Copart Inc (CPRT) 2015 Q2 法說會逐字稿

Good day, everyone, welcome to the Copart Incorporated second quarter 2015 earnings call. Today's conference is being recorded. For opening remarks and introductions I would like to turn the call over to Mr. Jay Adair. Please go ahead, sir.

All right, thank you, Noel. Good morning, everyone, before we start I will pass it over to Will Franklin, CFO, who will give us an update on numbers and I will give you a quick update on the Company, and we'll keep those remarks brief and open it up for questions. With that it is my pleasure to turn it over to Will.

Thank you, Jay. Before we begin our comments I would like to remind everyone on the call our remarks will contain forward-looking statements, including statements concerning our views of trends in our business. These statements are neither promises nor guarantees and are subject to certain risks and uncertainties that could cause the final results to differ substantially from those implied by our comments. The Company expressly disclaims any obligation to update or revise these statements or comments. For a more complete discussion of the risks that could affect our business please review the management's discussion and analysis and the risk factors in our 10-K, 10-Q and other SEC filings.

So with that I will begin by making a few brief remarks concerning the financial performance of our Company in our second quarter. Total revenue declined by $10.2 million or 3.6% due to a change in the mix between cars sold as an agent, and cars sold on a principle basis which we refer to as purchased cars. Purchase car revenue declined $13 million. As a percentage of total revenue, it declined 4 percentage points to 13.7%.

Purchase car unit volume represented 6% of the total volume if the current quarter versus 6.8% in the same quarter last year. The decline in purchase car revenue is driven primarily by reduced volume as direct purchase activity in both the UK and North America, and cars purchased on behalf of insurance companies on a principle basis in the UK declined. Service revenue increased by $2.8 million driven primarily by volume as revenue per car remained relatively con constant.

On a year-over-year basis in North America, unit sales grew by 2% and inventory grew by 10%. On a consolidated basis, unit sales grew by 1% and inventory grew by 8%. as the UK saw a reduction in unit sales and unit in inventory. Our operation expenses decreased by $1.1 million. Adjusted for one time QCSA integration costs of $2.2 million incurred in the same quarter last year, costs were up $1.1 million or 1%. The increase was due to growth in volume as the cost to process each car remained relatively constant. General and administrative costs declined by approximately $4.9 million. Same quarter last year contained $2.3 million in severance, lease termination and relocation costs associated with the QCSA integration and the move of our technology team from California to Texas.

We have completed the QCSA integration and the IT department relocation. In addition we have completed the transition in IT. strategy in which we have moved away from the third party ERP system and from a third party solution for infrastructure and support. During the quarter we expended $16.1 million for yard expansion technology and equipment. This number also included one lease buyout. Finally, during the quarter we refinanced our debt. We replaced our term loan A with a credit structure utilizing private placement debt in the amount of $400 million, due in four traunches ranging from 10 to 15 years, a term loan A of $300 million due in 2019, and revolver of $300 million also due in 2019. At the end of the quarter $681 million was outstanding, none of which was from the revolver.

Currently the blended interest rate is approximately 3.35%. Refinancing added approximately $2.5 million to our interest expense this quarter compared to the same quarter last year. That concludes my remarks. I will now turn the call back over to Jay Adair, our CEO for further color on the quarter.

Thank you, Will. In an effort not to repeat some of the information that Will just discussed with you I will go ahead and give you some additional information that may put some color around some of the things we are doing. We discussed the fact that revenues were flat. We had one less business day in this quarter as compared to the same quarter a year ago. The rest of it I would say is timing due to a very strong Q1 this year as was witnessed. And so some of those -- it just depends when vehicles come in, when they are going to sell. And we saw some heavy sales in Q1 and a little slower in this quarter.

I suspect we'll see a good sell off in Q3. Inventories as you heard, are up 10% in North America and more importantly right now is the G&A has been a big focus for us on not only getting the costs down -- I think the quarter reflects a modest effort so far, but more materially is the improvements that we are making in the home office, both on a spend per person, and how we are actually executing on the dollars that we spend in G&A as well as the fact that total dollars are down. So we are getting more, as they say, more bang for the buck on the dollars that we are spending.

And we are actually reducing those numbers as well. We are happy about that. Sale price was down in the quarter. We believe this is primarily due to scrap. Scrap pricing has come off substantially. Not only year-over-year, but Q1 to Q2. Cycle times have remained relatively flat at this time. We try to anticipate the questions, but I'm sure there is something we have missed. At this time I would like to turn it over to Noel and we will go ahead and open it up for questions

Thank you. (Operator Instructions). Our first question comes from Bob Labick with CJS Securities.

Good morning. Thank you for taking my questions.

Hi, Bob.

Start with a simple one in terms of FX. Obviously there has been a huge currency swing over the last quarter or so. Can you tell us what, if any, FX impact there was on the top line sales on the quarter and just a little further what you expect if it impacts your export sales or how you expect the stronger dollar to impact you going forward?

We are seeing a negative impact in both aspects. It had a marginal impact on revenue. In the quarter it was about $3 million and primarily that's due to the change in the FX between the dollar and the pound. At the EBIT level it represented slightly less than $1 million in negative impact. It's also had a detrimental impact on our export business, slightly. So I think our -- we have gone from about 25% to 23.5% of our total volume being exported.

Got it, thank you. And then in terms of -- obviously you are at record volumes and the proceeds are I think near highs, certainly for your customers. You are just starting to get back to that gross margin recovery from the fact that you increased your service levels. Is that -- is this trend of two quarters of gross margin recovery sustainable, and can you describe some of the services you did increase to impact margins right now?

Well as I said many times, we don't focus on the gross margin percentage because that is subject to the percentage of our sales that are purchase cars versus agency cars. We focus on EBIT per car. When you look at that level, we're up -- we have been growing for the last three quarters year-over-year. The target is to reach what we were in 2012, but we are not there yet. But like I've said, we have had nice growth in that metric in the last three quarters on a year-over-year basis.

Got it. I suppose you won't say exactly what the target is in dollars or how close you are?

I'm sorry, we don't disclose that, Bob.

No, I assumed not, but I figured I would ask since you put it that way. And last one, obviously you said -- good control on the G&A side down to the 31%, 32% level. I think we had spoken about 31% to 33% being the sustainable run rate once you got rid of the redundant expenses from QCSA and the IT transition. We were expecting that a little later in the year. Is the current level the right base and sustainable going forward?

Well, we think it is based on our current activity. As we talked about there is a focus to expand internationally. We think that that will probably come into play in 2016 far more than it has 2015. But any change in our fundamental activity level will have a change on G&A. At this activity level, this sales and volume level, this is an appropriate G&A level. G&A spend.

Great. I will (inaudible) Thanks very much.

Thanks, Bob.

Thank you. Our next question comes from John Lovallo with Bank of America.

Hi, guys. Thanks for taking the call.

Good morning.

First question, Jay, I want to make sure I understood your comments correctly on the timing of the service revenue department here. So service revenue was up a little over 1% in the quarter and I think inventory at the end of last quarter was up 9%. You are talking about timing, but I guess -- was the flow through of those vehicles slower than expected? What am I missing?

We had a real big Q2. We were able to not only build inventory, but we had large sales. You can compare that to -- I meant Q1 if I said Q2. You can compare that to Q1 of fiscal 2014 and see that the growth in those two quarters as opposed to the growth in Q2 a year ago versus Q2 this year. Some is just timing. It is the type of vehicles you get the mix meaning some of our accounts move vehicles twice as fast as others on the insurance side. On the non-insurance side we have a mix of vehicles that are far more profitable because they are dealer cars as opposed to a mix of vehicles that are more charity focused.

It depends on mix, it depends on timing and I just want to give you a little color that why the quarter when you look at it may look in terms of revenues, a little soft. As Will said, he pointed out the purchase car activity, I was really just focused on the fact that the revenue aside from purchase cars and the fact that we had one less business day in the quarter this year than we did a year ago. Those are the main factors I was trying to point out.

Let me add one element to that. Our inventory grew at the end of the quarter. We had a significant increase in assignments toward the end of the quarter which did not allow us to cycle that through the sales process. That will flow through in our third quarter.

That's helpful. I guess on the vehicle sales line, the principal business here, is this a business that you see winding down completely over time? I am just trying to think from a modeling standpoint here.

The purchase cars? No, we will continue to do that. We have become focused on trying to make sure when we process cars we are making a certain margin. If we are handling cars and we're not making a profit we are exiting that type of business. No, we will continue to handle vehicles like that, and you will continue to see that. And I suspect it to grow, actually, in the future. What we have done right now is made some corrective changes that will bring it down, and then will come back, but at a higher margin. At the end of the day we are not willing to grab market share in a particular segment like vehicles where we are purchasing them and then -- and do it at a low margin.

Great. And the final question you guys historically have been -- and I think you still are today -- very big believers in the business and you have demonstrated that buying back a good amount of shares over time. Over the past few years we have been hit with a number of things like the reconversion noise, the acquisition integration, some of the ERP system stuff that went on. With a lot of that behind us when you guys took on a turn of leverage, is it -- how are you thinking about share repurchases going forward just broadly? Is that something we should be thinking about could accelerate?

We might want to add Sandy to that mix, of all the items that you threw out as well. We have said historically it is something we view as an opportunity to deploy cash as well as acquisitions, buying companies, expanding locations, buying out leases. It is one of the many, and we have never given guidance as to what dollar amount we will buy it back or when we will buy it back. It is still something we consider an option and something we discuss at the board level.

Okay, appreciate it guys.

You bet. Thanks, John.

Thank you. Our next question comes from John Healy with Northcoast Research.

Jay, I wanted to follow-up on that question there. Can you help us think about the decision to add internal leverage in the month of December? I understand the opportunities for acquisition or land assets or even buying back stock, but what was the trigger to say, okay, we need to now bring this on to the balance sheet and pay money to have this flexibility? How do you think about timing of executing against that flexibility?

Sure, so I will give you an example. Back in 2008, fiscal 2008, we went out to the market and bought back stock, split adjusted, off the top of my head, That's my qualifier there. I think it was in the $20s. And subsequent to the financial crisis, our stock was in the $12s. We were sitting with a very low cash position and we reached out to the banks. As you can appreciate nobody was willing to loan money at that time. So having cash in our balance sheet is part of our thought process in terms of a fiscally prudent approach to the markets. We think interest rates are very low right now as a company and as a board.

We were able to borrow debt that goes out 10 to 15 years before it has to be paid off, and it is cheap as Will gave you the rates earlier. We viewed that as a smart move to go ahead and increase the amount of debt on our balance sheet, to refinance the debt that was coming due this year. We had a couple hundred million, I believe, that was coming due this year and that debt has now been pushed out roughly five years. So part of the restructure, was it was the right thing to do, part of increasing the debt we felt was just a prudent approach to hedging, if you will, the future. We are not sure what the market will do, and we are not sure if we will be able to -- you don't know what your stock price is going to do.

We are very bullish on the Company. If for some reason we had a financial issue again in the future as a country, we want to make sure we have cash on hand and we are not in a position where we are trying reach out and borrow money at that time. As a Company and as a board we felt it was important to refinance the debt and also increase the amount of debt on our balance sheet.

Makes sense. Along those same lines I want to ask you made it known that Will is going to be transitioning to more of an operating role. I was curious where you guys were at with the CFO search process.

We have an SVP of Finance in the Company. He is sitting in the room right now. His name is Bruce Bishop. We love Bruce. Bruce is a great guy.

Thank you.

And we've -- Will has gone into a heavy operating role and that is great. He is doing a fantastic job. And Bruce has been taking over the financials. I will leave it at that. In the future if there is a change in CFO title we'll make that announcement.

Okay. Thank you.

I thank you.

Thank you. Our next question comes from Ryan Brinkman with JPMorgan.

Thanks for taking my call. I guess I will tackle the stock buy back, capital allocation, capital structure question in maybe a different way. This is the first time you have ever had long-term debt on your balance sheet, 10 to 15 years you mentioned. You levered once before in the recent past, really only to buy back stock, but that was with a medium term -- a medium duration term loan and revolver which the contractual terms had you then immediately begin paying down. Is there anything philosophically that you are thinking differently when it comes to capital structure with having that long-term debt on the balance sheet?

Well, this is the first time that we've seen interest rates for long-term debt at this level. We picked up the $400 million of debt over 10 years before we have to pay it back at a rate over 4%. That really is the first time that we saw an opportunity like that, A. B, we historically -- many of you in the analyst community I believe know this. Our founder, Phyllis Johnson, historically built the Company before we went public, on debt and historically has been debt averse in the past when interest rates were much higher than they are today. When interest rates got lower back in 2010, 2011, and the opportunity to put some debt on, we all agreed including our Chairman, that it was something we should do.

Now that we've seen interest rates get low for long-term debt we believe that was again something that made sense long-term. The last piece I would throw is because of the relationship we have between our international entities and our U.S. entity there are some tax advantage that we get by having debt. If we didn't have the debt we would actually lose that tax advantage, basically. There is a benefit to having some debt, especially at these levels and especially at these rates for the foreseeable future, and that was really the reason for locking up some long-term debt.

Thanks. That's helpful. And maybe just on the quarter, it looks like general administrative expense fell nicely sequentially down, I think, like $7 million. Is this the savings that was previously communicated regarding the non-implementation of the earlier planned ERP system? Is this quarter's run rate now more or less clean or is there still noise running through the data centers, headquarters (inaudible)? Thanks

Well, the change in the IT strategy is certainly part of that. We did incur a significant amount of costs that reflected in the prior, actually three quarters, ever since we took the impairment in Q3 of last year to make that change. The other elements which I spoke to were costs associated with moving our IT department up from California and just the cost of integrating QCSA which was a significant operations. And at this point we think those costs are primarily behind us. They will always be one-time costs, and frankly if they are not significant we will not point them out. But in general, at this activity level, we think this is an appropriate run rate for our G&A spend.

Great. And then sticking with the quarter, one of your competitors recently mentioned lower scrap prices weighing on pricing at salvage car auctions. Are you seeing that? Can you directionally, proportionally size up how important scrap metal is versus the lower U.S. dollar (inaudible) for pricing versus used car prices which seem to be holding up the best of all of the factors?

Well, in North America the scrap metal pricing had a significant impact on our lower end cars. On an overall basis it was a marginal decline. On a consolidated basis, because we had growth and revenue per car in our other areas of our operations internationally, it was relatively flat. In terms of importance, scrap metal pricing is a significant factor. We look at two primary drivers when we correlate our pricing and that's used car pricing and commodity pricing. In terms of significance, I would weight used car pricing as slightly more significant.

Okay, that's good to hear. And then just last question for me if I can on the weather, I am in Miami today, but we have had a lot of snow in New York and a lot of snow in Boston. It seems like the sort of weather that is good for you. It is not significant storms that leads to like extra expense on your part. Can you kind of confirm that? And then of course you have very difficult comparisons with favorable weather for you a year ago. How is weather going to play on your results over the next couple of quarters maybe on a year-over-year basis? Thanks.

I would just say this. It is hard to isolate on a call, how weather compares in the northeast compared to the Midwest, compared to the west coast, et cetera. We look at when we peak. We peaked in inventory at the end of January. And we have been selling off those inventories now in February. So we continued to see strong volumes coming in. But we have seen the peak come in. Sometimes it that peak is the first week of February, sometimes the second week of February. Right now peaked at the end of January. Once you peak and come off, which we have, it won't go back to those levels. We are now selling off substantial amounts of units in February, so again I think it's going to be a good quarter based on inventory build, and based on the volume we are seeing come in. It is definitely not a bad winter, but we have peaked already

And I'll add one more comment on that. I talked about the decline of volume in the UK, and we can trace that back to significant influence of weather. This time last year they were incurring floods in a number of areas in the UK which made the comp for volume more difficult for us this quarter.

Helpful. Thank you.

Thank you. Our next question comes from Craig Kennison with Baird.

Hi Craig.

Good morning. Thanks a lot for taking my question as well. On market share, you know, your largest competitor reported 11% revenue growth in a similar period versus your 1% service revenue growth, and I recognize very much that it is apples and oranges when you are looking at those two metrics. But to what extent if any does it suggest you are not gaining shares quickly as much as your largest competitor?

I think both of us have been relatively mature in the last year. There is quite a few RFPs that went out over the last two years. The mix has been very steady over the last year. Again they are not completely comparable quarters. Theirs ends December. Ours ends January. January is the biggest month in terms of cost and building inventories and that process. I think the easy answer to give you is just that the mix hasn't really changed between either of us in the last year.

Craig, let me point out another thing. We are in a number of different markets. They tend to focus on the insurance market, but we are in the charity market, and we're in the repo market, and we are on what's called the -- in the market folks just buy and sell cars on our platform as part of the business. So you have to look at each of those individually to conclude about where our market share resides. For example in charities we may be up or not, and that enters into our total volume mix.

Did you see relative weakness in those non insurance categories?

In certain categories we did.

Shifting gears to gas prices, Will, give us a sense for how lower gas prices will affect your revenue and cost structure.

Typically it has an impact on sub haul cost. That's one element to those costs. I can tell you there are so many other factors that enter into our average cost to pick up the car and probably the main one is the volume. When you have more volume you have reduced opportunities to select the low cost provider. We talked about that. There are other elements. We are picking up a far higher percentage of cars on the same day than we did previously. Our pick up time is well below one day and is declining. When you are trying to provide better service to your insurance customers by picking up the cars faster, you have less opportunity to aggregate hauls. You have more single hauls in the total mix. So despite the fact we have declining diesel fuel pricing, we are challenged to reduce our self-haul costs on a per car basis.

Good, that helps. And maybe finally, Jay, on the dealer to dealer market and that whole car side, we have seen a number of business models pop up in this dealer to dealer space where technology essentially disintermediates the physical auction to some extent. I am just curious, you tend to like these disruptive models and have done well with technology. How do you see that market as a potential addressable market for Copart?

For the industry, I think it has been slow to adopt. I expected 12 years ago that we would see much further progress in the adoption on that, especially on the whole car side. With respect to our dealer processing of vehicles, we added -- and this may be partially true for the whole cars as well, we provide a service by getting the vehicle off their lot. I don't see that technology disrupting our business because the dealer has limited space on the lot. They want those vehicles that they're not going to sell off the lot. And they've basically got two quick options. They can wholesale it or they can take it to auction.

In both scenarios it gets off the lot immediately. If you are talking about using a technology to do a B to B process and get rid of the vehicle, it is sitting on the lot while they go through that. So I suspect that those vehicles will continue to be vehicles we will get and will continue to grow in that segment. It is not just returns. It is not just the ease of selling the vehicle. It is the fact that it is being physically moved. We don't sell vehicles typically at the lot. The vast majority of our vehicles are being moved to our sites and so it is out of their -- it's off their facility and that's a big improvement for them.

Got it. Thank you.

Thank you.

Thanks, Craig.

Thank you. Our next question comes from Bret Jordan with BB&T Capital Markets.

Hey, good morning.

Hi, Bret.

Just a follow-up question on sort of the capital allocation, and I think there was a comment about M&A and international expansion potential. Now that you have liquidity, how are your thoughts about international growth, M&A given the fact you wrote off the ERP system last year? Are you thinking smaller size or relative lower risk transactions because of the lack of an IT system or do they not change them all?

Well the ERP was really -- I would put that separately and our reasons for doing the ERP and our reasons for exiting the ERP are really separate from international markets. We can grow internationally without the ERP and we are doing that, we are building systems to do that. Our desire to have an international footprint is the same as it was 10 years ago when we first expanded into Canada. It has been a strong desire and it eventually brought us to the UK, and Brazil, and Dubai, and everywhere else that we do business. We will continue to develop tools necessary to expand in those markets. When the opportunities arise for us to make an acquisition in those market we are going to do that.

Thanks. So that was not a critical backbone for M&A integration. That was just another piece of the puzzle.

Correct.

All right. Thank you.

Thank you. Our next question comes from Bill Armstrong. (Operator Instructions)

Good morning, guys. You already answered my question on market share, but I did have a question on the other income line. You had a spike there to $4.1 million. I just wanted to dig into that a little bit. What's in there?

It includes a number of different elements. It includes some rent, so we rent out properties and we don't put that in our operating income. It includes gain on sell of fixed assets, but it also includes an FX impact. So, our hedging strategy is pretty simple. When we accumulate cash offshore, we convert it to USD. Well, the accounting rules, which I can't explain, but we hold this cash in USD to eliminate economic risk to the business. Nevertheless accounting rules make us recognize the gain and loss on that cash relative to the home currency of the country that owns the cash. In this situation we had USD owned by our UK entity. And that generated a gain on FX in the UK. And that was the primary driver in the spike.

How much was that out of the $4.1 million, that forex gain?

Hold one second. It was about $3 million.

Okay. So going forward are we looking at maybe a run rate of roughly a million dollars a quarter on that other income line?

It is impossible to predict. It all hinges on the relative values of the different currencies.

Right. Understood. Okay, thanks.

Thank you.

Thank you. Our last and final question comes from John Lawrence with Stevens.

Good morning, guys.

Good morning, John.

Hi, John.

Would you comment just a little bit -- Will I don't know if you will give us this number, but what is the delta from when you talk about 12 at the peak of EBITDA or EBIT per car, how far away are we from that peak at this point?

I'm sorry. I can't give you that. I can talk about it directionally. Directionally, like I said, we have seen a consistent growth in the EBIT per car. We can't look at it on a sequential quarterly basis because of the seasonality of business. We have to reach back two years and look at what we did in the second quarter of 2013 or 2014. We have had a nice growth.

Is it unfair to compare that to the operating margin 32%, 32.5% back in June of 2012?

You really can't look at it on a percentage basis. The impact of purchase car activity. You have to look it on EBIT per car basis.

Got it. And secondly to follow on Bret's question, Jay, can you comment just the environment what you are seeing over there, expanded internationally, the environment, what are you seeing over there as far as progress in the industry that may or may not want to expand and at what point?

Well, I guess I would just comment by saying we have people on the ground. We've got operating businesses. The first step would be to expand the operating businesses that are already there. And then we've got people on the ground in new markets where we don't do any volume yet and we've got relationships with opportune acquisition targets, and when the time arises and when we feel it is the right time to do that, we will step into those markets as new markets. Right now we are really focused on improving the markets we are already in before we expand into the new.

And there is nothing that is changing that is causing you to think about pulling back or anything like that?

No, I mean we are always -- each market you look at they will have their own tax laws and they will have their own process. Sometimes we have to build systems around the new tax law before we can get into that market. Sometimes we have a completely different process than we are familiar with in the US, UK, Brazil, as an example, in Dubai. And so we have to go into a market and convert that existing process that they've got to a new model, and show them that the model is better. It just depends market by market. Some markets you can move quicker than others. But we are committed to that strategy of expanding our global footprint.

Great, thanks for your help.

Thank you.

Thanks, John.

Thank you. There are no further questions at this time. I would now like to turn the call back over to Jay Adair.

Thank you, Noel. Thank everyone for coming on the second quarter call. We look forward to reporting Q3 in ninety days. Bye-bye.

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