Rb Global Inc. Q3 FY2020 Earnings Call

Good morning and welcome to IAA Inc's Third Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, today's event is being recorded. I'd now like to turn the conference over to Arif Ahmed, Vice President of Treasury. Please go ahead, sir.

Good morning, everyone, and thanks for joining us today for IAA's third quarter fiscal 2020 earnings conference call. Speaking today are John Kett, Chief Executive Officer and President, and Vance Johnston, our Chief Financial Officer. After John and Vance have made their formal remarks, we will open the call to questions. Before we begin, I would like to remind you that certain comments made during this call regarding our plans, strategies and goals, and our anticipated financial performance constitute forward-looking statements as made pursuant to and within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on management's current assumptions and expectations and are subject to risks and uncertainties that could cause actual results to differ materially from such statements. Those important factors are referred to in IAA's press release issued today and in the Risk Factors section included in our Annual Report on Form 10-K for the year ended December 29, 2019, filed with the SEC on March 18, 2020, updated in our Form Q filed with the SEC on May 6, 2020. The forward-looking statements made today are as of the date of this call, and IAA does not undertake any obligation to update those forward-looking statements. Finally, the speakers will refer to certain adjusted or non-GAAP financial measures on this call. A reconciliation schedule of the non-GAAP financial measures to the most directly comparable GAAP measures is available in IAA's press release issued today. A copy of today’s press release may be obtained by visiting the Investor Relations page of the website at www.iaai.com. I will now turn the call over to John. John?

Thanks, Arif. Good morning, and thank you all for joining us on our third quarter earnings call. As we noted in our Q2 call in early August, our third quarter started off strong with continued improvement in assignment volumes and units sold, along with the continuation of the record level revenue per unit that we'd experienced in the second quarter. As the third quarter progressed, we continued to see strength across our business, as both assignments and units sold continued to improve at a greater rate than we had anticipated. In fact, we exited the third quarter with assignments down only slightly from pre-COVID-19 levels. As we also noted in our Q2 call, we thought revenue per unit strength might moderate in Q3, but that did not prove to be the case. Similar to Q2, we ended Q3 with revenue per unit near record levels. As a result of these stronger-than-anticipated trends and the benefits we are seeing from our margin expansion plan, we saw a meaningful improvement in our overall results in Q3, with an 8.8% growth in organic adjusted EBITDA versus Q3 2019, even despite a decline of 4.7% in organic revenue versus last year. As a follow-up to our discussion on the Q2 call, we continue to believe that some of the underlying drivers of higher revenue per unit can be attributed to first the additional revenue that's associated with the full rollout of our digital-only auction platform, second, the positive impact from new products and tools that we are now offering buyers, such as 360 View and Feature Tour as part of the interact platform, third, the positive impact that less supply may have on bidding activity and proceeds per vehicle, and fourth, higher used car prices. We are feeling more and more confident that the impact from moving to an enhanced digital-only auction model and the tools and information we are providing as part of the interact platform are having a more significant and sustained impact on proceeds revenue per unit, and importantly, returns for our seller partners. At this point, it is a bit unclear to the degree to which reductions in the supply of vehicles are impacting proceeds in revenue per unit, but we do believe that elevated used car prices are having a positive impact. The September Manheim used car index was up 15.2% versus the prior year. Another notable bright spot in the quarter was the strong growth in our non-insurance business, which was primarily the result of a targeted focus from our sales force. Now let me shift gears to review our progress against our strategic growth priorities. Regarding our margin expansion plan, following the successful rollout of the buyer digital transformation in early April in the U.S., we accelerated the transition to online-only auctions in Canada in late July, and I'm happy to report the transition was without incident. Similar to the U.S., we are seeing the benefits from the deployment of 360 View in both Canada and the U.K. As for the other aspects of our margin expansion plan, we remain on track with the timing and expected benefits from our initiatives around towing optimization, pricing optimization, and branch process improvement and efficiency. I'd like to turn now to talk about our focused effort on enhancing our buyer network and their experience. As we have transitioned the business to a fully digital model, we have been focused on continued engagement with our buyer network and remain laser-focused on further elevating the buyer customer experience that we deliver across our platform. We are serving our buyers regularly with both quantitative and qualitative metrics, and incorporating their feedback into our platform and service enhancements. As an example of this feedback, we recently have expanded our payment options, including among other changes, the addition of PayPal, which provides increased purchasing power and flexibility for our buyers. While COVID-19 initially had impacted buyer attendance, we have seen steady improvement in attendance this quarter. Domestic buyer attendance was above prior levels throughout the third quarter, and by the end of Q3, international buyer attendance also exceeded the levels of one year ago. In addition, at quarter end, the levels of active international buyers were up nearly 15% versus the same time last year. As we look ahead, we will continue to focus on enhancing our international buyer network, along with making further progress on our other strategic growth initiatives. Now shifting to talk about our CAT response efforts, there have been several hurricanes and tropical storms primarily in the Southeastern U.S. over the last couple of months. We have done an excellent job of serving our provider customers during this period, and the feedback that we've received from them has been extremely positive. In addition to taking advantage of our deep pool of towing resources, as well as leveraging our NASCAR partnership, our Flexible Capacity model provided safe accessible acreage and towing capacity, where and when it was needed and in close proximity to the affected areas. With our customers' safety and convenience in mind, we established CAT yards and locations that ensured vehicles would not have to be moved far distances. Our employees put in an incredible amount of planning and dedication towards these events, and I continue to thank them for their efforts. I'm very proud of our teams and the progress we have made on our initiatives throughout 2020, despite a very uncertain macro backdrop. We're a little over a month into Q4 and continue to see positive trends, but we are also mindful of the uncertainty that remains with the pandemic. With that, I'll now turn the call over to Vance to review our financial results. Vance?

Thanks, John, and good morning, everyone. As John discussed, our third quarter results were stronger than we had anticipated, as favorable industry trends drove record level revenue per unit, and we continue to benefit from our margin expansion plan and other strategic initiatives. Before I touch on our current trend, let me first review the key financial highlights of our Q3 performance. I will focus my discussion today on our adjusted non-GAAP results and just touch on some key highlights. Please see today's press release for more details on our Q3 financial performance and our methodology in calculating non-GAAP results. For the first quarter, consolidated revenues decreased 5.4% to $338 million from $357.3 million in the third quarter of fiscal 2019. Organic revenues, which excludes the impact of our DDI acquisition, foreign currency, and a non-cash revenue adjustment in the prior year, declined 4.7% to $336.9 million. For the quarter, volumes declined approximately 20.4% primarily due to the impact of COVID-19 and fewer miles traveled. This was partially offset by higher revenue per unit, as John already reviewed. Branch inventory increased by 1.2% versus the prior year. Looking at our geographic performance, both our U.S. and international segments had lower volumes and higher revenue per unit, with the international business actually growing slightly due to higher purchase vehicle revenue in Canada. Gross profit increased to $138.3 million from $136 million in the third quarter of fiscal 2019. Gross margin increased 280 basis points in the quarter driven primarily by the benefits of both higher revenue per unit and the cost reductions achieved from our buyer digital transformation, as well as some other cost reductions specific to COVID-19. SG&A expenses were $34.9 million compared to $38.9 million in the prior year. Adjusted SG&A expenses were $34.5 million, a decrease of 6.8% compared to $37 million in the prior year period, driven by a reduction in discretionary spending across the organization, including items such as travel and meetings as a result of the COVID-19 pandemic. We are extremely focused on cost containment and continue to find ways to be more efficient. Adjusted EBITDA increased by 4.7% to $103.8 million from $99.1 million in the third quarter of fiscal 2019. Excluding the impact of foreign currency, DDI, and the $3.6 million non-cash revenue adjustment in the prior year, organic adjusted EBITDA increased by 8.8% to $103.9 million in the third quarter of fiscal 2020. Interest expense declined by $4.2 million to $13.3 million compared to $17.5 million in the third quarter of fiscal 2019. The decline was primarily driven by lower interest rates on floating rate debt, as well as a slightly lower debt balance. The interest rate on our term loan is currently 2.44%, which is over 200 basis points lower than the third quarter of last year. The effective tax rate was 25.5% versus 27.3% in the third quarter of fiscal 2019. The lower effective tax rate in 2020 was primarily due to the benefit from certain tax optimization initiatives. Net income increased to $52.8 million from $41.8 million in the prior year. Adjusted net income increased by 17% to $55.7 million or $0.41 per diluted share compared to $47.6 million or $0.35 per diluted share in the third quarter of fiscal 2019. Adjusted net income increased more than adjusted EBITDA relative to the prior year due to the benefits of lower interest expense and a lower tax rate, as well as a lower level of amortization. Turning now to our cash flow and balance sheet. Capital expenditures for the quarter were $19.8 million compared to $18.9 million in the prior year. Capital expenditures in the quarter were at a higher rate than earlier in the year due to a catch-up in certain maintenance projects as well as incremental spending levels related to real estate projects. Our balance sheet remains very strong as we exited the third quarter with total liquidity of over $578 million, which is over $300 million higher than our year-end level. We ended the period with a leverage ratio of 2.8x which is down from 3.2x at the time of spending. We remained very comfortable with our total liquidity and leverage. During the first nine months of 2020, we generated free cash flows of over $223 million. As we had noted in our last call, we saw a reversal of the benefits from the deferral of certain cash tax payments this quarter that we expected but still generated positive free cash flow for the quarter due to the aforementioned improvement in operating results and EBITDA along with improved working capital management. We made good strides in further improving working capital, including extending payment terms. As noted in our earnings release, given the continued uncertainty regarding COVID-19, we are not providing guidance today. However, quarter to date, we have seen assignments, units sold, and revenue per unit all consistent with the levels we saw exit in Q3. With that, we'll open up the call to questions. Operator?

Thank you. We will now begin the question-and-answer session. Today's first question comes from Craig Kennison with Baird. Please go ahead.

Question for you on your innovation here. You released a few press releases on some patents you've been awarded. I'm curious if you can explain the importance of the tower dispatch and also the auction management patents and then help us understand whether that innovation is something for which you can get paid either through higher ARPU or higher fees.

Great, Craig. Good morning. This is John. The patents that we announced are really around the processes that we've put in to drive higher revenue, higher recoveries for our sellers, and better service to our buyers. So they're not in themselves monetized specifically; we just think they're all part of our overall offering that can continue to drive better and better results for our buyers and sellers.

Okay, thanks. Just on the non-insurance side, it sounds like you had solid growth there, but are the economics in that business as good as your insurance business, or are those economics not quite as good based on the nature of some of your relationships?

So regarding the non-insurance business, there is a wide breadth of customers in there, everything from charities to car dealers, rental car companies, and the profitability profile spans that based on the value of the vehicles. But all in, we believe that it’s a strong element of our proposition and our growth, and we think it's a good business and we're going to continue to capitalize on it.

The next question today comes from Bret Jordan with Jefferies. Please go ahead.

You called out your towing relationships in response to cat events? You've talked about towing costs maybe being one of the largest drivers. Could you give us any numbers year-over-year as far as your towing expense?

Yes, Bret. This is Vance. We don't typically break out towing expense. What we have said is that it's a very large contributor to the cost of sales. In terms of how relevant it is, we haven't given out specific numbers related to that. But, as we commented on, clearly part of our margin expansion plan is that we have initiatives aimed at optimizing towing expense and reducing that, and we continue to be on track with that.

Okay. Probably a similar response to this one, but could you give us any color as far as the expansion of the international buyer base? You also called out that they were up 15% year-over-year, but could you give us sort of a benchmark for the volumes?

Yes. Somewhat similar, Bret. I mean, I think we tried to give as much color as we could. The fact that during the COVID-19 pandemic, we were able to see that increase bodes well for the actions we are taking in developing our global buyer base, which, as we commented before, a big portion of those are around digital marketing, search engine optimization, things of that nature. So, I can’t get any more specific numbers than what we provided, but we did say that we feel really good about the progress we are making.

Okay. And then one final one. This one should be that the drivers of revenue per unit is the average age of the vehicle that was being totaled this year, significantly lower year-over-year. I'm just sort of thinking about what the insurance companies are doing that is dragging this higher used vehicle values, the demographic of the car changing, in addition to the underlying Mannheim going up.

We haven't seen anything that is materially different in terms of average age of the vehicle than what we would have seen last year. Obviously, that's a contributing factor, as you do, but also, I think, Bret, what you're also implying around younger vehicles and being more apt to be totaled as well. But in terms of the average age across our universe of total loss, we haven't seen anything that's significantly different at this point.

The next question today comes from Daniel Imbro with Stephens Inc. Please go ahead.

John, I wanted to start on a follow-up on the non-insurance business. It appears in your social media there's been more of an emphasis on fleet and rental volume in the last few months. I think you mentioned that’s the focus for your salesforce. Can you talk about where you're seeing that growth within non-insurance? And then, maybe how different is that from six to twelve months ago within the business?

Yes. I mean, as I said earlier, there's a variety of areas of growth there. The fleet and rental, we’ve focused some of our tools, and as we moved to this digital platform, we’ve been able to build some things that are very specific to that market, making it more attractive to them. So we've been successful with that compared to last year. I also think we've done some restructuring of our teams to get them more focused on that segment, and I think we're reaping the benefits of that.

It’s great. And then, the follow-up on Bret's question about revenue per unit being up almost 20%. You mentioned in your remarks that some of it was driven by initiatives such as online fees and ancillary services that you guys offer. Can you help us quantify how much of the increase is being driven by AI-specific initiatives in your opinion? What can you quantify based on the changes you guys are making?

Yes. No, it's very difficult to quantify that, because as you can imagine what we're seeing play out, and first of all we've alluded to for revenues per unit, we're at record levels. And it's tough to quantify the degree to which the things that we've done, which we believe are definitely having a positive impact. Things like the new options, the digital-only option for our platform, things like 360 View, Feature Tour, Auto Executive Pilot, and some time back on 360 View, we commented on the fact that they were having an impact of between $300 and $600 per vehicle in terms of proceeds—not revenue per unit, but proceeds per vehicle. So you can certainly, if you think about that, that can give you some indication. We do continue to believe that 360 View and other tools that we've added since then are all having a positive impact. But what we don't know, it's very difficult to ascertain is the degree to which supply-demand characteristics are impacting it. And as we've also alluded to, in addition to supply and demand, higher used car prices are having an effect as well, increasing what a buyer is willing to pay for a car—all things considered equal. But trying to figure out how much of the difference it makes is very challenging, as you can probably appreciate.

Yes, I've never heard that perspective before. And then lastly for me, just to clarify on the inventory growth, you said it was about 1% to end the quarter. Did the recent hurricanes have a quantifiable impact on that? Or maybe ask a different way: What would inventory growth be if we excluded catastrophic volume from this year and last year? Just trying to get a sense of where run rate volume is, relative to some of the noise from hurricanes?

Yes. So I think the best way to think about it is there have obviously been a number of storms this year. But in terms of the volume of cars that have come from those storms, it's actually been relatively low. So we haven't had any, thank God, for those parts of the country. There hasn't been any extraordinarily significant storms that have caused a massive amount of vehicles. There has been some volume, but the volume, relatively speaking, has been not so significant.

The comparison to last year shows that the base is relatively small as well.

And our next question today comes from Stephanie Benjamin with Truist. Please go ahead.

Just to actually follow up on the last question there. I'm curious on how, just with the inventory number up 1% but still sitting assignments down slightly, pre-COVID levels? Can you maybe discuss the discrepancy between those two metrics?

Yes. So, there are a couple of things that drive inventory levels. One is obviously the amount of assignments that we get. We've seen assignments come way back up during the third quarter. But in addition to that is also the conversion rates and also kind of the time between when it's assigned and when the unit sold. So it has—we're certainly happy and pleased with the fact that we've seen a lot more assignments and units sold come back up with that as well. But we have seen maybe a little bit of a decline in some areas around conversion rates. Nothing significant, but that's been one element in addition to the increase in assignments that's kind of resulted in inventory being up, which is a good thing because as we go into the fourth quarter, that means we have more units available for sale.

Got it helpful. And then, on some recently announced expansions in the Northeast, could you maybe talk about why you chose these specific projects? And then, what's really in your pipeline for additional opportunities for the board? Thank you.

Stephanie, I think you're breaking up a little bit. But I think the intent, the sense of your question was around other real estate projects. Is that correct?

Yes, I'm sorry. Just I think some of the most recent announcements have been primarily in the Northeast. So just wondering why you chose specifically those yards and what's your outlook for additional expansions going forward?

Yes, Stephanie. We've talked about the process of identifying, developing, and getting a new piece of property in place can take 6, 9, 12, or even 18 months. So some of this is just the timing of when these particular projects actually got live and were able to be taken live. We've got a deep pipeline of expansion. We've looked very closely at where we're growing, where our customers are growing, and where we see opportunities for growth, and we're looking at additional property where we need it. It’s an ongoing process that we go through, and we will continue to invest in real estate where we need it and where we believe we've got opportunities, and again, where our customers are growing as well.

And the next question today comes from Bob Labick with CJS Securities. Please go ahead.

It's Peter Lukas for Bob. Just on a macro level, can you talk about from a business industry perspective when you think that higher ASPs will lead to higher total loss frequencies? And I think you’d said there’d been no change in total loss frequencies. But do you expect that to change?

Yes. I'm not sure we said that. There's been no change in frequency. I think there was a question around the average age of vehicles. So I do think the most recent data from CCC, I think picked up.

Yes. I think what we're seeing is a trend with totals, and maybe this can help you, is that continues to go off. There are some seasonal adjustments to that. But in general, it tends to follow the trend that has been continuing to increase. So we're not seeing anything much different without at this point.

Great. And the last one for me, you talked about the increase in the international buyers. Is the percentage of units sold internationally now greater or smaller than pre-pandemic, given the increase that you've had?

I don't think we've broken it out. Between, we can’t say two things. One is we've commented that during the pandemic we had a really good response from buyers, domestic buyers, and that was a very good thing during the pandemic, as you would expect the onset of the pandemic. International buyer participation went down a little bit as you had a very difficult situation, and since then, it's bounced back really nicely. We've continued to have good traction with our domestic buyers, and international has picked up as we alluded to in a call, and we feel really good about that as well.

Today's next question comes from Gary Prestopino with Barrington Research. Please go ahead.

John, I want to just make sure I'm clear on this when you're doing non-insurance vehicles. They are all total losses. Is that correct, or am I wrong here?

They are predominantly damaged vehicles, but we do sell clear title vehicles for non-insurance sellers without a question.

Okay. All right. And can you give us an idea of the growth of that metric in the quarter and/or the percentage change? What are the percentage of non-insurance this quarter versus last year at this time?

Gary, that's not something that we're providing as a metric. However, what we did say is that we had really good growth in the non-insurance segment in the quarter. So I think from that comment, one would be able to ask our team that non-insurance, rather the percentage of our total mix would be up somewhat.

Okay. But by the rules of your spin-off, you cannot go into the dealer market, is that correct and sell a whole car, right?

It's not quite that simple, Gary; there are elements where we can continue to grow. And there are some royalty payments that would be made if we exceed certain thresholds.

Okay, great. And then, lastly, just with the new services that you put in enveloped in the interact, I guess it's called when you talk to your buyers, which one of these services that they cited as being extremely helpful in helping them make a decision whether to bid on a vehicle?

Yes. I mean, I don't know that there's one; I think we track and measure at several different points from registration right through bidding and buying and we're seeing improvement in all of them. I think the overall— the level of information that we're now providing through interact, whether it's 360 View or Feature Tour or enhanced vehicle detail page, we are de-risking the transaction, and they appreciate that because it gives them the ability to bid with more confidence. The more transparency that we can provide, generally, I'd say that's been the best feedback that we've received around interact.

Ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to the management team for the final remarks.

Well, thank you all for joining us this morning. Thank you for your continued support of IAA, and we look forward to talking to you in the future. Have a great day.

Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.