, facilities costs, technology expenses, logistics and fulfillment expenses, and other administrative
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expenses. SG&A expenses exclude the costs related to reconditioning vehicles and inbound transportation, which are included in cost of sales, and payroll costs of employees related to the development of software products for internal use, which are capitalized to software and depreciated over the estimated useful lives of the related assets.
Advertising Costs
Advertising production costs are expensed the first time the advertising takes place. All other advertising costs are expensed as incurred. Advertising expenses are included in SG&A expenses on the accompanying consolidated statements of operations. Advertising expense was approximately $204.0 million, $111.2 million, and $55.7 million during the years ended December 31, 2019, 2018, and 2017, respectively.
Equity-Based Compensation
The Company classifies equity-based awards granted in exchange for services as either equity awards or liability awards. The classification of an award as either an equity award or a liability award is generally based upon cash settlement options. Equity awards are measured based on the fair value of the award at the grant date. Liability awards are re-measured to fair value each reporting period. Prior to the adoption of ASU 2018-07, Compensation - Stock Compensation (Topic 718) ("ASU 2018-07"), on January 1, 2019, each reporting period, the Company recognized the change in fair value of awards issued to non-employees as expense. Following adoption of ASU 2018-07, accounting requirements for equity-based awards to nonemployees are aligned with those to employees, including measuring the equity instruments at the grant-date fair value. The Company recognizes equity-based compensation on a straight-line basis over the award’s requisite service period, which is generally the vesting period of the award, less actual forfeitures. No compensation expense is recognized for awards for which participants do not render the requisite services. For equity and liability awards earned based on performance or upon occurrence of a contingent event, when and if the awards will be earned is estimated. If an award is not considered probable of being earned, no amount of equity-based compensation is recognized. If the award is deemed probable of being earned, related compensation expense is recorded over the estimated service period. To the extent the estimate of awards considered probable of being earned changes, the amount of equity-based compensation recognized will also change. See Note 12 — Equity-Based Compensation for additional information on equity-based compensation.
Shipping and Handling
The Company's logistics costs related to transporting its used vehicle inventory include fuel, maintenance, and depreciation related to operating its own transportation fleet and third party transportation fees. The portion of these costs related to inbound transportation from the point of acquisition to the inspection and reconditioning center are capitalized to inventory and then included in cost of sales when the related used vehicle is sold. Logistics costs not included in cost of sales are included in selling, general and administrative expenses in the accompanying consolidated statements of operations and were approximately $58.1 million, $35.2 million, and $14.4 million during the years ended December 31, 2019, 2018, and 2017, respectively, excluding compensation and benefits.
Defined Contribution Plan
The Company sponsors a qualified 401(k) retirement plan (defined contribution plan) for its employees. The plan covers substantially all employees who have attained the age of 18. Participants may voluntarily contribute to the plan up to the maximum limits established by Internal Revenue Service regulations. The Company provides matching contributions of 40% up to the first 6% of an employee’s compensation, which vests evenly over the employee’s initial five-year service period. Employer contributions to the plan, net of forfeitures, were approximately $2.0 million, $1.1 million, and $0.7 million for the years ended December 31, 2019, 2018, and 2017, respectively. Employer contributions are included in selling, general, and administrative expenses in the accompanying consolidated statements of operations.
Derivative Instruments and Hedging Activities
The Company enters into short-term derivative instruments to manage risks arising from its business operations and economic conditions, primarily cash flow variability that may arise from interest rate changes between the time the Company originates finance receivables and the time it sells them through securitizations. The Company does not designate these derivative instruments as hedges under ASC 815, Derivatives and Hedging for hedge accounting treatment and as a result they are accounted for as economic hedges. Gains and losses related to the derivative instruments are included within other sales and revenues to follow the presentation of the hedged item within the accompanying consolidated statements of operations and any
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derivative instruments outstanding as of the end of the period are reported at fair value on the accompanying consolidated balance sheets.
Fair Value Measurements
The fair value of financial instruments is based on estimates using quoted market prices, discounted cash flows, or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and the estimated timing and amount of future cash flows. Therefore, the estimates of fair value may differ substantially from amounts that ultimately may be realized or paid at settlement or maturity of the financial instruments, and those differences may be material. Accordingly, the aggregate fair value amounts presented may not represent the Company’s underlying institutional value.
The Company uses the three-tier hierarchy established by U.S. GAAP, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value to determine the fair value of its financial instruments. This hierarchy indicates to what extent the inputs used in the Company’s calculations are observable in the market. The different levels of the hierarchy are defined as follows:
| | | | | |
Level 1: | Unadjusted quoted prices in active markets for identical assets or liabilities. |
| |
Level 2: | Other than quoted prices that are observable in the market for the asset or liability, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or model-derived valuations or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. |
| |
Level 3: | Inputs are unobservable and reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. |
The Company has elected the fair value option for its beneficial interests in securitizations, which primarily include notes and certificates of the securitization trusts. Electing the fair value option allows the Company to recognize changes in the fair value of these assets in the period the fair value changes. The changes in fair value are recorded within other expense, net and amounts attributable to interest income are reported in interest expense, net on the accompanying consolidated statements of operations.
See Note 17 — Fair Value of Financial Instruments for additional information.
Segments
Business segments are defined as components of an enterprise about which discrete financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing operating performance. Based on the way the Company manages its business, the Company has determined that it currently operates with 1 reportable segment. The chief operating decision maker focuses on consolidated results in assessing operating performance and allocating resources. Furthermore, the Company offers similar products and services and uses similar processes to sell those products and services to similar classes of customers throughout the United States ("U.S."). Substantially all revenue is generated and all assets are held in the U.S. for all periods presented.
Income Taxes
The Company accounts for income taxes pursuant to the asset and liability method, which requires the recognition of deferred income tax assets and liabilities related to the expected future tax consequences arising from temporary differences between the carrying amounts and tax bases of assets and liabilities based on enacted statutory tax rates applicable to the periods in which the temporary differences are expected to reverse. Any effects of changes in income tax rates or laws are included in income tax expense in the period of enactment. The Company reduces the carrying amounts of deferred tax assets by a valuation allowance if, based on the evidence available, it is more likely than not that such assets will not be realized. In making the assessment under the more likely than not standard, appropriate consideration must be given to all positive and negative evidence related to the realization of the deferred tax assets. The assessment considers, among other matters, the
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nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carry forward periods by jurisdiction, the Company's experience with loss carryforwards not expiring unutilized, and all tax planning alternatives that may be available. A valuation allowance is recognized if under applicable accounting standards the Company determines it is more likely than not that its deferred tax assets would not be realized. See Note 14 — Income Taxes for additional information.
Adoption of New Accounting Standards
Beginning in February 2016, the FASB issued several accounting standards updates related to the new leasing model in ASC 842, Leases ("ASC 842"). ASC 842 introduced a model that requires leases to be presented on the balance sheet and eliminates the requirement for an entity to use bright-line tests in determining lease classification. Expense recognition under ASC 842 on the income statement remains similar to previous lease accounting guidance.
The Company adopted ASC 842 on January 1, 2019 using the modified retrospective approach, the practical expedient package and the transition relief option, which allowed the Company to, among other things, avoid reassessing lease classification for existing leases, forego the balance sheet recognition requirements with respect to short-term leases and avoid restating comparative periods presented. The adoption of ASC 842 resulted in initial recognition of ROU assets and operating lease liabilities of approximately $80.3 million and $86.8 million, respectively, as of January 1, 2019, and did not have an impact on the beginning equity balances as of the implementation date. Adopting ASC 842 did not have a material impact on the Company's sale-leaseback transactions, which have typically been accounted for as financing transactions in prior periods and under ASC 842. The standard did not have a material impact on the Company's consolidated statements of operations or statements of cash flows.
In June 2018, the FASB issued ASU 2018-07, Compensation — Stock Compensation (Topic 718) ("ASU 2018-07") related to the accounting for share-based payment transactions for acquiring goods and services from nonemployees. Under ASU 2018-07, the intent is to simplify and align most requirements for share-based payments to nonemployees with the requirements for share-based payments granted to employees under ASC 718, including measuring the equity instruments at the grant-date fair value. The Company adopted ASU 2018-07 on January 1, 2019 using the modified retrospective approach. The adoption of ASU 2018-07 did not have a material effect on the Company’s consolidated financial statements.
Accounting Standards Issued But Not Yet Adopted
In June 2016, the FASB issued ASU 2016-13, Financial instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13") and subsequent related ASUs, which amends the guidance on the impairment of financial instruments by requiring measurement and recognition of expected credit losses for financial assets held. ASU 2016-13 is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2019. Financial assets measured at fair value through net income are excluded from the scope of ASU 2016-13. The Company's beneficial interests in securitizations are carried at fair value and are thus excluded from ASU 2016-13. Finance receivables originated in connection with the Company’s vehicle sales are held for sale and presented at the lower of amortized cost or fair value. The Company intends to sell the finance receivables prior to their contractual maturity, therefore the recovery of the asset is from its sale rather than maturity and the Company is not required to measure the expected lifetime credit losses. The Company will adopt ASU 2016-13 for its fiscal year beginning January 1, 2020 and does not expect the adoption to have a material impact on its consolidated financial statements.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement ("ASU 2018-13") related to updated requirements over the disclosures of fair value measurements. Under ASU 2018-13, certain disclosure requirements for fair value measurements will be eliminated, modified or added to facilitate better communication around recurring and nonrecurring fair value measurements. ASU 2018-13 is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2019, with some amendments applied prospectively, some applied retrospectively, and early adoption permitted. The Company will adopt ASU 2018-13 for its fiscal year beginning January 1, 2020 and does not expect the adoption to have a material impact on its disclosures within its consolidated financial statements.
In August 2018, the FASB issued ASU 2018-15, Intangibles — Goodwill and Other — Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract ("ASU 2018-15"). The intent of this pronouncement is to align the requirements for capitalizing implementation costs incurred in a cloud computing arrangement that is a service contract with the requirements for capitalizing implementation costs
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incurred to develop or obtain internal-use software as defined in ASC 350-40. Under ASU 2018-15, the capitalized implementation costs related to a cloud computing arrangement will be amortized over the term of the arrangement and all capitalized implementation amounts will be required to be presented in the same line items of the financial statements as the related hosting fees. ASU 2018-15 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. The Company will adopt ASU 2018-15 for its fiscal year beginning January 1, 2020 and does not expect the adoption to have a material impact on its consolidated financial statements.
In October 2018, the FASB issued ASU 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities ("ASU 2018-17"). ASU 2018-17 requires reporting entities to consider indirect interests held through related parties under common control on a proportional basis rather than as the equivalent of a direct interest in its entirety for determining whether a decision-making fee is a variable interest. The standard is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. Entities are required to apply the amendments in ASU 2018-17 retrospectively with a cumulative-effect adjustment to retained earnings at the beginning of the earliest period presented. The Company will adopt ASU 2018-17 for its fiscal year beginning January 1, 2020 and does not expect the adoption to have a material impact on its consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes ("ASU 2019-12"). ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. ASU 2019-12 will be effective for interim and annual periods beginning after December 15, 2020, with early adoption permitted. The Company plans to adopt ASU 2019-12 for its fiscal year beginning January 1, 2021 and is currently assessing the impact, if any, the guidance will have on its consolidated financial statements.
NOTE 3 — PROPERTY AND EQUIPMENT, NET
The following table summarizes property and equipment, net as of December 31, 2019 and 2018 (in thousands):
| | | | | | | | | | | |
| December 31, | | |
| 2019 | | 2018 |
Land and site improvements | $ | 98,530 | | | $ | 45,702 | |
Buildings and improvements | 229,640 | | | 123,705 | |
Transportation fleet | 110,302 | | | 65,760 | |
Software | 66,875 | | | 36,452 | |
Furniture, fixtures, and equipment | 38,123 | | | 20,675 | |
Total property and equipment excluding construction in progress | 543,470 | | | 292,294 | |
Less: accumulated depreciation and amortization on property and equipment | (88,795) | | | (44,050) | |
Property and equipment excluding construction in progress, net | 454,675 | | | 248,244 | |
Construction in progress | 88,796 | | | 48,595 | |
Property and equipment, net | $ | 543,471 | | | $ | 296,839 | |
Depreciation and amortization expense on property and equipment was approximately $39.6 million, $22.5 million, and $11.6 million for the years ended December 31, 2019, 2018, and 2017, respectively. These amounts primarily relate to selling, general, and administrative activities and are included as a component of selling, general, and administrative expenses in the accompanying consolidated statements of operations.
The Company capitalized internal use software costs totaling approximately $31.7 million, $17.4 million, and $11.5 million during the years ended December 31, 2019, 2018, and 2017, respectively, which is included in software and construction in progress in the table above. The Company capitalized approximately $24.7 million, $13.6 million, and $7.9 million during the years ended December 31, 2019, 2018, and 2017, respectively, of payroll and payroll-related costs for employees who are directly associated with and who devote time to the development of software products for internal use.
The Company capitalizes interest in connection with various construction projects to build, upgrade, or remodel certain of its facilities. During the years ended December 31, 2019, 2018, and 2017, the Company incurred total interest costs, net of interest income, of approximately $84.2 million, $26.6 million, and $8.6 million, respectively, of which approximately $3.6 million, $1.6 million, and $0.9 million, respectively, were capitalized.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
NOTE 4 — GOODWILL AND INTANGIBLE ASSETS
On April 12, 2018, the Company acquired Car360, Inc. ("Car360"), a provider of app-based photo capture technology, for approximately $16.7 million, net of cash acquired of approximately $0.4 million. The purchase price was comprised of approximately $6.7 million cash, net of cash acquired, and approximately 0.5 million Class A Units of Carvana Group, with a fair value of approximately $10.0 million.
The purchase price was allocated to net tangible assets of approximately $0.2 million and intangible assets of approximately $9.9 million based on their fair values on the acquisition date and a related deferred tax liability of approximately $2.5 million. The deferred tax liability will amortize over two to seven years, and approximately $0.4 million and $0.3 million was amortized during the years ended December 31, 2019 and 2018, respectively. The excess of the purchase price over the amounts allocated to assets acquired, liabilities assumed and the deferred tax liability was approximately $9.4 million, which has been recorded as goodwill. The historical results of operations for Car360 were not significant to the Company's consolidated results of operations for the periods presented.
The following table summarizes intangible assets and goodwill related to the Car360 acquisition as of December 31, 2019 and 2018 (in thousands):
| | | | | | | | | | | | | | | | | |
| | | December 31, | | |
| Useful Life | | 2019 | | 2018 |
Intangible assets: | | | | | |
Developed technology | 7 years | | $ | 8,642 | | | $ | 8,642 | |
Customer relationships | 2 years | | 523 | | | 523 | |
Non-compete agreements | 5 years | | 774 | | | 774 | |
Intangible assets, acquired cost | | | 9,939 | | | 9,939 | |
Less: accumulated amortization | | | (2,707) | | | (1,070) | |
Intangible assets, net | | | $ | 7,232 | | | $ | 8,869 | |
| | | | | |
Goodwill | N/A | | $ | 9,353 | | | $ | 9,353 | |
Amortization expense was $1.6 million and $1.1 million during the years ended December 31, 2019 and 2018, respectively. As of December 31, 2019, the remaining weighted-average amortization period for definite-lived intangible assets was approximately 4.9 years. The anticipated annual amortization expense to be recognized in future years as of December 31, 2019 is as follows (in thousands):
| | | | | |
| Expected Future Amortization |
2020 | $ | 1,590 | |
2021 | 1,389 | |
2022 | 1,389 | |
2023 | 1,279 | |
2024 | 1,235 | |
Thereafter | 350 | |
Total | $ | 7,232 | |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
NOTE 5 — ACCOUNTS PAYABLE AND OTHER ACCRUED LIABILITIES
The following table summarizes accounts payable and other accrued liabilities as of December 31, 2019 and 2018 (in thousands):
| | | | | | | | | | | |
| December 31, | | |
| 2019 | | 2018 |
Accounts payable, including $9,549 and $3,891, respectively, due to related parties | $ | 63,576 | | | $ | 33,032 | |
Sales taxes and vehicle licenses and fees | 45,812 | | | 27,651 | |
Accrued property and equipment | 23,433 | | | 7,414 | |
Accrued compensation and benefits | 21,726 | | | 13,477 | |
Reserve for returns and cancellations | 19,721 | | | 11,284 | |
Accrued interest expense | 15,650 | | | 9,206 | |
Accrued advertising costs | 11,403 | | | 4,398 | |
Customer deposits | | 6,379 | | | 2,890 | |
Other accrued liabilities | | 26,743 | | | 12,063 | |
Total accounts payable and other accrued liabilities | $ | 234,443 | | | $ | 121,415 | |
NOTE 6 — RELATED PARTY TRANSACTIONS
Lease Agreements
In November 2014, the Company and DriveTime entered into a lease agreement that governs the Company’s access to and utilization of temporary storage, reconditioning, offices and parking space at various DriveTime facilities (the "DriveTime Lease Agreement"). The DriveTime Lease Agreement was most recently amended in December 2018. Lease duration varies by location with cancellable terms, provided 60 days' prior written notice is given, expiring between 2021 and 2024. Most of the facilities allow the Company to exercise up to 2 consecutive one-year renewal options at up to 10 of these locations, less the numbers of locations renewed under the DriveTime Hub Lease Agreement described below.
In March 2017, the Company and DriveTime entered into a lease agreement that governs the Company's access to and utilization of office and parking space at various DriveTime facilities (the "DriveTime Hub Lease Agreement"). The DriveTime Hub Lease Agreement was most recently amended in December 2018. Lease expiration varies by location with most having cancellable terms, provided 60 days' prior written notice is given, expiring in 2021 and the Company having the right to exercise up to 2 consecutive one-year renewal options at up to 10 of these locations, less the number of locations renewed under the DriveTime Lease Agreement described above.
The DriveTime Lease Agreement and the DriveTime Hub Lease Agreement both have non-cancellable lease terms of less than twelve months with rights to terminate at the Company's election with 60 days' prior written notice and extension options as described above. At our non-reconditioning locations, it is not reasonably certain that the Company will exercise its options to extend the leases or abstain from exercising its termination rights within these lease agreements to create a lease term greater than one year and therefore the Company accounts for them as short-term leases. For these locations the Company makes variable monthly lease payments based on its pro rata utilization of space at each facility plus a pro rata share of each facility’s actual insurance costs and real estate taxes. The DriveTime Lease Agreement includes the Blue Mound and Delanco inspection and reconditioning centers ("IRCs"). At both of these locations, the Company expects to extend the lease terms beyond twelve months, therefore those locations are not considered short-term leases. The Company occupies all of the space at these IRCs and makes monthly lease payments based on DriveTime's actual rent expense. In addition, the Company is responsible for the actual insurance costs and real estate taxes at these IRC locations.
At all locations, the Company is additionally responsible for paying for any tenant improvements it requires to conduct its operations and its share of estimated costs incurred by DriveTime related to preparing these sites for use. Management has determined that the costs allocated to the Company are based on a reasonable methodology.
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In December 2016, the Company entered into a lease agreement related to an IRC in Tolleson, Arizona, with Verde Investments, Inc., an affiliate of DriveTime ("Verde"), with an initial term of approximately 15 years. In August 2018, the Company entered into an additional lease agreement with a coterminous initial term with Verde for contiguous space to that IRC. The lease agreements require monthly rental payments and can each be extended for 4 additional five-year periods.
In February 2017, the Company entered into a lease agreement with DriveTime for sole occupancy of a fully operational IRC in Winder, Georgia, where the Company previously maintained partial occupancy. The lease has an initial term of eight years, subject to the Company's ability to exercise 3 renewal options of five years each.
In November 2018, the Company entered into a lease agreement with DriveTime for access to and utilization of a fully operational IRC near Cleveland, Ohio. DriveTime vacated the facility in February 2019, at which point the Company became the sole occupant and began leasing the full facility from DriveTime. The lease has an initial term of three years, subject to the Company's ability to exercise 3 renewal options of five years each. Before DriveTime vacated the facility, the Company paid a monthly rental fee for facility and shared reconditioning costs, calculated based on the Company's pro rate utilization of space at the IRC in a given month, along with a pro rata share of the facility's actual insurance costs and real estate taxes. Management has determined that the costs allocated to the Company are based on a reasonable methodology.
Expenses related to these operating lease agreements are allocated based on usage to inventory and selling, general and administrative expenses in the accompanying consolidated balance sheets and statements of operations. Costs allocated to inventory are recognized as cost of sales when the inventory is sold. During the year ended December 31, 2019, total costs related to these operating lease agreements, including those noted above, were approximately $7.9 million with approximately $3.3 million and $4.6 million allocated to each of inventory and selling, general, and administrative expenses, respectively. During the year ended December 31, 2018, total costs related to these operating lease agreements were approximately $8.8 million with approximately $4.4 million allocated to each of inventory and selling, general, and administrative expenses. During the year ended December 31, 2017, total costs related to these operating lease agreements were approximately $7.2 million with approximately $2.8 million and $4.4 million allocated to inventory and selling, general, and administrative expenses, respectively.
In February 2019, the Company entered into an agreement to assume a lease of an IRC near Nashville, Tennessee that DriveTime leased from an unrelated landlord. The Company became the sole occupant in April 2019. The lease expires in four years, subject to the ability to exercise 3 renewal options of five years each. DriveTime remained an occupant of the facility through April 1, 2019 but is not fully released from lease obligations by the landlord.
During 2019, the Company purchased certain leasehold improvements and equipment from DriveTime at facilities the Company previously shared with them for DriveTime's net book value of approximately $6.3 million.
Corporate Office Leases
During the first quarter of 2017, the Company subleased additional office space at DriveTime’s corporate headquarters in Tempe, Arizona. Pursuant to this arrangement, the Company incurred rent of approximately $0.1 million during the year ended December 31, 2017. This arrangement terminated in March 2017.
In September 2016, the Company entered into a lease for the second floor of its corporate headquarters in Tempe, Arizona. DriveTime guaranteed up to $0.5 million of the Company's rent payments under that lease through September 2019. In connection with that lease, the Company entered into a sublease with DriveTime for the use of the first floor of the same building. The lease and sublease each have a term of 83 months, subject to the right to exercise 3 five-year extension options. Pursuant to the sublease, the Company will pay the rent equal to the amounts due under DriveTime's master lease directly to DriveTime's landlord. The rent expense incurred related to this first floor sublease was approximately $0.9 million during both of the years ended December 31, 2019 and 2018 and $0.7 million during the year ended December 31, 2017.
In December 2019, Verde purchased an office building in Tempe, Arizona that the Company leased from an unrelated party prior to Verde's purchase. In connection with the purchase, Verde assumed that lease. The lease has an initial term of ten years, subject to the right to exercise 2 five-year extension options. During the year ended December 31, 2019, the rent expense incurred under the lease with Verde was approximately $42.5 thousand.
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Master Dealer Agreement
In December 2016, the Company entered into a master dealer agreement with DriveTime (the "Master Dealer Agreement"), pursuant to which the Company may sell VSCs to customers purchasing a vehicle from the Company. The Company earns a commission on each VSC sold to its customers and DriveTime is obligated by and subsequently administers the VSCs. The Company collects the retail purchase price of the VSCs from its customers and remits the purchase price net of commission to DriveTime. During the years ended December 31, 2019, 2018, and 2017, the Company recognized approximately $55.6 million, $23.7 million, and $8.9 million, respectively, of commissions earned on VSCs sold to its customers and administered by DriveTime, net of a reserve for estimated contract cancellations. The commission earned on the sale of these VSCs is included in other sales and revenues in the accompanying consolidated statements of operations. In November 2018, the Company amended the Master Dealer Agreement to allow the Company to receive payments for excess reserves based on the performance of the VSCs versus the reserves held by the VSC administrator, once a required claims period for such VSCs has passed. During the years ended December 31, 2019, 2018, and 2017, the Company recognized approximately $4.1 million, $1.9 million, and $0.0 million, respectively, related to payments for excess reserves to which it expects to be entitled, which is included in other sales and revenues in the accompanying consolidated statements of operations.
Beginning in 2017, DriveTime also administers a portion of the Company's GAP waiver coverage and the limited warranty provided to all customers under the Master Dealer Agreement. The Company pays a per-contract fee to DriveTime to administer a portion of the GAP waiver coverage it sells to its customers and a per-vehicle fee to DriveTime to administer the limited warranty included with every purchase. The Company incurred approximately $4.3 million, $2.2 million, and $0.6 million during the years ended December 31, 2019, 2018, and 2017, respectively, related to the administration of GAP waiver coverage and limited warranty. As of December 31, 2019, the majority of the Company's GAP waiver coverage sales are administered by an unrelated party.
GAP Waiver Insurance Policy
During the year ended December 31, 2019, the Company purchased insurance policies from BlueShore Insurance Company ("BlueShore"), an affiliate of DriveTime, for approximately $1.8 million that reimburses the lienholder of finance receivables with GAP waiver coverage for any GAP waiver claims on a defined set of finance receivables that the Company sold in its securitization transactions. This insurance is transferred with the underlying finance receivable. In March 2019, the Company entered into a retrospective profit sharing agreement with BlueShore under which the Company will share in the profits generated from the insurance policies by receiving a portion of the excess of the premium it paid to BlueShore, net of a fee, compared to the amount BlueShore pays out related to the GAP waiver claims. As of December 31, 2019, the Company held a receivable of approximately $0.2 million, which is included in other assets on the accompanying consolidated balance sheets, related to this retrospective profit sharing agreement.
Servicing and Administrative Fees
DriveTime provides servicing and administrative functions associated with the Company's finance receivables. The Company incurred expenses of approximately $4.2 million, $0.9 million, and $0.2 million for the years ended December 31, 2019, 2018, and 2017, respectively, related to these services.
Aircraft Time Sharing Agreement
The Company entered into an agreement to share usage of 2 aircraft owned by Verde and operated by DriveTime in 2015, and the agreement was subsequently amended in 2017. Pursuant to the agreement, the Company agreed to reimburse DriveTime for actual expenses for each of its flights. The original agreement was for 12 months, with perpetual 12-month automatic renewals. Either the Company or DriveTime can terminate the agreement with 30 days’ prior written notice. The Company reimbursed DriveTime approximately $0.5 million during both of the years ended December 31, 2019 and 2018 and approximately $0.4 million during the year ended 2017 under this agreement.
Shared Services Agreement with DriveTime
In November 2014, the Company and DriveTime entered into a shared services agreement whereby DriveTime provided certain accounting and tax, legal and compliance, information technology, telecommunications, benefits, insurance, real estate, equipment, corporate communications, software and production, and other services to facilitate the transition of these services to the Company on a standalone basis (the "Shared Services Agreement"). The Shared Services Agreement was most recently amended and restated in April 2017 and operates on a year-to-year basis after February 2019, with the Company having the
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(Continued)
right to terminate any or all services with 30 days' prior written notice and DriveTime having the right to terminate any or all services with 90 days' prior written notice. Charges allocated to the Company were based on the Company’s actual use of the specific services detailed in the Shared Services Agreement. Total expenses related to the Shared Services Agreement were approximately $0.0 million for both of the years ended December 31, 2019 and 2018, and approximately $0.1 million during the year ended December 31, 2017, all of which are included in selling, general and administrative expenses in the accompanying consolidated statements of operations.
Accounts Payable Due to Related Party
As of December 31, 2019 and 2018, approximately $9.5 million and $3.9 million, respectively, was due to related parties primarily related to the agreements mentioned above, and is included in accounts payable and accrued liabilities in the accompanying consolidated balance sheets.
Senior Unsecured Notes Held by Verde
As of both December 31, 2019 and 2018, Verde held $15.0 million of principal of the Company's outstanding senior unsecured notes, which are described further in Note 9 — Debt Instruments.
Credit Facility with Verde
On February 27, 2017, the Company entered into a credit facility with Verde for an amount up to $50.0 million (the "Verde Credit Facility"). Amounts outstanding accrued interest at a rate of 12.0% per annum. Upon execution of the agreement, the Company paid Verde a commitment fee of $1.0 million. In connection with the IPO completed on May 3, 2017, the Company repaid the outstanding principal balance of $35.0 million and accrued interest of approximately $0.4 million in full and the Verde Credit Facility agreement terminated.
Contribution Agreements
On September 10, 2018, the Company announced a commitment by its Chief Executive Officer, Ernest Garcia III, to contribute shares of the Company's Class A common stock, for each then-current employee from his personal shareholdings to the Company at 0 charge (the "Share Contributions"). His contributions funded equity awards of 165 restricted stock units to each of the Company's then-current employees upon their satisfying certain employment tenure requirements (the "100k Milestone Gift"). The Company entered into certain contribution agreements related to his commitment in order to effect the transfer of shares from Mr. Garcia to the Company. The Company does not expect Mr. Garcia to incur any tax obligations related to the Share Contributions, but pursuant to a series of Contribution Agreements, it has indemnified Mr. Garcia from any such obligations that may arise. See Note 10 — Stockholders' Equity and Note 12 — Equity-Based Compensation for further discussion. As of December 31, 2019, Mr. Garcia's commitment related to the 100k Milestone Gift has been fulfilled.
IP License Agreement
In February 2017, the Company entered into a license agreement that governs the rights of certain intellectual property owned by the Company and the rights of certain intellectual property owned by DriveTime. The license agreement, which was amended and restated in April 2017, generally provides that each party grants to the other certain limited exclusive (other than with respect to the licensor party and its affiliates) and non-exclusive licenses to use certain of its intellectual property, and each party agrees to certain covenants not to sue the other party, its affiliates, and certain of its service providers in connection with various patent claims. The exclusive license to DriveTime is limited to the business that is primarily of subprime used car sales to retail customers. However, upon a change of control of either party, both parties’ license rights as to certain future improvements to licensed intellectual property and all limited exclusivity rights are terminated. The agreement does not provide a license to any of the Company's patents, trademarks, logos, customers’ personally identifiable information or any intellectual property related to the Company's vending machines, automated vehicle photography, or certain other elements of the Company's brand.
NOTE 7 — FINANCE RECEIVABLE SALE AGREEMENTS
In December 2016, the Company entered into a master purchase and sale agreement (the "Master Purchase and Sale Agreement" or "MPSA") and a master transfer agreement (the "2016 Master Transfer Agreement") pursuant to which it sells finance receivables meeting certain underwriting criteria to certain financing partners, including Ally Bank and Ally Financial
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(Continued)
(the "Ally Parties"). Through November 2017 under the Purchase and Sale Agreement and the 2016 Master Transfer Agreement, the Company could sell up to an aggregate of $375.0 million, and $292.2 million, respectively, in principal balances of finance receivables subject to adjustment as described in the respective agreements.
On November 3, 2017, the Company amended its MPSA to increase the aggregate amount of principal balances of finance receivables it can sell from $375.0 million to $1.5 billion. On November 2, 2018, the Company amended the MPSA to, among other things and subject to the terms of the agreement, commit the purchaser to purchase up to a maximum of $1.25 billion of principal balances of finance receivables after the amendment date. Subsequently, on April 19, 2019, the Company amended the MPSA to, among other things and subject to the terms of the agreement, commit the purchaser to purchase up to a maximum of $1.0 billion of principal balances of finance receivables after the amendment date.
During the years ended December 31, 2019 and 2018, the Company sold approximately $418.8 million and $733.4 million, respectively, in principal balances of finance receivables under the MPSA and had approximately $658.3 million of unused capacity as of December 31, 2019.
On November 3, 2017, the Company terminated the remaining capacity under the 2016 Master Transfer Agreement and replaced this facility by entering into a new master transfer agreement (the "2017 Master Transfer Agreement") with a purchaser trust (the "2017 Purchaser Trust") under which the trust committed to purchase up to an aggregate of approximately $357.1 million in principal balances of finance receivables. On November 2, 2018, the Company amended the 2017 Master Transfer Agreement to, among other things and subject to the terms of the agreement, increase and extend the trust's commitment to purchase finance receivables from the Company.
On August 7, 2018, in connection with a refinancing transaction discussed further below, the Company purchased finance receivables it had previously sold under the 2017 Master Transfer Agreement and simultaneously entered into a transfer agreement with a purchaser trust under which the trust immediately purchased such finance receivables from the Company.
On December 21, 2018, the Company entered into a transfer agreement with a purchaser trust under which the trust purchased principal balances of finance receivables from the Company, a portion of which were related to a refinancing transaction, discussed further below (the "2018 Transfer Agreement").
On May 7, 2019, the Company purchased the certificate of the 2017 Purchaser Trust for $34.0 million, net of cash acquired. At the time of acquisition the trust assets included $139.7 million of finance receivables that the Company had previously sold to the trust under the 2017 Master Transfer Agreement, and its liabilities included $105.7 million in associated debt and other liabilities. In connection with the certificate purchase, the Company and Ally Bank entered into an Amended and Restated Loan and Security Agreement (the "A&R Loan and Security Agreement") pursuant to which Ally Bank agreed to provide a $350.0 million revolving credit facility (the "SART 2017-1 Credit Facility") to fund certain automotive finance receivables originated by the Company, as further described in Note 9 — Debt Instruments.
During the year ended December 31, 2019, prior to the acquisition of the certificate in the trust, the Company sold approximately $139.3 million in principal balances of finance receivables under the 2017 Master Transfer Agreement. During the year ended December 31, 2018, the Company sold approximately $348.8 million in principal balances of finance receivables under the 2017 Master Transfer Agreement, and approximately $115.0 million in principal balances of finance receivables under the 2018 Transfer Agreement, excluding those that were part of the refinancing transactions described below.
During the year ended December 31, 2019, prior to the certificate purchase, the Company also purchased finance receivables that it previously sold to the purchaser trust under the 2017 Master Transfer Agreement for a total price of approximately $127.7 million and immediately resold such finance receivables into a securitization transaction, which is described further in Note 8 — Securitizations and Variable Interest Entities. This transaction was entered into in connection with the securitization transaction and was entered into independently from the terms of the 2017 Master Transfer Agreement.
The total gain related to finance receivables sold to financing partners under the MPSA, the 2016 Master Transfer Agreement, the 2017 Master Transfer Agreement, and to investors in securitization transactions discussed in Note 8 — Securitizations and Variable Interest Entities was approximately $137.3 million, $51.7 million, and $21.7 million during the years ended December 31, 2019, 2018, and 2017, respectively, which is included in other sales and revenues in the accompanying consolidated statements of operations.
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(Continued)
During the year ended December 31, 2018, the Company purchased finance receivables that it previously sold to a purchaser trust under the 2017 Master Transfer Agreement for a total price of approximately $387.4 million and immediately resold such finance receivables to other trusts with the same certificate holder for the same price under separate transfer agreements, one of which was the 2018 Transfer Agreement. Other than customary repurchase obligations, the Company is not obligated to, nor does it have a right to, purchase or sell finance receivables it has previously sold under the 2017 Master Transfer Agreement. These transactions completed in 2018 were entered into in connection with a refinancing by the trusts' certificate holder and were entered into independently from the terms of the 2017 Master Transfer Agreement. The Company received fees totaling approximately $6.3 million for structuring and participating in these transactions, which are included in other sales and revenues in the accompanying consolidated statements of operations.
NOTE 8 — SECURITIZATIONS AND VARIABLE INTEREST ENTITIES
Beginning in 2019, the Company sponsors and establishes securitization trusts to purchase finance receivables from the Company. The securitization trusts issue asset-backed securities, which are collateralized by the finance receivables that the Company sells to the securitization trusts. Upon transfer of the finance receivables to the securitization trusts, the Company recognizes a gain or loss on sales of finance receivables. The net proceeds from the sales are the fair value of the assets obtained as part of the transactions and typically include cash and at least 5% of the beneficial interests issued by the securitization trusts to comply with Risk Retention Rules. The beneficial interests retained by the Company include but are not limited to rated notes and certificates of the securitization trusts. The holders of the certificates issued by the securitization trusts have rights to cash flows only after the holders of the notes issued by the securitization trusts have received their contractual cash flows. The securitization trusts have no direct recourse to the Company’s assets, and holders of the securities issued by the securitization trusts can look only to the assets of the securitization trusts that issued their securities for payment. The beneficial interests held by the Company are subject principally to the credit and prepayment risk stemming from the underlying finance receivables.
As described in Note 2 — Summary of Significant Accounting Policies, the securitization trusts established in connection with asset-backed securitization transactions are VIEs. For each VIE that the Company establishes in its role as sponsor of securitization transactions, it performs an analysis to determine whether or not it is the primary beneficiary of the VIE. The Company’s continuing involvement with the VIEs consists of retaining a portion of the securities issued by the VIEs and performing ministerial duties as the trust administrator. As of December 31, 2019, the Company is not the primary beneficiary of these securitization trusts because its retained interests in the VIEs do not have exposures to losses or benefits that could potentially be significant to the VIEs. The Company does not consolidate the securitization trusts.
The assets the Company retains in the unconsolidated VIEs are presented as beneficial interests in securitizations on the accompanying consolidated balance sheets, which as of December 31, 2019 were approximately $98.8 million. The Company held no other assets or liabilities related to its involvement with unconsolidated VIEs as of December 31, 2019.
The following table summarizes the carrying value and total exposure to losses of its assets related to unconsolidated VIEs with which the Company has continuing involvement, but is not the primary beneficiary at December 31, 2019. Total exposure represents the estimated loss the Company would incur under severe, hypothetical circumstances, such as if the value of the interests in the securitization trusts and any associated collateral declined to zero. The Company believes the possibility of this is remote. As such, the total exposure presented below is not an indication of the Company's expected losses.
| | | | | | | | | | | |
| Carrying Value | | Total Exposure |
| | | |
| (in thousands) | | |
Rated notes | $ | 85,234 | | | $ | 85,234 | |
Certificates and other assets | 13,546 | | | 13,546 | |
Total unconsolidated VIEs | $ | 98,780 | | | $ | 98,780 | |
The beneficial interests in securitizations are considered securities available for sale subject to restrictions on transfer pursuant to the Company’s obligations as a sponsor under Risk Retention Rules. These securities are interests in securitization
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trusts, thus there are no contractual maturities. The amortized cost and fair value of securities available for sale as of December 31, 2019 were as follows (in thousands):
| | | | | | | | | | | |
| Amortized Cost | | Fair Value |
Rated notes | $ | 84,983 | | | $ | 85,234 | |
Certificates and other assets | 13,456 | | | 13,546 | |
Total securities available for sale | $ | 98,439 | | | $ | 98,780 | |
NOTE 9 — DEBT INSTRUMENTS
Debt instruments, excluding finance leases, which are discussed in Note 15 — Leases, as of December 31, 2019 and 2018 consisted of the following (in thousands):
| | | | | | | | | | | | | | |
| | December 31, | | |
| | 2019 | | 2018 |
Asset-Based Financing: | | | | |
Floor Plan Facility | | $ | 515,487 | | | $ | 196,963 | |
Finance Receivable Facilities | | 53,353 | | | — | |
Financing of beneficial interests in securitizations | | 84,982 | | | — | |
Notes payable | | 31,757 | | | 33,015 | |
Real estate financing | | 177,221 | | | 44,956 | |
Total asset-based financing | | 862,800 | | | 274,934 | |
Senior Notes (1) | | 600,000 | | | 350,000 | |
Total debt | | 1,462,800 | | | 624,934 | |
Less: current portion | | (606,644) | | | (208,096) | |
Less: unamortized premium and debt issuance costs (2) | | (13,642) | | | (7,643) | |
Total long-term debt, net | | $ | 842,514 | | | $ | 409,195 | |
| | | | |
(1) As of both December 31, 2019 and 2018, Verde held $15.0 million of the Senior Notes.
(2) The unamortized debt issuance costs related to long-term debt are presented as a reduction of the carrying amount of the corresponding liabilities on the accompanying consolidated balance sheets. Unamortized debt issuance costs related to revolving debt arrangements are presented within other current assets and other assets on the accompanying consolidated balance sheets. The unamortized premium is presented as an increase to the carrying amount of the Senior Notes on the accompanying consolidated balance sheets.
Short-Term Revolving Facilities
Floor Plan Facility
The Company has a floor plan facility with a lender to finance its used vehicle inventory, which is secured by substantially all of its assets, other than the Company's interests in real property (the "Floor Plan Facility"). The facility has a maturity date of October 31, 2020 and requires monthly interest payments on borrowings under the Floor Plan Facility. The Company most recently amended the Floor Plan Facility in November 2019 to, among other things, increase the available capacity to $950.0 million from $650.0 million, adding flexibility to acquire more vehicles from customers. The annual interest rate was reduced to one-month LIBOR plus 3.15% if the average outstanding balance on the Floor Plan Facility in the previous calendar month is greater than $500.0 million and otherwise remains unchanged from one-month LIBOR plus 3.40%. The amendment also requires that at least 7.5% of the total principal amount owed to the lender is held as restricted cash, a change from 5%.
Repayment in an amount equal to the amount of the advance or loan must be made within five business days of selling or otherwise disposing of the underlying vehicle inventory, unless customers financed the purchase by originating an automotive finance receivable. For used vehicle sales involving financing originated by the Company and sold or pledged under either the
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MPSA or the Finance Receivable Facilities (as defined below), the lender has extended repayment to the earlier of fifteen business days after the sale of the used vehicle or one day following the sale or pledge of the related finance receivable. With respect to such used vehicle sales involving financing that are not sold or pledged under either the MPSA or the Finance Receivable Facilities, the lender agreed to extend repayment of the advance or the loan for such vehicles to the earlier of fifteen business days after the sale of the vehicle or two business days following the funding of the related finance receivable. Outstanding balances related to vehicles held in inventory for more than 180 days require monthly principal payments equal to 10% of the original principal amount of that vehicle until the remaining outstanding balance is the lesser of (i) 50% of the original principal amount or (ii) 50% of the wholesale value. Prepayments may be made without incurring a premium or penalty. Additionally, the Company is permitted to make prepayments to the lender to be held as principal payments under the Floor Plan Facility and subsequently reborrow such amounts.
As of December 31, 2019, the interest rate on the Floor Plan Facility was approximately 4.91%, the Company had an outstanding balance under this facility of approximately $515.5 million, unused capacity of approximately $434.5 million, and held approximately $38.7 million in restricted cash related to this facility. As of December 31, 2018, the interest rate on the Floor Plan Facility was 5.90%, the Company had an outstanding balance of approximately $197.0 million, and held approximately $9.8 million in restricted cash related to this facility.
Finance Receivable Facilities
In April 2019, the Company and Ally Bank entered in a Loan and Security Agreement pursuant to which Ally Bank agreed to provide a $300.0 million revolving credit facility (the "DART I Credit Facility") to fund certain automotive finance receivables originated by the Company. The Company can draw upon the DART I Credit Facility until April 17, 2020, and it has an annual interest rate of one-month LIBOR plus a spread ranging from 1.00% to 1.80%.
In May 2019, the Company and Ally Bank entered into the A&R Loan and Security Agreement in connection with the $350.0 million SART 2017-1 Credit Facility to fund certain automotive finance receivables originated by the Company. The Company can draw upon the SART 2017-1 Credit Facility until April 17, 2020, and it has an annual interest rate of one-month LIBOR plus 1.95%.
The DART I Credit Facility and the SART 2017-1 Credit Facility (collectively, the "Finance Receivable Facilities") each require that at least 2% of the outstanding pledged finance receivables principal balances, plus any undistributed amounts collected on the pledged finance receivables amount, is held as restricted cash.
Interest payments on the Finance Receivable Facilities are payable monthly on each draw date. Principal repayments will occur on the fifteenth day of each calendar month in an amount equal to the undistributed receivables collected. The lender will receive repayment in accordance with its respective commitment. Prepayment of the entire aggregate outstanding principal and any accrued unpaid interest through the next draw date is permitted twice per calendar quarter.
As of December 31, 2019, the DART I Credit Facility had an interest rate ranging between approximately 2.76% and 3.56% and the SART 2017-1 Credit Facility had an interest rate of approximately 3.71%. The Company had an outstanding balance under the Finance Receivable Facilities of approximately $53.4 million, unused capacity of $596.6 million, and held approximately $3.7 million in restricted cash related to these facilities.
Long-Term Debt
Senior Unsecured Notes
On September 21, 2018, the Company issued an aggregate of $350.0 million in senior unsecured notes due 2023 (the "Existing Notes") under an indenture entered into by and among the Company, each of the guarantors party thereto and U.S. Bank National Association, as trustee (the "Indenture"). On May 24, 2019, the Company issued $250.0 million in aggregate principal amount of additional notes (the "New Notes") under the Indenture, at a 100.5% premium. The Existing Notes and New Notes (together the "Senior Notes") are treated as a single class for all purposes and have the same terms. The Senior Notes accrue interest at a rate of 8.875% per annum, which is payable semi-annually in arrears on April 1 and October 1 of each year beginning April 1, 2019. The Senior Notes mature on October 1, 2023, unless earlier repurchased or redeemed, and are guaranteed by the Company's existing domestic restricted subsidiaries (other than the subsidiaries formed solely for the purpose of facilitating the Company's sales of its finance receivables, if any). The Company may redeem some or all of the Senior Notes on or after October 1, 2020 at redemption prices set forth in the Indenture, plus any accrued and unpaid interest to the
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redemption date. Prior to October 1, 2020, the Company may redeem up to 35.0% of the aggregate principal amount of the Senior Notes at a redemption price equal to 108.875%, together with accrued and unpaid interest to, but not including, the date of redemption, with the net cash proceeds of certain equity offerings. In addition, the Company may, at its option, redeem some or all of the Senior Notes prior to October 1, 2020, by paying a make-whole premium plus any accrued and unpaid interest, to, but not including, the redemption date. If the Company experiences certain change of control events, it must make an offer to purchase all of the Senior Notes at 101.0% of the principal amount thereof, plus any accrued and unpaid interest, to the repurchase date.
The Indenture governing the Senior Notes contains restrictive covenants that limit the ability of the Company to, among other things, incur additional debt or issue preferred stock, create new liens, make intercompany payments, pay dividends and make other distributions in respect of the Company's capital stock, redeem or repurchase the Company’s capital stock or prepay subordinated indebtedness, make certain investments or certain other restricted payments, guarantee indebtedness, designate unrestricted subsidiaries, sell certain kinds of assets, enter into certain types of transactions with affiliates, and effect mergers or consolidations. Certain of these covenants will be suspended if the Senior Notes are assigned an investment grade rating from any two of Moody’s Investors Service, Inc., Standard & Poor’s Rating Services, and Fitch Ratings, Inc., and there is no continuing default. As of December 31, 2019, the Company was in compliance with all covenants.
In connection with the issuance of these Senior Notes, Carvana Group amended its LLC agreement to create a class of non-convertible preferred units, which Carvana Co. purchased with its net proceeds from the issuance of these Senior Notes, as further discussed in Note 10 — Stockholders' Equity.
The outstanding principal of the Senior Notes, net of debt issuance costs and including the premium, was approximately $591.1 million and $342.9 million as of December 31, 2019 and December 31, 2018, respectively, of which $15.0 million of principal was held by Verde as of both periods, and is included in long-term debt in the accompanying consolidated balance sheets.
Notes Payable
The Company has entered into promissory note and disbursement agreements to finance certain equipment for its transportation fleet and building improvements. The assets financed with the proceeds from these notes serve as the collateral for each note and certain security agreements related to these assets have cross collateralization and cross default provisions with respect to one another. Each note has a fixed annual interest rate, a two- to five-year term and requires monthly payments. As of December 31, 2019, the outstanding principal of these notes had a weighted-average interest rate of 6.6% and totaled approximately $31.8 million, of which approximately $10.9 million is due within the next twelve months and is included as current portion of long-term debt in the accompanying consolidated balance sheets.
Financing of Beneficial Interests in Securitizations
In June 2019, the Company entered into a secured borrowing facility through which it finances certain retained beneficial interests in securitizations whereby the Company sells such interests and agrees to repurchase them for their fair value at a stated time of repurchase. As discussed in Note 8 — Securitizations and Variable Interest Entities, the Company has retained certain beneficial interests in securitizations pursuant to the Company’s obligations as a sponsor under Risk Retention Rules.
As of December 31, 2019, the Company has pledged approximately $85.0 million of its beneficial interests in securitizations as collateral under the repurchase agreement with expected repurchases ranging from January 2026 to October 2026. The securitization trusts distribute payments related to the Company's pledged beneficial interests in securitizations directly to the lender, which reduces the beneficial interests in securitizations and the related debt balance. Pledged collateral levels are monitored daily and are generally maintained at an agreed-upon percentage of the fair value of the amounts borrowed during the life of the transaction. In the event of a decline in the fair value of the pledged collateral, the repurchase price of the pledged collateral will be increased by the amount of the decline.
The outstanding balance of this facility, net of debt issuance costs, was approximately $82.7 million as of December 31, 2019, of which approximately $26.4 million is included in current portion of long-term debt in the accompanying consolidated balance sheets.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The following table summarizes the aggregate maturities due in each period for notes payable, Senior Notes, and financing of beneficial interests in securitizations as of December 31, 2019 (in thousands). Maturities related to financing of beneficial interests in securitizations are estimated based on expected timing of payments from the securitization trusts to the lender.
| | | | | | |
| | |
2020 | $ | 37,804 | | |
2021 | 36,624 | | |
2022 | 23,198 | | |
2023 | 613,347 | | |
2024 | 5,766 | | |
Thereafter | — | | |
Total | $ | 716,739 | | |
Real Estate Financing
The Company finances certain purchases and construction of its property and equipment through various sale and leaseback transactions. As of December 31, 2019, none of these transactions have qualified for sale accounting due to meeting the criteria for finance leases, or forms of continuing involvement, such as repurchase options or renewal periods that extend the lease for substantially all of the asset's remaining useful life, and are therefore accounted for as financing transactions. These arrangements require monthly payments and have initial terms of 20 to 25 years. Some of the agreements are subject to renewal options of up to 25 years and some are subject to base rent increases throughout the term. As of December 31, 2019 and 2018, the outstanding liability associated with these sale and leaseback arrangements, net of unamortized debt issuance costs, was approximately $174.7 million and $44.4 million, respectively, and was included in long-term debt in the accompanying consolidated balance sheets.
In November 2017, the Company entered into a master sale-leaseback agreement (the "Master Sale-Leaseback Agreement" or "MSLA"), which was amended in November 2018, pursuant to which it may sell and lease back certain of its owned or leased properties and construction improvements. Under the MSLA, at any time the Company may elect to, and beginning in November 2020 or until a property owner of a leased site consents to the sale-leaseback, the purchaser has the right to demand that the Company repurchase 1 or more properties sold and leased back pursuant to the MSLA for an amount equal to the repurchase price. Repurchase prices are defined in each of the applicable leases and are generally the original purchase prices plus any accrued and unpaid rent. Under the MSLA, the total sales price of properties the Company has sold and is leasing back at any point in time is limited to $75.0 million. By December 31, 2018, the Company repurchased all properties it had previously sold under the MSLA for a price of approximately $28.8 million. As of December 31, 2019, the Company may sell and lease back approximately $75.0 million of its property and equipment under the MSLA.
NOTE 10 — STOCKHOLDERS' EQUITY
Organizational Transactions
Immediately prior to the IPO, Carvana Co. amended and restated its certificate of incorporation to, among other things authorize (i) 50.0 million shares of Preferred Stock, par value $0.01 per share, (ii) 500.0 million shares of Class A common stock, par value $0.001 per share, and (iii) 125.0 million shares of Class B common stock, par value $0.001 per share. On December 5, 2017, Carvana Co. amended and restated its certificate of incorporation to authorize 100,000 shares of Convertible Preferred Stock, with an initial stated value of $1,000 per share and a par value of $0.01 per share. Each share of Class A common stock generally entitles its holder to 1 vote on all matters to be voted on by stockholders. Each share of Class B common stock held by the Garcia Parties generally entitles its holder to 10 votes on all matters to be voted on by stockholders, for so long as the Garcia Parties maintain direct or indirect beneficial ownership of at least 25% of the outstanding shares of Carvana Co.'s Class A common stock determined on an as-exchanged basis assuming that all of the Class A Units and Class B Units were exchanged for Class A common stock. All other shares of Class B common stock generally entitle their holders to 1 vote per share on all matters to be voted on by stockholders. Holders of Class B common stock are not entitled to receive dividends and would not be entitled to receive any distributions upon the liquidation, dissolution or winding down of the Company. Holders of Class A and Class B common stock vote together as a single class on all matters presented to stockholders for their vote or approval, except as otherwise required by applicable law.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
As described in Note 1 — Business Organization, Carvana Group amended and restated its LLC Agreement to, among other things, provide for 2 classes of common ownership interests in Carvana Group. Carvana Group’s 2 remaining classes of common ownership interests are Class A Units and Class B Units. Carvana Co. is required to, at all times, maintain (i) a four-to-five ratio between the number of shares of Class A common stock issued by Carvana Co. and the number of Class A Units owned by Carvana Co. (subject to certain exceptions for treasury shares and shares underlying certain convertible or exchangeable securities and subject to adjustment as set forth in the exchange agreement (the "Exchange Agreement") further discussed below, and taking into account Carvana Sub’s 0.1% ownership interest in Carvana, LLC) and (ii) a four-to-five ratio between the number of shares of Class B common stock owned by the Original LLC Unitholders and the number of Class A Units owned by the Original LLC Unitholders. The Company may issue shares of Class B common stock only to the extent necessary to maintain these ratios. Shares of Class B common stock are transferable only if an Original LLC Unitholder elects to exchange them, together with 1.25 times as many LLC Units, for consideration from the Company. Such consideration from the Company can be, at the Company's election, either shares of Class A common stock or cash.
As of December 31, 2019, there were approximately 189.7 million and 4.9 million Class A Units and Class B Units (as adjusted for the participation thresholds and closing price of Class A common stock on December 31, 2019), respectively, issued and outstanding. As of December 31, 2018, there were approximately 182.3 million and 5.6 million Class A Units and Class B Units (as adjusted for the participation thresholds and closing price of Class A common stock on December 31, 2018), respectively, issued and outstanding. As discussed in Note 12 — Equity-Based Compensation, Class B Units were issued under the Company’s LLC Equity Incentive Plan through the completion of the IPO (the "LLC Equity Incentive Plan"), are subject to a participation threshold, and are earned over the requisite service period.
Initial Public Offering
As described in Note 1 — Business Organization, on May 3, 2017, Carvana Co. completed its IPO of 15.0 million shares of Class A common stock at a public offering price of $15.00 per share. Carvana Co. received approximately $205.8 million in proceeds, net of underwriting discounts and commissions and offering expenses. Carvana Co. used the proceeds to purchase approximately 18.8 million newly-issued LLC Units of Carvana Group at a price per unit equal to 0.8 times the initial public offering price less underwriting discounts and commissions. In connection with the IPO, Carvana Co. transferred approximately 0.2 million Class A Units to Ernest Garcia II in exchange for his 0.1% ownership interest in Carvana, LLC, a majority-owned subsidiary of Carvana Group. After the transfer Carvana Co. owned approximately 18.6 million Class A Units.
The Company incurred approximately $4.9 million of legal, accounting, printing, and other professional fees directly related to the IPO, including $1.3 million incurred during 2016, of which $0.4 million were paid during 2016. Upon completion of the IPO, the total costs incurred for the IPO were charged against additional paid-in capital.
Public Equity Offerings
On April 30, 2018, the Company completed a follow-on offering of 6.6 million shares of its Class A common stock at a public offering price of $27.50 per share and received net proceeds from the offering of approximately $172.3 million after underwriting discounts and commissions and offering expenses.
The Selling Stockholder and the Selling LLC Unitholders sold a total of approximately 6.1 million shares of Class A common stock as part of the offering. The Selling LLC Unitholders exchanged approximately 6.9 million LLC Units for approximately 5.6 million shares of Class A common stock to be sold in the offering, and to the extent such Selling LLC Unitholder held Class B common stock, the corresponding shares of Class B common stock were immediately retired by the Company. The Company did not receive any proceeds from the sale of the approximately 6.1 million shares of Class A common stock by the Selling Stockholder and the Selling LLC Unitholders.
On May 24, 2019, the Company completed a follow-on offering of 4.2 million shares of the Company's Class A common stock at a public offering price of $65.00 per share and received net proceeds from the offering of approximately $258.8 million after underwriting discounts and commissions and offering expenses. As part of the offering, the Company granted the underwriters a 30-day option to purchase all or part of approximately 0.6 million additional shares of Class A common stock. On June 20, 2019, the underwriters exercised their option in full for an additional $38.9 million in proceeds after offering expenses.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Exchange Agreement
Carvana Co. and the LLC Unitholders entered into an Exchange Agreement under which each LLC Unitholder (and certain permitted transferees thereof) may receive shares of the Company's Class A common stock in exchange for their LLC Units on a four-to-five conversion ratio, or cash at the option of the Company, subject to conversion ratio adjustments for stock splits, stock dividends, reclassifications, and similar transactions and subject to vesting for certain Class A Units and subject to vesting and the respective participation threshold for Class B Units. To the extent such owners also hold Class B common stock, they will be required to deliver to Carvana Co. a number of shares of Class B common stock equal to the number of shares of Class A common stock being exchanged for. Any shares of Class B common stock so delivered will be canceled. The number of exchangeable Class B Units is determined based on the value of Carvana Co.'s Class A common stock and the applicable participation threshold.
During the years ended December 31, 2019 and December 31, 2018, certain LLC Unitholders exchanged 5.4 million and 14.2 million LLC Units and 3.1 million and 10.3 million shares of Class B common stock for 4.3 million and 11.3 million newly-issued shares of Class A common stock, respectively. Simultaneously, and in connection with these exchanges, Carvana Co. received 5.4 million and 14.2 million LLC Units during the years ended December 31, 2019 and December 31, 2018, respectively, increasing its total ownership interest in Carvana Group, and canceled the exchanged shares of Class B common stock.
Class C Redeemable Preferred Units
On April 27, 2016, the Company authorized the issuance of and sold approximately 18.3 million Class C Redeemable Preferred Units for approximately $100.0 million to Ernest Garcia II. On July 12, 2016, the Company authorized the issuance of and sold approximately 8.6 million Class C Redeemable Preferred Units to CVAN Holdings, LLC, and approximately 1.7 million Class C Redeemable Preferred Units to GV Auto I, LLC for approximately $50.0 million and $9.7 million, respectively. On December 9, 2016, the Company authorized the issuance of and sold approximately 0.5 million Class C Redeemable Preferred Units to the Fidel Family Trust for approximately $2.7 million. The Company recorded the issuance and sale of Class C Redeemable Preferred Units at fair value, net of issuance costs.
In accordance with the Company’s Operating Agreement, the Class C Redeemable Preferred Units accrued a return (the "Class C Return") at a coupon rate of 12.5% compounding annually on the aggregate amount of capital contributions made with respect to the Class C Redeemable Preferred Units.
On May 3, 2017, the Company closed its IPO at a price such that the Company is no longer liable for the accrued Class C Return, and the 43.1 million outstanding Class C Redeemable Preferred Units converted to Class A Units on a 1-to-one basis and the related balance became a component of permanent equity on the accompanying consolidated balance sheet.
Convertible Preferred Stock
On December 5, 2017, Carvana Co. sold 100,000 shares of Convertible Preferred Stock for a purchase price of $100.0 million and net proceeds of approximately $98.5 million, which it used to purchase 100,000 Convertible Preferred Units of Carvana Group at a price per unit equal to the initial stated value of the Convertible Preferred Stock less issuance costs. The Convertible Preferred Stock has a par value of $0.01 per share and a liquidation value of $1,000 per share.
At the holder's request beginning on January 29, 2018, any or all shares of the Convertible Preferred Stock were convertible into shares of Class A common stock at an initial conversion rate of 50.78 shares of Class A common stock per share of Convertible Preferred Stock. On or after December 5, 2018, the Company had the option to cause all shares of Convertible Preferred Shares to be converted into shares of Class A common stock or cash, at the Company's election, if the 10-day volume-weighted average price equaled or exceeded 150% of the conversion price as set forth in the agreement. In the event Carvana Co. issued any shares of Class A common stock upon conversion of any shares of Convertible Preferred Stock or in connection with any change of control repurchase of shares of Convertible Preferred Stock, a corresponding number of Convertible Preferred Units would be canceled and cease to be outstanding, and Carvana Group would issue Class A Units to Carvana Co. on a four-to-five ratio between the number of shares of Class A common stock issued by Carvana Co. to the holders of the Convertible Preferred Stock and the number of Class A Units issued.
During the year ended December 31, 2018, at the holder's request 75,000 shares of Convertible Preferred Stock, and at the Company's election 25,000 shares of Convertible Preferred Stock, were converted into a total of approximately 5.1 million
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
shares of Class A common stock. Simultaneously, and in connection with these conversions, 100,000 Convertible Preferred Units were canceled and Carvana Group issued approximately 6.3 million Class A Units to Carvana Co.
The initial conversion price was $19.6945, which was calculated based on a 20.0% premium to the volume weighted average price for Class A common stock during the 5 trading days immediately preceding December 4, 2017. Following announcement of the transaction, the share price of Class A common stock increased and exceeded the conversion price on the commitment date and resulted in a beneficial conversion feature ("BCF") of approximately $2.6 million. The BCF was originally recorded as a reduction of the Convertible Preferred Stock with an offset to additional paid-in capital. The BCF accreted as a deemed dividend through January 29, 2018, the first available conversion date, increasing the carrying value of the Convertible Preferred Stock with an offsetting charge to additional paid-in capital. During the year ended December 31, 2018, the Company recorded approximately $1.4 million in accretion related to the BCF.
Upon a change of control, as defined in the agreement, any holder of Convertible Preferred Stock had the option to require the Company (or its successor) to purchase, any or all of its Convertible Preferred Stock at a purchase price per share, payable at the Company’s option in any combination of cash or shares of Class A common stock, of 101% of the liquidation preference, plus all accumulated dividends.
Holders of the Convertible Preferred Stock had no voting rights. The Convertible Preferred Stock ranked senior, as to payment of dividends and distributions of assets upon the liquidation, dissolution or winding up of Company, to the Company’s common stock and any shares of capital stock of the Company not expressly ranking senior to or pari passu with the Convertible Preferred Stock, and junior to all shares of capital stock of the Company issued after the issuance of the Convertible Preferred Stock, if the terms of which expressly provided that such shares would rank senior to the Convertible Preferred Stock.
The Convertible Preferred Stock accrued dividends at 5.5% per annum of the liquidation preference of $1,000 per share. The dividends were payable in cash quarterly commencing March 15, 2018 so long as the Company had funds legally available and the Board declared a cash dividend payable. The Company could not declare dividends on shares of its common stock or purchase or redeem shares of its common stock, unless all accumulated and unpaid dividends on the Convertible Preferred Stock had been paid in full or a sum for such amounts had been set aside for payment. As the Company declared and paid dividends on the Convertible Preferred Stock, Carvana Group made distributions to Carvana Co. with respect to the Convertible Preferred Units in an amount equal to the related Convertible Preferred Stock dividend amount and any corresponding tax payments.
During the year ended December 31, 2018, the Company paid approximately $4.6 million of dividends to the holders of the Convertible Preferred Stock and Carvana Group distributed approximately $4.6 million to Carvana Co. with respect to the Convertible Preferred Units.
As of December 31, 2018, there were 0 outstanding shares of Convertible Preferred Stock and 0 related accrued dividends.
Class A Non-Convertible Preferred Units
On October 2, 2018, Carvana Group amended its LLC Agreement to create a class of non-convertible preferred units (the "Class A Non-Convertible Preferred Units"), effective September 21, 2018. The Class A Non-Convertible Preferred Units were created in connection with Carvana Co.'s issuance of the Senior Notes in September 2018 and May 2019, as discussed further in Note 9 — Debt Instruments. Carvana Co. used its net proceeds from the Senior Notes to purchase 600,000 Class A Non-Convertible Preferred Units. In the event Carvana Co. makes payments on the Senior Notes, Carvana Group will make an equal cash distribution, as necessary, to the Class A Non-Convertible Preferred Units. For each $1,000 principal amount of Senior Notes that Carvana Co. repays or otherwise retires, 1 Class A Non-Convertible Preferred Unit shall be canceled and retired.
Contributions of Class A Common Shares From Ernest Garcia III
During the years ended December 31, 2019 and 2018, the Company and its Chief Executive Officer, Ernest Garcia III, entered into contribution agreements (the "Contribution Agreements") in connection with the 100k Milestone Gift, as defined in Note 6 — Related Party Transactions. Pursuant to the Contribution Agreements, Mr. Garcia contributed approximately 0.2 million shares during both of the years ended December 31, 2019 and 2018 of the Company's Class A common stock to the Company, at 0 charge. The Company subsequently granted approximately 0.2 million restricted stock units during both of the
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
years ended December 31, 2019 and 2018 to employees. Refer to Note 12 — Equity-Based Compensation for further discussion. Although the Company does not expect Mr. Garcia to incur any tax obligations related to the Share Contributions, it has indemnified Mr. Garcia from any such obligations that may arise.
NOTE 11 — NON-CONTROLLING INTERESTS
As discussed in Note 1 — Business Organization, Carvana Co. consolidates the financial results of Carvana Group and reports a non-controlling interest related to the portion of Carvana Group owned by the LLC Unitholders. Changes in the ownership interest in Carvana Group while Carvana Co. retains its controlling interest will be accounted for as equity transactions. Exchanges of LLC Units result in a change in ownership and reduce the amount recorded as non-controlling interests and increase additional paid-in capital.
Upon the issuance of shares of Class A common stock by Carvana Co. related to the Company's equity compensation plans such as the issuance of restricted or non-restricted stock, exercise of options, payment of bonuses in stock or settlement of stock appreciation rights in stock, Carvana Group is required to issue to Carvana Co. a number of Class A Units equal to 1.25 times the number of shares of Class A common stock being issued in connection with the exercise of such options or issuance of other types of equity compensation, subject to adjustment for stock splits, stock dividends, reclassifications, and similar transactions. Activity related to the Company's equity compensation plans may result in a change in ownership which will impact the amount recorded as non-controlling interest and additional paid-in capital.
The non-controlling interest related to the Class B Units is determined based on the respective participation thresholds and the share price of Class A common stock on an as-converted basis. To the extent that the number of as-converted Class B Units change or Class B Units are forfeited, the resulting difference in ownership will be accounted for as equity transactions adjusting the non-controlling interest and additional paid-in capital.
During the year ended December 31, 2019, the total adjustments related to exchanges of LLC Units was a decrease in non-controlling interests and a corresponding increase in additional paid-in capital of approximately $4.9 million, which has been included in exchanges of LLC Units in the accompanying consolidated statement of stockholders' equity. During the year ended December 31, 2019, Carvana Co. utilized its net proceeds from its equity offering to purchase LLC Units, which resulted in an adjustment to increase non-controlling interests and to decrease additional paid-in capital by approximately $201.0 million, which has been included in adjustment to non-controlling interests related to equity offering in the accompanying consolidated statement of stockholders' equity.
During the year ended December 31, 2018, the total adjustments related to exchanges of LLC Units was a decrease in non-controlling interests and a corresponding increase in additional paid-in capital of approximately $15.8 million, which has been included in exchanges of LLC Units in the accompanying consolidated statement of stockholders' equity. During the year ended December 31, 2018, Carvana Co. utilized its net proceeds from its equity offering to purchase LLC Units, which together with the equity offering resulted in an adjustment to increase non-controlling interests and to decrease additional paid-in capital by approximately $132.4 million, which has been included in adjustment to noncontrolling interests related to equity offering in the accompanying consolidated statement of stockholders' equity. During the year ended December 31, 2018, Carvana Group issued approximately 0.5 million Class A Units with a fair value of approximately $10.0 million as part of the purchase price consideration for Car360, which is reflected as an increase in non-controlling interests in the accompanying consolidated statement of stockholders' equity. The adjustment related to the issuance of Class A Units to acquire Car360 was a decrease in non-controlling interests and a corresponding increase in additional paid-in capital of approximately $1.3 million, which has been included in adjustment to non-controlling interests related to business acquisitions in the accompanying consolidated statement of stockholders' equity. During the year ended December 31, 2018, the 100,000 shares of Convertible Preferred Stock converted into approximately 5.1 million shares of Class A common stock, Carvana Co. canceled and retired 100,000 Convertible Preferred Units, and Carvana Group issued approximately 6.3 million Class A Units to Carvana Co. The adjustment related to the conversion of Convertible Preferred Stock was an increase in non-controlling interests and a corresponding decrease in additional paid-in capital of approximately $68.0 million, which has been included in adjustment to non-controlling interests related to conversion of Class A Convertible Preferred Stock in the accompanying consolidated statement of stockholders' equity.
During the year ended December 31, 2017, the total adjustments related to exchanges of LLC Units was a decrease in non-controlling interests and a corresponding increase in additional paid-in capital of approximately $3.6 million, which has been included in exchanges of LLC Units in the accompanying consolidated statement of stockholders' equity. During the year ended December 31, 2017, the total adjustments related to equity compensation plan activity, changes in the number of as-converted
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Class B Units and forfeitures of Class B Units, was a decrease in non-controlling interests and a corresponding increase in additional paid-in capital of approximately $0.3 million, which has been included in adjustments to non-controlling interests in the accompanying consolidated statement of stockholders' equity.
As of December 31, 2019, Carvana Co. owned approximately 32.3% of Carvana Group with the LLC Unitholders owning the remaining 67.7%. The net loss attributable to the non-controlling interests on the accompanying consolidated statements of operations represents the portion of the net loss attributable to the economic interest in Carvana Group held by the non-controlling LLC Unitholders calculated based on the weighted average non-controlling interests' ownership during the periods presented.
The following table summarizes the effects of changes in ownership in Carvana Group on the Company's equity during the years ended December 31, 2019, 2018, and 2017 (in thousands):
| | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, | | | | |
| 2019 | | 2018 | | 2017 |
| | | | | |
Transfers (to) from non-controlling interests: | | | | | | | |
Decrease as a result of issuance of Class A common stock | $ | (201,015) | | | $ | (132,375) | | | $ | (174,144) | |
| | | | | |
Increase as a result of Carvana Group's issuance of Class A Units in connection with business acquisitions | — | | | 1,297 | | | — | |
Increase as a result of exchanges of LLC Units | 4,948 | | | 15,828 | | | 3,631 | |
Decrease as a result of conversion of Class A Convertible Preferred Stock | — | | | (67,972) | | | — | |
Increase as a result of adjustments to the non-controlling interests | — | | | — | | | 340 | |
Total transfers to non-controlling interests | $ | (196,067) | | | $ | (183,222) | | | $ | (170,173) | |
NOTE 12 — EQUITY-BASED COMPENSATION
Equity-based compensation is recognized based on amortizing the grant-date fair value on a straight-line basis over the requisite service period, which is generally the vesting period of the award, less actual forfeitures. A summary of equity based compensation recognized during the years ended December 31, 2019, 2018, and 2017 is as follows (in thousands):
| | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, | | | | |
| 2019 | | 2018 | | 2017 |
Class B Units | $ | 2,361 | | | $ | 2,474 | | | $ | 1,771 | |
Restricted Stock Units and Awards excluding those granted in relation to the 100k Milestone Gift | 13,057 | | | 6,897 | | | 2,662 | |
Restricted Stock Units granted in relation to the 100k Milestone Gift | 12,694 | | | 12,120 | | | — | |
Options | 5,377 | | | 2,357 | | | 1,178 | |
Class A Units | 2,184 | | | 1,897 | | | — | |
Total equity-based compensation | 35,673 | | | 25,745 | | | 5,611 | |
Equity-based compensation capitalized to property and equipment | (2,610) | | | (1,650) | | | — | |
Equity-based compensation capitalized to inventory | (4,505) | | | (3,776) | | | — | |
Equity-based compensation, net of capitalized amounts | $ | 28,558 | | | $ | 20,319 | | | $ | 5,611 | |
During the years ended December 31, 2019, 2018, and 2017 the Company capitalized approximately $2.6 million, $1.7 million, and $0.0 million, respectively, of equity-based compensation to property and equipment related to software development and real estate projects and approximately $4.5 million, $3.8 million, and $0.0 million, respectively, to inventory related to reconditioning and inbound transportation of vehicles. Prior to 2018, amounts capitalized to property and equipment and inventory were immaterial. All other equity-based compensation is included in selling, general, and administrative expenses in the accompanying consolidated statements of operations.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
As of December 31, 2019, unrecognized equity-based compensation related to outstanding awards and the related weighted-average period over which it is expected to be recognized subsequent to December 31, 2019 is presented in the table below. Total unrecognized equity-based compensation will be adjusted for actual forfeitures.
| | | | | | | | | | | |
| Unrecognized Equity-Based Compensation Related to Outstanding Awards (in thousands) | | Remaining Weighted-Average Amortization Period (in years) |
Class B Units | $ | 2,253 | | | 1.9 |
Restricted Stock Units and Awards | 36,136 | | | 3.0 |
Options | 13,819 | | | 2.8 |
Class A Units | 3,217 | | | 2.1 |
Total unrecognized equity-based compensation | $ | 55,425 | | | |
2017 Omnibus Incentive Plan
In connection with the IPO, the Company adopted the 2017 Omnibus Incentive Plan (the "2017 Incentive Plan"). Under the 2017 Incentive Plan 14.0 million shares of Class A common stock are available for issuance, which the Company may grant as stock options, stock appreciation rights, restricted stock, restricted stock units ("RSUs") and other stock-based awards to employees, directors, officers, and consultants. The majority of the Company's equity awards, other than those granted in relation to Mr. Garcia's 100k Milestone Gift, vest over two- to five-year periods based on continued employment with the Company. As of December 31, 2019, approximately 10.8 million shares remain available for future equity-based award grants under this plan.
Restricted Stock Awards and Restricted Stock Units
Restricted stock awards ("RSAs") entitle recipients to vote and to receive all dividends declared with respect to such shares, payable upon vesting. RSAs vest over a period of two to five years, subject to the recipient's continued employment or service. The Company did 0t grant any RSAs during the year ended December 31, 2019. During the years ended December 31, 2018 and 2017, the Company issued certain employees and consultants an aggregate of approximately 0.1 million and 0.6 million RSAs, respectively, pursuant to the terms of the 2017 Incentive Plan with a weighted-average grant-date fair value of $45.05 and $16.97, respectively. The Company determined the grant-date fair value of the RSAs granted during the years ended December 31, 2018 and 2017 based on the closing price of the Company's Class A common stock on the grant date.
Restricted stock units ("RSUs") do not entitle recipients to vote or receive dividends. RSUs generally vest over a period of one to five years, subject to the recipient's continued employment. During the years ended December 31, 2019, 2018, and 2017, the Company issued certain employees an aggregate of approximately 0.7 million, 0.7 million, and 22,000 RSUs, respectively, pursuant to the terms of the 2017 Incentive Plan with a weighted-average grant-date fair value of $60.91, $46.41, and $20.64, respectively. The Company determined the grant-date fair value of the RSUs granted during the years ended December 31, 2019, 2018, and 2017 based on the closing price of the Company's Class A common stock on the grant date. RSUs are settled in shares of Class A common stock on a 1-to-one basis within thirty days of vesting. As discussed in Note 10 — Stockholders' Equity, included in these RSUs, in connection with the 100k Milestone Gift, during both the years ended December 31, 2019 and 2018 the Company granted approximately 0.2 million RSUs with a vesting period of one week or less following receipt of Class A common stock from its Chief Executive Officer, Ernest Garcia III. The Company recognized approximately $12.7 million and $12.1 million during the years ended December 31, 2019 and 2018, respectively, of equity-based compensation, a portion of which related to the production of the Company's used vehicle inventory and was therefore capitalized to inventory.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
RSA and RSU activity during the years ended December 31, 2019, 2018, and 2017 was as follows:
| | | | | | | | | | | |
| Number of RSAs/RSUs (in thousands) | | Weighted-Average Grant-Date Fair Value |
Outstanding at January 1, 2017 | — | | | n/a | |
Granted | 584 | | | $ | 17.11 | |
Settled | (135) | | | $ | 15.91 | |
Forfeited | (29) | | | $ | 15.06 | |
Outstanding at December 31, 2017(1) | 420 | | | $ | 17.63 | |
| | | |
Granted | 791 | | | $ | 46.19 | |
Settled | (391) | | | $ | 42.35 | |
Forfeited | (56) | | | $ | 21.64 | |
Outstanding at December 31, 2018(1) | 764 | | | $ | 34.25 | |
| | | |
Granted | 672 | | | $ | 60.91 | |
Settled | (461) | | | $ | 45.05 | |
Forfeited | (47) | | | $ | 37.15 | |
Outstanding at December 31, 2019(1) | 928 | | | $ | 48.04 | |
(1) All outstanding RSAs and RSUs at December 31, 2019, 2018, and 2017 are nonvested.
Non-Qualified Stock Options
Non-qualified stock options allow recipients to purchase shares of Class A common stock at a fixed exercise price. The fixed exercise price is equal to the price of a share of Class A common stock at the time of grant. The options typically vest 20% or 25% on the anniversary of the grant date and in equal monthly installments thereafter for a total vesting period of four or five years and expire ten years after the grant date.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Stock option activity during the years ended December 31, 2019, 2018, and 2017 was as follows (shares and intrinsic value in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Number of Options | | Weighted-Average Exercise Price | | Weighted-Average Remaining Contractual Life (in years) | | Aggregate Intrinsic Value |
Outstanding at January 1, 2017 | — | | | | | | | |
Options granted | 784 | | | $ | 15.58 | | | | | n/a | |
Options exercised | (3) | | | $ | 15.00 | | | | | $ | 14 | |
Options forfeited or expired | (26) | | | $ | 15.00 | | | | | n/a | |
Outstanding at December 31, 2017 | 755 | | | $ | 15.60 | | | 9.5 | | $ | 3,000 | |
| | | | | | | |
Options granted | 294 | | | $ | 44.81 | | | | | |
Options exercised | (60) | | | $ | 13.26 | | | | | $ | 1,224 | |
Options forfeited or expired | (58) | | | $ | 16.15 | | | | | |
Outstanding at December 31, 2018 | 931 | | | $ | 24.95 | | | 8.9 | | $ | 11,306 | |
| | | | | | | |
Options granted | 364 | | | $ | 37.70 | | | | | |
Options exercised | (104) | | | $ | 16.28 | | | | | $ | 5,388 | |
Options forfeited or expired | (44) | | | $ | 17.53 | | | | | |
Outstanding at December 31, 2019 | 1,147 | | | $ | 30.07 | | | 8.3 | | $ | 71,101 | |
| | | | | | | |
Vested and exercisable as of December 31, 2019 | 338 | | | $ | 24.64 | | | 7.8 | | $ | 22,784 | |
Expected to vest as of December 31, 2019 | 809 | | | $ | 32.33 | | | 8.5 | | $ | 48,317 | |
The Company determined the grant-date fair value of the options granted during the years ended December 31, 2019, 2018, and 2017 using the Black-Scholes valuation model with the following weighted-average assumptions:
| | | | | | | | | | | | | | | | | |
| Years Ended December 31, | | | | |
| 2019 | | 2018 | | 2017 |
Expected volatility(1) | 66.7 | % | | 65.5 | % | | 63.0 | % |
Expected dividend yield | — | % | | — | % | | — | % |
Expected term (in years)(2) | 6.11 | | 6.00 | | 6.27 |
Risk-free interest rate | 2.5 | % | | 3.0 | % | | 2.0 | % |
Weighted-average grant-date fair value per option | $23.87 | | $26.93 | | $9.18 |
(1) Measured using the Company's historical data and selected high-growth guideline companies and considering the risk factors that would influence the range of expected volatility because the Company does not have sufficient historical data to provide a reasonable basis upon which to estimate the expected volatility for the entirety of the term.
(2) Expected term represents the estimated period of time until an option is exercised and was determined using the simplified method because the Company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term.
Class A Units
During the year ended December 31, 2018, the Company granted certain employees approximately 0.4 million Class A Units with service-based vesting over two- to four-year periods and a grant-date fair value of $18.58 per Class A Unit. The grantees entered into the Exchange Agreement under which each LLC Unitholder (and certain permitted transferees thereof) may receive shares of the Company's Class A common stock in exchange for their LLC Units on a four-to-five conversion ratio,
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
or cash at the option of the Company, subject to conversion ratio adjustments for stock splits, stock dividends, reclassifications, and similar transactions and subject to vesting.
A summary of the Class A Unit activity for the years ended December 31, 2019 and 2018 is as follows:
| | | | | | | | | | | |
| Class A Units | | |
| Number of Class A Units (in thousands) | | Weighted-Average Grant Date Fair Value |
Outstanding at January 1, 2018 | — | | | n/a | |
Granted | 393 | | | $ | 18.58 | |
Exchanged | — | | | n/a | |
Forfeited | — | | | n/a | |
Outstanding at December 31, 2018 | 393 | | | |
| | | |
Granted | — | | | n/a | |
Exchanged | (172) | | | $ | 18.58 | |
Forfeited | — | | | n/a | |
Outstanding at December 31, 2019 | 221 | | | |
| | | |
Vested as of December 31, 2019 | 18 | | | $ | 18.58 | |
Expected to vest as of December 31, 2019 | 203 | | | $ | 18.58 | |
Class B Units
In March 2015, Carvana Group adopted the LLC Equity Incentive Plan. Under the LLC Equity Incentive Plan, Carvana Group could grant Class B Units to eligible employees, non-employee officers, consultants and directors with service vesting conditions. In connection with the completion of the IPO, Carvana Group discontinued the grant of new awards under the LLC Equity Incentive Plan, however the LLC Equity Incentive Plan will continue in connection with administration of existing awards that remain outstanding. The awards granted under the LLC Equity Incentive Plan are earned over the requisite service period, which is typically four to five years, and must meet the participation threshold requirements to participate in any distributions. As of December 31, 2019, outstanding Class B Units had participation thresholds between $0.00 to $12.00. Vested Class B Units participate in any distributions of Carvana Group in excess of those required for the Class A Units subject to the participation threshold. As discussed in Note 10 — Stockholders' Equity, participants may receive shares of Carvana Co. Class A common stock in exchange for Class B Units on a four-to-five conversion ratio, or cash at the option of Carvana Co., subject to conversion ratio adjustments for stock splits, stock dividends, reclassifications, and similar transactions and subject to vesting and the respective participation threshold for Class B Units. Class B Units do not expire.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
A summary of the Class B Unit activity for the year ended December 31, 2019, 2018, and 2017 is as follows:
| | | | | | | | | | | | | | | |
| Class B Units | | | | | | |
| Number of Class B Units (in thousands) | | Weighted-Average Participation Threshold per Class B Unit | | | | |
Outstanding at January 1, 2017 | 6,740 | | | $ | 1.91 | | | | | |
Granted | 767 | | | $ | 12.00 | | | | | |
Exchanged | (51) | | | $ | 1.81 | | | | | |
Forfeited | (35) | | | $ | 3.48 | | | | | |
Outstanding at December 31, 2017 | 7,421 | | | $ | 2.95 | | | | | |
| | | | | | | |
Granted | — | | | n/a | | | | | |
Exchanged | (901) | | | $ | 0.96 | | | | | |
Forfeited | (127) | | | $ | 10.49 | | | | | |
Outstanding at December 31, 2018 | 6,393 | | | $ | 3.08 | | | | | |
| | | | | | | |
Granted | — | | | n/a | | | | | |
Exchanged | (1,202) | | | $ | 1.17 | | | | | |
Forfeited | (23) | | | $ | 5.23 | | | | | |
Outstanding at December 31, 2019 | 5,168 | | | $ | 3.51 | | | | | |
| | | | | | | |
Vested as of December 31, 2019 | 4,416 | | | $ | 2.87 | | | | | |
Expected to vest as of December 31, 2019 | 752 | | | $ | 7.28 | | | | | |
The Company used a third party valuation specialist to assist management in its estimation of the grant-date fair value of the Class B Units on the respective grant dates during 2017. There were no Class B Units granted in 2018 or 2019. As the participation threshold provides a threshold similar to that of an exercise price for a stock option, the Company used option pricing valuation models with the following weighted-average assumptions:
| | | | | | | | | |
| | | | | |
| | | For the Year Ended December 31, 2017 | | |
Expected volatility(1) | | | 63.0 | % | | |
Expected dividend yield | | | — | % | | |
Expected term (in years)(2) | | | 6.3 | | |
Risk-free interest rate | | | 1.9 | % | | |
Weighted-average grant date fair value per Class B Unit | | | $7.04 | | |
(1) Measured using selected high-growth guideline companies and considering the risk factors that would influence the range of expected volatility because the Company does not have sufficient historical data to provide a reasonable basis upon which to estimate the expected volatility.
(2) In 2017, the expected term represents the estimated period of time until an award is exchanged and was determined using the simplified method because the Company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term.
Company Performance Plan
The Company created the Performance Plan on July 25, 2016, whereby the Company was authorized to grant up to 1.0 million performance units (the "Performance Units") to certain employees and consultants. The Performance Units granted were subject to continued employment and were only exercisable upon a qualifying transaction, which included an initial public
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
offering, as defined in the Performance Plan. The IPO completed on May 3, 2017 constituted a qualifying transaction under the terms of the Performance Plan. The Company chose to settle the outstanding Performance Units in equity awards of Carvana Co. and recognized compensation expense related to the vested portion of these equity awards upon completion of the IPO.
NOTE 13 — LOSS PER SHARE
Basic and diluted net loss per share is computed by dividing the net loss attributable to Class A common stockholders by the weighted-average shares of Class A common stock outstanding during the period. Diluted net loss per share is computed by giving effect to all potentially dilutive shares. For all periods presented, potentially dilutive shares are excluded from diluted net loss per share because they have an anti-dilutive impact. Therefore, basic and diluted net loss per share attributable to Class A common stockholders are the same for all periods presented.
As discussed in Note 1 — Business Organization, the Organizational Transactions are considered transactions between entities under common control and the financial statements for periods prior to the IPO and Organizational Transactions have been adjusted to combine the previously separate entities for presentation purposes. For purposes of calculating both the numerator and denominator of net loss per share for periods prior to the IPO, the Company has retroactively reflected the 15.0 million shares issued in the IPO and the LLC Units outstanding as of the Organizational Transactions as if they had been issued and outstanding as of the beginning of each period presented. These calculations for periods prior to the IPO do not consider the options or shares of Class A common stock issued on the IPO date under the 2017 Incentive Plan.
The following table presents the calculation of basic and diluted net loss per share during the years ended December 31, 2019, 2018, and 2017 (in thousands, except per share data):
| | | | | | | | | | | | | | | | | |
| For the years ended December 31, | | | | |
| 2019 | | 2018 | | 2017 |
Numerator: | | | | | |
Net loss | $ | (364,639) | | | $ | (254,745) | | | $ | (164,316) | |
Net loss attributable to non-controlling interests(1) | 249,980 | | | 199,269 | | | 146,003 | |
Dividends on Class A convertible preferred stock | — | | | (4,206) | | | (413) | |
Accretion of beneficial conversion feature on Class A convertible preferred stock | — | | | (1,380) | | | (1,237) | |
Net loss attributable to Carvana Co. Class A common stockholders, basic and diluted(1) | $ | (114,659) | | | $ | (61,062) | | | $ | (19,963) | |
Denominator: | | | | | |
Weighted-average shares of Class A common stock outstanding | 47,079 | | | 30,362 | | | 15,517 | |
Nonvested weighted-average restricted stock awards | (232) | | | (319) | | | (276) | |
Weighted-average shares of Class A common stock to compute basic and diluted net loss per Class A common share | 46,847 | | | 30,043 | | | 15,241 | |
Net loss per share of Class A common stock, basic and diluted(1) | $ | (2.45) | | | $ | (2.03) | | | $ | (1.31) | |
(1) The 2018 amounts reflect the revision discussed in Note 2 — Summary of Significant Accounting Policies.
Shares of Class B common stock do not share in the losses of the Company and are therefore not participating securities. As such, separate presentation of basic and diluted net loss per share of Class B common stock under the two-class method has not been presented. LLC Units (adjusted for the Exchange Ratio and participation thresholds) are considered potentially dilutive shares of Class A common stock because they are exchangeable into shares of Class A common stock, if the Company elects not to settle exchanges in cash.
Weighted-average as-converted shares of Convertible Preferred Stock of approximately 0.0 million, 3.9 million, and 0.4 million for the years ended December 31, 2019, 2018, and 2017, respectively, were evaluated under the if-converted method for potentially dilutive effects and were determined to be anti-dilutive. Weighted-average as-converted Class A Units of approximately 106.6 million, 109.0 million, and 117.0 million together with the related Class B common stock for the years ended December 31, 2019, 2018, and 2017, respectively, were evaluated under the if-converted method for potentially dilutive effects and were determined to be anti-dilutive. Outstanding Class B Units of approximately 5.2 million, 6.4 million, and 7.4 million at December 31, 2019, 2018, and 2017, respectively, were evaluated for potentially dilutive effects and were determined to be anti-dilutive. Weighted-average potentially dilutive restricted stock awards and units of approximately 0.8 million, 0.5
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
million, and 0.3 million outstanding during the years ended December 31, 2019, 2018, and 2017, respectively, were evaluated under the treasury stock method for potentially dilutive effects and were determined to be anti-dilutive. As of December 31, 2019, 2018, and 2017, approximately 1.1 million, 0.9 million, and 0.8 million options, respectively, were outstanding and evaluated under the treasury stock method for potentially dilutive effects and were determined to be anti-dilutive.
NOTE 14 — INCOME TAXES
As described in Note 1 — Business Organization, as a result of the IPO, Carvana Co. began consolidating the financial results of Carvana Group. Carvana Group is treated as a partnership for U.S. federal and most applicable state and local income tax purposes. As a partnership, Carvana Group is not subject to U.S. federal and certain state and local income taxes. Any taxable income or loss generated by Carvana Group is passed through to and included in the taxable income or loss of its members, including Carvana Co., based on its economic interest held in Carvana Group. Carvana Co. was formed on November 29, 2016 and did not engage in any operations prior to the IPO. Carvana Co. is taxed as a corporation and is subject to U.S. federal, state and local income taxes with respect to its allocable share of any taxable income or loss of Carvana Group, as well as any stand-alone income or loss generated by Carvana Co.
Net loss before income taxes was $364.6 million, $254.7 million, and $164.3 million for the years ended December 31, 2019, 2018, and 2017, respectively. The Company had 0 income tax expense for the years ended December 31, 2019, 2018, and 2017.
A reconciliation of the U.S. federal rate to the Company’s effective income tax rate is as follows (in thousands, except percentages):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | | | | | | | | | | |
| | | 2019 | | | | 2018 | | | | 2017 | | |
| | | Amount | | Percent | | Amount | | Percent | | Amount | | Percent |
Expected U.S. federal income taxes at statutory rate | | | $ | (76,574) | | | 21.0 | % | | $ | (53,496) | | | 21.0 | % | | $ | (57,511) | | | 35.0 | % |
Impact of 2017 Tax Cuts and Jobs Act | | | — | | | — | % | | — | | | — | % | | 9,303 | | | (5.7) | % |
Loss attributable to non-controlling interests | | | 52,496 | | | (14.4) | % | | 41,024 | | | (16.1) | % | | 52,607 | | | (32.0) | % |
State taxes | | | (2,945) | | | 0.8 | % | | (2,363) | | | 0.9 | % | | (553) | | | 0.3 | % |
Valuation allowance | | | 18,039 | | | (4.9) | % | | 14,771 | | | (5.8) | % | | (3,911) | | | 2.4 | % |
Effect due to LLC flow-through structure | | | 10,004 | | | (2.7) | % | | — | | | — | % | | — | | | — | % |
Other | | | (1,020) | | | 0.2 | % | | 65 | | | 0.0 | % | | 65 | | | 0.0 | % |
Income tax expense | | | $ | — | | | — | % | | $ | — | | | — | % | | $ | — | | | — | % |
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Deferred income taxes reflect the net tax effects of temporary differences between the tax basis in an asset or liability and its reported amount under U.S. GAAP. These temporary differences result in taxable or deductible amounts in future years. The components of the Company’s deferred tax assets are as follows (in thousands):
| | | | | | | | | | | | | | | | | |
| | | Years Ended December 31, | | |
| | | 2019 | | 2018 |
Deferred tax assets: | | | | | |
| Investment in Carvana Group | | $ | 155,775 | | | $ | 100,977 | |
| Net operating loss carryforward | | 44,771 | | | 23,323 | |
| Interest expense carryforward | | 13,721 | | | 2,262 | |
| Tax credit carryforward | | 586 | | | — | |
| Total gross deferred tax assets | | 214,853 | | | 126,562 | |
Valuation allowance | | | (214,853) | | | (126,562) | |
Total deferred tax assets, net of valuation allowance | | | $ | — | | | $ | — | |
| | | | | |
Deferred tax liabilities: | | | | | |
| Intangibles | | $ | (1,808) | | | $ | (2,217) | |
| Total gross deferred tax liabilities | | (1,808) | | | (2,217) | |
Net deferred tax liabilities | | | $ | (1,808) | | | $ | (2,217) | |
As of December 31, 2019, the Company had federal and state net operating loss carry forwards of $188.2 million. Federal losses that arose prior to 2018 will begin to expire in 2037. Federal losses that arose in 2018 will be carried forward indefinitely.
As described in Note 10 — Stockholders' Equity, the Company acquired 5.4 million LLC Units during the year ended December 31, 2019 in connection with exchanges with Existing LLC Unitholders. During the year ended December 31, 2019, the Company recorded a gross deferred tax asset of $70.3 million associated with the basis difference in its investment in Carvana Group related to the acquisition of the LLC Units which is reflected as an increase to additional paid-in capital in the accompanying statements of stockholders' equity.
As described in Note 1 — Business Organization and Note 10 — Stockholders' Equity, Carvana Co. purchased approximately 18.8 million newly-issued LLC Units of Carvana Group in connection with the IPO. The Company recognized a gross deferred tax asset of $0.5 million associated with a portion of the basis difference resulting from this purchase of LLC Units which is reflected as an increase to additional paid-in capital in the accompanying statements of stockholders' equity. The Company has not recorded a deferred tax asset of $43.1 million related to the remaining basis difference associated with this purchase of LLC Units as the difference will only reverse upon the sale of its interest in Carvana Group.
As described in Note 1 — Business Organization and Note 10 — Stockholders' Equity, on April 30, 2018, Carvana Co. completed a follow-on offering of 6.6 million shares of its Class A common stock. The Company recognized a gross deferred tax asset of $2.5 million associated with the portion of the basis difference resulting from the purchase of LLC Units which is reflected as an increase to additional paid-in capital in the accompanying statement of stockholders' equity. The Company has not recorded a deferred tax asset of $30.6 million related to the remaining basis difference associated with the purchase of LLC Units as the difference will only reverse upon the sale of its interest in Carvana Group.
As described in Note 1 — Business Organization and Note 10 — Stockholders' Equity, on May 24, 2019, Carvana Co. completed a follow-on offering of 4.2 million shares of the Class A common stock. As part of the offering, the underwriters were given an option to purchase all or part of approximately 0.6 million additional shares of Class A common stock which the underwriters exercised in full. The Company recognized a gross deferred asset of approximately $7.5 million associated with a portion of the basis difference resulting from this purchase of LLC Units which is reflected as an increase to additional paid-in capital in the accompanying consolidated statements of stockholder's equity. The Company has not recorded a deferred tax asset of $42.7 million related to the remaining basis difference associated with the purchase of LLC Units as the difference will only reverse upon the sale of its interest in Carvana Group.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
As described in Note 4 — Goodwill and Intangible Assets, Carvana Group acquired Car360 on April 12, 2018. The acquisition included various intangible assets, and as a result the Company recognized a deferred tax liability of approximately $2.5 million which is reflected within other liabilities in the accompanying consolidated balance sheets. The deferred tax liability will be amortized over two to seven years and approximately $0.4 million and $0.3 million was amortized during the years ended December 31, 2019 and 2018, respectively.
During the year ended December 31, 2019, management performed an assessment of the recoverability of deferred tax assets. Management determined, based on the accounting standards applicable to such assessment, that there was sufficient negative evidence as a result of the Company’s cumulative losses to conclude it was more likely than not that its deferred tax assets would not be realized and has recorded a full valuation allowance of $214.9 million against its deferred tax assets. The Company has $1.8 million of deferred tax liabilities not available to offset deferred tax assets. In the event that management was to determine that the Company would be able to realize its deferred tax assets in the future in excess of their net recorded amount, an adjustment to the valuation allowance would be made which would reduce the provision for income taxes.
The Company recognizes uncertain income tax positions when it is more-likely-than-not the position will be sustained upon examination. As of the year ended December 31, 2019, the Company has 0t identified any uncertain tax positions and has 0t recognized any related reserves.
On December 22, 2017, the U.S. government enacted tax legislation referred to as the 2017 Tax Cuts and Jobs Act (the "2017 Tax Act"). The 2017 Tax Act reduces the U.S. federal corporate tax rate from the previous rate of 35 to 21 effective January 1, 2018. The 2017 Tax Act also makes broad and complex changes to the U.S. tax code, including, but not limited to (i) limitations on net operating loss carryforwards created in tax years beginning after December 31, 2017 while also allowing such net operating losses to be carried forward indefinitely; (ii) bonus depreciation allowing full expensing of qualified property; (iii) limitations on the deductibility of certain executive compensation; and, (iv) limitations to the amount of deductible interest.
On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 Income Tax Accounting Implications of the Tax Cuts and Jobs Act ("SAB 118") which provides guidance on accounting for the 2017 Tax Act’s impact. SAB 118 provides a measurement period, which in no case should extend beyond one year from the 2017 Tax Act enactment date, during which a company acting in good faith may complete the accounting for the impacts of the 2017 Tax Act under ASC Topic 740, Income Taxes ("ASC 740"). In accordance with SAB 118, the Company must reflect the income tax effects of the 2017 Tax Act in the reporting period in which it completes its analysis. The Company has recorded the impact of the Tax Act on its deferred tax balances related to the change in tax rate. During the year ended December 31, 2017, the Company recorded a decrease in its deferred tax assets of $9.3 million with a corresponding decrease in valuation allowance. SAB 118 allowed the Company to refrain from making a decision on certain provisions in the 2017 Tax Act and the Company continued to review and assess the potential impact of the legislation on its consolidated financial statements factoring in changes due to, among other things, further refinement of the Company's calculations, changes in interpretations and assumptions that the Company has made and additional guidance that may be issued by the U.S. government. As of December 31, 2018, the Company completed accounting for all of the enactment date income tax effects of the 2017 Tax Act and determined there were no material adjustments.
Tax Receivable Agreement
Carvana Co. expects to obtain an increase in its share of the tax basis in the net assets of Carvana Group when LLC Units are exchanged by the Existing LLC Unitholders and other qualifying transactions. As described in Note 10 — Stockholders' Equity, each change in outstanding shares of Class A common stock results in a corresponding increase or decrease in Carvana Co.'s ownership of LLC Units. The Company intends to treat any exchanges of LLC Units as direct purchases of LLC interests for U.S. federal income tax purposes. These increases in tax basis may reduce the amounts that Carvana Co. would otherwise pay in the future to various taxing authorities. They may also decrease gains (or increase losses) on future dispositions of certain capital assets to the extent tax basis is allocated to those capital assets.
In connection with the IPO, the Company entered into a Tax Receivable Agreement (the "TRA"). Under the TRA, the Company generally will be required to pay to the Existing LLC Unitholders 85% of the amount of cash savings, if any, in U.S. federal, state or local tax that the Company actually realizes directly or indirectly (or are deemed to realize in certain circumstances) as a result of (i) certain tax attributes created as a result of any sales or exchanges (as determined for U.S. federal income tax purposes) to or with the Company of their interests in Carvana Group for shares of Carvana Co.'s Class A common stock or cash, including any basis adjustment relating to the assets of Carvana Group and (ii) tax benefits attributable to payments made under the TRA (including imputed interest). The Company expects to benefit from the remaining 15% of any
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
tax benefits that it may actually realize. To the extent that the Company is unable to timely make payments under the TRA for any reason, such payments generally will be deferred and will accrue interest until paid.
If the Internal Revenue Service or a state or local taxing authority challenges the tax basis adjustments that give rise to payments under the TRA and the tax basis adjustments are subsequently disallowed, the recipients of payments under the agreement will not reimburse the Company for any payments the Company previously made to them. Any such disallowance would be taken into account in determining future payments under the TRA and would, therefore, reduce the amount of any such future payments. Nevertheless, if the claimed tax benefits from the tax basis adjustments are disallowed, the Company’s payments under the TRA could exceed its actual tax savings, and the Company may not be able to recoup payments under the TRA that were calculated on the assumption that the disallowed tax savings were available.
The TRA provides that if (i) certain mergers, asset sales, other forms of business combinations, or other changes of control were to occur, (ii) there is a material breach of any material obligations under the TRA; or (iii) the Company elects an early termination of the TRA, then the TRA will terminate and the Company's obligations, or the Company's successor’s obligations, under the TRA will accelerate and become due and payable, based on certain assumptions, including an assumption that the Company would have sufficient taxable income to fully utilize all potential future tax benefits that are subject to the TRA and that any LLC Units that have not been exchanged are deemed exchanged for the fair market value of the Company's Class A common stock at the time of termination.
As of December 31, 2019, the Company has concluded, based on applicable accounting standards, that it was more likely than not that its deferred tax assets subject to the TRA would not be realized; therefore, the Company has not recorded a liability related to the tax savings it may realize from utilization of such deferred tax assets. As of December 31, 2019, the total unrecorded TRA liability is approximately $178.4 million. If utilization of the deferred tax assets subject to the TRA becomes more likely than not in the future, the Company will record a liability related to the TRA which will be recognized as expense within its consolidated statements of operations.
Uncertain Tax Positions
Based on the Company's analysis of tax positions taken on income tax returns filed, 0 uncertain tax positions existed as of December 31, 2019, 2018, and 2017. Carvana Co. was formed in November 2016 and did not engage in any operations prior to the IPO and Organizational Transactions. Carvana Co. was not required to file 2016 tax returns and filed its first tax returns for the tax year 2017, the first year it became subject to examination by taxing authorities for U.S. federal and state income tax purposes. Carvana Group is treated as a partnership for U.S. federal and state income tax purposes and its tax returns are subject to examination by taxing authorities. Carvana Group has filed income tax returns for years through 2017. These returns are subject to examination by the taxing authorities in the respective jurisdictions, generally for three or four years after they were filed.
NOTE 15 — LEASES
The Company is party to various lease agreements for real estate and transportation equipment. For each lease agreement, the Company determines its lease term as the non-cancellable period of the lease and includes options to extend or terminate the lease when it is reasonably certain that it will exercise that option. The Company also assesses whether each lease is an operating or finance lease at the lease commencement date. Rent expense of operating leases is recognized on a straight-line basis over the lease term and includes scheduled rent increases as well as amortization of tenant improvement allowances.
Operating Leases
As of December 31, 2019, the Company is a tenant under various operating leases related to certain of its hubs, vending machines and corporate offices. The initial terms expire at various dates between 2020 and 2032. Many of the leases include 1 or more renewal options ranging from one to twenty years and some contain purchase options. The Company also had operating leases for certain of its transportation fleet. In March 2019, the Company reassessed the lease terms of the transportation equipment leases based on the likelihood of exercising its extension options and reclassified them to finance leases. Rent expense for the Company's operating leases was approximately $7.9 million and $4.3 million for years ended December 31, 2018 and 2017, respectively.
Refer to Note 6 — Related Party Transactions for further discussion of operating leases with related parties.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Advertising Costs
Advertising production costs are expensed the first time the advertising takes place. All other advertising costs are expensed as incurred. Advertising expenses are included in SG&A expenses on the accompanying consolidated statements of operations. Advertising expense was approximately $204.0 million, $111.2 million, and $55.7 million during the years ended December 31, 2019, 2018, and 2017, respectively.
Equity-Based Compensation
The Company classifies equity-based awards granted in exchange for services as either equity awards or liability awards. The classification of an award as either an equity award or a liability award is generally based upon cash settlement options. Equity awards are measured based on the fair value of the award at the grant date. Liability awards are re-measured to fair value each reporting period. Prior to the adoption of ASU 2018-07, Compensation - Stock Compensation (Topic 718) ("ASU 2018-07"), on January 1, 2019, each reporting period, the Company recognized the change in fair value of awards issued to non-employees as expense. Following adoption of ASU 2018-07, accounting requirements for equity-based awards to nonemployees are aligned with those to employees, including measuring the equity instruments at the grant-date fair value. The Company recognizes equity-based compensation on a straight-line basis over the award’s requisite service period, which is generally the vesting period of the award, less actual forfeitures. No compensation expense is recognized for awards for which participants do not render the requisite services. For equity and liability awards earned based on performance or upon occurrence of a contingent event, when and if the awards will be earned is estimated. If an award is not considered probable of being earned, no amount of equity-based compensation is recognized. If the award is deemed probable of being earned, related compensation expense is recorded over the estimated service period. To the extent the estimate of awards considered probable of being earned changes, the amount of equity-based compensation recognized will also change. See Note 12 — Equity-Based Compensation for additional information on equity-based compensation.
Shipping and Handling
The Company's logistics costs related to transporting its used vehicle inventory include fuel, maintenance, and depreciation related to operating its own transportation fleet and third party transportation fees. The portion of these costs related to inbound transportation from the point of acquisition to the inspection and reconditioning center are capitalized to inventory and then included in cost of sales when the related used vehicle is sold. Logistics costs not included in cost of sales are included in selling, general and administrative expenses in the accompanying consolidated statements of operations and were approximately $58.1 million, $35.2 million, and $14.4 million during the years ended December 31, 2019, 2018, and 2017, respectively, excluding compensation and benefits.
Defined Contribution Plan
The Company sponsors a qualified 401(k) retirement plan (defined contribution plan) for its employees. The plan covers substantially all employees who have attained the age of 18. Participants may voluntarily contribute to the plan up to the maximum limits established by Internal Revenue Service regulations. The Company provides matching contributions of 40% up to the first 6% of an employee’s compensation, which vests evenly over the employee’s initial five-year service period. Employer contributions to the plan, net of forfeitures, were approximately $2.0 million, $1.1 million, and $0.7 million for the years ended December 31, 2019, 2018, and 2017, respectively. Employer contributions are included in selling, general, and administrative expenses in the accompanying consolidated statements of operations.
Derivative Instruments and Hedging Activities
The Company enters into short-term derivative instruments to manage risks arising from its business operations and economic conditions, primarily cash flow variability that may arise from interest rate changes between the time the Company originates finance receivables and the time it sells them through securitizations. The Company does not designate these derivative instruments as hedges under ASC 815, Derivatives and Hedging for hedge accounting treatment and as a result they are accounted for as economic hedges. Gains and losses related to the derivative instruments are included within other sales and revenues to follow the presentation of the hedged item within the accompanying consolidated statements of operations and any
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
derivative instruments outstanding as of the end of the period are reported at fair value on the accompanying consolidated balance sheets.
Fair Value Measurements
The fair value of financial instruments is based on estimates using quoted market prices, discounted cash flows, or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and the estimated timing and amount of future cash flows. Therefore, the estimates of fair value may differ substantially from amounts that ultimately may be realized or paid at settlement or maturity of the financial instruments, and those differences may be material. Accordingly, the aggregate fair value amounts presented may not represent the Company’s underlying institutional value.
The Company uses the three-tier hierarchy established by U.S. GAAP, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value to determine the fair value of its financial instruments. This hierarchy indicates to what extent the inputs used in the Company’s calculations are observable in the market. The different levels of the hierarchy are defined as follows:
| | | | | |
Level 1: | Unadjusted quoted prices in active markets for identical assets or liabilities. |
| |
Level 2: | Other than quoted prices that are observable in the market for the asset or liability, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or model-derived valuations or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. |
| |
Level 3: | Inputs are unobservable and reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. |
The Company has elected the fair value option for its beneficial interests in securitizations, which primarily include notes and certificates of the securitization trusts. Electing the fair value option allows the Company to recognize changes in the fair value of these assets in the period the fair value changes. The changes in fair value are recorded within other expense, net and amounts attributable to interest income are reported in interest expense, net on the accompanying consolidated statements of operations.
See Note 17 — Fair Value of Financial Instruments for additional information.
Segments
Business segments are defined as components of an enterprise about which discrete financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing operating performance. Based on the way the Company manages its business, the Company has determined that it currently operates with 1 reportable segment. The chief operating decision maker focuses on consolidated results in assessing operating performance and allocating resources. Furthermore, the Company offers similar products and services and uses similar processes to sell those products and services to similar classes of customers throughout the United States ("U.S."). Substantially all revenue is generated and all assets are held in the U.S. for all periods presented.
Income Taxes
The Company accounts for income taxes pursuant to the asset and liability method, which requires the recognition of deferred income tax assets and liabilities related to the expected future tax consequences arising from temporary differences between the carrying amounts and tax bases of assets and liabilities based on enacted statutory tax rates applicable to the periods in which the temporary differences are expected to reverse. Any effects of changes in income tax rates or laws are included in income tax expense in the period of enactment. The Company reduces the carrying amounts of deferred tax assets by a valuation allowance if, based on the evidence available, it is more likely than not that such assets will not be realized. In making the assessment under the more likely than not standard, appropriate consideration must be given to all positive and negative evidence related to the realization of the deferred tax assets. The assessment considers, among other matters, the
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carry forward periods by jurisdiction, the Company's experience with loss carryforwards not expiring unutilized, and all tax planning alternatives that may be available. A valuation allowance is recognized if under applicable accounting standards the Company determines it is more likely than not that its deferred tax assets would not be realized. See Note 14 — Income Taxes for additional information.
Adoption of New Accounting Standards
Beginning in February 2016, the FASB issued several accounting standards updates related to the new leasing model in ASC 842, Leases ("ASC 842"). ASC 842 introduced a model that requires leases to be presented on the balance sheet and eliminates the requirement for an entity to use bright-line tests in determining lease classification. Expense recognition under ASC 842 on the income statement remains similar to previous lease accounting guidance.
The Company adopted ASC 842 on January 1, 2019 using the modified retrospective approach, the practical expedient package and the transition relief option, which allowed the Company to, among other things, avoid reassessing lease classification for existing leases, forego the balance sheet recognition requirements with respect to short-term leases and avoid restating comparative periods presented. The adoption of ASC 842 resulted in initial recognition of ROU assets and operating lease liabilities of approximately $80.3 million and $86.8 million, respectively, as of January 1, 2019, and did not have an impact on the beginning equity balances as of the implementation date. Adopting ASC 842 did not have a material impact on the Company's sale-leaseback transactions, which have typically been accounted for as financing transactions in prior periods and under ASC 842. The standard did not have a material impact on the Company's consolidated statements of operations or statements of cash flows.
In June 2018, the FASB issued ASU 2018-07, Compensation — Stock Compensation (Topic 718) ("ASU 2018-07") related to the accounting for share-based payment transactions for acquiring goods and services from nonemployees. Under ASU 2018-07, the intent is to simplify and align most requirements for share-based payments to nonemployees with the requirements for share-based payments granted to employees under ASC 718, including measuring the equity instruments at the grant-date fair value. The Company adopted ASU 2018-07 on January 1, 2019 using the modified retrospective approach. The adoption of ASU 2018-07 did not have a material effect on the Company’s consolidated financial statements.
Accounting Standards Issued But Not Yet Adopted
In June 2016, the FASB issued ASU 2016-13, Financial instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13") and subsequent related ASUs, which amends the guidance on the impairment of financial instruments by requiring measurement and recognition of expected credit losses for financial assets held. ASU 2016-13 is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2019. Financial assets measured at fair value through net income are excluded from the scope of ASU 2016-13. The Company's beneficial interests in securitizations are carried at fair value and are thus excluded from ASU 2016-13. Finance receivables originated in connection with the Company’s vehicle sales are held for sale and presented at the lower of amortized cost or fair value. The Company intends to sell the finance receivables prior to their contractual maturity, therefore the recovery of the asset is from its sale rather than maturity and the Company is not required to measure the expected lifetime credit losses. The Company will adopt ASU 2016-13 for its fiscal year beginning January 1, 2020 and does not expect the adoption to have a material impact on its consolidated financial statements.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement ("ASU 2018-13") related to updated requirements over the disclosures of fair value measurements. Under ASU 2018-13, certain disclosure requirements for fair value measurements will be eliminated, modified or added to facilitate better communication around recurring and nonrecurring fair value measurements. ASU 2018-13 is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2019, with some amendments applied prospectively, some applied retrospectively, and early adoption permitted. The Company will adopt ASU 2018-13 for its fiscal year beginning January 1, 2020 and does not expect the adoption to have a material impact on its disclosures within its consolidated financial statements.
In August 2018, the FASB issued ASU 2018-15, Intangibles — Goodwill and Other — Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract ("ASU 2018-15"). The intent of this pronouncement is to align the requirements for capitalizing implementation costs incurred in a cloud computing arrangement that is a service contract with the requirements for capitalizing implementation costs
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
incurred to develop or obtain internal-use software as defined in ASC 350-40. Under ASU 2018-15, the capitalized implementation costs related to a cloud computing arrangement will be amortized over the term of the arrangement and all capitalized implementation amounts will be required to be presented in the same line items of the financial statements as the related hosting fees. ASU 2018-15 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. The Company will adopt ASU 2018-15 for its fiscal year beginning January 1, 2020 and does not expect the adoption to have a material impact on its consolidated financial statements.
In October 2018, the FASB issued ASU 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities ("ASU 2018-17"). ASU 2018-17 requires reporting entities to consider indirect interests held through related parties under common control on a proportional basis rather than as the equivalent of a direct interest in its entirety for determining whether a decision-making fee is a variable interest. The standard is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. Entities are required to apply the amendments in ASU 2018-17 retrospectively with a cumulative-effect adjustment to retained earnings at the beginning of the earliest period presented. The Company will adopt ASU 2018-17 for its fiscal year beginning January 1, 2020 and does not expect the adoption to have a material impact on its consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes ("ASU 2019-12"). ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. ASU 2019-12 will be effective for interim and annual periods beginning after December 15, 2020, with early adoption permitted. The Company plans to adopt ASU 2019-12 for its fiscal year beginning January 1, 2021 and is currently assessing the impact, if any, the guidance will have on its consolidated financial statements.
NOTE 3 — PROPERTY AND EQUIPMENT, NET
The following table summarizes property and equipment, net as of December 31, 2019 and 2018 (in thousands):
| | | | | | | | | | | |
| December 31, | | |
| 2019 | | 2018 |
Land and site improvements | $ | 98,530 | | | $ | 45,702 | |
Buildings and improvements | 229,640 | | | 123,705 | |
Transportation fleet | 110,302 | | | 65,760 | |
Software | 66,875 | | | 36,452 | |
Furniture, fixtures, and equipment | 38,123 | | | 20,675 | |
Total property and equipment excluding construction in progress | 543,470 | | | 292,294 | |
Less: accumulated depreciation and amortization on property and equipment | (88,795) | | | (44,050) | |
Property and equipment excluding construction in progress, net | 454,675 | | | 248,244 | |
Construction in progress | 88,796 | | | 48,595 | |
Property and equipment, net | $ | 543,471 | | | $ | 296,839 | |
Depreciation and amortization expense on property and equipment was approximately $39.6 million, $22.5 million, and $11.6 million for the years ended December 31, 2019, 2018, and 2017, respectively. These amounts primarily relate to selling, general, and administrative activities and are included as a component of selling, general, and administrative expenses in the accompanying consolidated statements of operations.
The Company capitalized internal use software costs totaling approximately $31.7 million, $17.4 million, and $11.5 million during the years ended December 31, 2019, 2018, and 2017, respectively, which is included in software and construction in progress in the table above. The Company capitalized approximately $24.7 million, $13.6 million, and $7.9 million during the years ended December 31, 2019, 2018, and 2017, respectively, of payroll and payroll-related costs for employees who are directly associated with and who devote time to the development of software products for internal use.
The Company capitalizes interest in connection with various construction projects to build, upgrade, or remodel certain of its facilities. During the years ended December 31, 2019, 2018, and 2017, the Company incurred total interest costs, net of interest income, of approximately $84.2 million, $26.6 million, and $8.6 million, respectively, of which approximately $3.6 million, $1.6 million, and $0.9 million, respectively, were capitalized.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
NOTE 4 — GOODWILL AND INTANGIBLE ASSETS
On April 12, 2018, the Company acquired Car360, Inc. ("Car360"), a provider of app-based photo capture technology, for approximately $16.7 million, net of cash acquired of approximately $0.4 million. The purchase price was comprised of approximately $6.7 million cash, net of cash acquired, and approximately 0.5 million Class A Units of Carvana Group, with a fair value of approximately $10.0 million.
The purchase price was allocated to net tangible assets of approximately $0.2 million and intangible assets of approximately $9.9 million based on their fair values on the acquisition date and a related deferred tax liability of approximately $2.5 million. The deferred tax liability will amortize over two to seven years, and approximately $0.4 million and $0.3 million was amortized during the years ended December 31, 2019 and 2018, respectively. The excess of the purchase price over the amounts allocated to assets acquired, liabilities assumed and the deferred tax liability was approximately $9.4 million, which has been recorded as goodwill. The historical results of operations for Car360 were not significant to the Company's consolidated results of operations for the periods presented.
The following table summarizes intangible assets and goodwill related to the Car360 acquisition as of December 31, 2019 and 2018 (in thousands):
| | | | | | | | | | | | | | | | | |
| | | December 31, | | |
| Useful Life | | 2019 | | 2018 |
Intangible assets: | | | | | |
Developed technology | 7 years | | $ | 8,642 | | | $ | 8,642 | |
Customer relationships | 2 years | | 523 | | | 523 | |
Non-compete agreements | 5 years | | 774 | | | 774 | |
Intangible assets, acquired cost | | | 9,939 | | | 9,939 | |
Less: accumulated amortization | | | (2,707) | | | (1,070) | |
Intangible assets, net | | | $ | 7,232 | | | $ | 8,869 | |
| | | | | |
Goodwill | N/A | | $ | 9,353 | | | $ | 9,353 | |
Amortization expense was $1.6 million and $1.1 million during the years ended December 31, 2019 and 2018, respectively. As of December 31, 2019, the remaining weighted-average amortization period for definite-lived intangible assets was approximately 4.9 years. The anticipated annual amortization expense to be recognized in future years as of December 31, 2019 is as follows (in thousands):
| | | | | |
| Expected Future Amortization |
2020 | $ | 1,590 | |
2021 | 1,389 | |
2022 | 1,389 | |
2023 | 1,279 | |
2024 | 1,235 | |
Thereafter | 350 | |
Total | $ | 7,232 | |
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
NOTE 5 — ACCOUNTS PAYABLE AND OTHER ACCRUED LIABILITIES
The following table summarizes accounts payable and other accrued liabilities as of December 31, 2019 and 2018 (in thousands):
| | | | | | | | | | | |
| December 31, | | |
| 2019 | | 2018 |
Accounts payable, including $9,549 and $3,891, respectively, due to related parties | $ | 63,576 | | | $ | 33,032 | |
Sales taxes and vehicle licenses and fees | 45,812 | | | 27,651 | |
Accrued property and equipment | 23,433 | | | 7,414 | |
Accrued compensation and benefits | 21,726 | | | 13,477 | |
Reserve for returns and cancellations | 19,721 | | | 11,284 | |
Accrued interest expense | 15,650 | | | 9,206 | |
Accrued advertising costs | 11,403 | | | 4,398 | |
Customer deposits | | 6,379 | | | 2,890 | |
Other accrued liabilities | | 26,743 | | | 12,063 | |
Total accounts payable and other accrued liabilities | $ | 234,443 | | | $ | 121,415 | |
NOTE 6 — RELATED PARTY TRANSACTIONS
Lease Agreements
In November 2014, the Company and DriveTime entered into a lease agreement that governs the Company’s access to and utilization of temporary storage, reconditioning, offices and parking space at various DriveTime facilities (the "DriveTime Lease Agreement"). The DriveTime Lease Agreement was most recently amended in December 2018. Lease duration varies by location with cancellable terms, provided 60 days' prior written notice is given, expiring between 2021 and 2024. Most of the facilities allow the Company to exercise up to 2 consecutive one-year renewal options at up to 10 of these locations, less the numbers of locations renewed under the DriveTime Hub Lease Agreement described below.
In March 2017, the Company and DriveTime entered into a lease agreement that governs the Company's access to and utilization of office and parking space at various DriveTime facilities (the "DriveTime Hub Lease Agreement"). The DriveTime Hub Lease Agreement was most recently amended in December 2018. Lease expiration varies by location with most having cancellable terms, provided 60 days' prior written notice is given, expiring in 2021 and the Company having the right to exercise up to 2 consecutive one-year renewal options at up to 10 of these locations, less the number of locations renewed under the DriveTime Lease Agreement described above.
The DriveTime Lease Agreement and the DriveTime Hub Lease Agreement both have non-cancellable lease terms of less than twelve months with rights to terminate at the Company's election with 60 days' prior written notice and extension options as described above. At our non-reconditioning locations, it is not reasonably certain that the Company will exercise its options to extend the leases or abstain from exercising its termination rights within these lease agreements to create a lease term greater than one year and therefore the Company accounts for them as short-term leases. For these locations the Company makes variable monthly lease payments based on its pro rata utilization of space at each facility plus a pro rata share of each facility’s actual insurance costs and real estate taxes. The DriveTime Lease Agreement includes the Blue Mound and Delanco inspection and reconditioning centers ("IRCs"). At both of these locations, the Company expects to extend the lease terms beyond twelve months, therefore those locations are not considered short-term leases. The Company occupies all of the space at these IRCs and makes monthly lease payments based on DriveTime's actual rent expense. In addition, the Company is responsible for the actual insurance costs and real estate taxes at these IRC locations.
At all locations, the Company is additionally responsible for paying for any tenant improvements it requires to conduct its operations and its share of estimated costs incurred by DriveTime related to preparing these sites for use. Management has determined that the costs allocated to the Company are based on a reasonable methodology.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
In December 2016, the Company entered into a lease agreement related to an IRC in Tolleson, Arizona, with Verde Investments, Inc., an affiliate of DriveTime ("Verde"), with an initial term of approximately 15 years. In August 2018, the Company entered into an additional lease agreement with a coterminous initial term with Verde for contiguous space to that IRC. The lease agreements require monthly rental payments and can each be extended for 4 additional five-year periods.
In February 2017, the Company entered into a lease agreement with DriveTime for sole occupancy of a fully operational IRC in Winder, Georgia, where the Company previously maintained partial occupancy. The lease has an initial term of eight years, subject to the Company's ability to exercise 3 renewal options of five years each.
In November 2018, the Company entered into a lease agreement with DriveTime for access to and utilization of a fully operational IRC near Cleveland, Ohio. DriveTime vacated the facility in February 2019, at which point the Company became the sole occupant and began leasing the full facility from DriveTime. The lease has an initial term of three years, subject to the Company's ability to exercise 3 renewal options of five years each. Before DriveTime vacated the facility, the Company paid a monthly rental fee for facility and shared reconditioning costs, calculated based on the Company's pro rate utilization of space at the IRC in a given month, along with a pro rata share of the facility's actual insurance costs and real estate taxes. Management has determined that the costs allocated to the Company are based on a reasonable methodology.
Expenses related to these operating lease agreements are allocated based on usage to inventory and selling, general and administrative expenses in the accompanying consolidated balance sheets and statements of operations. Costs allocated to inventory are recognized as cost of sales when the inventory is sold. During the year ended December 31, 2019, total costs related to these operating lease agreements, including those noted above, were approximately $7.9 million with approximately $3.3 million and $4.6 million allocated to each of inventory and selling, general, and administrative expenses, respectively. During the year ended December 31, 2018, total costs related to these operating lease agreements were approximately $8.8 million with approximately $4.4 million allocated to each of inventory and selling, general, and administrative expenses. During the year ended December 31, 2017, total costs related to these operating lease agreements were approximately $7.2 million with approximately $2.8 million and $4.4 million allocated to inventory and selling, general, and administrative expenses, respectively.
In February 2019, the Company entered into an agreement to assume a lease of an IRC near Nashville, Tennessee that DriveTime leased from an unrelated landlord. The Company became the sole occupant in April 2019. The lease expires in four years, subject to the ability to exercise 3 renewal options of five years each. DriveTime remained an occupant of the facility through April 1, 2019 but is not fully released from lease obligations by the landlord.
During 2019, the Company purchased certain leasehold improvements and equipment from DriveTime at facilities the Company previously shared with them for DriveTime's net book value of approximately $6.3 million.
Corporate Office Leases
During the first quarter of 2017, the Company subleased additional office space at DriveTime’s corporate headquarters in Tempe, Arizona. Pursuant to this arrangement, the Company incurred rent of approximately $0.1 million during the year ended December 31, 2017. This arrangement terminated in March 2017.
In September 2016, the Company entered into a lease for the second floor of its corporate headquarters in Tempe, Arizona. DriveTime guaranteed up to $0.5 million of the Company's rent payments under that lease through September 2019. In connection with that lease, the Company entered into a sublease with DriveTime for the use of the first floor of the same building. The lease and sublease each have a term of 83 months, subject to the right to exercise 3 five-year extension options. Pursuant to the sublease, the Company will pay the rent equal to the amounts due under DriveTime's master lease directly to DriveTime's landlord. The rent expense incurred related to this first floor sublease was approximately $0.9 million during both of the years ended December 31, 2019 and 2018 and $0.7 million during the year ended December 31, 2017.
In December 2019, Verde purchased an office building in Tempe, Arizona that the Company leased from an unrelated party prior to Verde's purchase. In connection with the purchase, Verde assumed that lease. The lease has an initial term of ten years, subject to the right to exercise 2 five-year extension options. During the year ended December 31, 2019, the rent expense incurred under the lease with Verde was approximately $42.5 thousand.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Master Dealer Agreement
In December 2016, the Company entered into a master dealer agreement with DriveTime (the "Master Dealer Agreement"), pursuant to which the Company may sell VSCs to customers purchasing a vehicle from the Company. The Company earns a commission on each VSC sold to its customers and DriveTime is obligated by and subsequently administers the VSCs. The Company collects the retail purchase price of the VSCs from its customers and remits the purchase price net of commission to DriveTime. During the years ended December 31, 2019, 2018, and 2017, the Company recognized approximately $55.6 million, $23.7 million, and $8.9 million, respectively, of commissions earned on VSCs sold to its customers and administered by DriveTime, net of a reserve for estimated contract cancellations. The commission earned on the sale of these VSCs is included in other sales and revenues in the accompanying consolidated statements of operations. In November 2018, the Company amended the Master Dealer Agreement to allow the Company to receive payments for excess reserves based on the performance of the VSCs versus the reserves held by the VSC administrator, once a required claims period for such VSCs has passed. During the years ended December 31, 2019, 2018, and 2017, the Company recognized approximately $4.1 million, $1.9 million, and $0.0 million, respectively, related to payments for excess reserves to which it expects to be entitled, which is included in other sales and revenues in the accompanying consolidated statements of operations.
Beginning in 2017, DriveTime also administers a portion of the Company's GAP waiver coverage and the limited warranty provided to all customers under the Master Dealer Agreement. The Company pays a per-contract fee to DriveTime to administer a portion of the GAP waiver coverage it sells to its customers and a per-vehicle fee to DriveTime to administer the limited warranty included with every purchase. The Company incurred approximately $4.3 million, $2.2 million, and $0.6 million during the years ended December 31, 2019, 2018, and 2017, respectively, related to the administration of GAP waiver coverage and limited warranty. As of December 31, 2019, the majority of the Company's GAP waiver coverage sales are administered by an unrelated party.
GAP Waiver Insurance Policy
During the year ended December 31, 2019, the Company purchased insurance policies from BlueShore Insurance Company ("BlueShore"), an affiliate of DriveTime, for approximately $1.8 million that reimburses the lienholder of finance receivables with GAP waiver coverage for any GAP waiver claims on a defined set of finance receivables that the Company sold in its securitization transactions. This insurance is transferred with the underlying finance receivable. In March 2019, the Company entered into a retrospective profit sharing agreement with BlueShore under which the Company will share in the profits generated from the insurance policies by receiving a portion of the excess of the premium it paid to BlueShore, net of a fee, compared to the amount BlueShore pays out related to the GAP waiver claims. As of December 31, 2019, the Company held a receivable of approximately $0.2 million, which is included in other assets on the accompanying consolidated balance sheets, related to this retrospective profit sharing agreement.
Servicing and Administrative Fees
DriveTime provides servicing and administrative functions associated with the Company's finance receivables. The Company incurred expenses of approximately $4.2 million, $0.9 million, and $0.2 million for the years ended December 31, 2019, 2018, and 2017, respectively, related to these services.
Aircraft Time Sharing Agreement
The Company entered into an agreement to share usage of 2 aircraft owned by Verde and operated by DriveTime in 2015, and the agreement was subsequently amended in 2017. Pursuant to the agreement, the Company agreed to reimburse DriveTime for actual expenses for each of its flights. The original agreement was for 12 months, with perpetual 12-month automatic renewals. Either the Company or DriveTime can terminate the agreement with 30 days’ prior written notice. The Company reimbursed DriveTime approximately $0.5 million during both of the years ended December 31, 2019 and 2018 and approximately $0.4 million during the year ended 2017 under this agreement.
Shared Services Agreement with DriveTime
In November 2014, the Company and DriveTime entered into a shared services agreement whereby DriveTime provided certain accounting and tax, legal and compliance, information technology, telecommunications, benefits, insurance, real estate, equipment, corporate communications, software and production, and other services to facilitate the transition of these services to the Company on a standalone basis (the "Shared Services Agreement"). The Shared Services Agreement was most recently amended and restated in April 2017 and operates on a year-to-year basis after February 2019, with the Company having the
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
right to terminate any or all services with 30 days' prior written notice and DriveTime having the right to terminate any or all services with 90 days' prior written notice. Charges allocated to the Company were based on the Company’s actual use of the specific services detailed in the Shared Services Agreement. Total expenses related to the Shared Services Agreement were approximately $0.0 million for both of the years ended December 31, 2019 and 2018, and approximately $0.1 million during the year ended December 31, 2017, all of which are included in selling, general and administrative expenses in the accompanying consolidated statements of operations.
Accounts Payable Due to Related Party
As of December 31, 2019 and 2018, approximately $9.5 million and $3.9 million, respectively, was due to related parties primarily related to the agreements mentioned above, and is included in accounts payable and accrued liabilities in the accompanying consolidated balance sheets.
Senior Unsecured Notes Held by Verde
As of both December 31, 2019 and 2018, Verde held $15.0 million of principal of the Company's outstanding senior unsecured notes, which are described further in Note 9 — Debt Instruments.
Credit Facility with Verde
On February 27, 2017, the Company entered into a credit facility with Verde for an amount up to $50.0 million (the "Verde Credit Facility"). Amounts outstanding accrued interest at a rate of 12.0% per annum. Upon execution of the agreement, the Company paid Verde a commitment fee of $1.0 million. In connection with the IPO completed on May 3, 2017, the Company repaid the outstanding principal balance of $35.0 million and accrued interest of approximately $0.4 million in full and the Verde Credit Facility agreement terminated.
Contribution Agreements
On September 10, 2018, the Company announced a commitment by its Chief Executive Officer, Ernest Garcia III, to contribute shares of the Company's Class A common stock, for each then-current employee from his personal shareholdings to the Company at 0 charge (the "Share Contributions"). His contributions funded equity awards of 165 restricted stock units to each of the Company's then-current employees upon their satisfying certain employment tenure requirements (the "100k Milestone Gift"). The Company entered into certain contribution agreements related to his commitment in order to effect the transfer of shares from Mr. Garcia to the Company. The Company does not expect Mr. Garcia to incur any tax obligations related to the Share Contributions, but pursuant to a series of Contribution Agreements, it has indemnified Mr. Garcia from any such obligations that may arise. See Note 10 — Stockholders' Equity and Note 12 — Equity-Based Compensation for further discussion. As of December 31, 2019, Mr. Garcia's commitment related to the 100k Milestone Gift has been fulfilled.
IP License Agreement
In February 2017, the Company entered into a license agreement that governs the rights of certain intellectual property owned by the Company and the rights of certain intellectual property owned by DriveTime. The license agreement, which was amended and restated in April 2017, generally provides that each party grants to the other certain limited exclusive (other than with respect to the licensor party and its affiliates) and non-exclusive licenses to use certain of its intellectual property, and each party agrees to certain covenants not to sue the other party, its affiliates, and certain of its service providers in connection with various patent claims. The exclusive license to DriveTime is limited to the business that is primarily of subprime used car sales to retail customers. However, upon a change of control of either party, both parties’ license rights as to certain future improvements to licensed intellectual property and all limited exclusivity rights are terminated. The agreement does not provide a license to any of the Company's patents, trademarks, logos, customers’ personally identifiable information or any intellectual property related to the Company's vending machines, automated vehicle photography, or certain other elements of the Company's brand.
NOTE 7 — FINANCE RECEIVABLE SALE AGREEMENTS
In December 2016, the Company entered into a master purchase and sale agreement (the "Master Purchase and Sale Agreement" or "MPSA") and a master transfer agreement (the "2016 Master Transfer Agreement") pursuant to which it sells finance receivables meeting certain underwriting criteria to certain financing partners, including Ally Bank and Ally Financial
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(the "Ally Parties"). Through November 2017 under the Purchase and Sale Agreement and the 2016 Master Transfer Agreement, the Company could sell up to an aggregate of $375.0 million, and $292.2 million, respectively, in principal balances of finance receivables subject to adjustment as described in the respective agreements.
On November 3, 2017, the Company amended its MPSA to increase the aggregate amount of principal balances of finance receivables it can sell from $375.0 million to $1.5 billion. On November 2, 2018, the Company amended the MPSA to, among other things and subject to the terms of the agreement, commit the purchaser to purchase up to a maximum of $1.25 billion of principal balances of finance receivables after the amendment date. Subsequently, on April 19, 2019, the Company amended the MPSA to, among other things and subject to the terms of the agreement, commit the purchaser to purchase up to a maximum of $1.0 billion of principal balances of finance receivables after the amendment date.
During the years ended December 31, 2019 and 2018, the Company sold approximately $418.8 million and $733.4 million, respectively, in principal balances of finance receivables under the MPSA and had approximately $658.3 million of unused capacity as of December 31, 2019.
On November 3, 2017, the Company terminated the remaining capacity under the 2016 Master Transfer Agreement and replaced this facility by entering into a new master transfer agreement (the "2017 Master Transfer Agreement") with a purchaser trust (the "2017 Purchaser Trust") under which the trust committed to purchase up to an aggregate of approximately $357.1 million in principal balances of finance receivables. On November 2, 2018, the Company amended the 2017 Master Transfer Agreement to, among other things and subject to the terms of the agreement, increase and extend the trust's commitment to purchase finance receivables from the Company.
On August 7, 2018, in connection with a refinancing transaction discussed further below, the Company purchased finance receivables it had previously sold under the 2017 Master Transfer Agreement and simultaneously entered into a transfer agreement with a purchaser trust under which the trust immediately purchased such finance receivables from the Company.
On December 21, 2018, the Company entered into a transfer agreement with a purchaser trust under which the trust purchased principal balances of finance receivables from the Company, a portion of which were related to a refinancing transaction, discussed further below (the "2018 Transfer Agreement").
On May 7, 2019, the Company purchased the certificate of the 2017 Purchaser Trust for $34.0 million, net of cash acquired. At the time of acquisition the trust assets included $139.7 million of finance receivables that the Company had previously sold to the trust under the 2017 Master Transfer Agreement, and its liabilities included $105.7 million in associated debt and other liabilities. In connection with the certificate purchase, the Company and Ally Bank entered into an Amended and Restated Loan and Security Agreement (the "A&R Loan and Security Agreement") pursuant to which Ally Bank agreed to provide a $350.0 million revolving credit facility (the "SART 2017-1 Credit Facility") to fund certain automotive finance receivables originated by the Company, as further described in Note 9 — Debt Instruments.
During the year ended December 31, 2019, prior to the acquisition of the certificate in the trust, the Company sold approximately $139.3 million in principal balances of finance receivables under the 2017 Master Transfer Agreement. During the year ended December 31, 2018, the Company sold approximately $348.8 million in principal balances of finance receivables under the 2017 Master Transfer Agreement, and approximately $115.0 million in principal balances of finance receivables under the 2018 Transfer Agreement, excluding those that were part of the refinancing transactions described below.
During the year ended December 31, 2019, prior to the certificate purchase, the Company also purchased finance receivables that it previously sold to the purchaser trust under the 2017 Master Transfer Agreement for a total price of approximately $127.7 million and immediately resold such finance receivables into a securitization transaction, which is described further in Note 8 — Securitizations and Variable Interest Entities. This transaction was entered into in connection with the securitization transaction and was entered into independently from the terms of the 2017 Master Transfer Agreement.
The total gain related to finance receivables sold to financing partners under the MPSA, the 2016 Master Transfer Agreement, the 2017 Master Transfer Agreement, and to investors in securitization transactions discussed in Note 8 — Securitizations and Variable Interest Entities was approximately $137.3 million, $51.7 million, and $21.7 million during the years ended December 31, 2019, 2018, and 2017, respectively, which is included in other sales and revenues in the accompanying consolidated statements of operations.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
During the year ended December 31, 2018, the Company purchased finance receivables that it previously sold to a purchaser trust under the 2017 Master Transfer Agreement for a total price of approximately $387.4 million and immediately resold such finance receivables to other trusts with the same certificate holder for the same price under separate transfer agreements, one of which was the 2018 Transfer Agreement. Other than customary repurchase obligations, the Company is not obligated to, nor does it have a right to, purchase or sell finance receivables it has previously sold under the 2017 Master Transfer Agreement. These transactions completed in 2018 were entered into in connection with a refinancing by the trusts' certificate holder and were entered into independently from the terms of the 2017 Master Transfer Agreement. The Company received fees totaling approximately $6.3 million for structuring and participating in these transactions, which are included in other sales and revenues in the accompanying consolidated statements of operations.
NOTE 8 — SECURITIZATIONS AND VARIABLE INTEREST ENTITIES
Beginning in 2019, the Company sponsors and establishes securitization trusts to purchase finance receivables from the Company. The securitization trusts issue asset-backed securities, which are collateralized by the finance receivables that the Company sells to the securitization trusts. Upon transfer of the finance receivables to the securitization trusts, the Company recognizes a gain or loss on sales of finance receivables. The net proceeds from the sales are the fair value of the assets obtained as part of the transactions and typically include cash and at least 5% of the beneficial interests issued by the securitization trusts to comply with Risk Retention Rules. The beneficial interests retained by the Company include but are not limited to rated notes and certificates of the securitization trusts. The holders of the certificates issued by the securitization trusts have rights to cash flows only after the holders of the notes issued by the securitization trusts have received their contractual cash flows. The securitization trusts have no direct recourse to the Company’s assets, and holders of the securities issued by the securitization trusts can look only to the assets of the securitization trusts that issued their securities for payment. The beneficial interests held by the Company are subject principally to the credit and prepayment risk stemming from the underlying finance receivables.
As described in Note 2 — Summary of Significant Accounting Policies, the securitization trusts established in connection with asset-backed securitization transactions are VIEs. For each VIE that the Company establishes in its role as sponsor of securitization transactions, it performs an analysis to determine whether or not it is the primary beneficiary of the VIE. The Company’s continuing involvement with the VIEs consists of retaining a portion of the securities issued by the VIEs and performing ministerial duties as the trust administrator. As of December 31, 2019, the Company is not the primary beneficiary of these securitization trusts because its retained interests in the VIEs do not have exposures to losses or benefits that could potentially be significant to the VIEs. The Company does not consolidate the securitization trusts.
The assets the Company retains in the unconsolidated VIEs are presented as beneficial interests in securitizations on the accompanying consolidated balance sheets, which as of December 31, 2019 were approximately $98.8 million. The Company held no other assets or liabilities related to its involvement with unconsolidated VIEs as of December 31, 2019.
The following table summarizes the carrying value and total exposure to losses of its assets related to unconsolidated VIEs with which the Company has continuing involvement, but is not the primary beneficiary at December 31, 2019. Total exposure represents the estimated loss the Company would incur under severe, hypothetical circumstances, such as if the value of the interests in the securitization trusts and any associated collateral declined to zero. The Company believes the possibility of this is remote. As such, the total exposure presented below is not an indication of the Company's expected losses.
| | | | | | | | | | | |
| Carrying Value | | Total Exposure |
| | | |
| (in thousands) | | |
Rated notes | $ | 85,234 | | | $ | 85,234 | |
Certificates and other assets | 13,546 | | | 13,546 | |
Total unconsolidated VIEs | $ | 98,780 | | | $ | 98,780 | |
The beneficial interests in securitizations are considered securities available for sale subject to restrictions on transfer pursuant to the Company’s obligations as a sponsor under Risk Retention Rules. These securities are interests in securitization
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
trusts, thus there are no contractual maturities. The amortized cost and fair value of securities available for sale as of December 31, 2019 were as follows (in thousands):
| | | | | | | | | | | |
| Amortized Cost | | Fair Value |
Rated notes | $ | 84,983 | | | $ | 85,234 | |
Certificates and other assets | 13,456 | | | 13,546 | |
Total securities available for sale | $ | 98,439 | | | $ | 98,780 | |
NOTE 9 — DEBT INSTRUMENTS
Debt instruments, excluding finance leases, which are discussed in Note 15 — Leases, as of December 31, 2019 and 2018 consisted of the following (in thousands):
| | | | | | | | | | | | | | |
| | December 31, | | |
| | 2019 | | 2018 |
Asset-Based Financing: | | | | |
Floor Plan Facility | | $ | 515,487 | | | $ | 196,963 | |
Finance Receivable Facilities | | 53,353 | | | — | |
Financing of beneficial interests in securitizations | | 84,982 | | | — | |
Notes payable | | 31,757 | | | 33,015 | |
Real estate financing | | 177,221 | | | 44,956 | |
Total asset-based financing | | 862,800 | | | 274,934 | |
Senior Notes (1) | | 600,000 | | | 350,000 | |
Total debt | | 1,462,800 | | | 624,934 | |
Less: current portion | | (606,644) | | | (208,096) | |
Less: unamortized premium and debt issuance costs (2) | | (13,642) | | | (7,643) | |
Total long-term debt, net | | $ | 842,514 | | | $ | 409,195 | |
| | | | |
(1) As of both December 31, 2019 and 2018, Verde held $15.0 million of the Senior Notes.
(2) The unamortized debt issuance costs related to long-term debt are presented as a reduction of the carrying amount of the corresponding liabilities on the accompanying consolidated balance sheets. Unamortized debt issuance costs related to revolving debt arrangements are presented within other current assets and other assets on the accompanying consolidated balance sheets. The unamortized premium is presented as an increase to the carrying amount of the Senior Notes on the accompanying consolidated balance sheets.
Short-Term Revolving Facilities
Floor Plan Facility
The Company has a floor plan facility with a lender to finance its used vehicle inventory, which is secured by substantially all of its assets, other than the Company's interests in real property (the "Floor Plan Facility"). The facility has a maturity date of October 31, 2020 and requires monthly interest payments on borrowings under the Floor Plan Facility. The Company most recently amended the Floor Plan Facility in November 2019 to, among other things, increase the available capacity to $950.0 million from $650.0 million, adding flexibility to acquire more vehicles from customers. The annual interest rate was reduced to one-month LIBOR plus 3.15% if the average outstanding balance on the Floor Plan Facility in the previous calendar month is greater than $500.0 million and otherwise remains unchanged from one-month LIBOR plus 3.40%. The amendment also requires that at least 7.5% of the total principal amount owed to the lender is held as restricted cash, a change from 5%.
Repayment in an amount equal to the amount of the advance or loan must be made within five business days of selling or otherwise disposing of the underlying vehicle inventory, unless customers financed the purchase by originating an automotive finance receivable. For used vehicle sales involving financing originated by the Company and sold or pledged under either the
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
MPSA or the Finance Receivable Facilities (as defined below), the lender has extended repayment to the earlier of fifteen business days after the sale of the used vehicle or one day following the sale or pledge of the related finance receivable. With respect to such used vehicle sales involving financing that are not sold or pledged under either the MPSA or the Finance Receivable Facilities, the lender agreed to extend repayment of the advance or the loan for such vehicles to the earlier of fifteen business days after the sale of the vehicle or two business days following the funding of the related finance receivable. Outstanding balances related to vehicles held in inventory for more than 180 days require monthly principal payments equal to 10% of the original principal amount of that vehicle until the remaining outstanding balance is the lesser of (i) 50% of the original principal amount or (ii) 50% of the wholesale value. Prepayments may be made without incurring a premium or penalty. Additionally, the Company is permitted to make prepayments to the lender to be held as principal payments under the Floor Plan Facility and subsequently reborrow such amounts.
As of December 31, 2019, the interest rate on the Floor Plan Facility was approximately 4.91%, the Company had an outstanding balance under this facility of approximately $515.5 million, unused capacity of approximately $434.5 million, and held approximately $38.7 million in restricted cash related to this facility. As of December 31, 2018, the interest rate on the Floor Plan Facility was 5.90%, the Company had an outstanding balance of approximately $197.0 million, and held approximately $9.8 million in restricted cash related to this facility.
Finance LeasesReceivable Facilities
In April 2019, the Company and Ally Bank entered in a Loan and Security Agreement pursuant to which Ally Bank agreed to provide a $300.0 million revolving credit facility (the "DART I Credit Facility") to fund certain automotive finance receivables originated by the Company. The Company can draw upon the DART I Credit Facility until April 17, 2020, and it has an annual interest rate of one-month LIBOR plus a spread ranging from 1.00% to 1.80%.
In May 2019, the Company and Ally Bank entered into the A&R Loan and Security Agreement in connection with the $350.0 million SART 2017-1 Credit Facility to fund certain automotive finance receivables originated by the Company. The Company can draw upon the SART 2017-1 Credit Facility until April 17, 2020, and it has an annual interest rate of one-month LIBOR plus 1.95%.
The DART I Credit Facility and the SART 2017-1 Credit Facility (collectively, the "Finance Receivable Facilities") each require that at least 2% of the outstanding pledged finance receivables principal balances, plus any undistributed amounts collected on the pledged finance receivables amount, is held as restricted cash.
Interest payments on the Finance Receivable Facilities are payable monthly on each draw date. Principal repayments will occur on the fifteenth day of each calendar month in an amount equal to the undistributed receivables collected. The lender will receive repayment in accordance with its respective commitment. Prepayment of the entire aggregate outstanding principal and any accrued unpaid interest through the next draw date is permitted twice per calendar quarter.
As of December 31, 2019, the DART I Credit Facility had an interest rate ranging between approximately 2.76% and 3.56% and the SART 2017-1 Credit Facility had an interest rate of approximately 3.71%. The Company had an outstanding balance under the Finance Receivable Facilities of approximately $53.4 million, unused capacity of $596.6 million, and held approximately $3.7 million in restricted cash related to these facilities.
Long-Term Debt
Senior Unsecured Notes
On September 21, 2018, the Company issued an aggregate of $350.0 million in senior unsecured notes due 2023 (the "Existing Notes") under an indenture entered into by and among the Company, each of the guarantors party thereto and U.S. Bank National Association, as trustee (the "Indenture"). On May 24, 2019, the Company issued $250.0 million in aggregate principal amount of additional notes (the "New Notes") under the Indenture, at a 100.5% premium. The Existing Notes and New Notes (together the "Senior Notes") are treated as a single class for all purposes and have the same terms. The Senior Notes accrue interest at a rate of 8.875% per annum, which is payable semi-annually in arrears on April 1 and October 1 of each year beginning April 1, 2019. The Senior Notes mature on October 1, 2023, unless earlier repurchased or redeemed, and are guaranteed by the Company's existing domestic restricted subsidiaries (other than the subsidiaries formed solely for the purpose of facilitating the Company's sales of its finance receivables, if any). The Company may redeem some or all of the Senior Notes on or after October 1, 2020 at redemption prices set forth in the Indenture, plus any accrued and unpaid interest to the
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
redemption date. Prior to October 1, 2020, the Company may redeem up to 35.0% of the aggregate principal amount of the Senior Notes at a redemption price equal to 108.875%, together with accrued and unpaid interest to, but not including, the date of redemption, with the net cash proceeds of certain equity offerings. In addition, the Company may, at its option, redeem some or all of the Senior Notes prior to October 1, 2020, by paying a make-whole premium plus any accrued and unpaid interest, to, but not including, the redemption date. If the Company experiences certain change of control events, it must make an offer to purchase all of the Senior Notes at 101.0% of the principal amount thereof, plus any accrued and unpaid interest, to the repurchase date.
The Indenture governing the Senior Notes contains restrictive covenants that limit the ability of the Company to, among other things, incur additional debt or issue preferred stock, create new liens, make intercompany payments, pay dividends and make other distributions in respect of the Company's capital stock, redeem or repurchase the Company’s capital stock or prepay subordinated indebtedness, make certain investments or certain other restricted payments, guarantee indebtedness, designate unrestricted subsidiaries, sell certain kinds of assets, enter into certain types of transactions with affiliates, and effect mergers or consolidations. Certain of these covenants will be suspended if the Senior Notes are assigned an investment grade rating from any two of Moody’s Investors Service, Inc., Standard & Poor’s Rating Services, and Fitch Ratings, Inc., and there is no continuing default. As of December 31, 2019, the Company was in compliance with all covenants.
In connection with the issuance of these Senior Notes, Carvana Group amended its LLC agreement to create a class of non-convertible preferred units, which Carvana Co. purchased with its net proceeds from the issuance of these Senior Notes, as further discussed in Note 10 — Stockholders' Equity.
The outstanding principal of the Senior Notes, net of debt issuance costs and including the premium, was approximately $591.1 million and $342.9 million as of December 31, 2019 and December 31, 2018, respectively, of which $15.0 million of principal was held by Verde as of both periods, and is included in long-term debt in the accompanying consolidated balance sheets.
Notes Payable
The Company has entered into promissory note and disbursement agreements to finance certain equipment for its transportation fleet and building improvements. The assets financed with the proceeds from these notes serve as the collateral for each note and certain security agreements related to these assets have cross collateralization and cross default provisions with respect to one another. Each note has a fixed annual interest rate, a two- to five-year term and requires monthly payments. As of December 31, 2019, the outstanding principal of these notes had a weighted-average interest rate of 6.6% and totaled approximately $31.8 million, of which approximately $10.9 million is due within the next twelve months and is included as current portion of long-term debt in the accompanying consolidated balance sheets.
Financing of Beneficial Interests in Securitizations
In June 2019, the Company entered into a secured borrowing facility through which it finances certain retained beneficial interests in securitizations whereby the Company sells such interests and agrees to repurchase them for their fair value at a stated time of repurchase. As discussed in Note 8 — Securitizations and Variable Interest Entities, the Company has retained certain beneficial interests in securitizations pursuant to the Company’s obligations as a sponsor under Risk Retention Rules.
As of December 31, 2019, the Company has pledged approximately $85.0 million of its beneficial interests in securitizations as collateral under the repurchase agreement with expected repurchases ranging from January 2026 to October 2026. The securitization trusts distribute payments related to the Company's pledged beneficial interests in securitizations directly to the lender, which reduces the beneficial interests in securitizations and the related debt balance. Pledged collateral levels are monitored daily and are generally maintained at an agreed-upon percentage of the fair value of the amounts borrowed during the life of the transaction. In the event of a decline in the fair value of the pledged collateral, the repurchase price of the pledged collateral will be increased by the amount of the decline.
The outstanding balance of this facility, net of debt issuance costs, was approximately $82.7 million as of December 31, 2019, of which approximately $26.4 million is included in current portion of long-term debt in the accompanying consolidated balance sheets.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The following table summarizes the aggregate maturities due in each period for notes payable, Senior Notes, and financing of beneficial interests in securitizations as of December 31, 2019 (in thousands). Maturities related to financing of beneficial interests in securitizations are estimated based on expected timing of payments from the securitization trusts to the lender.
| | | | | | |
| | |
2020 | $ | 37,804 | | |
2021 | 36,624 | | |
2022 | 23,198 | | |
2023 | 613,347 | | |
2024 | 5,766 | | |
Thereafter | — | | |
Total | $ | 716,739 | | |
Real Estate Financing
The Company finances certain purchases and construction of its property and equipment through various sale and leaseback transactions. As of December 31, 2019, none of these transactions that do not qualifyhave qualified for sale accounting due to meeting the criteria for finance leases, or forms of continuing involvement. Accordingly,involvement, such as repurchase options or renewal periods that extend the Company recordslease for substantially all of the assetsasset's remaining useful life, and are therefore accounted for as financing transactions. These arrangements require monthly payments and have initial terms of 20 to 25 years. Some of the agreements are subject to renewal options of up to 25 years and some are subject to base rent increases throughout the term. As of December 31, 2019 and 2018, the outstanding liability associated with these transactions within propertysale and equipmentleaseback arrangements, net of unamortized debt issuance costs, was approximately $174.7 million and the sales proceeds as finance leases within$44.4 million, respectively, and was included in long-term debt in the accompanying consolidated balance sheets. Required monthly payments, less
In November 2017, the portion consideredCompany entered into a master sale-leaseback agreement (the "Master Sale-Leaseback Agreement" or "MSLA"), which was amended in November 2018, pursuant to which it may sell and lease back certain of its owned or leased properties and construction improvements. Under the MSLA, at any time the Company may elect to, and beginning in November 2020 or until a property owner of a leased site consents to the sale-leaseback, the purchaser has the right to demand that the Company repurchase 1 or more properties sold and leased back pursuant to the MSLA for an amount equal to the repurchase price. Repurchase prices are defined in each of the applicable leases and are generally the original purchase prices plus any accrued and unpaid rent. Under the MSLA, the total sales price of properties the Company has sold and is leasing back at any point in time is limited to $75.0 million. By December 31, 2018, the Company repurchased all properties it had previously sold under the MSLA for a price of approximately $28.8 million. As of December 31, 2019, the Company may sell and lease back approximately $75.0 million of its property and equipment under the MSLA.
NOTE 10 — STOCKHOLDERS' EQUITY
Organizational Transactions
Immediately prior to the IPO, Carvana Co. amended and restated its certificate of incorporation to, among other things authorize (i) 50.0 million shares of Preferred Stock, par value $0.01 per share, (ii) 500.0 million shares of Class A common stock, par value $0.001 per share, and (iii) 125.0 million shares of Class B common stock, par value $0.001 per share. On December 5, 2017, Carvana Co. amended and restated its certificate of incorporation to authorize 100,000 shares of Convertible Preferred Stock, with an initial stated value of $1,000 per share and a par value of $0.01 per share. Each share of Class A common stock generally entitles its holder to 1 vote on all matters to be interest expense, reducevoted on by stockholders. Each share of Class B common stock held by the corresponding liabilities. See Note 7 — Debt InstrumentsGarcia Parties generally entitles its holder to 10 votes on all matters to be voted on by stockholders, for additional information on finance leases.
Other Current Assets
Other current assets consistso long as the Garcia Parties maintain direct or indirect beneficial ownership of various items, including, among other items, software licenses and subscriptions, prepaid expenses, debt issuance costs on revolving debt instruments, deposits and commitment fees related to the Company's finance receivable sale agreements.
Other Assets
Other assets consist of various items, including, among other items, the purchase price adjustment receivable based on the performanceat least 25% of the Company's finance receivables, depositsoutstanding shares of Carvana Co.'s Class A common stock determined on an as-exchanged basis assuming that all of the Class A Units and debt issuance costsClass B Units were exchanged for Class A common stock. All other shares of Class B common stock generally entitle their holders to 1 vote per share on revolving debt instruments.
Accrued Liabilities
Accrued liabilities consist of various items payable within one year including, among other items, accruals for capital expenditures, sales tax, compensation and benefits, vehicle licenses and fees, inventory costs and advertising expenses.
Other Liabilities
Other liabilities consist of various items payable beyond one year including, among other items, the long-term portion of deferred rent. Other liabilities also include itemsall matters to be recognized beyond one year includingvoted on by stockholders. Holders of Class B common stock are not entitled to receive dividends and would not be entitled to receive any distributions upon the long-term portionliquidation, dissolution or winding down of the tenant improvement allowance associated with the Company's corporate headquarters.Company. Holders of Class A and Class B common stock vote together as a single class on all matters presented to stockholders for their vote or approval, except as otherwise required by applicable law.
Revenue Recognition
Revenue consists of used vehicle sales, wholesale vehicle sales and other sales and revenues. The Company recognizes revenue when the earnings process is complete.
Used Vehicle Sales
The Company sells used vehicles directly to its customers through its website. Revenue from used vehicle sales is recognized upon delivery, when the sales contract is signed and the purchase price has been received or financing has been arranged. Used vehicle sales revenue is recognized net of a reserve for returns, which is estimated using historical experience and trends. Revenues exclude any sales taxes that are collected from customers.
Wholesale Vehicle Sales
The Company sells vehicles to wholesalers. These vehicles sold to wholesalers are primarily acquired from customers who trade-in their existing vehicles that do not meet the Company’s quality standards to list and sell through its website. Revenue from wholesale vehicle sales is recognized when the vehicle is sold at auction or directly to a wholesaler.
Other Sales and Revenues
Other sales and revenues include commissions on vehicle service contracts (“VSCs”), gains on the sales of finance receivables, GAP waiver coverage, interest income received on finance receivables prior to selling them to investors and delivery fee revenues charged to customers taking delivery of purchased used vehicles outside the Company’s free delivery area.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
As described in Note 1 — Business Organization, Carvana Group amended and restated its LLC Agreement to, among other things, provide for 2 classes of common ownership interests in Carvana Group. Carvana Group’s 2 remaining classes of common ownership interests are Class A Units and Class B Units. Carvana Co. is required to, at all times, maintain (i) a four-to-five ratio between the number of shares of Class A common stock issued by Carvana Co. and the number of Class A Units owned by Carvana Co. (subject to certain exceptions for treasury shares and shares underlying certain convertible or exchangeable securities and subject to adjustment as set forth in the exchange agreement (the "Exchange Agreement") further discussed below, and taking into account Carvana Sub’s 0.1% ownership interest in Carvana, LLC) and (ii) a four-to-five ratio between the number of shares of Class B common stock owned by the Original LLC Unitholders and the number of Class A Units owned by the Original LLC Unitholders. The Company may issue shares of Class B common stock only to the extent necessary to maintain these ratios. Shares of Class B common stock are transferable only if an Original LLC Unitholder elects to exchange them, together with 1.25 times as many LLC Units, for consideration from the Company. Such consideration from the Company can be, at the Company's election, either shares of Class A common stock or cash.
As of December 31, 2019, there were approximately 189.7 million and 4.9 million Class A Units and Class B Units (as adjusted for the participation thresholds and closing price of Class A common stock on December 31, 2019), respectively, issued and outstanding. As of December 31, 2018, there were approximately 182.3 million and 5.6 million Class A Units and Class B Units (as adjusted for the participation thresholds and closing price of Class A common stock on December 31, 2018), respectively, issued and outstanding. As discussed in Note 12 — Equity-Based Compensation, Class B Units were issued under the Company’s LLC Equity Incentive Plan through the completion of the IPO (the "LLC Equity Incentive Plan"), are subject to a participation threshold, and are earned over the requisite service period.
Initial Public Offering
As described in Note 1 — Business Organization, on May 3, 2017, Carvana Co. completed its IPO of 15.0 million shares of Class A common stock at a public offering price of $15.00 per share. Carvana Co. received approximately $205.8 million in proceeds, net of underwriting discounts and commissions and offering expenses. Carvana Co. used the proceeds to purchase approximately 18.8 million newly-issued LLC Units of Carvana Group at a price per unit equal to 0.8 times the initial public offering price less underwriting discounts and commissions. In connection with the IPO, Carvana Co. transferred approximately 0.2 million Class A Units to Ernest Garcia II in exchange for his 0.1% ownership interest in Carvana, LLC, a majority-owned subsidiary of Carvana Group. After the transfer Carvana Co. owned approximately 18.6 million Class A Units.
The Company incurred approximately $4.9 million of legal, accounting, printing, and other professional fees directly related to the IPO, including $1.3 million incurred during 2016, of which $0.4 million were paid during 2016. Upon completion of the IPO, the total costs incurred for the IPO were charged against additional paid-in capital.
Public Equity Offerings
On April 30, 2018, the Company completed a follow-on offering of 6.6 million shares of its Class A common stock at a public offering price of $27.50 per share and received net proceeds from the offering of approximately $172.3 million after underwriting discounts and commissions and offering expenses.
The Company sellsSelling Stockholder and receivesthe Selling LLC Unitholders sold a commission on VSCs. Priortotal of approximately 6.1 million shares of Class A common stock as part of the offering. The Selling LLC Unitholders exchanged approximately 6.9 million LLC Units for approximately 5.6 million shares of Class A common stock to December 9, 2016,be sold in the VSCsoffering, and to the extent such Selling LLC Unitholder held Class B common stock, the corresponding shares of Class B common stock were sold and administeredimmediately retired by third parties. On December 9, 2016, the Company entered into a master dealer agreement with DriveTime, pursuant to which the Company sells VSCs that DriveTime administers and is the obligor.Company. The Company recognizes commission revenue at the time of sale, net of a reserve for estimated contract cancellations. The reserve for cancellations is estimated based upon historical experience and recent trends and is reflected as a reduction of other sales and revenues on the accompanying consolidated statements of operations and a component of accounts payable and accrued liabilities on the accompanying consolidated balance sheets.
The Company originates finance receivables to facilitatedid not receive any proceeds from the sale of used vehiclesthe approximately 6.1 million shares of Class A common stock by the Selling Stockholder and sells them to both third parties and, tothe Selling LLC Unitholders.
On May 24, 2019, the Company completed a lesser extent, related parties. Any unsold finance receivables at the endfollow-on offering of 4.2 million shares of the reporting period are reportedCompany's Class A common stock at a public offering price of $65.00 per share and received net proceeds from the offering of a valuation allowance as finance receivables held for sale onapproximately $258.8 million after underwriting discounts and commissions and offering expenses. As part of the accompanying consolidated balance sheets. Interest income is recognized on a cash basis whenoffering, the Company receives periodic payments contractually due from customers priorgranted the underwriters a 30-day option to sellingpurchase all or part of approximately 0.6 million additional shares of Class A common stock. On June 20, 2019, the underlying finance receivable.underwriters exercised their option in full for an additional $38.9 million in proceeds after offering expenses.
The Company accounts for the sale of finance receivables in accordance with ASC Topic 860, Transfers and Servicing of Financial Assets. ASC 860 states that a transfer of an entire financial asset, a group of entire financial assets, or a participating interest in an entire financial asset in which the transferor surrenders control over those financial assets is accounted for as a sale only if all of the following conditions are met:
•The transferred financial assets have been isolated from the transferor — put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership.
•Each transferee has the right to pledge or exchange the assets (or beneficial interests) it received, and no condition both constrains the transferee (or third-party holder of its beneficial interests) from taking advantage of its right to pledge or exchange the asset and provides more than a trivial benefit to the transferor.
•The transferor, its consolidated affiliates included in the financial statements being presented or its agents do not maintain effective control over the transferred financial assets or third-party beneficial interests related to those transferred assets.
For the years ended December 31, 2017, 2016 and 2015, all transfers of finance receivables met the requirements for sale treatment. The Company records the gain or loss on the sale of a finance receivable upon cash receipt, in an amount equal to the net proceeds received less the carrying amount of the finance receivable.
Customers that finance their vehicle purchase with the Company may purchase GAP waiver coverage, which provides customers with the promise that whomever then holds the underlying finance receivable will not attempt collection of a loan balance that is in excess of the value of the financed vehicle in the event of a total loss. GAP waiver coverage is recognized over the period of protection, generally the term of the related finance receivable. Upon selling the finance receivable, the Company recognizes any remaining deferred revenue. DriveTime administers the GAP waiver coverage.
Cost of Sales
Cost of sales includes the cost to acquire used vehicles and direct and indirect vehicle reconditioning costs associated with preparing the vehicles for resale. Vehicle reconditioning costs include parts, labor, inbound transportation costs and other incremental overhead costs, which are allocated to inventory via specific identification and standard costing. Occupancy and labor costs incurred in connection with expanding production capacity are expensed as incurred as a component of selling, general and administrative expense. The Company has certain inventory that does not meet its specifications to sell to customers and disposes of this inventory through sales at auction or through other channels. The cost of these disposals are recorded on a net basis in cost of sales. Cost of sales also includes any necessary adjustments to reflect vehicle inventory at the lower of cost or net realizable value.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Exchange Agreement
Carvana Co. and the LLC Unitholders entered into an Exchange Agreement under which each LLC Unitholder (and certain permitted transferees thereof) may receive shares of the Company's Class A common stock in exchange for their LLC Units on a four-to-five conversion ratio, or cash at the option of the Company, subject to conversion ratio adjustments for stock splits, stock dividends, reclassifications, and similar transactions and subject to vesting for certain Class A Units and subject to vesting and the respective participation threshold for Class B Units. To the extent such owners also hold Class B common stock, they will be required to deliver to Carvana Co. a number of shares of Class B common stock equal to the number of shares of Class A common stock being exchanged for. Any shares of Class B common stock so delivered will be canceled. The number of exchangeable Class B Units is determined based on the value of Carvana Co.'s Class A common stock and the applicable participation threshold.
During the years ended December 31, 2019 and December 31, 2018, certain LLC Unitholders exchanged 5.4 million and 14.2 million LLC Units and 3.1 million and 10.3 million shares of Class B common stock for 4.3 million and 11.3 million newly-issued shares of Class A common stock, respectively. Simultaneously, and in connection with these exchanges, Carvana Co. received 5.4 million and 14.2 million LLC Units during the years ended December 31, 2019 and December 31, 2018, respectively, increasing its total ownership interest in Carvana Group, and canceled the exchanged shares of Class B common stock.
Class C Redeemable Preferred Units
On April 27, 2016, the Company authorized the issuance of and sold approximately 18.3 million Class C Redeemable Preferred Units for approximately $100.0 million to Ernest Garcia II. On July 12, 2016, the Company authorized the issuance of and sold approximately 8.6 million Class C Redeemable Preferred Units to CVAN Holdings, LLC, and approximately 1.7 million Class C Redeemable Preferred Units to GV Auto I, LLC for approximately $50.0 million and $9.7 million, respectively. On December 9, 2016, the Company authorized the issuance of and sold approximately 0.5 million Class C Redeemable Preferred Units to the Fidel Family Trust for approximately $2.7 million. The Company recorded the issuance and sale of Class C Redeemable Preferred Units at fair value, net of issuance costs.
In accordance with the Company’s Operating Agreement, the Class C Redeemable Preferred Units accrued a return (the "Class C Return") at a coupon rate of 12.5% compounding annually on the aggregate amount of capital contributions made with respect to the Class C Redeemable Preferred Units.
On May 3, 2017, the Company closed its IPO at a price such that the Company is no longer liable for the accrued Class C Return, and the 43.1 million outstanding Class C Redeemable Preferred Units converted to Class A Units on a 1-to-one basis and the related balance became a component of permanent equity on the accompanying consolidated balance sheet.
Convertible Preferred Stock
On December 5, 2017, Carvana Co. sold 100,000 shares of Convertible Preferred Stock for a purchase price of $100.0 million and net proceeds of approximately $98.5 million, which it used to purchase 100,000 Convertible Preferred Units of Carvana Group at a price per unit equal to the initial stated value of the Convertible Preferred Stock less issuance costs. The Convertible Preferred Stock has a par value of $0.01 per share and a liquidation value of $1,000 per share.
At the holder's request beginning on January 29, 2018, any or all shares of the Convertible Preferred Stock were convertible into shares of Class A common stock at an initial conversion rate of 50.78 shares of Class A common stock per share of Convertible Preferred Stock. On or after December 5, 2018, the Company had the option to cause all shares of Convertible Preferred Shares to be converted into shares of Class A common stock or cash, at the Company's election, if the 10-day volume-weighted average price equaled or exceeded 150% of the conversion price as set forth in the agreement. In the event Carvana Co. issued any shares of Class A common stock upon conversion of any shares of Convertible Preferred Stock or in connection with any change of control repurchase of shares of Convertible Preferred Stock, a corresponding number of Convertible Preferred Units would be canceled and cease to be outstanding, and Carvana Group would issue Class A Units to Carvana Co. on a four-to-five ratio between the number of shares of Class A common stock issued by Carvana Co. to the holders of the Convertible Preferred Stock and the number of Class A Units issued.
During the year ended December 31, 2018, at the holder's request 75,000 shares of Convertible Preferred Stock, and at the Company's election 25,000 shares of Convertible Preferred Stock, were converted into a total of approximately 5.1 million
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
shares of Class A common stock. Simultaneously, and in connection with these conversions, 100,000 Convertible Preferred Units were canceled and Carvana Group issued approximately 6.3 million Class A Units to Carvana Co.
Selling, GeneralThe initial conversion price was $19.6945, which was calculated based on a 20.0% premium to the volume weighted average price for Class A common stock during the 5 trading days immediately preceding December 4, 2017. Following announcement of the transaction, the share price of Class A common stock increased and Administrative Expensesexceeded the conversion price on the commitment date and resulted in a beneficial conversion feature ("BCF") of approximately $2.6 million. The BCF was originally recorded as a reduction of the Convertible Preferred Stock with an offset to additional paid-in capital. The BCF accreted as a deemed dividend through January 29, 2018, the first available conversion date, increasing the carrying value of the Convertible Preferred Stock with an offsetting charge to additional paid-in capital. During the year ended December 31, 2018, the Company recorded approximately $1.4 million in accretion related to the BCF.
Selling,Upon a change of control, as defined in the agreement, any holder of Convertible Preferred Stock had the option to require the Company (or its successor) to purchase, any or all of its Convertible Preferred Stock at a purchase price per share, payable at the Company’s option in any combination of cash or shares of Class A common stock, of 101% of the liquidation preference, plus all accumulated dividends.
Holders of the Convertible Preferred Stock had no voting rights. The Convertible Preferred Stock ranked senior, as to payment of dividends and distributions of assets upon the liquidation, dissolution or winding up of Company, to the Company’s common stock and any shares of capital stock of the Company not expressly ranking senior to or pari passu with the Convertible Preferred Stock, and junior to all shares of capital stock of the Company issued after the issuance of the Convertible Preferred Stock, if the terms of which expressly provided that such shares would rank senior to the Convertible Preferred Stock.
The Convertible Preferred Stock accrued dividends at 5.5% per annum of the liquidation preference of $1,000 per share. The dividends were payable in cash quarterly commencing March 15, 2018 so long as the Company had funds legally available and the Board declared a cash dividend payable. The Company could not declare dividends on shares of its common stock or purchase or redeem shares of its common stock, unless all accumulated and unpaid dividends on the Convertible Preferred Stock had been paid in full or a sum for such amounts had been set aside for payment. As the Company declared and paid dividends on the Convertible Preferred Stock, Carvana Group made distributions to Carvana Co. with respect to the Convertible Preferred Units in an amount equal to the related Convertible Preferred Stock dividend amount and any corresponding tax payments.
During the year ended December 31, 2018, the Company paid approximately $4.6 million of dividends to the holders of the Convertible Preferred Stock and Carvana Group distributed approximately $4.6 million to Carvana Co. with respect to the Convertible Preferred Units.
As of December 31, 2018, there were 0 outstanding shares of Convertible Preferred Stock and 0 related accrued dividends.
Class A Non-Convertible Preferred Units
On October 2, 2018, Carvana Group amended its LLC Agreement to create a class of non-convertible preferred units (the "Class A Non-Convertible Preferred Units"), effective September 21, 2018. The Class A Non-Convertible Preferred Units were created in connection with Carvana Co.'s issuance of the Senior Notes in September 2018 and May 2019, as discussed further in Note 9 — Debt Instruments. Carvana Co. used its net proceeds from the Senior Notes to purchase 600,000 Class A Non-Convertible Preferred Units. In the event Carvana Co. makes payments on the Senior Notes, Carvana Group will make an equal cash distribution, as necessary, to the Class A Non-Convertible Preferred Units. For each $1,000 principal amount of Senior Notes that Carvana Co. repays or otherwise retires, 1 Class A Non-Convertible Preferred Unit shall be canceled and retired.
Contributions of Class A Common Shares From Ernest Garcia III
During the years ended December 31, 2019 and 2018, the Company and its Chief Executive Officer, Ernest Garcia III, entered into contribution agreements (the "Contribution Agreements") in connection with the 100k Milestone Gift, as defined in Note 6 — Related Party Transactions. Pursuant to the Contribution Agreements, Mr. Garcia contributed approximately 0.2 million shares during both of the years ended December 31, 2019 and 2018 of the Company's Class A common stock to the Company, at 0 charge. The Company subsequently granted approximately 0.2 million restricted stock units during both of the
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
years ended December 31, 2019 and 2018 to employees. Refer to Note 12 — Equity-Based Compensation for further discussion. Although the Company does not expect Mr. Garcia to incur any tax obligations related to the Share Contributions, it has indemnified Mr. Garcia from any such obligations that may arise.
NOTE 11 — NON-CONTROLLING INTERESTS
As discussed in Note 1 — Business Organization, Carvana Co. consolidates the financial results of Carvana Group and reports a non-controlling interest related to the portion of Carvana Group owned by the LLC Unitholders. Changes in the ownership interest in Carvana Group while Carvana Co. retains its controlling interest will be accounted for as equity transactions. Exchanges of LLC Units result in a change in ownership and reduce the amount recorded as non-controlling interests and increase additional paid-in capital.
Upon the issuance of shares of Class A common stock by Carvana Co. related to the Company's equity compensation plans such as the issuance of restricted or non-restricted stock, exercise of options, payment of bonuses in stock or settlement of stock appreciation rights in stock, Carvana Group is required to issue to Carvana Co. a number of Class A Units equal to 1.25 times the number of shares of Class A common stock being issued in connection with the exercise of such options or issuance of other types of equity compensation, subject to adjustment for stock splits, stock dividends, reclassifications, and similar transactions. Activity related to the Company's equity compensation plans may result in a change in ownership which will impact the amount recorded as non-controlling interest and additional paid-in capital.
The non-controlling interest related to the Class B Units is determined based on the respective participation thresholds and the share price of Class A common stock on an as-converted basis. To the extent that the number of as-converted Class B Units change or Class B Units are forfeited, the resulting difference in ownership will be accounted for as equity transactions adjusting the non-controlling interest and additional paid-in capital.
During the year ended December 31, 2019, the total adjustments related to exchanges of LLC Units was a decrease in non-controlling interests and a corresponding increase in additional paid-in capital of approximately $4.9 million, which has been included in exchanges of LLC Units in the accompanying consolidated statement of stockholders' equity. During the year ended December 31, 2019, Carvana Co. utilized its net proceeds from its equity offering to purchase LLC Units, which resulted in an adjustment to increase non-controlling interests and to decrease additional paid-in capital by approximately $201.0 million, which has been included in adjustment to non-controlling interests related to equity offering in the accompanying consolidated statement of stockholders' equity.
During the year ended December 31, 2018, the total adjustments related to exchanges of LLC Units was a decrease in non-controlling interests and a corresponding increase in additional paid-in capital of approximately $15.8 million, which has been included in exchanges of LLC Units in the accompanying consolidated statement of stockholders' equity. During the year ended December 31, 2018, Carvana Co. utilized its net proceeds from its equity offering to purchase LLC Units, which together with the equity offering resulted in an adjustment to increase non-controlling interests and to decrease additional paid-in capital by approximately $132.4 million, which has been included in adjustment to noncontrolling interests related to equity offering in the accompanying consolidated statement of stockholders' equity. During the year ended December 31, 2018, Carvana Group issued approximately 0.5 million Class A Units with a fair value of approximately $10.0 million as part of the purchase price consideration for Car360, which is reflected as an increase in non-controlling interests in the accompanying consolidated statement of stockholders' equity. The adjustment related to the issuance of Class A Units to acquire Car360 was a decrease in non-controlling interests and a corresponding increase in additional paid-in capital of approximately $1.3 million, which has been included in adjustment to non-controlling interests related to business acquisitions in the accompanying consolidated statement of stockholders' equity. During the year ended December 31, 2018, the 100,000 shares of Convertible Preferred Stock converted into approximately 5.1 million shares of Class A common stock, Carvana Co. canceled and retired 100,000 Convertible Preferred Units, and Carvana Group issued approximately 6.3 million Class A Units to Carvana Co. The adjustment related to the conversion of Convertible Preferred Stock was an increase in non-controlling interests and a corresponding decrease in additional paid-in capital of approximately $68.0 million, which has been included in adjustment to non-controlling interests related to conversion of Class A Convertible Preferred Stock in the accompanying consolidated statement of stockholders' equity.
During the year ended December 31, 2017, the total adjustments related to exchanges of LLC Units was a decrease in non-controlling interests and a corresponding increase in additional paid-in capital of approximately $3.6 million, which has been included in exchanges of LLC Units in the accompanying consolidated statement of stockholders' equity. During the year ended December 31, 2017, the total adjustments related to equity compensation plan activity, changes in the number of as-converted
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Class B Units and forfeitures of Class B Units, was a decrease in non-controlling interests and a corresponding increase in additional paid-in capital of approximately $0.3 million, which has been included in adjustments to non-controlling interests in the accompanying consolidated statement of stockholders' equity.
As of December 31, 2019, Carvana Co. owned approximately 32.3% of Carvana Group with the LLC Unitholders owning the remaining 67.7%. The net loss attributable to the non-controlling interests on the accompanying consolidated statements of operations represents the portion of the net loss attributable to the economic interest in Carvana Group held by the non-controlling LLC Unitholders calculated based on the weighted average non-controlling interests' ownership during the periods presented.
The following table summarizes the effects of changes in ownership in Carvana Group on the Company's equity during the years ended December 31, 2019, 2018, and 2017 (in thousands):
| | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, | | | | |
| 2019 | | 2018 | | 2017 |
| | | | | |
Transfers (to) from non-controlling interests: | | | | | | | |
Decrease as a result of issuance of Class A common stock | $ | (201,015) | | | $ | (132,375) | | | $ | (174,144) | |
| | | | | |
Increase as a result of Carvana Group's issuance of Class A Units in connection with business acquisitions | — | | | 1,297 | | | — | |
Increase as a result of exchanges of LLC Units | 4,948 | | | 15,828 | | | 3,631 | |
Decrease as a result of conversion of Class A Convertible Preferred Stock | — | | | (67,972) | | | — | |
Increase as a result of adjustments to the non-controlling interests | — | | | — | | | 340 | |
Total transfers to non-controlling interests | $ | (196,067) | | | $ | (183,222) | | | $ | (170,173) | |
NOTE 12 — EQUITY-BASED COMPENSATION
Equity-based compensation is recognized based on amortizing the grant-date fair value on a straight-line basis over the requisite service period, which is generally the vesting period of the award, less actual forfeitures. A summary of equity based compensation recognized during the years ended December 31, 2019, 2018, and 2017 is as follows (in thousands):
| | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, | | | | |
| 2019 | | 2018 | | 2017 |
Class B Units | $ | 2,361 | | | $ | 2,474 | | | $ | 1,771 | |
Restricted Stock Units and Awards excluding those granted in relation to the 100k Milestone Gift | 13,057 | | | 6,897 | | | 2,662 | |
Restricted Stock Units granted in relation to the 100k Milestone Gift | 12,694 | | | 12,120 | | | — | |
Options | 5,377 | | | 2,357 | | | 1,178 | |
Class A Units | 2,184 | | | 1,897 | | | — | |
Total equity-based compensation | 35,673 | | | 25,745 | | | 5,611 | |
Equity-based compensation capitalized to property and equipment | (2,610) | | | (1,650) | | | — | |
Equity-based compensation capitalized to inventory | (4,505) | | | (3,776) | | | — | |
Equity-based compensation, net of capitalized amounts | $ | 28,558 | | | $ | 20,319 | | | $ | 5,611 | |
During the years ended December 31, 2019, 2018, and 2017 the Company capitalized approximately $2.6 million, $1.7 million, and $0.0 million, respectively, of equity-based compensation to property and equipment related to software development and real estate projects and approximately $4.5 million, $3.8 million, and $0.0 million, respectively, to inventory related to reconditioning and inbound transportation of vehicles. Prior to 2018, amounts capitalized to property and equipment and inventory were immaterial. All other equity-based compensation is included in selling, general, and administrative (“SG&A”) expenses primarily includein the accompanying consolidated statements of operations.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
As of December 31, 2019, unrecognized equity-based compensation related to outstanding awards and benefits, advertising, depreciation expense, facilities costs, technology expenses, fulfillmentthe related weighted-average period over which it is expected to be recognized subsequent to December 31, 2019 is presented in the table below. Total unrecognized equity-based compensation will be adjusted for actual forfeitures.
| | | | | | | | | | | |
| Unrecognized Equity-Based Compensation Related to Outstanding Awards (in thousands) | | Remaining Weighted-Average Amortization Period (in years) |
Class B Units | $ | 2,253 | | | 1.9 |
Restricted Stock Units and Awards | 36,136 | | | 3.0 |
Options | 13,819 | | | 2.8 |
Class A Units | 3,217 | | | 2.1 |
Total unrecognized equity-based compensation | $ | 55,425 | | | |
2017 Omnibus Incentive Plan
In connection with the IPO, the Company adopted the 2017 Omnibus Incentive Plan (the "2017 Incentive Plan"). Under the 2017 Incentive Plan 14.0 million shares of Class A common stock are available for issuance, which the Company may grant as stock options, stock appreciation rights, restricted stock, restricted stock units ("RSUs") and other administrative expenses,stock-based awards to employees, directors, officers, and consultants. The majority of the Company's equity awards, other than those granted in relation to Mr. Garcia's 100k Milestone Gift, vest over two- to five-year periods based on continued employment with the Company. As of December 31, 2019, approximately 10.8 million shares remain available for future equity-based award grants under this plan.
Restricted Stock Awards and Restricted Stock Units
Restricted stock awards ("RSAs") entitle recipients to vote and to receive all dividends declared with respect to such shares, payable upon vesting. RSAs vest over a period of two to five years, subject to the recipient's continued employment or service. The Company did 0t grant any RSAs during the year ended December 31, 2019. During the years ended December 31, 2018 and 2017, the Company issued certain employees and consultants an aggregate of approximately 0.1 million and 0.6 million RSAs, respectively, pursuant to the terms of the 2017 Incentive Plan with a weighted-average grant-date fair value of $45.05 and $16.97, respectively. The Company determined the grant-date fair value of the RSAs granted during the years ended December 31, 2018 and 2017 based on the closing price of the Company's Class A common stock on the grant date.
Restricted stock units ("RSUs") do not entitle recipients to vote or receive dividends. RSUs generally vest over a period of one to five years, subject to the recipient's continued employment. During the years ended December 31, 2019, 2018, and 2017, the Company issued certain employees an aggregate of approximately 0.7 million, 0.7 million, and 22,000 RSUs, respectively, pursuant to the terms of the 2017 Incentive Plan with a weighted-average grant-date fair value of $60.91, $46.41, and $20.64, respectively. The Company determined the grant-date fair value of the RSUs granted during the years ended December 31, 2019, 2018, and 2017 based on the closing price of the Company's Class A common stock on the grant date. RSUs are settled in shares of Class A common stock on a 1-to-one basis within thirty days of vesting. As discussed in Note 10 — Stockholders' Equity, included in these RSUs, in connection with the 100k Milestone Gift, during both the years ended December 31, 2019 and 2018 the Company granted approximately 0.2 million RSUs with a vesting period of one week or less following receipt of Class A common stock from its Chief Executive Officer, Ernest Garcia III. The Company recognized approximately $12.7 million and $12.1 million during the years ended December 31, 2019 and 2018, respectively, of equity-based compensation, a portion of which related to reconditioning vehiclesthe production of the Company's used vehicle inventory and inbound transportation.was therefore capitalized to inventory.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
RSA and RSU activity during the years ended December 31, 2019, 2018, and 2017 was as follows:
| | | | | | | | | | | |
| Number of RSAs/RSUs (in thousands) | | Weighted-Average Grant-Date Fair Value |
Outstanding at January 1, 2017 | — | | | n/a | |
Granted | 584 | | | $ | 17.11 | |
Settled | (135) | | | $ | 15.91 | |
Forfeited | (29) | | | $ | 15.06 | |
Outstanding at December 31, 2017(1) | 420 | | | $ | 17.63 | |
| | | |
Granted | 791 | | | $ | 46.19 | |
Settled | (391) | | | $ | 42.35 | |
Forfeited | (56) | | | $ | 21.64 | |
Outstanding at December 31, 2018(1) | 764 | | | $ | 34.25 | |
| | | |
Granted | 672 | | | $ | 60.91 | |
Settled | (461) | | | $ | 45.05 | |
Forfeited | (47) | | | $ | 37.15 | |
Outstanding at December 31, 2019(1) | 928 | | | $ | 48.04 | |
(1) All outstanding RSAs and RSUs at December 31, 2019, 2018, and 2017 are nonvested.
Non-Qualified Stock Options
Non-qualified stock options allow recipients to purchase shares of Class A common stock at a fixed exercise price. The fixed exercise price is equal to the price of a share of Class A common stock at the time of grant. The options typically vest 20% or 25% on the anniversary of the grant date and in equal monthly installments thereafter for a total vesting period of four or five years and expire ten years after the grant date.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Stock option activity during the years ended December 31, 2019, 2018, and 2017 was as follows (shares and intrinsic value in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Number of Options | | Weighted-Average Exercise Price | | Weighted-Average Remaining Contractual Life (in years) | | Aggregate Intrinsic Value |
Outstanding at January 1, 2017 | — | | | | | | | |
Options granted | 784 | | | $ | 15.58 | | | | | n/a | |
Options exercised | (3) | | | $ | 15.00 | | | | | $ | 14 | |
Options forfeited or expired | (26) | | | $ | 15.00 | | | | | n/a | |
Outstanding at December 31, 2017 | 755 | | | $ | 15.60 | | | 9.5 | | $ | 3,000 | |
| | | | | | | |
Options granted | 294 | | | $ | 44.81 | | | | | |
Options exercised | (60) | | | $ | 13.26 | | | | | $ | 1,224 | |
Options forfeited or expired | (58) | | | $ | 16.15 | | | | | |
Outstanding at December 31, 2018 | 931 | | | $ | 24.95 | | | 8.9 | | $ | 11,306 | |
| | | | | | | |
Options granted | 364 | | | $ | 37.70 | | | | | |
Options exercised | (104) | | | $ | 16.28 | | | | | $ | 5,388 | |
Options forfeited or expired | (44) | | | $ | 17.53 | | | | | |
Outstanding at December 31, 2019 | 1,147 | | | $ | 30.07 | | | 8.3 | | $ | 71,101 | |
| | | | | | | |
Vested and exercisable as of December 31, 2019 | 338 | | | $ | 24.64 | | | 7.8 | | $ | 22,784 | |
Expected to vest as of December 31, 2019 | 809 | | | $ | 32.33 | | | 8.5 | | $ | 48,317 | |
The Company determined the grant-date fair value of the options granted during the years ended December 31, 2019, 2018, and 2017 using the Black-Scholes valuation model with the following weighted-average assumptions:
| | | | | | | | | | | | | | | | | |
| Years Ended December 31, | | | | |
| 2019 | | 2018 | | 2017 |
Expected volatility(1) | 66.7 | % | | 65.5 | % | | 63.0 | % |
Expected dividend yield | — | % | | — | % | | — | % |
Expected term (in years)(2) | 6.11 | | 6.00 | | 6.27 |
Risk-free interest rate | 2.5 | % | | 3.0 | % | | 2.0 | % |
Weighted-average grant-date fair value per option | $23.87 | | $26.93 | | $9.18 |
(1) Measured using the Company's historical data and selected high-growth guideline companies and considering the risk factors that would influence the range of expected volatility because the Company does not have sufficient historical data to provide a reasonable basis upon which to estimate the expected volatility for the entirety of the term.
(2) Expected term represents the estimated period of time until an option is exercised and was determined using the simplified method because the Company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term.
Class A Units
During the year ended December 31, 2018, the Company granted certain employees approximately 0.4 million Class A Units with service-based vesting over two- to four-year periods and a grant-date fair value of $18.58 per Class A Unit. The grantees entered into the Exchange Agreement under which each LLC Unitholder (and certain permitted transferees thereof) may receive shares of the Company's Class A common stock in exchange for their LLC Units on a four-to-five conversion ratio,
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
or cash at the option of the Company, subject to conversion ratio adjustments for stock splits, stock dividends, reclassifications, and similar transactions and subject to vesting.
A summary of the Class A Unit activity for the years ended December 31, 2019 and 2018 is as follows:
| | | | | | | | | | | |
| Class A Units | | |
| Number of Class A Units (in thousands) | | Weighted-Average Grant Date Fair Value |
Outstanding at January 1, 2018 | — | | | n/a | |
Granted | 393 | | | $ | 18.58 | |
Exchanged | — | | | n/a | |
Forfeited | — | | | n/a | |
Outstanding at December 31, 2018 | 393 | | | |
| | | |
Granted | — | | | n/a | |
Exchanged | (172) | | | $ | 18.58 | |
Forfeited | — | | | n/a | |
Outstanding at December 31, 2019 | 221 | | | |
| | | |
Vested as of December 31, 2019 | 18 | | | $ | 18.58 | |
Expected to vest as of December 31, 2019 | 203 | | | $ | 18.58 | |
Class B Units
In March 2015, Carvana Group adopted the LLC Equity Incentive Plan. Under the LLC Equity Incentive Plan, Carvana Group could grant Class B Units to eligible employees, non-employee officers, consultants and directors with service vesting conditions. In connection with the completion of the IPO, Carvana Group discontinued the grant of new awards under the LLC Equity Incentive Plan, however the LLC Equity Incentive Plan will continue in connection with administration of existing awards that remain outstanding. The awards granted under the LLC Equity Incentive Plan are earned over the requisite service period, which is typically four to five years, and must meet the participation threshold requirements to participate in any distributions. As of December 31, 2019, outstanding Class B Units had participation thresholds between $0.00 to $12.00. Vested Class B Units participate in any distributions of Carvana Group in excess of those required for the Class A Units subject to the participation threshold. As discussed in Note 10 — Stockholders' Equity, participants may receive shares of Carvana Co. Class A common stock in exchange for Class B Units on a four-to-five conversion ratio, or cash at the option of Carvana Co., subject to conversion ratio adjustments for stock splits, stock dividends, reclassifications, and similar transactions and subject to vesting and the respective participation threshold for Class B Units. Class B Units do not expire.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
A summary of the Class B Unit activity for the year ended December 31, 2019, 2018, and 2017 is as follows:
| | | | | | | | | | | | | | | |
| Class B Units | | | | | | |
| Number of Class B Units (in thousands) | | Weighted-Average Participation Threshold per Class B Unit | | | | |
Outstanding at January 1, 2017 | 6,740 | | | $ | 1.91 | | | | | |
Granted | 767 | | | $ | 12.00 | | | | | |
Exchanged | (51) | | | $ | 1.81 | | | | | |
Forfeited | (35) | | | $ | 3.48 | | | | | |
Outstanding at December 31, 2017 | 7,421 | | | $ | 2.95 | | | | | |
| | | | | | | |
Granted | — | | | n/a | | | | | |
Exchanged | (901) | | | $ | 0.96 | | | | | |
Forfeited | (127) | | | $ | 10.49 | | | | | |
Outstanding at December 31, 2018 | 6,393 | | | $ | 3.08 | | | | | |
| | | | | | | |
Granted | — | | | n/a | | | | | |
Exchanged | (1,202) | | | $ | 1.17 | | | | | |
Forfeited | (23) | | | $ | 5.23 | | | | | |
Outstanding at December 31, 2019 | 5,168 | | | $ | 3.51 | | | | | |
| | | | | | | |
Vested as of December 31, 2019 | 4,416 | | | $ | 2.87 | | | | | |
Expected to vest as of December 31, 2019 | 752 | | | $ | 7.28 | | | | | |
The Company used a third party valuation specialist to assist management in its estimation of the grant-date fair value of the Class B Units on the respective grant dates during 2017. There were no Class B Units granted in 2018 or 2019. As the participation threshold provides a threshold similar to that of an exercise price for a stock option, the Company used option pricing valuation models with the following weighted-average assumptions:
| | | | | | | | | |
| | | | | |
| | | For the Year Ended December 31, 2017 | | |
Expected volatility(1) | | | 63.0 | % | | |
Expected dividend yield | | | — | % | | |
Expected term (in years)(2) | | | 6.3 | | |
Risk-free interest rate | | | 1.9 | % | | |
Weighted-average grant date fair value per Class B Unit | | | $7.04 | | |
(1) Measured using selected high-growth guideline companies and considering the risk factors that would influence the range of expected volatility because the Company does not have sufficient historical data to provide a reasonable basis upon which to estimate the expected volatility.
(2) In 2017, the expected term represents the estimated period of time until an award is exchanged and was determined using the simplified method because the Company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term.
Company Performance Plan
The Company created the Performance Plan on July 25, 2016, whereby the Company was authorized to grant up to 1.0 million performance units (the "Performance Units") to certain employees and consultants. The Performance Units granted were subject to continued employment and were only exercisable upon a qualifying transaction, which included an initial public
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
offering, as defined in the Performance Plan. The IPO completed on May 3, 2017 constituted a qualifying transaction under the terms of the Performance Plan. The Company chose to settle the outstanding Performance Units in equity awards of Carvana Co. and recognized compensation expense related to the vested portion of these equity awards upon completion of the IPO.
NOTE 13 — LOSS PER SHARE
Basic and diluted net loss per share is computed by dividing the net loss attributable to Class A common stockholders by the weighted-average shares of Class A common stock outstanding during the period. Diluted net loss per share is computed by giving effect to all potentially dilutive shares. For all periods presented, potentially dilutive shares are excluded from diluted net loss per share because they have an anti-dilutive impact. Therefore, basic and diluted net loss per share attributable to Class A common stockholders are the same for all periods presented.
As discussed in Note 1 — Business Organization, the Organizational Transactions are considered transactions between entities under common control and the financial statements for periods prior to the IPO and Organizational Transactions have been adjusted to combine the previously separate entities for presentation purposes. For purposes of calculating both the numerator and denominator of net loss per share for periods prior to the IPO, the Company has retroactively reflected the 15.0 million shares issued in the IPO and the LLC Units outstanding as of the Organizational Transactions as if they had been issued and outstanding as of the beginning of each period presented. These calculations for periods prior to the IPO do not consider the options or shares of Class A common stock issued on the IPO date under the 2017 Incentive Plan.
The following table presents the calculation of basic and diluted net loss per share during the years ended December 31, 2019, 2018, and 2017 (in thousands, except per share data):
| | | | | | | | | | | | | | | | | |
| For the years ended December 31, | | | | |
| 2019 | | 2018 | | 2017 |
Numerator: | | | | | |
Net loss | $ | (364,639) | | | $ | (254,745) | | | $ | (164,316) | |
Net loss attributable to non-controlling interests(1) | 249,980 | | | 199,269 | | | 146,003 | |
Dividends on Class A convertible preferred stock | — | | | (4,206) | | | (413) | |
Accretion of beneficial conversion feature on Class A convertible preferred stock | — | | | (1,380) | | | (1,237) | |
Net loss attributable to Carvana Co. Class A common stockholders, basic and diluted(1) | $ | (114,659) | | | $ | (61,062) | | | $ | (19,963) | |
Denominator: | | | | | |
Weighted-average shares of Class A common stock outstanding | 47,079 | | | 30,362 | | | 15,517 | |
Nonvested weighted-average restricted stock awards | (232) | | | (319) | | | (276) | |
Weighted-average shares of Class A common stock to compute basic and diluted net loss per Class A common share | 46,847 | | | 30,043 | | | 15,241 | |
Net loss per share of Class A common stock, basic and diluted(1) | $ | (2.45) | | | $ | (2.03) | | | $ | (1.31) | |
(1) The 2018 amounts reflect the revision discussed in Note 2 — Summary of Significant Accounting Policies.
Shares of Class B common stock do not share in the losses of the Company and are therefore not participating securities. As such, separate presentation of basic and diluted net loss per share of Class B common stock under the two-class method has not been presented. LLC Units (adjusted for the Exchange Ratio and participation thresholds) are considered potentially dilutive shares of Class A common stock because they are exchangeable into shares of Class A common stock, if the Company elects not to settle exchanges in cash.
Weighted-average as-converted shares of Convertible Preferred Stock of approximately 0.0 million, 3.9 million, and 0.4 million for the years ended December 31, 2019, 2018, and 2017, respectively, were evaluated under the if-converted method for potentially dilutive effects and were determined to be anti-dilutive. Weighted-average as-converted Class A Units of approximately 106.6 million, 109.0 million, and 117.0 million together with the related Class B common stock for the years ended December 31, 2019, 2018, and 2017, respectively, were evaluated under the if-converted method for potentially dilutive effects and were determined to be anti-dilutive. Outstanding Class B Units of approximately 5.2 million, 6.4 million, and 7.4 million at December 31, 2019, 2018, and 2017, respectively, were evaluated for potentially dilutive effects and were determined to be anti-dilutive. Weighted-average potentially dilutive restricted stock awards and units of approximately 0.8 million, 0.5
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
million, and 0.3 million outstanding during the years ended December 31, 2019, 2018, and 2017, respectively, were evaluated under the treasury stock method for potentially dilutive effects and were determined to be anti-dilutive. As of December 31, 2019, 2018, and 2017, approximately 1.1 million, 0.9 million, and 0.8 million options, respectively, were outstanding and evaluated under the treasury stock method for potentially dilutive effects and were determined to be anti-dilutive.
NOTE 14 — INCOME TAXES
As described in Note 1 — Business Organization, as a result of the IPO, Carvana Co. began consolidating the financial results of Carvana Group. Carvana Group is treated as a partnership for U.S. federal and most applicable state and local income tax purposes. As a partnership, Carvana Group is not subject to U.S. federal and certain state and local income taxes. Any taxable income or loss generated by Carvana Group is passed through to and included in the taxable income or loss of its members, including Carvana Co., based on its economic interest held in Carvana Group. Carvana Co. was formed on November 29, 2016 and did not engage in any operations prior to the IPO. Carvana Co. is taxed as a corporation and is subject to U.S. federal, state and local income taxes with respect to its allocable share of any taxable income or loss of Carvana Group, as well as any stand-alone income or loss generated by Carvana Co.
Net loss before income taxes was $364.6 million, $254.7 million, and $164.3 million for the years ended December 31, 2019, 2018, and 2017, respectively. The Company had 0 income tax expense for the years ended December 31, 2019, 2018, and 2017.
A reconciliation of the U.S. federal rate to the Company’s effective income tax rate is as follows (in thousands, except percentages):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | | | | | | | | | | |
| | | 2019 | | | | 2018 | | | | 2017 | | |
| | | Amount | | Percent | | Amount | | Percent | | Amount | | Percent |
Expected U.S. federal income taxes at statutory rate | | | $ | (76,574) | | | 21.0 | % | | $ | (53,496) | | | 21.0 | % | | $ | (57,511) | | | 35.0 | % |
Impact of 2017 Tax Cuts and Jobs Act | | | — | | | — | % | | — | | | — | % | | 9,303 | | | (5.7) | % |
Loss attributable to non-controlling interests | | | 52,496 | | | (14.4) | % | | 41,024 | | | (16.1) | % | | 52,607 | | | (32.0) | % |
State taxes | | | (2,945) | | | 0.8 | % | | (2,363) | | | 0.9 | % | | (553) | | | 0.3 | % |
Valuation allowance | | | 18,039 | | | (4.9) | % | | 14,771 | | | (5.8) | % | | (3,911) | | | 2.4 | % |
Effect due to LLC flow-through structure | | | 10,004 | | | (2.7) | % | | — | | | — | % | | — | | | — | % |
Other | | | (1,020) | | | 0.2 | % | | 65 | | | 0.0 | % | | 65 | | | 0.0 | % |
Income tax expense | | | $ | — | | | — | % | | $ | — | | | — | % | | $ | — | | | — | % |
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Deferred income taxes reflect the net tax effects of temporary differences between the tax basis in an asset or liability and its reported amount under U.S. GAAP. These temporary differences result in taxable or deductible amounts in future years. The components of the Company’s deferred tax assets are as follows (in thousands):
| | | | | | | | | | | | | | | | | |
| | | Years Ended December 31, | | |
| | | 2019 | | 2018 |
Deferred tax assets: | | | | | |
| Investment in Carvana Group | | $ | 155,775 | | | $ | 100,977 | |
| Net operating loss carryforward | | 44,771 | | | 23,323 | |
| Interest expense carryforward | | 13,721 | | | 2,262 | |
| Tax credit carryforward | | 586 | | | — | |
| Total gross deferred tax assets | | 214,853 | | | 126,562 | |
Valuation allowance | | | (214,853) | | | (126,562) | |
Total deferred tax assets, net of valuation allowance | | | $ | — | | | $ | — | |
| | | | | |
Deferred tax liabilities: | | | | | |
| Intangibles | | $ | (1,808) | | | $ | (2,217) | |
| Total gross deferred tax liabilities | | (1,808) | | | (2,217) | |
Net deferred tax liabilities | | | $ | (1,808) | | | $ | (2,217) | |
As of December 31, 2019, the Company had federal and state net operating loss carry forwards of $188.2 million. Federal losses that arose prior to 2018 will begin to expire in 2037. Federal losses that arose in 2018 will be carried forward indefinitely.
As described in Note 10 — Stockholders' Equity, the Company acquired 5.4 million LLC Units during the year ended December 31, 2019 in connection with exchanges with Existing LLC Unitholders. During the year ended December 31, 2019, the Company recorded a gross deferred tax asset of $70.3 million associated with the basis difference in its investment in Carvana Group related to the acquisition of the LLC Units which is reflected as an increase to additional paid-in capital in the accompanying statements of stockholders' equity.
As described in Note 1 — Business Organization and Note 10 — Stockholders' Equity, Carvana Co. purchased approximately 18.8 million newly-issued LLC Units of Carvana Group in connection with the IPO. The Company recognized a gross deferred tax asset of $0.5 million associated with a portion of the basis difference resulting from this purchase of LLC Units which is reflected as an increase to additional paid-in capital in the accompanying statements of stockholders' equity. The Company has not recorded a deferred tax asset of $43.1 million related to the remaining basis difference associated with this purchase of LLC Units as the difference will only reverse upon the sale of its interest in Carvana Group.
As described in Note 1 — Business Organization and Note 10 — Stockholders' Equity, on April 30, 2018, Carvana Co. completed a follow-on offering of 6.6 million shares of its Class A common stock. The Company recognized a gross deferred tax asset of $2.5 million associated with the portion of the basis difference resulting from the purchase of LLC Units which is reflected as an increase to additional paid-in capital in the accompanying statement of stockholders' equity. The Company has not recorded a deferred tax asset of $30.6 million related to the remaining basis difference associated with the purchase of LLC Units as the difference will only reverse upon the sale of its interest in Carvana Group.
As described in Note 1 — Business Organization and Note 10 — Stockholders' Equity, on May 24, 2019, Carvana Co. completed a follow-on offering of 4.2 million shares of the Class A common stock. As part of the offering, the underwriters were given an option to purchase all or part of approximately 0.6 million additional shares of Class A common stock which the underwriters exercised in full. The Company recognized a gross deferred asset of approximately $7.5 million associated with a portion of the basis difference resulting from this purchase of LLC Units which is reflected as an increase to additional paid-in capital in the accompanying consolidated statements of stockholder's equity. The Company has not recorded a deferred tax asset of $42.7 million related to the remaining basis difference associated with the purchase of LLC Units as the difference will only reverse upon the sale of its interest in Carvana Group.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
As described in Note 4 — Goodwill and Intangible Assets, Carvana Group acquired Car360 on April 12, 2018. The acquisition included various intangible assets, and as a result the Company recognized a deferred tax liability of approximately $2.5 million which is reflected within other liabilities in the accompanying consolidated balance sheets. The deferred tax liability will be amortized over two to seven years and approximately $0.4 million and $0.3 million was amortized during the years ended December 31, 2019 and 2018, respectively.
During the year ended December 31, 2019, management performed an assessment of the recoverability of deferred tax assets. Management determined, based on the accounting standards applicable to such assessment, that there was sufficient negative evidence as a result of the Company’s cumulative losses to conclude it was more likely than not that its deferred tax assets would not be realized and has recorded a full valuation allowance of $214.9 million against its deferred tax assets. The Company has $1.8 million of deferred tax liabilities not available to offset deferred tax assets. In the event that management was to determine that the Company would be able to realize its deferred tax assets in the future in excess of their net recorded amount, an adjustment to the valuation allowance would be made which would reduce the provision for income taxes.
The Company recognizes uncertain income tax positions when it is more-likely-than-not the position will be sustained upon examination. As of the year ended December 31, 2019, the Company has 0t identified any uncertain tax positions and has 0t recognized any related reserves.
On December 22, 2017, the U.S. government enacted tax legislation referred to as the 2017 Tax Cuts and Jobs Act (the "2017 Tax Act"). The 2017 Tax Act reduces the U.S. federal corporate tax rate from the previous rate of 35 to 21 effective January 1, 2018. The 2017 Tax Act also makes broad and complex changes to the U.S. tax code, including, but not limited to (i) limitations on net operating loss carryforwards created in tax years beginning after December 31, 2017 while also allowing such net operating losses to be carried forward indefinitely; (ii) bonus depreciation allowing full expensing of qualified property; (iii) limitations on the deductibility of certain executive compensation; and, (iv) limitations to the amount of deductible interest.
On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 Income Tax Accounting Implications of the Tax Cuts and Jobs Act ("SAB 118") which provides guidance on accounting for the 2017 Tax Act’s impact. SAB 118 provides a measurement period, which in no case should extend beyond one year from the 2017 Tax Act enactment date, during which a company acting in good faith may complete the accounting for the impacts of the 2017 Tax Act under ASC Topic 740, Income Taxes ("ASC 740"). In accordance with SAB 118, the Company must reflect the income tax effects of the 2017 Tax Act in the reporting period in which it completes its analysis. The Company has recorded the impact of the Tax Act on its deferred tax balances related to the change in tax rate. During the year ended December 31, 2017, the Company recorded a decrease in its deferred tax assets of $9.3 million with a corresponding decrease in valuation allowance. SAB 118 allowed the Company to refrain from making a decision on certain provisions in the 2017 Tax Act and the Company continued to review and assess the potential impact of the legislation on its consolidated financial statements factoring in changes due to, among other things, further refinement of the Company's calculations, changes in interpretations and assumptions that the Company has made and additional guidance that may be issued by the U.S. government. As of December 31, 2018, the Company completed accounting for all of the enactment date income tax effects of the 2017 Tax Act and determined there were no material adjustments.
Tax Receivable Agreement
Carvana Co. expects to obtain an increase in its share of the tax basis in the net assets of Carvana Group when LLC Units are exchanged by the Existing LLC Unitholders and other qualifying transactions. As described in Note 10 — Stockholders' Equity, each change in outstanding shares of Class A common stock results in a corresponding increase or decrease in Carvana Co.'s ownership of LLC Units. The Company intends to treat any exchanges of LLC Units as direct purchases of LLC interests for U.S. federal income tax purposes. These increases in tax basis may reduce the amounts that Carvana Co. would otherwise pay in the future to various taxing authorities. They may also decrease gains (or increase losses) on future dispositions of certain capital assets to the extent tax basis is allocated to those capital assets.
In connection with the IPO, the Company entered into a Tax Receivable Agreement (the "TRA"). Under the TRA, the Company generally will be required to pay to the Existing LLC Unitholders 85% of the amount of cash savings, if any, in U.S. federal, state or local tax that the Company actually realizes directly or indirectly (or are deemed to realize in certain circumstances) as a result of (i) certain tax attributes created as a result of any sales or exchanges (as determined for U.S. federal income tax purposes) to or with the Company of their interests in Carvana Group for shares of Carvana Co.'s Class A common stock or cash, including any basis adjustment relating to the assets of Carvana Group and (ii) tax benefits attributable to payments made under the TRA (including imputed interest). The Company expects to benefit from the remaining 15% of any
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
tax benefits that it may actually realize. To the extent that the Company is unable to timely make payments under the TRA for any reason, such payments generally will be deferred and will accrue interest until paid.
If the Internal Revenue Service or a state or local taxing authority challenges the tax basis adjustments that give rise to payments under the TRA and the tax basis adjustments are subsequently disallowed, the recipients of payments under the agreement will not reimburse the Company for any payments the Company previously made to them. Any such disallowance would be taken into account in determining future payments under the TRA and would, therefore, reduce the amount of any such future payments. Nevertheless, if the claimed tax benefits from the tax basis adjustments are disallowed, the Company’s payments under the TRA could exceed its actual tax savings, and the Company may not be able to recoup payments under the TRA that were calculated on the assumption that the disallowed tax savings were available.
The TRA provides that if (i) certain mergers, asset sales, other forms of business combinations, or other changes of control were to occur, (ii) there is a material breach of any material obligations under the TRA; or (iii) the Company elects an early termination of the TRA, then the TRA will terminate and the Company's obligations, or the Company's successor’s obligations, under the TRA will accelerate and become due and payable, based on certain assumptions, including an assumption that the Company would have sufficient taxable income to fully utilize all potential future tax benefits that are subject to the TRA and that any LLC Units that have not been exchanged are deemed exchanged for the fair market value of the Company's Class A common stock at the time of termination.
As of December 31, 2019, the Company has concluded, based on applicable accounting standards, that it was more likely than not that its deferred tax assets subject to the TRA would not be realized; therefore, the Company has not recorded a liability related to the tax savings it may realize from utilization of such deferred tax assets. As of December 31, 2019, the total unrecorded TRA liability is approximately $178.4 million. If utilization of the deferred tax assets subject to the TRA becomes more likely than not in the future, the Company will record a liability related to the TRA which will be recognized as expense within its consolidated statements of operations.
Uncertain Tax Positions
Based on the Company's analysis of tax positions taken on income tax returns filed, 0 uncertain tax positions existed as of December 31, 2019, 2018, and 2017. Carvana Co. was formed in November 2016 and did not engage in any operations prior to the IPO and Organizational Transactions. Carvana Co. was not required to file 2016 tax returns and filed its first tax returns for the tax year 2017, the first year it became subject to examination by taxing authorities for U.S. federal and state income tax purposes. Carvana Group is treated as a partnership for U.S. federal and state income tax purposes and its tax returns are subject to examination by taxing authorities. Carvana Group has filed income tax returns for years through 2017. These returns are subject to examination by the taxing authorities in the respective jurisdictions, generally for three or four years after they were filed.
NOTE 15 — LEASES
The Company is party to various lease agreements for real estate and transportation equipment. For each lease agreement, the Company determines its lease term as the non-cancellable period of the lease and includes options to extend or terminate the lease when it is reasonably certain that it will exercise that option. The Company also assesses whether each lease is an operating or finance lease at the lease commencement date. Rent expense of operating leases is recognized on a straight-line basis over the lease term and includes scheduled rent increases as well as amortization of tenant improvement allowances.
Operating Leases
As of December 31, 2019, the Company is a tenant under various operating leases related to certain of its hubs, vending machines and corporate offices. The initial terms expire at various dates between 2020 and 2032. Many of the leases include 1 or more renewal options ranging from one to twenty years and some contain purchase options. The Company also had operating leases for certain of its transportation fleet. In March 2019, the Company reassessed the lease terms of the transportation equipment leases based on the likelihood of exercising its extension options and reclassified them to finance leases. Rent expense for the Company's operating leases was approximately $7.9 million and $4.3 million for years ended December 31, 2018 and 2017, respectively.
Refer to Note 6 — Related Party Transactions for further discussion of operating leases with related parties.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Advertising Costs
Advertising production costs are expensed the first time the advertising takes place. All other advertising costs are expensed as incurred. Advertising expenses are included in SG&A expenses on the accompanying consolidated statements of operations. Advertising expense was approximately $55.7$204.0 million, $27.0$111.2 million, and $10.7$55.7 million during the years ended December 31, 2017, 20162019, 2018, and 2015,2017, respectively.
Equity-Based Compensation
The Company classifies equity-based awards granted in exchange for services as either equity awards or liability awards. The classification of an award as either an equity award or a liability award is generally based upon cash settlement options. Equity awards are measured based on the fair value of the award at the grant date. Liability awards are re-measured to fair value each reporting period. EachPrior to the adoption of ASU 2018-07, Compensation - Stock Compensation (Topic 718) ("ASU 2018-07"), on January 1, 2019, each reporting period, the Company recognizesrecognized the change in fair value of awards issued to non-employees as expense. Following adoption of ASU 2018-07, accounting requirements for equity-based awards to nonemployees are aligned with those to employees, including measuring the equity instruments at the grant-date fair value. The Company recognizes equity-based compensation on a straight-line basis over the award’s requisite service period, which is generally the vesting period of the award, less actual forfeitures. No compensation expense is recognized for awards for which participants do not render the requisite services. For equity and liability awards earned based on performance or upon occurrence of a contingent event, when and if the awards will be earned is estimated. If an award is not considered probable of being earned, no amount of equity-based compensation is recognized. If the award is deemed probable of being earned, related compensation expense is recorded over the estimated service period. To the extent the estimate of awards considered probable of being earned changes, the amount of equity-based compensation recognized will also change. See Note 1012 — Equity-Based Compensation for additional information on equity-based compensation.
Shipping and Handling Fees and Costs
Transportation fees billed to customers that take delivery of the purchased used vehicle outside the Company’s free delivery area are a component of other sales and revenues in the accompanying consolidated statements of operations. Third party transportationThe Company's logistics costs related to transporting its used vehicle inventory include fuel, maintenance, and depreciation related to operating its own transportation fleet and third party transportation fees. The portion of these deliveries were approximately $1.2 million, $0.4 millioncosts related to inbound transportation from the point of acquisition to the inspection and $0.2 million duringreconditioning center are capitalized to inventory and then included in cost of sales when the years ended December 31, 2017, 2016 and 2015, respectively, andrelated used vehicle is sold. Logistics costs not included in cost of sales are included in selling, general and administrative expenses in the accompanying consolidated statements of operations.operations and were approximately $58.1 million, $35.2 million, and $14.4 million during the years ended December 31, 2019, 2018, and 2017, respectively, excluding compensation and benefits.
Defined Contribution Plan
The Company sponsors a qualified 401(k) retirement plan (defined contribution plan) for its employees. The plan covers substantially all employees having no less than 31 days of service, who have attained the age of 18 and work at least 1,000 hours per year.18. Participants may voluntarily contribute to the plan up to the maximum limits established by Internal Revenue Service regulations. The Company provides matching contributions of 40% onup to the first 6% of an employee’s contribution,compensation, which vests evenly over the employee’s initial five-yearfive-year service period. Employer contributions to the plan, net of forfeitures, were approximately $0.7$2.0 million, $0.3$1.1 million, and $0.1$0.7 million for the years ended December 31, 2017, 20162019, 2018, and 2015,2017, respectively. Employer contributions are included in selling, general, and administrative expenses in the accompanying consolidated statements of operations.
Derivative Instruments and Hedging Activities
The Company enters into short-term derivative instruments to manage risks arising from its business operations and economic conditions, primarily cash flow variability that may arise from interest rate changes between the time the Company originates finance receivables and the time it sells them through securitizations. The Company does not designate these derivative instruments as hedges under ASC 815, Derivatives and Hedging for hedge accounting treatment and as a result they are accounted for as economic hedges. Gains and losses related to the derivative instruments are included within other sales and revenues to follow the presentation of the hedged item within the accompanying consolidated statements of operations and any
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(Continued)
derivative instruments outstanding as of the end of the period are reported at fair value on the accompanying consolidated balance sheets.
Fair Value Measurements
The fair value of financial instruments is based on estimates using quoted market prices, discounted cash flows, or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and the estimated timing and amount of future cash flows. Therefore, the estimates of fair value may differ substantially from amounts that ultimately may be realized or paid at settlement or maturity of the financial instruments, and those differences may be material. Accordingly, the aggregate fair value amounts presented may not represent the Company’s underlying institutional value.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The Company uses the three-tier hierarchy established by U.S. GAAP, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value to determine the fair value of its financial instruments. This hierarchy indicates to what extent the inputs used in the Company’s calculations are observable in the market. The different levels of the hierarchy are defined as follows:
|
| | | | |
Level 1: | Unadjusted quoted prices in active markets for identical assets or liabilities. |
| |
Level 2: | Other than quoted prices that are observable in the market for the asset or liability, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or model-derived valuations or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. |
| |
Level 3: | Inputs are unobservable and reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. |
The Company has elected the fair value option for its beneficial interests in securitizations, which primarily include notes and certificates of the securitization trusts. Electing the fair value option allows the Company to recognize changes in the fair value of these assets in the period the fair value changes. The changes in fair value are recorded within other expense, net and amounts attributable to interest income are reported in interest expense, net on the accompanying consolidated statements of operations.
See Note 1417 — Fair Value of Financial Instruments for additional information.
Segments
Business segments are defined as components of an enterprise about which discrete financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing operating performance. Based on the way the Company manages its business, the Company has determined that it currently operates with one1 reportable segment. The chief operating decision maker focuses on consolidated results in assessing operating performance and allocating resources. Furthermore, the Company offers similar products and services and uses similar processes to sell those products and services to similar classes of customers throughout the United States (“("U.S.”"). AllSubstantially all revenue is generated and all assets are held in the U.S. for all periods presented.
Income Taxes
The Company accounts for income taxes pursuant to the asset and liability method, which requires the recognition of deferred income tax assets and liabilities related to the expected future tax consequences arising from temporary differences between the carrying amounts and tax bases of assets and liabilities based on enacted statutory tax rates applicable to the periods in which the temporary differences are expected to reverse. Any effects of changes in income tax rates or laws are included in income tax expense in the period of enactment. The Company reduces the carrying amounts of deferred tax assets by a valuation allowance if, based on the evidence available, it is more likely than not that such assets will not be realized. In making the assessment under the more likely than not standard, appropriate consideration must be given to all positive and negative evidence related to the realization of the deferred tax assets. The assessment considers, among other matters, the
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(Continued)
nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carry forward periods by jurisdiction, the Company's experience with loss carryforwards not expiring unutilized, and all tax planning alternatives that may be available. A valuation allowance is recognized if under applicable accounting standards the Company determines it is more likely than not that its deferred tax assets would not be realized. See Note 1214 — Income Taxes for additional information.
Adoption of New Accounting Standards
Beginning in February 2016, the FASB issued several accounting standards updates related to the new leasing model in ASC 842, Leases ("ASC 842"). ASC 842 introduced a model that requires leases to be presented on the balance sheet and eliminates the requirement for an entity to use bright-line tests in determining lease classification. Expense recognition under ASC 842 on the income statement remains similar to previous lease accounting guidance.
The Company adopted ASC 842 on January 1, 2019 using the modified retrospective approach, the practical expedient package and the transition relief option, which allowed the Company to, among other things, avoid reassessing lease classification for existing leases, forego the balance sheet recognition requirements with respect to short-term leases and avoid restating comparative periods presented. The adoption of ASC 842 resulted in initial recognition of ROU assets and operating lease liabilities of approximately $80.3 million and $86.8 million, respectively, as of January 1, 2019, and did not have an impact on the beginning equity balances as of the implementation date. Adopting ASC 842 did not have a material impact on the Company's sale-leaseback transactions, which have typically been accounted for as financing transactions in prior periods and under ASC 842. The standard did not have a material impact on the Company's consolidated statements of operations or statements of cash flows.
In June 2018, the FASB issued ASU 2018-07, Compensation — Stock Compensation (Topic 718) ("ASU 2018-07") related to the accounting for share-based payment transactions for acquiring goods and services from nonemployees. Under ASU 2018-07, the intent is to simplify and align most requirements for share-based payments to nonemployees with the requirements for share-based payments granted to employees under ASC 718, including measuring the equity instruments at the grant-date fair value. The Company adopted ASU 2018-07 on January 1, 2019 using the modified retrospective approach. The adoption of ASU 2018-07 did not have a material effect on the Company’s consolidated financial statements.
Accounting Standards Issued But Not Yet Adopted
Since May 2014, the FASB has issued several accounting standards updates related to revenue recognition including ASC 606, Revenue from Contracts with Customers ("ASC 606"), which amends the guidance in ASC 605, Revenue Recognition ("ASC 605"), and provides a single, comprehensive revenue recognition model for all contracts with customers. ASC 606 contains principles that an entity will apply to determine the measurement of revenue and timing of when it is recognized. The entity will recognize revenue to reflect the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. ASC 606 addresses how entities should identify goods and services being provided to a customer, the unit of account for a principal versus agent assessment, how to evaluate whether a good or service is
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
controlled before being transferred to a customer and how to assess whether an entity controls services performed by another party. ASC 606 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017 with early adoption permitted. The Company will adopt ASC 606 for interim and annual periods beginning January 1, 2018 using the modified retrospective method.
The Company has evaluated the potential impacts of ASC 606 by gaining an understanding of the new standard, inventorying its revenue streams, analyzing and mapping contract features to revenue streams and considering the enhancement of disclosures related to revenue. Based on its evaluation, the Company has concluded that it will have similar performance obligations under ASC 606 as compared with deliverables and separate units of accounting identified under ASC 605. Adoption of ASC 606 will impact the presentation of vehicle inventory returns on its consolidated balance sheets by decreasing vehicle inventory and increasing other current assets by an immaterial amount. Based on its evaluation and the manner in which the Company recognizes revenue, the Company has concluded that the adoption of ASC 606 will not have a material impact on the amount or timing of its revenue recognition.
In June 2016, the FASB issued ASU 2016-13, Financial instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“"ASU 2016-13”2016-13"), and subsequent related ASUs, which amends the guidance on the impairment of financial instruments by requiring measurement and recognition of expected credit losses for financial assets held. ASU 2016-13 is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2019,2019. Financial assets measured at fair value through net income are excluded from the scope of ASU 2016-13. The Company's beneficial interests in securitizations are carried at fair value and earlier adoption is permitted beginning in the first quarter of fiscal 2019. The Company is currently evaluating the impact on its consolidated financial statements, and plans to adopt thisare thus excluded from ASU for its fiscal year beginning January 1, 2020.2016-13. Finance receivables originated in connection with the Company’s vehicle sales are held for sale and are soldpresented at the lower of amortized cost or fair value. The Company intends to third partiessell the finance receivables prior to their contractual maturity, therefore the recovery of the asset is from its sale rather than maturity and related parties. As a result, the Company doesis not presently hold any finance receivables until maturityrequired to measure the expected lifetime credit losses. The Company will adopt ASU 2016-13 for its fiscal year beginning January 1, 2020 and does not expect the adoption of ASU 2016-13 to have a material impact on its consolidated financial statements.
In August 2016,2018, the FASB issued ASU 2016-15, Statement2018-13, Fair Value Measurement (Topic 820): Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement ("ASU 2018-13") related to updated requirements over the disclosures of Cash Flows — Classification of Certain Receiptsfair value measurements. Under ASU 2018-13, certain disclosure requirements for fair value measurements will be eliminated, modified or added to facilitate better communication around recurring and Payments (“nonrecurring fair value measurements. ASU 2016-15”), which provides additional clarity on the classification of specific events on the statement of cash flows including debt prepayment and extinguishment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds from settlement of insurance claims, distributions received from equity method investees and beneficial interests in securitization transactions. The update2018-13 is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2017,2019, with some amendments applied prospectively, some applied retrospectively, and early adoption permitted. The Company will adopt this ASU 2018-13 for its fiscal year beginning January 1, 2018. ASU 2016-15 requires retrospective application to all periods presented, unless retrospective application would be impracticable, in which case prospective application is permissible. The Company2020 and does not expect the adoption of ASU 2016-15 to have a material effectimpact on its disclosures within its consolidated statements of cash flows.financial statements.
In November 2016,August 2018, the FASB issued ASU 2016-18, Statement of Cash Flows2018-15, Intangibles — Restricted Cash (“Goodwill and Other — Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract ("ASU 2016-18”2018-15"), which requires the statement of cash flows to include restricted cash with its cash and cash equivalents balance and a reconciliation between all cash items on the balance sheet and the balance per the statement of cash flows. In addition, changes in restricted cash related to transfers between cash and cash equivalents and restricted cash will not be presented as cash flow activities in the statement of cash flows. ASU 2016-18 requires retrospective application and is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted.. The Company will adopt this ASU for its fiscal year beginning January 1, 2018. The effect of the adoption of these updates will be to include restricted cash in the beginning and end of period balances of cash presented on the Company's consolidated statement of cash flows. The change in restricted cash is currently included in investing activities in the consolidated statements of cash flows.
In February 2016, the FASB issued ASU 2016-02, Leases(Topic 842) (“ASU 2016-02”) related to the accounting for leases. This ASU introduces a lessee model that requires recording a right-of-use asset and lease obligation on the balance sheet for all leases, whether operating or financing. Expense recognition on the income statement remains similar to current lease accounting guidance. The ASU is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2018. The Company plans to adopt this ASU for its fiscal year beginning January 1, 2019. The adoptionintent of this ASU will requirepronouncement is to align the recognition ofrequirements for capitalizing implementation costs incurred in a right-of-use asset andcloud computing arrangement that is a lease obligationservice contract with the requirements for the Company’s leases (see Note 13 — Commitments and Contingencies). The Company is currently evaluating the impact this standard will have on its consolidated financial statements and is unable to quantify the impact at this time, however, the expectation is that it may have a material effect on the balance sheets as a result of recognizing the new right-of-use assets and lease obligations for existing operating leases.
capitalizing implementation costs
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
incurred to develop or obtain internal-use software as defined in ASC 350-40. Under ASU 2018-15, the capitalized implementation costs related to a cloud computing arrangement will be amortized over the term of the arrangement and all capitalized implementation amounts will be required to be presented in the same line items of the financial statements as the related hosting fees. ASU 2018-15 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. The Company will adopt ASU 2018-15 for its fiscal year beginning January 1, 2020 and does not expect the adoption to have a material impact on its consolidated financial statements.
In October 2018, the FASB issued ASU 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities ("ASU 2018-17"). ASU 2018-17 requires reporting entities to consider indirect interests held through related parties under common control on a proportional basis rather than as the equivalent of a direct interest in its entirety for determining whether a decision-making fee is a variable interest. The standard is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted. Entities are required to apply the amendments in ASU 2018-17 retrospectively with a cumulative-effect adjustment to retained earnings at the beginning of the earliest period presented. The Company will adopt ASU 2018-17 for its fiscal year beginning January 1, 2020 and does not expect the adoption to have a material impact on its consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes ("ASU 2019-12"). ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. ASU 2019-12 will be effective for interim and annual periods beginning after December 15, 2020, with early adoption permitted. The Company plans to adopt ASU 2019-12 for its fiscal year beginning January 1, 2021 and is currently assessing the impact, if any, the guidance will have on its consolidated financial statements.
NOTE 3 — PROPERTY AND EQUIPMENT, NET
The following table summarizes property and equipment, net as of December 31, 20172019 and 20162018 (in thousands):
| | | | | | | | | | | |
| December 31, | | |
| 2019 | | 2018 |
Land and site improvements | $ | 98,530 | | | $ | 45,702 | |
Buildings and improvements | 229,640 | | | 123,705 | |
Transportation fleet | 110,302 | | | 65,760 | |
Software | 66,875 | | | 36,452 | |
Furniture, fixtures, and equipment | 38,123 | | | 20,675 | |
Total property and equipment excluding construction in progress | 543,470 | | | 292,294 | |
Less: accumulated depreciation and amortization on property and equipment | (88,795) | | | (44,050) | |
Property and equipment excluding construction in progress, net | 454,675 | | | 248,244 | |
Construction in progress | 88,796 | | | 48,595 | |
Property and equipment, net | $ | 543,471 | | | $ | 296,839 | |
|
| | | | | | | |
| December 31, |
| 2017 | | 2016 |
Land and site improvements | $ | 11,656 |
| | $ | 9,355 |
|
Buildings and improvements | 60,804 |
| | 14,750 |
|
Transportation fleet | 39,153 |
| | 16,520 |
|
Software | 21,009 |
| | 10,065 |
|
Furniture, fixtures and equipment | 12,239 |
| | 3,704 |
|
Total property and equipment excluding construction in progress | 144,861 |
| | 54,394 |
|
Less: accumulated depreciation and amortization | (20,453 | ) | | (9,752 | ) |
Property and equipment excluding construction in progress, net | 124,408 |
| | 44,642 |
|
Construction in progress | 24,273 |
| | 15,950 |
|
Property and equipment, net | $ | 148,681 |
| | $ | 60,592 |
|
Depreciation and amortization expense on property and equipment was approximately $11.6$39.6 million, $4.7$22.5 million, and $2.8$11.6 million for the years ended December 31, 2017, 20162019, 2018, and 2015,2017, respectively. These amounts primarily relate to assets associated with selling, general, and administrative activities and are included as a component of selling, general, and administrative expenses in the accompanying consolidated statements of operations.
The Company capitalized internal use software costs totaling approximately $11.5$31.7 million, $4.4$17.4 million, and $2.7$11.5 million during the years ended December 31, 2017, 20162019, 2018, and 2015,2017, respectively, which is included in software and construction in progress in the table above. The Company capitalized approximately $7.9$24.7 million, $3.7$13.6 million, and $2.1$7.9 million during the years ended December 31, 2017, 20162019, 2018, and 2015,2017, respectively, of payroll and payroll-related costs for employees who are directly associated with and who devote time to the development of software products for internal use.
The Company capitalizes interest in connection with various construction projects to build, upgrade, or remodel certain of its facilities. During the years ended December 31, 2017, 20162019, 2018, and 2015,2017, the Company incurred total interest costs, net of interest income, of approximately $8.6$84.2 million, $3.6$26.6 million, and $1.4$8.6 million, respectively, of which approximately $0.9$3.6 million, $0.0$1.6 million, and $0.0$0.9 million, respectively, were capitalized.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
NOTE 4 — GOODWILL AND INTANGIBLE ASSETS
On April 12, 2018, the Company acquired Car360, Inc. ("Car360"), a provider of app-based photo capture technology, for approximately $16.7 million, net of cash acquired of approximately $0.4 million. The purchase price was comprised of approximately $6.7 million cash, net of cash acquired, and approximately 0.5 million Class A Units of Carvana Group, with a fair value of approximately $10.0 million.
The purchase price was allocated to net tangible assets of approximately $0.2 million and intangible assets of approximately $9.9 million based on their fair values on the acquisition date and a related deferred tax liability of approximately $2.5 million. The deferred tax liability will amortize over two to seven years, and approximately $0.4 million and $0.3 million was amortized during the years ended December 31, 2019 and 2018, respectively. The excess of the purchase price over the amounts allocated to assets acquired, liabilities assumed and the deferred tax liability was approximately $9.4 million, which has been recorded as goodwill. The historical results of operations for Car360 were not significant to the Company's consolidated results of operations for the periods presented.
The following table summarizes intangible assets and goodwill related to the Car360 acquisition as of December 31, 2019 and 2018 (in thousands):
| | | | | | | | | | | | | | | | | |
| | | December 31, | | |
| Useful Life | | 2019 | | 2018 |
Intangible assets: | | | | | |
Developed technology | 7 years | | $ | 8,642 | | | $ | 8,642 | |
Customer relationships | 2 years | | 523 | | | 523 | |
Non-compete agreements | 5 years | | 774 | | | 774 | |
Intangible assets, acquired cost | | | 9,939 | | | 9,939 | |
Less: accumulated amortization | | | (2,707) | | | (1,070) | |
Intangible assets, net | | | $ | 7,232 | | | $ | 8,869 | |
| | | | | |
Goodwill | N/A | | $ | 9,353 | | | $ | 9,353 | |
Amortization expense was $1.6 million and $1.1 million during the years ended December 31, 2019 and 2018, respectively. As of December 31, 2019, the remaining weighted-average amortization period for definite-lived intangible assets was approximately 4.9 years. The anticipated annual amortization expense to be recognized in future years as of December 31, 2019 is as follows (in thousands):
| | | | | |
| Expected Future Amortization |
2020 | $ | 1,590 | |
2021 | 1,389 | |
2022 | 1,389 | |
2023 | 1,279 | |
2024 | 1,235 | |
Thereafter | 350 | |
Total | $ | 7,232 | |
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
NOTE 5 — ACCOUNTS PAYABLE AND OTHER ACCRUED LIABILITIES
The following table summarizes accounts payable and other accrued liabilities as of December 31, 20172019 and 20162018 (in thousands):
| | | | | | | | | | | |
| December 31, | | |
| 2019 | | 2018 |
Accounts payable, including $9,549 and $3,891, respectively, due to related parties | $ | 63,576 | | | $ | 33,032 | |
Sales taxes and vehicle licenses and fees | 45,812 | | | 27,651 | |
Accrued property and equipment | 23,433 | | | 7,414 | |
Accrued compensation and benefits | 21,726 | | | 13,477 | |
Reserve for returns and cancellations | 19,721 | | | 11,284 | |
Accrued interest expense | 15,650 | | | 9,206 | |
Accrued advertising costs | 11,403 | | | 4,398 | |
Customer deposits | | 6,379 | | | 2,890 | |
Other accrued liabilities | | 26,743 | | | 12,063 | |
Total accounts payable and other accrued liabilities | $ | 234,443 | | | $ | 121,415 | |
|
| | | | | | | |
| December 31, |
| 2017 | | 2016 |
Accounts payable | $ | 10,546 |
| | $ | 6,208 |
|
Sales taxes and vehicle licenses and fees | 9,034 |
| | 4,265 |
|
Accrued property and equipment | 8,325 |
| | 3,045 |
|
Accrued compensation and benefits | 5,054 |
| | 3,398 |
|
Accrued advertising costs | 4,265 |
| | 1,281 |
|
Accrued inventory costs | 1,386 |
| | 3,480 |
|
Other accrued liabilities | 11,696 |
| | 6,487 |
|
Total accounts payable and other accrued liabilities | $ | 50,306 |
| | $ | 28,164 |
|
NOTE 6 — RELATED PARTY TRANSACTIONS
Lease Agreements
In November 2014, the Company and DriveTime entered into a lease agreement that governs the Company’s access to and utilization of temporary storage, reconditioning, offices and parking space at various DriveTime facilities (the "DriveTime Lease Agreement"). The DriveTime Lease Agreement was most recently amended in December 2018. Lease duration varies by location with cancellable terms, provided 60 days' prior written notice is given, expiring between 2021 and 2024. Most of the facilities allow the Company to exercise up to 2 consecutive one-year renewal options at up to 10 of these locations, less the numbers of locations renewed under the DriveTime Hub Lease Agreement described below.
In March 2017, the Company and DriveTime entered into a lease agreement that governs the Company's access to and utilization of office and parking space at various DriveTime facilities (the "DriveTime Hub Lease Agreement"). The DriveTime Hub Lease Agreement was most recently amended in December 2018. Lease expiration varies by location with most having cancellable terms, provided 60 days' prior written notice is given, expiring in 2021 and the Company having the right to exercise up to 2 consecutive one-year renewal options at up to 10 of these locations, less the number of locations renewed under the DriveTime Lease Agreement described above.
The DriveTime Lease Agreement and the DriveTime Hub Lease Agreement both have non-cancellable lease terms of less than twelve months with rights to terminate at the Company's election with 60 days' prior written notice and extension options as described above. At our non-reconditioning locations, it is not reasonably certain that the Company will exercise its options to extend the leases or abstain from exercising its termination rights within these lease agreements to create a lease term greater than one year and therefore the Company accounts for them as short-term leases. For these locations the Company makes variable monthly lease payments based on its pro rata utilization of space at each facility plus a pro rata share of each facility’s actual insurance costs and real estate taxes. The DriveTime Lease Agreement includes the Blue Mound and Delanco inspection and reconditioning centers ("IRCs"). At both of these locations, the Company expects to extend the lease terms beyond twelve months, therefore those locations are not considered short-term leases. The Company occupies all of the space at these IRCs and makes monthly lease payments based on DriveTime's actual rent expense. In addition, the Company is responsible for the actual insurance costs and real estate taxes at these IRC locations.
At all locations, the Company is additionally responsible for paying for any tenant improvements it requires to conduct its operations and its share of estimated costs incurred by DriveTime related to preparing these sites for use. Management has determined that the costs allocated to the Company are based on a reasonable methodology.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
NOTE 5 — RELATED PARTY TRANSACTIONS
Shared Services Agreement with DriveTime
In November 2014,December 2016, the Company and DriveTime entered into a lease agreement related to an IRC in Tolleson, Arizona, with Verde Investments, Inc., an affiliate of DriveTime ("Verde"), with an initial term of approximately 15 years. In August 2018, the Company entered into an additional lease agreement with a coterminous initial term with Verde for contiguous space to that IRC. The lease agreements require monthly rental payments and can each be extended for 4 additional five-year periods.
In February 2017, the Company entered into a lease agreement with DriveTime for sole occupancy of a fully operational IRC in Winder, Georgia, where the Company previously maintained partial occupancy. The lease has an initial term of eight years, subject to the Company's ability to exercise 3 renewal options of five years each.
In November 2018, the Company entered into a lease agreement with DriveTime for access to and utilization of a fully operational IRC near Cleveland, Ohio. DriveTime vacated the facility in February 2019, at which point the Company became the sole occupant and began leasing the full facility from DriveTime. The lease has an initial term of three years, subject to the Company's ability to exercise 3 renewal options of five years each. Before DriveTime vacated the facility, the Company paid a monthly rental fee for facility and shared services agreement whereby DriveTime provided certain accountingreconditioning costs, calculated based on the Company's pro rate utilization of space at the IRC in a given month, along with a pro rata share of the facility's actual insurance costs and tax, legal and compliance, information technology, telecommunications, benefits, insurance, real estate equipment, corporate communications, software and production and other services to facilitatetaxes. Management has determined that the transition of these services to the Company on a standalone basis (the “Shared Services Agreement”). The Shared Services Agreement was most recently amended and restated in April 2017 and operates on a year-to-year basis after February 2019, with the Company having the right to terminate any or all services with 30 days' prior written notice and DriveTime having the right terminate certain services effective December 2017 and other services effective July 2018, in each case with 90 days' prior written notice. DriveTime provides the Company with certain benefits, telecommunications and information technology services under the amended agreement. Chargescosts allocated to the Company are based on the Company’s actual use of the specific services detailed in the Shared Services Agreement. Total expensesa reasonable methodology.
Expenses related to the shared services agreement were approximately $0.1 million, $0.7 millionthese operating lease agreements are allocated based on usage to inventory and $1.0 million for the years ended December 31, 2017, 2016 and 2015, respectively, which are included in selling, general and administrative expenses in the accompanying consolidated balance sheets and statements of operations. Costs allocated to inventory are recognized as cost of sales when the inventory is sold. During the year ended December 31, 2019, total costs related to these operating lease agreements, including those noted above, were approximately $7.9 million with approximately $3.3 million and $4.6 million allocated to each of inventory and selling, general, and administrative expenses, respectively. During the year ended December 31, 2018, total costs related to these operating lease agreements were approximately $8.8 million with approximately $4.4 million allocated to each of inventory and selling, general, and administrative expenses. During the year ended December 31, 2017, total costs related to these operating lease agreements were approximately $7.2 million with approximately $2.8 million and $4.4 million allocated to inventory and selling, general, and administrative expenses, respectively.
In February 2019, the Company entered into an agreement to assume a lease of an IRC near Nashville, Tennessee that DriveTime leased from an unrelated landlord. The Company became the sole occupant in April 2019. The lease expires in four years, subject to the ability to exercise 3 renewal options of five years each. DriveTime remained an occupant of the facility through April 1, 2019 but is not fully released from lease obligations by the landlord.
During 2019, the Company purchased certain leasehold improvements and equipment from DriveTime at facilities the Company previously shared with them for DriveTime's net book value of approximately $6.3 million.
Corporate Office Leases
During the first quarter of 2017, the Company subleased additional office space at DriveTime’s corporate headquarters in Tempe, Arizona. Pursuant to this arrangement, the Company incurred rent of approximately $0.1 million during the year ended December 31, 2017. This arrangement terminated in March 2017.
In September 2016, the Company entered into a lease for the second floor of its corporate headquarters in Tempe, Arizona. DriveTime guaranteed up to $0.5 million of the Company's rent payments under that lease through September 2019. In connection with that lease, the Company entered into a sublease with DriveTime for the use of the first floor of the same building. The lease and sublease each have a term of 83 months, subject to the right to exercise 3 five-year extension options. Pursuant to the sublease, the Company will pay the rent equal to the amounts due under DriveTime's master lease directly to DriveTime's landlord. The rent expense incurred related to this first floor sublease was approximately $0.9 million during both of the years ended December 31, 2019 and 2018 and $0.7 million during the year ended December 31, 2017.
In December 2019, Verde purchased an office building in Tempe, Arizona that the Company leased from an unrelated party prior to Verde's purchase. In connection with the purchase, Verde assumed that lease. The lease has an initial term of ten years, subject to the right to exercise 2 five-year extension options. During the year ended December 31, 2019, the rent expense incurred under the lease with Verde was approximately $42.5 thousand.
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Master Dealer Agreement
In December 2016, the Company entered into a master dealer agreement with DriveTime (the "Master Dealer Agreement"), pursuant to which the Company may sell VSCs to customers purchasing a vehicle from the Company. The Company earns a commission on each VSC sold to its customers and DriveTime is obligated by and subsequently administers the VSCs. The Company collects the retail purchase price of the VSCs from its customers and remits the purchase price net of commission to DriveTime. During the years ended December 31, 2019, 2018, and 2017, the Company recognized approximately $55.6 million, $23.7 million, and $8.9 million, respectively, of commissions earned on VSCs sold to its customers and administered by DriveTime, net of a reserve for estimated contract cancellations. The commission earned on the sale of these VSCs is included in other sales and revenues in the accompanying consolidated statements of operations. In November 2018, the Company amended the Master Dealer Agreement to allow the Company to receive payments for excess reserves based on the performance of the VSCs versus the reserves held by the VSC administrator, once a required claims period for such VSCs has passed. During the years ended December 31, 2019, 2018, and 2017, the Company recognized approximately $4.1 million, $1.9 million, and $0.0 million, respectively, related to payments for excess reserves to which it expects to be entitled, which is included in other sales and revenues in the accompanying consolidated statements of operations.
Beginning in 2017, DriveTime also administers a portion of the Company's GAP waiver coverage and the limited warranty provided to all customers under the Master Dealer Agreement. The Company pays a per-contract fee to DriveTime to administer a portion of the GAP waiver coverage it sells to its customers and a per-vehicle fee to DriveTime to administer the limited warranty included with every purchase. The Company incurred approximately $4.3 million, $2.2 million, and $0.6 million during the years ended December 31, 2019, 2018, and 2017, respectively, related to the administration of GAP waiver coverage and limited warranty. As of December 31, 2019, the majority of the Company's GAP waiver coverage sales are administered by an unrelated party.
GAP Waiver Insurance Policy
During the year ended December 31, 2019, the Company purchased insurance policies from BlueShore Insurance Company ("BlueShore"), an affiliate of DriveTime, for approximately $1.8 million that reimburses the lienholder of finance receivables with GAP waiver coverage for any GAP waiver claims on a defined set of finance receivables that the Company sold in its securitization transactions. This insurance is transferred with the underlying finance receivable. In March 2019, the Company entered into a retrospective profit sharing agreement with BlueShore under which the Company will share in the profits generated from the insurance policies by receiving a portion of the excess of the premium it paid to BlueShore, net of a fee, compared to the amount BlueShore pays out related to the GAP waiver claims. As of December 31, 2019, the Company held a receivable of approximately $0.2 million, which is included in other assets on the accompanying consolidated balance sheets, related to this retrospective profit sharing agreement.
Servicing and Administrative Fees
DriveTime provides servicing and administrative functions associated with the Company's finance receivables. The Company incurred expenses of approximately $4.2 million, $0.9 million, and $0.2 million for the years ended December 31, 2019, 2018, and 2017, respectively, related to these services.
Aircraft Time SharingMaster Dealer Agreement
The Company entered into an agreement to share usage of two aircraft operated by Verde Investments, Inc., an affiliate of DriveTime, (“Verde”) on October 22, 2015, and the agreement was subsequently amended on May 15, 2017. Pursuant to the agreement, the Company agreed to reimburse Verde for actual expenses for each of its flights. The original agreement was for 12 months, with perpetual 12-month automatic renewals. Either the Company or Verde can terminate the agreement with 30 days’ prior written notice. The Company reimbursed Verde approximately $0.4 million, $0.6 million and $0.1 million under this agreement during the years ended December 31, 2017, 2016 and 2015, respectively.
Lease Agreements
In November 2014, the Company and DriveTime entered into a lease agreement that governs the Company’s access to and utilization of temporary storage, reconditioning, offices and parking space at various DriveTime inspection and reconditioning centers ("IRCs") and retail facilities (the "DriveTime Lease Agreement"). The DriveTime Lease Agreement was most recently amended in March 2018. Lease duration varies by location with the initial terms expiring between 2018 and 2024. Most of the retail facilities have two-year terms and the Company is entitled to exercise up to two consecutive one-year renewal options at up to ten of these locations. The DriveTime Lease Agreement provides that the Company may take over DriveTime's leases for the IRCs that the Company uses in their entirety on July 31, 2018, subject to the Company obtaining releases of DriveTime's liability under the applicable leases and purchasing DriveTime's tenant improvements and furniture, fixtures and equipment at the net book value of such assets.
Under the DriveTime Lease Agreement, the Company pays a monthly rental fee related to its pro rata utilization of space at each facility plus a pro rata share of each facility’s actual insurance costs and real estate taxes. The Company is additionally responsible for paying for any tenant improvements it requires to conduct its operations and its share of estimated costs incurred by DriveTime related to preparing these sites for use. As it relates to locations where the Company reconditions vehicles, the Company’s share of facility and shared reconditioning supplies expenses are calculated monthly by multiplying the actual costs for operating the inspection centers by the Company’s pro rata share of total reconditioned vehicles and parking spaces at such inspection centers in a given month. Management has determined that the costs allocated to the Company are based on a reasonable methodology.
Separate from the DriveTime Lease Agreement, in December 2016, the Company entered into a leasemaster dealer agreement related to a vehicle inspection and reconditioning center in Tolleson, Arizona, with Verde, with an initial term of approximately 15 years. The lease agreement requires monthly rental payments and can be extended for four additional five-year periods. In February 2017, the Company also entered into a lease with DriveTime for sole occupancy of a fully-operational inspection and reconditioning center in Winder, Georgia, where the Company previously maintained partial occupancy. The lease has an initial term of eight years, subject(the "Master Dealer Agreement"), pursuant to the Company's ability to exercise three renewal options of five years each. The base rent for both of these leases will be subject to increases each year beginning January 1, 2018.
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Expenses related to these lease agreements are allocated based on usage to inventory and selling, general and administrative expenses in the accompanying consolidated balance sheets and statements of operations. Costs allocated to inventory are recognized as cost of sales when the inventory is sold. During the year ended December 31, 2017, total costs related to these lease agreements were approximately $7.2 million with approximately $2.8 million and $4.4 million allocated to inventory and selling, general and administrative expenses, respectively. During the year ended December 31, 2016, total costs related to these lease agreements were approximately $2.8 million with approximately $1.9 million and $0.9 million allocated to inventory and selling, general and administrative expenses, respectively. During the year ended December 31, 2015, total costs related to these lease agreements were approximately $0.8 million with approximately $0.5 million and $0.3 million allocated to inventory and selling, general and administrative expenses, respectively.
Corporate Office Leases
The Company paid a monthly rental fee for its use of space at DriveTime’s corporate headquarters through December 2015, at which time this agreement terminated. The monthly rental fees for this space for the year ended December 31, 2015 was approximately $0.3 million. In November 2015, the Company entered into a lease agreement with Verde for its then corporate headquarters. The rent expense incurred related to this lease for the years ended December 31, 2016 and 2015 was approximately $0.9 million and $0.1 million, respectively. In December 2016, Verde sold the building and assigned the lease to a third party, which the Company continued leasing through June 2017.
Duringmay sell VSCs to customers purchasing a vehicle from the first quarter of 2017,Company. The Company earns a commission on each VSC sold to its customers and DriveTime is obligated by and subsequently administers the VSCs. The Company subleased additional office space at DriveTime’s corporate headquarters in Tempe, Arizona. Pursuant to this arrangement,collects the Company incurred rent of approximately $0.1 million during the year ended December 31, 2017. This arrangement terminated in March 2017.
As discussed in Note 13 — Commitments and Contingencies, in September 2016, the Company entered into a lease with a third party for the second floor of its corporate headquarters in Tempe, Arizona. DriveTime guarantees up to $0.5 millionretail purchase price of the Company's rent payments under that lease through September 2019. In connection with that lease,VSCs from its customers and remits the Company entered into a sublease with DriveTime for the usepurchase price net of the first floor of the same building. Pursuantcommission to this sublease, which has a term of 83 months and is co-terminus with DriveTime's master lease, subject to the right to exercise three five-year extension options, the Company will pay DriveTime rent equal to the amounts due under DriveTime's master lease.DriveTime. During the years ended December 31, 2019, 2018, and 2017, the Company recognized approximately $55.6 million, $23.7 million, and 2016,$8.9 million, respectively, of commissions earned on VSCs sold to its customers and administered by DriveTime, net of a reserve for estimated contract cancellations. The commission earned on the rent expense incurred relatedsale of these VSCs is included in other sales and revenues in the accompanying consolidated statements of operations. In November 2018, the Company amended the Master Dealer Agreement to this first floor sublease wasallow the Company to receive payments for excess reserves based on the performance of the VSCs versus the reserves held by the VSC administrator, once a required claims period for such VSCs has passed. During the years ended December 31, 2019, 2018, and 2017, the Company recognized approximately $0.7$4.1 million, $1.9 million, and $0.0 million, respectively.respectively, related to payments for excess reserves to which it expects to be entitled, which is included in other sales and revenues in the accompanying consolidated statements of operations.
Vehicle Inventory Purchases
Through September 2016, the Company selected vehicle inventory and used DriveTime's auction numbers to facilitate purchases underBeginning in 2017, DriveTime also administers a non-interest bearing agreement requiring periodic repayments. Vehicles purchased under this agreement were acquired by the Company at DriveTime's costportion of the vehicles purchasedCompany's GAP waiver coverage and the limited warranty provided to all customers under the Master Dealer Agreement. The Company pays a per-contract fee to DriveTime to administer a portion of the GAP waiver coverage it sells to its customers and a per-vehicle fee to DriveTime to administer the limited warranty included with no markup. Beginning October 1, 2016,every purchase. The Company incurred approximately $4.3 million, $2.2 million, and $0.6 million during the Company began purchasing its vehicle inventory independentlyyears ended December 31, 2019, 2018, and making2017, respectively, related to the payments itself through its vehicle inventory financingadministration of GAP waiver coverage and security agreement. See Note 7 — Debt Instruments for further information.limited warranty. As of December 31, 2019, the majority of the Company's GAP waiver coverage sales are administered by an unrelated party.
Vehicle Inventory Transfer to DriveTimeGAP Waiver Insurance Policy
During the year ended December 31, 2016,2019, the Company transferred used vehicle inventory with a carrying valuepurchased insurance policies from BlueShore Insurance Company ("BlueShore"), an affiliate of DriveTime, for approximately $4.9$1.8 million to DriveTime to dispose of used vehicle inventory that no longer metreimburses the Company’s inventory specifications. The Company recorded a loss of approximately $0.8 million related to this disposal, which is included in cost of sales on the accompanying consolidated statement of operations.
Repurchase of Finance Receivables from DriveTime
On January 20, 2016, the Company repurchased approximately $72.4 millionlienholder of finance receivables from DriveTime related to loans the Company originated and previously sold under the termswith GAP waiver coverage for any GAP waiver claims on a defined set of the DriveTime receivable purchase agreement (the “DriveTime Receivable Purchase Agreement”) discussed below for a price of approximately $74.6 million. Such receivables were immediately sold by the Company to third party purchasers under the transfer and note purchase and security agreements for the same price of approximately $74.6 million.
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DriveTime Receivable Purchase Agreement
In June 2014, the Company entered into the DriveTime Receivable Purchase Agreement pursuant to which the Company may sell to DriveTime and DriveTime may purchase from the Company finance receivables that the Company originatessold in conjunctionits securitization transactions. This insurance is transferred with the sale of vehicles. Duringunderlying finance receivable. In March 2019, the year ended December 31, 2016, DriveTime purchasedCompany entered into a retrospective profit sharing agreement with BlueShore under which the Company will share in the profits generated from the insurance policies by receiving a portion of the finance receivablesexcess of the premium it paid to BlueShore, net of a fee, compared to the amount BlueShore pays out related to the GAP waiver claims. As of December 31, 2019, the Company originated representing approximately $11.5 million of gross outstanding principal balance, resulting inheld a gain on loan sale from related partyreceivable of approximately $0.3 million.$0.2 million, which is included in other assets on the accompanying consolidated balance sheets, related to this retrospective profit sharing agreement.
Servicing and Administrative Fees
DriveTime provides servicing and administrative functions associated with the Company's finance receivables. The Company did not sell any finance receivables under this agreement duringincurred expenses of approximately $4.2 million, $0.9 million, and $0.2 million for the years ended December 31, 2019, 2018, and 2017, and DriveTime is not obligatedrespectively, related to make any additional purchases under the agreement.these services.
Master Dealer Agreement
In December 2016, the Company entered into a master dealer agreement with DriveTime (the "Master Dealer Agreement"), pursuant to which the Company may sell certain ancillary products, including vehicle service contracts ("VSCs"),VSCs to customers purchasing a vehicle from the Company. The Company earns a commission on each VSC sold to its customers and DriveTime is obligated by and subsequently administers the VSCs. The Company collects the retail purchase price of the VSCs from its customers and remits the purchase price net feeof commission to DriveTime on a periodic basis.DriveTime. During the years ended December 31, 20172019, 2018, and 2016,2017, the Company recognized approximately $8.9$55.6 million, $23.7 million, and $0.2$8.9 million, respectively, of commissions earned on VSCs sold to its customers and administered by DriveTime.DriveTime, net of a reserve for estimated contract cancellations. The commission earned on the sale of these VSCs is included in other sales and revenues in the accompanying consolidated statements of operations. In November 2018, the Company amended the Master Dealer Agreement to allow the Company to receive payments for excess reserves based on the performance of the VSCs versus the reserves held by the VSC administrator, once a required claims period for such VSCs has passed. During the years ended December 31, 2019, 2018, and 2017, the Company recognized approximately $4.1 million, $1.9 million, and $0.0 million, respectively, related to payments for excess reserves to which it expects to be entitled, which is included in other sales and revenues in the accompanying consolidated statements of operations.
Beginning in 2017, DriveTime also administers a portion of the Company's GAP waiver coverage and the limited warranty provided to all customers under the Master Dealer Agreement. The Company pays a per-contract fee to DriveTime to administer a portion of the GAP waiver coverage it sells to its customers and a per-vehicle fee to DriveTime to administer the limited warranty included with every purchase. The Company incurred approximately $4.3 million, $2.2 million, and $0.6 million during the years ended December 31, 2019, 2018, and 2017, respectively, related to the administration of GAP waiver coverage and limited warranty. As of December 31, 2019, the majority of the Company's GAP waiver coverage sales are administered by an unrelated party.
GAP Waiver Insurance Policy
During the year ended December 31, 2019, the Company purchased insurance policies from BlueShore Insurance Company ("BlueShore"), an affiliate of DriveTime, for approximately $1.8 million that reimburses the lienholder of finance receivables with GAP waiver coverage for any GAP waiver claims on a defined set of finance receivables that the Company sold in its securitization transactions. This insurance is transferred with the underlying finance receivable. In March 2019, the Company entered into a retrospective profit sharing agreement with BlueShore under which the Company will share in the profits generated from the insurance policies by receiving a portion of the excess of the premium it paid to BlueShore, net of a fee, compared to the amount BlueShore pays out related to the GAP waiver claims. As of December 31, 2019, the Company held a receivable of approximately $0.2 million, which is included in other assets on the accompanying consolidated balance sheets, related to this retrospective profit sharing agreement.
Servicing and Administrative Fees
DriveTime provides servicing and administrative servicesfunctions associated with the Company's finance receivables and GAP waiver coverage.receivables. The Company incurred expenseexpenses of approximately $0.3$4.2 million, $0.0$0.9 million, and $0.0$0.2 million for the years ended December 31, 2019, 2018, and 2017, 2016respectively, related to these services.
Aircraft Time Sharing Agreement
The Company entered into an agreement to share usage of 2 aircraft owned by Verde and operated by DriveTime in 2015, respectively.and the agreement was subsequently amended in 2017. Pursuant to the agreement, the Company agreed to reimburse DriveTime for actual expenses for each of its flights. The original agreement was for 12 months, with perpetual 12-month automatic renewals. Either the Company or DriveTime can terminate the agreement with 30 days’ prior written notice. The Company reimbursed DriveTime approximately $0.5 million during both of the years ended December 31, 2019 and 2018 and approximately $0.4 million during the year ended 2017 under this agreement.
Shared Services Agreement with DriveTime
In November 2014, the Company and DriveTime entered into a shared services agreement whereby DriveTime provided certain accounting and tax, legal and compliance, information technology, telecommunications, benefits, insurance, real estate, equipment, corporate communications, software and production, and other services to facilitate the transition of these services to the Company on a standalone basis (the "Shared Services Agreement"). The Shared Services Agreement was most recently amended and restated in April 2017 and operates on a year-to-year basis after February 2019, with the Company having the
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right to terminate any or all services with 30 days' prior written notice and DriveTime having the right to terminate any or all services with 90 days' prior written notice. Charges allocated to the Company were based on the Company’s actual use of the specific services detailed in the Shared Services Agreement. Total expenses related to the Shared Services Agreement were approximately $0.0 million for both of the years ended December 31, 2019 and 2018, and approximately $0.1 million during the year ended December 31, 2017, all of which are included in selling, general and administrative expenses in the accompanying consolidated statements of operations.
Accounts Payable Due to Related Party
As of December 31, 2019 and 2018, approximately $9.5 million and $3.9 million, respectively, was due to related parties primarily related to the agreements mentioned above, and is included in accounts payable and accrued liabilities in the accompanying consolidated balance sheets.
Senior Unsecured Notes Held by Verde
As of both December 31, 2019 and 2018, Verde held $15.0 million of principal of the Company's outstanding senior unsecured notes, which are described further in Note 9 — Debt Instruments.
Credit Facility with Verde
On February 27, 2017, the Company entered into a credit facility with Verde for an amount up to $50.0 million (the "Verde Credit Facility"). Amounts outstanding accrued interest at a rate of 12.0% per annum and were scheduled to mature in August 2018.annum. Upon execution of the agreement, the Company paid Verde a commitment fee of $1.0 million. In connection with the IPO completed on May 3, 2017, the Company repaid the outstanding principal balance of $35.0 million and accrued interest of approximately $0.4 million in full and the Verde Credit Facility agreement terminated.
Loan fromContribution Agreements
On September 10, 2018, the Company announced a commitment by its Chief Executive Officer, Ernest Garcia II
On March 31, 2016,III, to contribute shares of the Company's Class A common stock, for each then-current employee from his personal shareholdings to the Company at 0 charge (the "Share Contributions"). His contributions funded equity awards of 165 restricted stock units to each of the Company's then-current employees upon their satisfying certain employment tenure requirements (the "100k Milestone Gift"). The Company entered into a loan and security agreement with Ernest Garcia, II ("Mr. Garcia") of $10.0 million. The loan bore interest at an annual rate of 4.0% and had a maturity date of May 1, 2016, at which time all unpaid principal and accrued interest were payablecertain contribution agreements related to Mr. Garcia. On April 1, 2016, the Company received the proceeds from the loan and on April 28, 2016, the Company repaid the principal and accrued interest, thereby terminating the loan.
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Investments with DriveTime
On July 21, 2015, the Company issued a $50.0 million note payable to DriveTime. The note payable accrued interest at one-month LIBOR plus 7.816% and was scheduled to mature on September 21, 2015. The proceeds from the note payable were used, in part, to fund an approximately $33.5 million dividend to Class A Unit holders on July 27, 2015. Certain of the Class A Unit holders used the proceeds from the dividend to make an approximately $33.5 million capital contribution to DriveTimehis commitment in order to releaseeffect the transfer of shares from Mr. Garcia to the Company. The Company does not expect Mr. Garcia to incur any tax obligations related to the Share Contributions, but pursuant to a series of Contribution Agreements, it has indemnified Mr. Garcia from its guarantees onany such obligations that may arise. See Note 10 — Stockholders' Equity and Note 12 — Equity-Based Compensation for further discussion. As of December 31, 2019, Mr. Garcia's commitment related to the obligations under DriveTime’s outstanding senior secured notes. On July 27, 2015, the Company also issued a stock dividend of approximately 1.5 million Class A Units to Class A Unit holders on a pro rata basis in satisfaction, together with the approximately $33.5 million cash dividend, of such Class A Unit holders’ remaining $40.0 million preference. Satisfaction of the Class A Unit holders’ preference was necessary in order to facilitate the Company’s sale of Class C redeemable preferred units (the “Class C Redeemable Preferred Units”) on July 27, 2015. The issuance of the Class A Unit dividend increased the number of Class A Units authorized and outstanding and did not impact the Company’s members’ equity (deficit). On July 27, 2015, the Company issued approximately 11.8 million Class A Units to DriveTime in exchange for the cancellation of the $50.0 million note payable to DriveTime plus accrued interest.100k Milestone Gift has been fulfilled.
IP License Agreement
In February 2017, the Company entered into a license agreement that governs the rights of certain intellectual property owned by the Company and the rights of certain intellectual property owned by DriveTime. The license agreement, which was amended and restated in April 2017, generally provides that each party grants to the other certain limited exclusive (other than with respect to the licensor party and its affiliates) and non-exclusive licenses to use certain of its intellectual property, and each party agrees to certain covenants not to sue the other party, its affiliates, and certain of its service providers in connection with various patent claims. The exclusive license to DriveTime is limited to the business that is primarily of subprime used car sales to retail customers. However, upon a change of control of either party, both parties’ license rights as to certain future improvements to licensed intellectual property and all limited exclusivity rights are terminated. The agreement does not provide a license to any of the Company's patents, trademarks, logos, customers’ personally identifiable information or any intellectual property related to the Company's vending machine,machines, automated vehicle photography, or certain other elements of the Company's brand.
Accounts Payable Due to Related Party
Amounts payable to DriveTime and Verde under the agreements explained above, as well as invoices DriveTime initially paid on behalf of the Company for vehicle reconditioning costs and general and administrative expenses, are included in accounts payable to related party in the accompanying consolidated balance sheets. As of December 31, 2017 and December 31, 2016, approximately $1.8 million and $1.9 million, respectively, was due to related parties primarily related to lease agreements, shared service fees, net VSC fees collected from customers and repayments to DriveTime for invoices paid on behalf of the Company.
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NOTE 67 — FINANCE RECEIVABLE SALE AGREEMENTS
Transfer Agreements and Note Purchase and Security Agreements
In January 2016, the Company entered into transfer agreements pursuant to which it sold finance receivables meeting certain underwriting criteria to certain third party purchasers who engage DriveTime as servicer of such receivables. Pursuant to certain note purchase and security agreements, entered into in connection with the transfer agreements, such third party purchasers of receivables issued notes to certain parties, including Delaware Life Insurance Company (“Delaware Life”), in which Mark Walter has a substantial ownership interest. Mark Walter also indirectly controls CVAN Holdings, LLC, an Existing LLC Unitholder, and has non-controlling ownership interests in the other note purchasers under the note purchase and security agreements. Pursuant to the note purchase and security agreements, Delaware Life advanced $63.0 million through December 31, 2016 to the trusts that purchased the Company's automotive finance receivables. Under this agreement through December 31, 2016, the Company had sold all $230.0 million of finance receivables, including approximately $72.4 million of finance receivables repurchased from DriveTime. On February 27, 2017, Delaware Life sold its interest in the notes under the note purchase and security agreements to an unrelated third party, but remains the administrative agent and paying agent for the note purchasers. The Company recognized gain on loan sales of approximately $6.6 million during the year ended December 31, 2016, which is included in other sales and revenues in the accompanying consolidated statements of operations. As of December 31, 2017, there was no unused capacity under the note purchase and security agreements.
Master Purchase and Sale Agreement and Master Transfer Agreement
In December 2016, the Company entered into a master purchase and sale agreement (the "Purchase"Master Purchase and Sale Agreement" or "MPSA") and a master transfer agreement (the "2016 Master Transfer Agreement") pursuant to which it sells finance receivables meeting certain underwriting criteria to certain third party purchasers,financing partners, including Ally Bank and Ally Financial (the
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(the "Ally Parties"). Through November 2017 under the Purchase and Sale Agreement and the 2016 Master Transfer Agreement, the Company could sell up to an aggregate of $375.0 million, and $292.2 million, respectively, in principal balances of finance receivables subject to adjustment as described in the respective agreements.
On November 3, 2017, the Company amended its Purchase and Sale AgreementMPSA to increase the aggregate amount of principal balances of finance receivables it can sell from $375.0 million to $1.5 billion. AlsoOn November 2, 2018, the Company amended the MPSA to, among other things and subject to the terms of the agreement, commit the purchaser to purchase up to a maximum of $1.25 billion of principal balances of finance receivables after the amendment date. Subsequently, on April 19, 2019, the Company amended the MPSA to, among other things and subject to the terms of the agreement, commit the purchaser to purchase up to a maximum of $1.0 billion of principal balances of finance receivables after the amendment date.
During the years ended December 31, 2019 and 2018, the Company sold approximately $418.8 million and $733.4 million, respectively, in principal balances of finance receivables under the MPSA and had approximately $658.3 million of unused capacity as of December 31, 2019.
On November 3, 2017, the Company terminated the remaining capacity under the 2016 Master Transfer Agreement and replaced this facility by entering into a new master transfer agreement (the "2017 Master Transfer Agreement") with a third partypurchaser trust (the "2017 Purchaser Trust") under which the third party hastrust committed to purchase up to an aggregate of approximately $357.1 million in principal balances of finance receivables. On November 2, 2018, the Company amended the 2017 Master Transfer Agreement to, among other things and subject to the terms of the agreement, increase and extend the trust's commitment to purchase finance receivables from the Company.
On August 7, 2018, in connection with a refinancing transaction discussed further below, the Company purchased finance receivables it had previously sold under the 2017 Master Transfer Agreement and simultaneously entered into a transfer agreement with a purchaser trust under which the trust immediately purchased such finance receivables from the Company.
On December 21, 2018, the Company entered into a transfer agreement with a purchaser trust under which the trust purchased principal balances of finance receivables from the Company, a portion of which were related to a refinancing transaction, discussed further below (the "2018 Transfer Agreement").
On May 7, 2019, the Company purchased the certificate of the 2017 Purchaser Trust for $34.0 million, net of cash acquired. At the time of acquisition the trust assets included $139.7 million of finance receivables that the Company had previously sold to the trust under the 2017 Master Transfer Agreement, and its liabilities included $105.7 million in associated debt and other liabilities. In connection with the certificate purchase, the Company and Ally Bank entered into an Amended and Restated Loan and Security Agreement (the "A&R Loan and Security Agreement") pursuant to which Ally Bank agreed to provide a $350.0 million revolving credit facility (the "SART 2017-1 Credit Facility") to fund certain automotive finance receivables originated by the Company, as further described in Note 9 — Debt Instruments.
During the year ended December 31, 2017,2019, prior to the acquisition of the certificate in the trust, the Company sold approximately $343.6$139.3 million in principal balances of finance receivables under the Purchase and Sale Agreement, and an aggregate of2017 Master Transfer Agreement. During the year ended December 31, 2018, the Company sold approximately $163.7$348.8 million in principal balances of finance receivables under both master transfer agreements. As of December 31, 2017, there was approximately $1.2 billion and $324.9 million of unused capacity under the Purchase and Sale Agreement and the 2017 Master Transfer Agreement, respectively.and approximately $115.0 million in principal balances of finance receivables under the 2018 Transfer Agreement, excluding those that were part of the refinancing transactions described below.
During the year ended December 31, 2019, prior to the certificate purchase, the Company also purchased finance receivables that it previously sold to the purchaser trust under the 2017 Master Transfer Agreement for a total price of approximately $127.7 million and immediately resold such finance receivables into a securitization transaction, which is described further in Note 8 — Securitizations and Variable Interest Entities. This transaction was entered into in connection with the securitization transaction and was entered into independently from the terms of the 2017 Master Transfer Agreement.
The total gain on loan sales related to finance receivables sold to third partiesfinancing partners under these agreementsthe MPSA, the 2016 Master Transfer Agreement, the 2017 Master Transfer Agreement, and to investors in securitization transactions discussed in Note 8 — Securitizations and Variable Interest Entities was approximately $137.3 million, $51.7 million, and $21.7 million during the years ended December 31, 20172019, 2018, and 2016, was approximately $21.7 million and $0.6 million,2017, respectively, which is included in other sales and revenues in the accompanying consolidated statements of operations.
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
During the year ended December 31, 2018, the Company purchased finance receivables that it previously sold to a purchaser trust under the 2017 Master Transfer Agreement for a total price of approximately $387.4 million and immediately resold such finance receivables to other trusts with the same certificate holder for the same price under separate transfer agreements, one of which was the 2018 Transfer Agreement. Other than customary repurchase obligations, the Company is not obligated to, nor does it have a right to, purchase or sell finance receivables it has previously sold under the 2017 Master Transfer Agreement. These transactions completed in 2018 were entered into in connection with a refinancing by the trusts' certificate holder and were entered into independently from the terms of the 2017 Master Transfer Agreement. The Company received fees totaling approximately $6.3 million for structuring and participating in these transactions, which are included in other sales and revenues in the accompanying consolidated statements of operations.
NOTE 78 — DEBT INSTRUMENTSSECURITIZATIONS AND VARIABLE INTEREST ENTITIES
Debt instrumentsBeginning in 2019, the Company sponsors and establishes securitization trusts to purchase finance receivables from the Company. The securitization trusts issue asset-backed securities, which are collateralized by the finance receivables that the Company sells to the securitization trusts. Upon transfer of the finance receivables to the securitization trusts, the Company recognizes a gain or loss on sales of finance receivables. The net proceeds from the sales are the fair value of the assets obtained as part of the transactions and typically include cash and at least 5% of the beneficial interests issued by the securitization trusts to comply with Risk Retention Rules. The beneficial interests retained by the Company include but are not limited to rated notes and certificates of the securitization trusts. The holders of the certificates issued by the securitization trusts have rights to cash flows only after the holders of the notes issued by the securitization trusts have received their contractual cash flows. The securitization trusts have no direct recourse to the Company’s assets, and holders of the securities issued by the securitization trusts can look only to the assets of the securitization trusts that issued their securities for payment. The beneficial interests held by the Company are subject principally to the credit and prepayment risk stemming from the underlying finance receivables.
As described in Note 2 — Summary of Significant Accounting Policies, the securitization trusts established in connection with asset-backed securitization transactions are VIEs. For each VIE that the Company establishes in its role as sponsor of securitization transactions, it performs an analysis to determine whether or not it is the primary beneficiary of the VIE. The Company’s continuing involvement with the VIEs consists of retaining a portion of the securities issued by the VIEs and performing ministerial duties as the trust administrator. As of December 31, 2019, the Company is not the primary beneficiary of these securitization trusts because its retained interests in the VIEs do not have exposures to losses or benefits that could potentially be significant to the VIEs. The Company does not consolidate the securitization trusts.
The assets the Company retains in the unconsolidated VIEs are presented as beneficial interests in securitizations on the accompanying consolidated balance sheets, which as of December 31, 20172019 were approximately $98.8 million. The Company held no other assets or liabilities related to its involvement with unconsolidated VIEs as of December 31, 2019.
The following table summarizes the carrying value and 2016total exposure to losses of its assets related to unconsolidated VIEs with which the Company has continuing involvement, but is not the primary beneficiary at December 31, 2019. Total exposure represents the estimated loss the Company would incur under severe, hypothetical circumstances, such as if the value of the interests in the securitization trusts and any associated collateral declined to zero. The Company believes the possibility of this is remote. As such, the total exposure presented below is not an indication of the Company's expected losses.
| | | | | | | | | | | |
| Carrying Value | | Total Exposure |
| | | |
| (in thousands) | | |
Rated notes | $ | 85,234 | | | $ | 85,234 | |
Certificates and other assets | 13,546 | | | 13,546 | |
Total unconsolidated VIEs | $ | 98,780 | | | $ | 98,780 | |
The beneficial interests in securitizations are considered securities available for sale subject to restrictions on transfer pursuant to the Company’s obligations as a sponsor under Risk Retention Rules. These securities are interests in securitization
CARVANA CO. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
trusts, thus there are no contractual maturities. The amortized cost and fair value of securities available for sale as of December 31, 2019 were as follows (in thousands):
| | | | | | | | | | | |
| Amortized Cost | | Fair Value |
Rated notes | $ | 84,983 | | | $ | 85,234 | |
Certificates and other assets | 13,456 | | | 13,546 | |
Total securities available for sale | $ | 98,439 | | | $ | 98,780 | |
NOTE 9 — DEBT INSTRUMENTS
Debt instruments, excluding finance leases, which are discussed in Note 15 — Leases, as of December 31, 2019 and 2018 consisted of the following (in thousands):
| | | | | | | | December 31, | |
| | December 31, | | 2019 | | 2018 |
| | 2017 | | 2016 | |
Asset-Based Financing: | | Asset-Based Financing: | | | | |
Floor Plan Facility | | $ | 248,792 |
| | $ | 165,313 |
| Floor Plan Facility | | $ | 515,487 | | | $ | 196,963 | |
Finance Receivable Facilities | | Finance Receivable Facilities | | 53,353 | | | — | |
Financing of beneficial interests in securitizations | | Financing of beneficial interests in securitizations | | 84,982 | | | — | |
Notes payable | | 26,641 |
| | 5,461 |
| Notes payable | | 31,757 | | | 33,015 | |
Finance leases | | 27,264 |
| | — |
| |
Real estate financing | | Real estate financing | | 177,221 | | | 44,956 | |
Total asset-based financing | | Total asset-based financing | | 862,800 | | | 274,934 | |
Senior Notes (1) | | Senior Notes (1) | | 600,000 | | | 350,000 | |
Total debt | | 302,697 |
| | 170,774 |
| Total debt | | 1,462,800 | | | 624,934 | |
Less: current portion | | (253,923 | ) | | (166,370 | ) | Less: current portion | | (606,644) | | | (208,096) | |
Less: debt issuance costs (1) | | (305 | ) | | — |
| |
Long-term debt, net | | $ | 48,469 |
| | $ | 4,404 |
| |
(1) The debt issuance costs related to notes payable and finance leases are presented as a reduction of the carrying amount of the liabilities. Debt issuance costs related to revolving debt arrangements are presented within other current assets and other assets on the accompanying consolidated balance sheets. | |
Less: unamortized premium and debt issuance costs (2) | | Less: unamortized premium and debt issuance costs (2) | | (13,642) | | | (7,643) | |
Total long-term debt, net | | Total long-term debt, net | | $ | 842,514 | | | $ | 409,195 | |
|