Copart Inc Q2 FY2023 Earnings Call

Thank you, Maria. Good morning, everyone, and welcome to our second quarter call and thanks for joining us. I’ll actually start briefly with the Safe Harbor. Good morning. During today's call, we'll discuss certain non-GAAP measures, including adjustments to income tax benefits related to stock-based compensation. We provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures on our Investor Relations website and in our press release issued yesterday. We believe these non-GAAP measures, together with the corresponding GAAP measures, are relevant in analyzing our results and assessing our business trends and performance. In addition, our comments today include forward-looking statements within the meaning of federal securities laws, including management's current views with respect to trends, opportunities, and uncertainties in our markets. These forward-looking statements involve substantial risks and uncertainties. For more detail on the risks associated with our business, we refer you to the section titled Risk Factors in our annual report on Form 10-K for the year ended July 31, 2022, and each of our subsequent quarterly reports on Form 10-Q. Any forward-looking statements are made as of today, and we have no obligation to update or revise any forward-looking statements. With that, I wanted to start today by introducing our new Chief Financial Officer, Leah Stearns, who will provide additional data and context in a few minutes as well. We're very excited to have her join the leadership team here at Copart after an expansive search. We hired Leah for the richness and relevance of her prior experience, both at CBRE and American Tower, two industry leaders and public companies in their own right. She has experience with institutional customers, complex regulatory environments, real estate certainly as well, and brings exceptional analytical capabilities and leadership skills as well. So we're very excited to have her on board. I'll start my comments today starting with our customers. We aspire to be a customer-centric organization first and foremost. And I'll start with our insurance business. Our insurance customers certainly have experienced the rapidly changing industry environment now for three years with remote work volatility and driving patterns and across-the-board cost inflation. They've made a number of business process and personnel adaptations that in many cases have proven more durable than they’ve initially expected and now we think may persist forever. We have likewise adapted our business processes to help them navigate this environment, including providing more virtual inspection, loan payoff, and title services and the like. For the quarter in terms of unit volume, we achieved U.S. insurance volume growth of 9% year-over-year, in large part attributable to the sell-through of volume from Hurricane Ian. The single most unexpected change, as most of you know, for our insurance customers has been the suspension and reversal of the rising total loss frequency trend that we had experienced almost completely uninterrupted for the past 40 years. According to CCC, total loss frequency increased from 17.4% in the third calendar quarter of 2022 to 19.7% in the fourth quarter. We think approximately half of this increase was attributable to flood vehicles from Hurricane Ian. Today, as has nearly always been true, total loss frequency is rising due to a combination of two forces. First, repairs are more expensive and less attractive due to increasing accident severity, vehicle complexity, labor costs, and rental car costs. And secondly, salvage economics are more attractive because the fastest-growing economies in the world in Central and South America, Africa, and Eastern Europe lean on our damaged vehicles to provide the mobility they need. We've discussed on prior calls what would happen if and when used vehicle prices were to decline. And we've said that we think our selling prices may compress somewhat but would be offset by increasing volume. We're seeing the beginnings of that phenomenon unfold today. In our second fiscal quarter, if total loss frequency had been at historical levels, we think our insurance volumes sold would have been 10% to 20% higher than it was. Now turning our attention to the non-insurance space. We've made a proactive effort to grow our business in the bank and finance fleet and rental car segments, a group we collectively call Blu Car. Blu Car volume for the quarter and the first half of the year has grown approximately 20% versus the prior year, despite a still supply-constrained environment. We believe we've outperformed the overall wholesale vehicle auction industry. The technology and service offerings required to support these customers are different, and we've invested meaningfully in our capabilities to enable us to serve these sellers, and our auction returns have enabled us to grow with them. Finally, I wanted to mention our members. In a supply-constrained inflationary environment, our buyers have certainly seen Copart as a valuable source of increasingly newer, lower damaged, and whole cars. And we've noted often that the fastest-growing economies in the world generally have the fewest vehicles per capita. We invest significantly in our staff, in traditional and digital marketing and in our global lounge network to expand our member base. We remain committed to empowering more buyers, driving auction returns, which in turn enables our sellers to consign still more vehicles through us. In closing, I wanted to note the bedrock principles that have guided us and are the foundation of our success. These principles certainly long predate both Leah and me, and there's nothing particularly magical about them. We continue to make decisions for the 30-year prosperity of our customers and our shareholders. We will invest in the technology of today and tomorrow to enable us to serve both our members and our sellers. We will invest to recruit members to engage them and to expand the marketplace of services available to them to continue to expand the buyer universe. For every vehicle we sell, we are committed to finding the highest and best use of that vehicle anywhere in the world. And finally, we will invest in land. We will own our land whenever possible to ensure that our ability to serve our customers is never compromised by the winds or economic optimizations of third-party landlords. With that, I'll turn it over to our CFO, Leah Stearns, to provide some additional commentary and data and to walk through some key statistics.

Thank you, Jeff, and good morning, everyone. I'd like to start by saying how excited I am to join Copart. For me, the opportunity was compelling for a number of reasons, including the collaborative and entrepreneurial culture, Copart's enduring focus on delivering best-in-class service to our customers, the business' natural position at the center of the circular economy in automotive, as well as our solid financial foundation. I believe that with these factors, Copart is positioned to deliver exceptional results for our customers and create enduring value for our shareholders over the long term. And I couldn't be more energized to help drive these objectives forward. Turning to the quarter. Global unit sales increased 4.7% year-over-year, including an increase of nearly 4% in the U.S. and over 10% internationally. In the U.S., our fee units grew about 5%, primarily due to growth across our insurance business and our purchased units declined 23%. Internationally, our unit growth came from a mix of fee and purchased units, which increased nearly 9% and over 23%, respectively. During the quarter, our U.S. insurance business grew relative to its one and two-year comp of 9% and 35%, respectively. This was primarily due to the continued recovery in driving activity, increasing accident frequency and severity, total loss frequency, and share gains. Our auction returns remain strong as we continue to invest in growing our global buyer base by driving member recruitment, registration, and retention. As a result, Copart auctions provide our insurance customers with best-in-class liquidity and returns, ultimately providing a more cost-effective way to manage growing claims costs by making it a more cost-effective way to deem vehicles a total loss. Turning to our financial results. For the second quarter, global revenue increased $89 million or just over 10%, including a nearly 2% or $15 million headwind due to currency. Global service revenue increased by $79 million or over 11% for the second quarter, primarily due to a higher average revenue per unit and increased volume. U.S. and international service revenue grew nearly 12% and 5%, respectively, for the quarter. ASPs were flat year-over-year for the quarter, with U.S. ASPs up nearly 1% compared to a nearly 13% decline in the Manheim Index ending January at 224.8. Purchased vehicle sales for the quarter increased $11 million or nearly 7%, with U.S. purchased vehicle revenue for the quarter down 15% and international up 42% for the quarter. Our reduced purchased unit activity in the U.S. during the quarter was a result of a proactive approach to mitigate our principal unit exposure in a softening vehicle pricing environment. We continue to believe that this portion of our business provides an opportunity for future growth and is an important enabler for us in new adjacent asset classes and geographies. Purchased vehicle cost of sales grew more than $14 million or 10% in the second quarter. As a result, purchased vehicle gross profit decreased by $4 million or approximately 24% during the quarter. Global gross profit in the second quarter increased by more than $23 million or 5.7% while our gross margin percentage decreased by approximately 200 basis points to 44.6%. U.S. margins decreased to 48.9% and international margins decreased to 24.3%. The year-over-year margin decline on a consolidated basis was driven primarily by cost inflation and towing and labor of about 200 to 250 basis points. Over the last two years, our direct costs have seen pressures from inflation, primarily related to labor and fuel. We will continue to manage these costs with a long-term perspective. We view the increase in labor costs as a direct investment in our people, which will translate into best-in-class service for our customers. We constantly seek to optimize our operational processes through technology and automation. Finally, we are committed to investing in our real estate, logistics, and technology assets to ensure we are positioned to scale appropriately to meet the demand of our customers. We believe with this approach, we can increase margins and returns on capital over time. Turning to general and administrative expenses, excluding stock-based compensation and depreciation. G&A spend in the quarter increased $5 million or 12%. While G&A can be volatile from period to period, over the longer term, we anticipate G&A to decline as a percentage of revenue, as we benefit from the scale of our corporate infrastructure. As a result of our strong revenue growth, offset by the cost increases experienced in our business, our GAAP operating income increased by more than 5% to $366 million for the second quarter. Our second quarter income tax expense was $83 million, which reflects a 22.1% effective tax rate. And finally, second quarter GAAP net income increased about 2% to $294 million or $0.61 per diluted common share. Our global inventory at the end of January decreased 1% from last year. And when excluding low-value units like wholesalers and charities, global inventory increased by 1%. That is compromised of a year-over-year decrease of 3% for U.S. inventory, which is actually down less than 1% when excluding low-value units and an increase of 12% for our international inventory. Turning to our liquidity and financial position. We remain in a solid position with respect to liquidity, which stands at $2.9 billion as of the end of the quarter, which is comprised of $1.7 billion in cash and cash equivalents and an undrawn revolving credit facility with capacity of over $1.2 billion. Year-to-date, we have generated operating cash flow of $500 million which is an increase of nearly 12% from the prior year period. In addition, we have invested nearly $257 million in capital expenditures, with over 80% of this amount attributable to our physical infrastructure, primarily capacity expansion. Finally, year-to-date, if you take our operating cash flow less CapEx, we've generated more than $243 million of free cash flow. Given the strong financial position, we intend on continuing to invest in our business to meet our customers' needs. These investments include yard expansion, new yard acquisition, our logistics and technology platform. We believe that these types of historical investments have differentiated Copart as a service provider while ensuring that we have the capacity necessary to serve our industry's future growth. With that, I've concluded my prepared remarks. And I'll turn the call over to Maria, and we're happy to take your questions.

At this time, we will be conducting a question-and-answer session. Our first question comes from Bob Labick with CJS Securities. Please proceed with your question.

Good morning. This is Stefanos Crist calling in for Bob. Thanks for taking our questions.

Good morning.

You touched on this during the call, but could you provide a little more detail on the cost structure of the yards, how it's changed since pre-COVID and maybe how much of those changes are permanent versus temporary?

Sure. I can take that one. In terms of our yard expenses, the majority of that cost comes from our labor as well as the costs associated with our sub haul and towing. So as we think about how those costs are either permanent or temporarily impacted as a result of the overall economic environment post COVID, labor costs certainly have increased and we don't expect those to abate, although we do focus on technology investments, which will over time make us more efficient in our processes and hopefully help to mitigate future growth on that line item. And from a sub haul perspective, a portion of that is directly attributable to fuel costs, and that is certainly something that we do see fluctuate. So that could be more of a temporary phenomenon. And those really account for the majority of the increase that we've seen from a yard ops expense over the last couple of years.

That's great. Thank you. Just a follow up. Can you just talk about what Copart's sweet spot is for non-salvage cars in terms of age and miles driven, and if you see that evolving in any direction over the next five years?

Yes. I think it's fair to say it has evolved and very steadily so since the company's inception. So if you look at the cars, if somehow there was a website in 1982 and you could see all the cars we had for sale, they would look markedly different from the cars that were available five years later, five years later, five years later, and so on. So over time, the sweet spot for us has expanded. And today, I think it's safe to say it includes vehicles you would customarily see at dealerships and so forth that are very much whole cars that are drivable off the lot. So I think that sweet spot does move and shift over time. So I think we'll expect the continued expansion. It's not a static view, right? It definitely expands progressively over time.

Great. Thanks so much.

Our next question comes from Craig Kennison with Baird. Please proceed with your question.

Hi. Good morning. Thanks for taking my questions and congratulations Leah. I had a housekeeping question first. Just what was the U.S. insurance volume growth ex-Ian?

Approximately flat or similar, Craig.

I think you mentioned Ian was 70,000 cars, but did you get more cars post the quarter last time?

In terms of post this quarter you mean?

Post your last conference call when you said you had about 70,000 car assignments.

A few more. But that was the strong majority of it.

Perfect. And then sort of a big picture question for you on AI making headlines across many industries. I'm just curious in your world, how you see AI impacting Copart since you guys like to think in decades?

Yes, we are closely monitoring AI developments and believe it will be implemented in various ways. If you consider AI and machine learning together as the future of technology, we already use some of these tools in our systems, particularly in our vehicle valuation guide ProQuote. This tool assists insurance carriers in making optimal real-time decisions about whether to total vehicles or not. However, I think you are specifically asking about automated chat systems. This represents the natural progression of FAQs, leading to smarter and more informed responses to frequently asked questions at Copart. Currently, the inquiries we receive from our sellers and members are often complex and specific to individual circumstances, which means we don’t have an immediate solution. However, our technology teams are actively studying this area, and when it becomes relevant for our business, we will implement it more broadly.

Great. Thank you.

Our next question comes from Chris Bottiglieri with BNP Paribas. Please proceed with your question.

Thanks for taking the questions. I wanted to follow up on the non-insurance aspect. Can you clarify the non-insurance segment further? If I understood correctly, you mentioned that 20% is now categorized as Copart Blu, which includes your dealer consignment and commercial channels. It seems that there might be some challenges with historical shared municipalities that could be impacting that growth. Could you provide more insight into the breakdown of these two segments?

Directionally speaking, what we characterize as non-insurance includes those Blu Car sales, which are rental cars, banks, and financial institution fleets rent of our companies and the like. That's a meaningful portion of our non-insurance volume. Copart Dealer Services, we didn't talk about specifically today. That's also a sizable portion of our non-insurance business. They are also performing well and growing the business in a difficult and challenging environment. The other elements of our non-insurance business include Copart Direct, which is our cash for cars business in which we buy cars throughout different consumers and sell them at auction. Here at Copart, Leah mentioned that in her comments as well as one of the elements of our “principal business” that had proven very successful for us over the years, but we also want to be thoughtful about how aggressive we are buying cars in a volatile price environment. And then the portion you mentioned as well, which is the charities and wholesalers business, relatively lower value vehicles. We have in some cases optimized our business to serve insurance companies, Blu Car, Copart Direct, Copart Dealer Services and the like and have foregone some of the volume in those lower value segments.

Got you. Okay, that's helpful. And then just a bigger picture question. One of your closest peers that's having to merge with an auctioneer of heavy machinery, has this led you to rethink the opportunity at all for TAM expansion in your business? Do you think these businesses are synergistic? Is there a place for Copart in those types of end markets? Just kind of curious how you think about TAM expansion generally speaking?

Yes, that's a valid question, Chris. While it may not be the main reason for our consideration, it is a topic we've reflected on ourselves. In assessing our strategy and opportunities for expansion into new areas, we prioritize our core strengths. We believe we excel at managing high-volume online auctions and attracting both sellers and buyers. We also have strong capabilities in both developing new facilities and acquiring existing ones, as well as managing the logistics for large amounts of physical equipment and vehicles. Additionally, we have a strong ability to navigate complex regulatory environments, dealing with numerous DMVs and various other regulatory factors both domestically and internationally. We feel we are uniquely positioned to tackle these challenges. We've evaluated these strengths and asked ourselves where we can apply them in adjacent markets to foster growth over time, doing so selectively and conservatively. For instance, we expanded into the Powersports sector through our acquisition of NPA about five and a half years ago. Currently, we are also extending our Blu Car initiative into the car market. Moreover, within Yellow Iron, we already sell specialty equipment, trucks, and trailers amounting to hundreds of millions of dollars annually without a focused effort to expand in that segment. This is something we continuously reassess. I believe this transaction doesn't significantly impact our interest, whether positively or negatively, in this area.

Okay, very helpful. Thanks, Jeff.

Our next question comes from Bret Jordan with Jefferies. Please proceed with your question.

Hi. Good morning, guys.

Hi, Bret.

During our brief discussion about the other company's deal, it's clear that the buyer sees potential in offering services related to salvage, which could provide an additional revenue stream. Do you recognize this potential? Is there a chance for opportunity here? For instance, when selling scrap cars to LKQ, they wouldn't require them to be cleaned first. Are there additional services you could provide through Blu or Dealer Services that would complement your offerings?

In short, I believe the answer is yes. There are additional services we can offer to both sides of the marketplace, and we are actively doing that today. We haven't discussed them in depth during earnings calls, as we find them to be more relevant in conversations with our sellers and members. These services certainly include items like delivery, financing, title services, and more. The buyer base is expanding in real-time. If you look back 30 years, buyers primarily consisted of dismantlers who were not interested in the additional services we offer. However, as we broaden our scope to include more drivable vehicles and those with lighter damage, these additional services become increasingly relevant. I would argue that we are leaders in this area compared to others in our industry. Thus, this perspective is particularly significant for us.

Okay. I have a quick question about the supply side. Which sellers are most reliant on you as the buyer rather than just acting as an agent? Clearly, Cars Direct is likely the most affected, but what about Blu compared to Dealer Services? Are those sellers anticipating that you will own the car instead of just consigning it?

No, they are not. The principal business is largely Copart Direct, in which we buy cars from consumers at some modest residual volume in the UK. I think you know that when we entered that business in 2007, probably four out of five cars or thereabouts was managed on a principal basis. Today, I think that's reversed and then some. So we are largely, when you're looking at principal volume for Copart, you're talking about Copart Direct.

And Germany is really not mostly agent?

Germany does a mix of both, that's fair. In Germany, we are doing both. We're selling consignment cars on behalf of insurance companies and we are also buying cars both directly from consumers and on residual value platforms.

So I guess does the temporary move away from or maybe cutting back on purchased vehicles impact Germany in the short term, or is it not meaningful enough to really move the needle?

No, that's principal. The principal car, the moderation of principal car volume is principally here in the U.S.

Okay, great. Thank you.

Thanks, Bret.

Our next question comes from Joseph Enderlin with Stephens Inc. Please proceed with your question.

Hi, guys. This is Joe Enderlin on for Daniel. Thanks for taking the question.

No problem.

So with total loss rate moving higher again this quarter and inventory bottlenecks improving, do you expect the industry to return to historically normal unit growth rates from here?

From here, yes. Precisely when, I think it's harder to forecast. That's a function of the variables we talked about, which is the value of used cars and therefore ACV or pre-accident value as the Europeans call it, and what the car is worth before it's in an accident, what happens to repair costs and rental car costs and the like. So I think we have total conviction, the total loss frequency revert to historical levels and continue to grow from there. The precise trajectory from today until that point I think is more difficult to forecast. But this is an unabated 40 or 50-year trend with the exception of the past 18 to 24 months. And so I think we do believe that it will revert.

That's helpful. Thank you. As a follow up, we wanted to ask about ASP trends during the quarter. Did we see ASPs decline and then increase along with Manheim, or was there a more consistent trend?

Do you mean within the quarter?

Within the quarter, yes.

I don't even know we know offhand. I think the prices I think remained quite strong at Copart and have meaningfully outperformed at least the headline numbers we're aware of for the Manheim used vehicle value Index. I don't know that there was any meaningful intra-quarter volatility of the cohort.

Super helpful. Thank you, guys.

Thank you.

Our next question comes from Gary Prestopino with Barrington Research. Please proceed with your question.

Hi. Good morning, everyone. I just want to get a couple of statistics go over correctly. Units processed, Leah, were up 7% globally. Is that correct?

Total units were up, yes, about 5%.

5%, okay. And then getting back to ASPs, I didn't quite get what you said on ASPs as you went through all these numbers. What were ASPs up year-over-year and sequentially? Do you have that?

Yes. So ASPs in total were basically flat year-over-year. And sequentially, they were down about 3%.

Okay. So we're starting to move down 3%. Okay. And then lastly, with total loss ratios, you said, Jeff, they were 19.7% in Q4?

Correct.

Versus 17.4, but a lot of that was flood vehicles, right, that led to that sequential increase?

Yes, we think half of that or thereabouts was flood related. And I should have noted that and I will now that there is some natural lag then between when cars are both deemed a total loss and when, of course, they are processed by companies like us, the title process, loans paid off, and the car is sold.

Okay. Just for comparative purposes, what were total losses, the ratios running in Q4 of '21? Do you have that handy?

We do. This is all straight from CCC here, but in the fourth quarter, 19.2 a year ago.

Okay. With the non-insurance business that you're doing, it has consistently been around 19% to 20% of vehicles. How much has that increased over time as you've expanded this business?

There is some seasonality to it. I would estimate that it falls between 18% to 25% when looking at it quarter-to-quarter, based on my memory. It has experienced long-term growth. However, it's important to note that over the past few years, we have also expanded our insurance business. Both sectors have seen growth. We generally do not concentrate on the mix; instead, we focus on expanding Blu Car, Copart Dealer Services, Copart Direct, and similar areas. Therefore, the mix ratio is not a primary focus for us. Both areas have grown significantly over the last five years.

Okay. Thank you.

Thanks, Gary.

There are no further questions at this time. I would now like to turn the floor back over to Jeff Liaw for closing comments.

Great. Thanks everybody for joining us, and we'll talk to you next quarter. Bye.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.