Copart Inc Q2 FY2020 Earnings Call

Good day, everyone, and welcome to the Copart Incorporated Second Quarter Fiscal 2020 Earnings Call. Just a reminder, today's conference is being recorded. For opening remarks and introductions, I would like to turn the call over to Mr. Jay Adair, Chief Executive Officer of Copart Incorporated. Please go ahead, sir.

Thank you, Samantha. Good morning, everyone, and it's a pleasure to welcome you all to the second quarter call. I’m going to turn it over to Jeff Liaw, our President for Safe Harbor, and then I'll give you a quick update on the company, and he will give an update on financial performance. So with that, Jeff?

Thanks, Jay. During today's call, we'll discuss certain non-GAAP measures, which include adjustments to reverse the effect of certain discrete income tax items, disposal of non-operating assets, foreign currency-related gains, certain income tax benefits, and payroll taxes related to accounting for stock option exercises, and the effect on common equivalent shares from ASU 2016-09. We've provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures on our website under the Investor Relations link, and in our press release issued yesterday. We believe these non-GAAP measures, together with our corresponding GAAP measures, are relevant in assessing our business trends and performance. We analyze our results on both GAAP and non-GAAP bases. In addition, this call may contain forward-looking statements, which are subject to risks and uncertainties that could cause actual results to differ materially from those projected or implied by our statements. We do not undertake to update any forward-looking statements. For a more complete discussion of the risks that could affect our business, please review the management's discussion and analysis portions in our related periodic reports filed with the SEC. Jay?

Thank you, Jeff. For starters, I'd like to state that we have never been better prepared for the future. When we think about capacity, we think about it globally, and whether it's in Europe or the U.S., we have more capacity to date than we have ever had. This is an effort that has been ongoing for the last five years to build out a network of locations that are closer to the car, and then have more room, so that we can continue to handle vehicles that come in, due to continued total loss rates, again due to technology in cars, and due to market share gains that we have seen over the last five years. We expect that both those trends will continue, and I'm happy to say we have the capacity to handle that. When it comes to catastrophes, whether they be small catastrophes or super storm events, there is no match for the way that Copart handles a cab. Our preparedness has never been better through equipment that we utilize in the field, through locations where we have large facilities that can store 20,000, 30,000, 40,000 vehicles in a super storm event, to the process we've developed over the last five years, and to the technology that we deploy. It is not an understatement to say that our position in the industry is unmatched when it comes to those events. Our people are also the best in the industry, whether it be through our tenure, as the company has achieved so many years of success now, whether it be the training, or the talent; their ability is unmatched, and I put a huge, huge amount of credit on our success over the last five years and wins due to the people that run this company. Our technology continues to lead the industry. We've been a leader in the technology space now for 20 years, moving completely online back in 2003, 17 years ago. And I would put our technology teams up against any of the tech titans in Silicon Valley. What we have developed over the years, and what we are developing currently and that we’ll be rolling out in the years to come, will continue to keep the gap between us and our competitors and offer a service offering to our customers that is unmatched. Copart is a technology company, but we're also a land-holding company with over 10,000 acres, over 200 facilities, and we're also a logistics company. We're picking up over 250,000 vehicles a month, and we do that from assignment to pick up in less than a day. Through our people, our process, and our technology, we’ll continue to win. With that, it's my pleasure to turn it over to our President, Jeffrey L., for an update on the financials and the performance of the company. Jeff?

Thank you, Jay. We are pleased with our second-quarter results, which set a record for Copart in revenue, gross profit, and operating income. We achieved global revenue growth of 6%, or $90 million, compared to last year, with U.S. revenue growing by 23.8%. International revenue saw a slight decline of 2.6% year-over-year, mainly due to converting a significant U.K. customer from a purchase-based sales contract to a fee-based model. Our global service revenue increased by $93.2 million, or 22% year-over-year, which, along with units sold, provides a clearer picture of our business activity. Vehicle sales and costs can overshadow their actual economic impact on our business. Our purchased vehicles decreased by $3 million, or 4.4%, year-over-year for the second quarter, again primarily due to the shift of the U.K. customer to a fee-based consignment model. Global unit sales increased by 13.7% year-over-year, with U.S. units growing 15.3% and international units up 5.7%. This U.S. growth was supported by organic growth from both our existing insurance and non-insurance customers, as well as market share gains. Ongoing trends favoring increased total loss frequency are continuing to drive organic growth from insurance customers, as the attractive salvage returns we produce at auction become even more appealing against rising repair costs. Additionally, our non-insurance business grew by 5.8% year-over-year on a unit basis, reflecting growth from specific seller groups, such as automotive dealers, while managing capacity with charities and wholesalers. Excluding those charities and wholesalers, our non-insurance business saw a 20.6% year-over-year growth on a unit basis, driven by increased marketing and sales efforts, coupled with enhanced auction liquidity at Copart. We successfully connected a vast pool of buyers and sellers, providing industry-leading auction liquidity. Our global inventory grew 7.5% year-over-year, with U.S. inventory growth matching that figure and international inventory growth slightly higher at 7.8%. This inventory growth was driven by the same unit growth trends mentioned earlier, reflecting industry growth and successful customer acquisitions. Our gross profit increased from $208.2 million to $259.9 million, representing a 24.8% year-over-year increase. We also saw a gross margin rate change from 42.9% to 45.2%, with margins expanding by 230 basis points. Part of this improvement is linked to the customer's shift from a principal-based arrangement to a fee-based one. We achieved operational efficiencies globally, contributing to the further rise in gross margins. While we face rising costs in labor, health insurance, and fuel, we also benefit from generally stable trends in average selling prices and operating leverage. In the U.S., our average selling prices increased by 0.7% year-over-year, marking 13 consecutive quarters of ASP growth. This growth results from a larger number of bidders, including international bidders, leading to greater auction liquidity. Close to 50% of the value in our U.S. auctions comes from international buyers, who significantly influence pricing. Regarding general and administrative expenditures, excluding stock compensation and depreciation, they rose from $33.2 million a year ago to $39.2 million this quarter, also seeing a slight sequential increase of about $400,000 from the first quarter. G&A expenses tend to fluctuate and grow over time, so we encourage taking a multi-quarter perspective when forecasting the business. We believe we can achieve operating leverage despite certain inflationary pressures in labor and healthcare costs. Our GAAP operating income grew from $164.7 million to $209.9 million, a 27.4% increase, resulting in a 250 basis points expansion of operating margins. Our net interest expense remained stable year-over-year at approximately $4.5 million. Other income of $400,000 was mainly due to currency gains, offset by losses in certain non-consolidated equity positions. Our income tax for the second quarter totaled $36.4 million, including a $14.8 million tax benefit from employee stock option exercises, which is reflected in our non-GAAP earnings. GAAP net income increased from $131.4 million to $168.7 million year-over-year, marking a 28.4% increase. Our non-GAAP net income grew from $124.9 million to $153.5 million, a 22.9% year-over-year increase. On the balance sheet, we ended the quarter with $93.5 million in cash and approximately $320 million in net debt. We adopted a new lease standard in the first quarter of 2020, which is reflected in an operating lease right of use assets of $104 million and a corresponding liability of $105 million. Our operating cash flow for the quarter was $144.5 million, up $37 million compared to the previous year, primarily driven by higher earnings. Capital expenditures totaled $269 million this quarter, mostly for capacity expansion in line with our ongoing aggressive investment efforts. While permitting can affect the timing of some projects, we are pleased with our ability to complete capital initiatives this past quarter. Although this quarter features an unusually high CapEx amount, we view the last few years as a more representative indicator of our general growth run rate. Lastly, regarding our initiatives in Germany, we are committed to investing significantly in people, technology, and land. We continue to source cars to build liquidity and are improving in our efforts. Our long-term goal remains to secure consignment volumes to benefit the insurance industry, enhancing economic advantages and policyholder experiences in cases of total loss. We are actively engaging with decision-makers at major carriers and have successfully sold cars on a consignment basis for the insurance sector in Germany. We look forward to discussing this further on future calls.

Thank you. Our first question will come from Bob Labick with CJS Securities.

Good morning. I just wanted to start on the last call you alluded to helping some carriers optimize their claims process. Can you talk more about that? How it's going? Have there been any initial results or is that a long-term game plan? Is that a 2020, 2021? How should we think about that?

Bob, I'd characterize that as a 40-year journey. That's something we do literally every day. We may have spoken about it in somewhat greater detail on the last earnings calls, but we view it as our principal job to improve the claims process and economic outcomes for our insurance customers and their clients. There are certainly individual products that we have in the queue: products we have released and are already selling, but I wouldn't view that as a discrete change per se in what we do, Bob. It's just an ongoing purposeful commitment to that very outcome.

Got it. Okay, thanks. And then you just spoke about obviously the highest CapEx quarter you've had. Was all the land in the U.S.? Is this international as well? Are you still looking to keep a similar pace in the last two years going forward? Can you just give us a little more color on that?

The vast majority of the capital expenditures will be in the U.S. with some internationally, but the vast majority will be U.S. I called it out because it is obviously a much higher rate that we have incurred in recent years. We have announced our 2020 initiatives in April of 2016, if memory serves, so approximately four years ago we began this aggressive capacity expansion phase in our history. I would look to the past few years as more indicative of the run rate of our expenditures in this capacity growth phase more so than this past quarter. It is the nature of the beast, Bob, as you know having been in the industry for a long time that CapEx is by nature is lumpy. For example, you could close on a property that could have been literally tens of millions of dollars and then it is delayed by six months. So the tens of millions of dollars of expenditures await you in a few quarters' time. We strive for acquisition and development of the land so we have it available for our customers and ourselves as soon as we can; sometimes it happens all at once.

Got it. Okay, great. It sounds I guess crazy to ask this given I think 14% volume growth in the quarter and for several years, double-digit volume growth. But are you currently constrained on growing faster based on your capacity? Have you reached equilibrium now that you're just acquiring new capacity for future growth? Can you talk about where you stand if there have been constraints before, if you've reached what you need to get for current levels?

So it's a fair question. I think as Jay noted at the top, we've invested in the land so that we could serve our customers exceptionally well across all markets if and when they are ready to do business with us. So that’s our commitment to them, which is also, as you may have heard during the discussion, to certain non-insurance sellers of ours. We've made proactive decisions to free capacity in that respect for these critical insurance customers in particular. I wouldn't say it's been a gating factor, Bob, but it has required us to make an all-hands-on-deck effort to acquire and develop that land.

Got it. Okay, super. Thank you so much.

Our next question will come from Craig Kennison with Baird.

Good morning. Thank you for taking my questions. I wanted to ask about industry trends, what you're seeing in terms of claims activity and the total loss rate and how you see that unfolding in 2020.

I'll take a bigger step back, Craig, and make a broader observation. I think we are seeing claims activity that is relatively flat year-over-year in terms of the nominal claims. These are the same data points I'm sure that you track already regarding certain carriers who have disposed of their claims results as well as certain industry aggregators doing the same. Over most of our 40-year history, I think we've seen claims frequency generally decline very modestly over time as cars get safer, and perhaps drivers get better. One anomalous period for that trend was 2011-2016 when smartphone distraction was perhaps at its peak, but otherwise, for most of our 40-year history, accident frequency has generally declined over time. However, one way tailwind in our business, as you know, has been total loss frequency, which has increased very steadily over time. I think individual months and quarters are tough to measure. There's always going to be a lot of noise in that number, but if you take any kind of step back, you can see that trend continues to move up for reasons that become reasonably clear once you dig below the surface. Cars are becoming more sophisticated over time, and therefore, repair costs are rising, making repairs less compelling while at the same time our auction liquidity is improving and our international buyer base is expanding. So, quite literally, at the same time, repairs are less viable, salvage is better, which is what has driven total loss frequency to increase fivefold or sixfold over the past 40 years, and why we think it will continue to rise over the years to come. I expect that in 2020, but frankly for years and decades to come.

Thanks. And then looking at your European business and European car park, are there any substantial differences in the constitution of that car park such that we'd see a different trend in total loss rate or claims frequency?

In broader strokes, no. There certainly are local and country-specific idiosyncrasies that can affect how we enter and how we participate. But in broad strokes, no. The cars are similar, and the underlying drivers that make total loss such a compelling economic proposition here in the U.S. and in the UK are by and large true there too, which is to say high-labor repair cost and vehicle complexity, and frankly, again emerging and growing it demand for those same brand of cars.

And lastly, how would you frame the conversations you're having today with European insurance carriers versus those conversations from maybe a year or two ago, now that you've got sort of assets on the ground and an active platform working in Europe?

Fair question, Craig. Conversations are much more productive. It's one thing to discuss analogs to the UK and the U.S. and why the economic proposition can or should be compelling. It's another matter to have yards open, people engaged selling cars, and actual sales results at auction which demonstrate the superior economic outcome. Literally buying cars on the platform, using and trading for profit on the ground in Germany to buyers outside of Germany, in many cases, is the most compelling argument of all. It's not that Germany can be like the U.S.; it's that Germany on February 19, 2020, is delivering auctions of X, Y, Z. So the conversations have advanced in part for that reason.

Our next question will come from John Healy with Northcoast Research.

Thank you. I wanted to ask you guys about the comments you made about technology. Clearly, you have led the industry for a long time on that front. When I think about the last few years, I feel like you've made some nice upgrades to the buying and selling applications. I was hoping to understand from a technology standpoint where you are pushing the envelope? One area that I have always thought about, and we talked about that could potentially create service benefits, would be if titling with the states could become a little bit more seamless and maybe you could develop applications there. So, just trying to understand on the back-end side of things, what can technology bring to the industry? And that said, if you bring technology into the industry, and potentially cars move quicker, does that erode some of the economics that you have been able to benefit from associated with storing the vehicle for an extended period?

Thanks, John. My response will likely echo what I mentioned to Bob, which is that we view this as a significant investment in technology aimed at improving outcomes, particularly for our sellers. For them, outcomes typically involve reducing cycle times, enabling quicker claims closures, managing vehicle titling, and expediting the salvage process so that we can auction vehicles more efficiently on a global platform. There are numerous steps in this process, each requiring specific processes and technologies to operate optimally for us. So, to answer your question broadly, yes, technology represents our largest investment at Copart aside from our land. If you were to tour Copart headquarters and engage with each department, you would see that the technology group holds a dominant presence in terms of both personnel and resource allocation. It plays a crucial role in our operations, and we discuss it more frequently with our sellers than during calls like this, but it remains our primary investment at Copart.

And I might have missed it, but I probably did. Did you guys mention what inventories were at the end of the quarter in the U.S.?

Inventories increased 7% year-over-year.

Our next question will come from Daniel Imbro with Stephens Inc.

Hey, good morning guys. Thanks for taking my questions. Jay, a quick clarifier on your opening comments. Talking about capacity growth and incremental market share. Are you seeing incremental market share out there today? Are there any large contracts coming up for RFP in the next year? Or was that just to comment on kind of overall strategy and recent trends?

We don't discuss specific clients or whether they are preparing for tender after an RFP. However, we have historically achieved market share wins, and I want to emphasize two points: first, we have the capacity to continue doing that, and second, I expect this trend to persist. Additionally, regarding the previous question about selling vehicles more quickly and its potential impact on storage, we generally benefit from selling vehicles faster. Our primary objective is to sell those vehicles as quickly as possible for our customers. Selling vehicles leads to a higher return, and storage plays a minor role in our business. I just wanted to clarify that point.

That's helpful. And then, Jeff, maybe a follow-up: You continue to call out a benefit from this mix shift within non-insurance towards dealer and away from municipality and charity. How far along in that mix shift are we? Should that continue or have we largely phased out a lot of the legacy municipality charity toward that it should be more steady state going forward? What's the right mix longer term, strategically?

That's a complex question. We definitely value our customers in all categories, but we occasionally encounter resource constraints that influence our decisions. I believe that shift is mostly finished. We aim to provide the best detailed insights into the changes between quarters and how this quarter compares to the previous year. Overall, I consider that shift to be largely complete.

That's helpful. And then just one last one from me. Historically, if we look at warm winters 2012-2017, there does tend to be some negative impact on volume growth in the coming quarters just due to less accident frequency. Are you guys thinking that this winter should have any impact on your results in the back half of the year, or are industry dynamics strong enough that we should really see that show up in this business? Thanks.

Yes, that's a very fair question. With the exception of extreme weather events, we usually don't discuss weather because it can be hard to quantify and may serve as an excuse for business factors. I agree that it was a mild winter overall, with higher temperatures and less precipitation in the United States, which generally leads to fewer claims initially. I can't provide a precise quantification, but inventory did increase by 7.5% year-over-year, so whether that was affected by temperatures or precipitation is likely a judgment better left to others than to me.

Thank you. Our next question will come from Stephanie Benjamin with SunTrust.

Hi, good afternoon. Jeff, I was hoping you could talk a little bit more about what you're seeing on the pricing or revenue per unit side of the equation. I think you called out another quarter of ASP growth. But on a year-over-year basis maybe it's a little bit slower from some historical trends. I think some are calling for some declines in used vehicle pricing this year. I don't know if that's going to materialize or not, but maybe if you could speak to that side of the equation on the pricing and revenue per unit side and what you're seeing in the market. Thanks.

I believe you're inquiring about two distinct economic factors. One is the selling prices of our cars at auction, which are influenced by both cyclical and secular forces. Some of the cyclical variables that can impact these selling prices include used car prices and currency fluctuations, among others. The second factor is that we expect the total loss frequency to increase, and as this frequency rises, we see more marginal totals and more drivable cars, which could elevate average selling prices. Over the long term, we believe this combination will lead to higher average selling prices in any given quarter or year. However, projecting these outcomes can be complicated due to the various influencing factors. Generally, we think the long-term secular trends are advantageous for us. As for revenue per unit, we do not disclose that information. Our focus is on driving unit volume as much as possible, and revenue growth is also enhanced by the additional services we offer to both sellers and buyers.

And then I just had a clarification, I know that’s twice, I apologize for hearing it, but on Germany, did you say that you were testing some consignment models with some carriers in Germany, or did I miss that twice? So just a clarification.

We have sold cars on a consignment basis for insurance carriers in Germany. That said, we continue to purchase cars through our principal activity as we build the physical infrastructure, people-based and technology, and talents to serve that industry long-term.

Our next question will come from Bret Jordan with Jefferies.

Hey, good morning, guys. When you think about the inventory growth in the quarter and you had some pretty big share gains last year, is there any way to look at what was the contribution from new customers versus what was core legacy-ish inventory growth?

I think that's a level of detail we probably wouldn't get into, but I would say there was both underlying market growth and market share gains in that year-over-year number.

Okay, great. And I guess we don't talk about scrap pricing anymore, but do you see any impact, I guess, from the Chinese market demand, relative to what's going on with the coronavirus? Is there any pending volatility on scrap price there?

I'll answer in two parts. Scrap price may have an effect on Copart, I would say is largely de minimis. Chinese buyers, in part for regulatory reasons, are a very tiny portion of our overall sales, below one percent when I last checked last year. So they are not a significant buyer of Copart cars. That said, the coronavirus obviously will not necessarily observe specific national borders, so if it spreads there could be an effect downstream, but today's situation presents no concern for us.

Okay, and then just one question on Germany. What's the total acreage there? I guess when you think about the yard size in Germany, I think about being somewhat smaller than the U.S. yard. So, is it better to think about it in acres versus locations?

Probably so, though not something we would discuss. Yes, we are investing in acreage. I think your intuition is generally correct in that our yards would be smaller today, in part because we needed to get operational rapidly. The lead time here in the U.S. and for that matter in Germany to develop acre parcels for vehicle storage is long, and we prefer to avoid waiting to do that. So, we have achieved operations in a number of facilities there more quickly by starting with smaller facilities in some cases.

Our next question will come from Gary Prestopino with Barrington Research.

Good morning, Jay, and Jeff, how are you? Hey, could you tell me, just as a percentage of the vehicles you're selling, insurance versus non-insurance, how is that mix changed? I mean, what is the current percentage now versus where it was maybe last year?

The current percentage is about 21%, which is slightly lower than the previous year's figure of 22%. There is some seasonal variation, but not on a year-over-year basis. This change is partly due to the shift we've mentioned previously regarding non-insurance.

And one could assume that most of the growth there is in dealer cars, correct? Is the growth for dealer cars?

That is a meaningful source of the growth in our non-insurance business, yes.

Do you have the capability, and I probably should know this, but I'm asking the question: With the dealer car, do you have the capability to sell it at their lot, or do you have to take it to one of your facilities to sell it?

So, there are — let's say, probably the safest way to characterize it is that we are exploring multiple ways to service those automotive dealers. I think clearly from their perspective today, our principal value proposition is the buyer base that we offer in comparison to other offerings in the marketplace. For example, we have a global buyer base. We already have the possibility from all over the world, and that is the value we offer. And how we deliver that, and whether physically we require taking the vehicles to a lot or not, those are all variables that are relatively simpler to manage, quite candidly, Gary. But I think the value proposition side I think is clear, and how we deliver it, we are experimenting with a number of different avenues.

Thank you. Our next question will come from Derek Glynn with Consumer Edge Research.

Thank you for taking the question. I actually had a follow-up on the non-insurance business and specifically your relationship with independent dealers. I'm curious how the vehicles sourced from them or that are purchased by them at your auctions differ from their own core inventory offering at retail. Are there any key differences in terms of age or quality? I'm just trying to get a better sense of how they're leveraging your platform.

I think the trends would be hard to draw very broad sweeping conclusions, but I'd say in general, of course, if they tend to specialize in brand X and receive brand Y, that would be a natural car to process through a Copart or consign to a Copart auction. But I think the variety is all over the map, and automotive dealers sometimes simply want to achieve near-term liquidity and consign a number of cars through us. You'll see a wide range sometimes, damaged cars, often intact cars that are perfectly drivable, sometimes both kinds of cars under facilities, sometimes newer ones as well. It's tough to provide rules on that.

Thank you. This is the final opportunity for questions. Our next question will be from Chris at Wolfe Research.

Thank you for taking my question. I'd like to ask about the European rollout. It seems you are demonstrating your capabilities and data to the insurers. Besides being a highly regulated industry, what other challenges are preventing insurers from moving faster, given the apparently compelling data? Also, once they decide to act, how long does it take them to change their disposition model and onboard? What is the typical timeline for conversion after they recognize that this model is more beneficial?

I think the single biggest barrier, Chris, is simply inertia, which is that it's been an insurance industry that is accustomed to a set of historical practices literally for decades, from their interactions with their policyholders all the way back through claims. So the practice habits are difficult to break. We believe that when carriers shift meaningful volume in this direction and improve the policyholder experience, there should be some momentum built that causes it to accelerate from there. Speculating as to exactly what that conversion time frame is tough to do. But the barrier, I think, is more habit than anything else.

Got you. That's helpful. And then can you help us think through kind of the CapEx, the implications of CapEx on kind of yard operating costs? I mean, the CapEx has been super robust lately, but how does that translate near-term? Is there a lag, or how do you basically translate the CapEx to yard operating costs in the coming quarters or years for that matter?

I believe that having access to every data point in our company would create too much noise to draw meaningful correlations. Regarding CapEx, I can provide some general insights: when we open a new facility, it tends to be beneficial as the new location is often closer to accident scenes or repair shops where the vehicles are retrieved. This enables us to realize immediate savings in vehicle retrieval. Additionally, we might save due to nearby congested yards, which currently incur extra labor costs to manage vehicles. However, opening new facilities also comes with fixed costs, such as utilities, telecom, and management labor. Therefore, there are various factors to consider. Overall, since we are opening and expanding enough facilities, the impact in any given quarter is likely to be minimal. This is why we don’t frequently address variations in gross margin or costs, as the establishment of new facilities creates a sufficiently large network that the financial impact of any specific openings in a quarter is not visibly significant.

Got you. That's very helpful. All right. Thank you for the time.

Thank you. At this time, I am not showing any further questions in the queue. I would like to turn the floor back over to the speakers for closing remarks.

Okay, thank you, Samantha. Thank you, everyone, for attending the call. We look forward to reporting Q3 in the next quarter. Thanks so much. Bye-bye.

Thanks, you guys.

Ladies and gentlemen, thank you for your participation. This does conclude today's conference. Have a great rest of your day.