Copart, Inc. (NASDAQ:CPRT) Q2 2023 Earnings Call Transcript

Copart, Inc. (NASDAQ:CPRT) Q2 2023 Earnings Call Transcript February 21, 2023

Operator: Good day, everyone, and welcome to the Copart, Incorporated Second Quarter Fiscal 2023 Earnings Call. Just a reminder, today’s conference is being recorded. For opening remarks, I would like to turn the call over to Jeff Liaw, Co-CEO of Copart Incorporated. Please go ahead, sir.

Jeff Liaw: 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 Web site 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 quite 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 is 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 wins 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. And then we’ll turn it over or open it up for Q&A.

Photo by BezeVision on Unsplash

Leah Stearns: 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 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.

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Q&A Session

Operator: 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.

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

Jeff Liaw: Good morning.

Stefanos Crist: 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?

Leah Stearns: 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.

Stefanos Crist: 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 any direction over the next five years?

Jeff Liaw: 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.

Stefanos Crist: Great. Thanks so much.

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

Craig Kennison: 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?

Jeff Liaw: Approximately flat or thereabout — flat or thereabout, Craig.

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

Jeff Liaw: In terms — post this quarter you mean?

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

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