Copart, Inc.

Greetings and welcome to the Copart Incorporated Third Quarter Fiscal 2023 Earnings Call. Just a reminder, today's conference is being recorded. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Before turning the call over to management, I will share Copart's statement on safe harbor and non-gap financial measures. During today's call, the company will discuss certain non-GAAP measures, including adjustments to income tax benefits related to stock-based compensation. The company has provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures on its investor relations website and in its press release issued at approximately 3 p.m. Central Time today. The company believes these non-GAAP measures, together with corresponding GAAP measures, are relevant in analyzing the company's results and assessing its business trends and performance. In addition, the company's comments today include forward-looking statements within the meaning of the federal securities laws, including management's current views with respect to trends, opportunities, and uncertainties in the company's markets. These forward-looking statements involve substantial risks and uncertainties. For more details On the risk associated with the company's business, we refer you to the section titled Risk Factors in the company's annual report on Form 10-K for the year ended July 31st, 2022, and each of the company's subsequent quarterly reports on Form 10-K. Any forward-looking statements are made as of today, and the company has no obligation to update or revise any forward-looking statements. I'll now turn the call over to the company's co-CEO, Jeff Leal.

Great, thank you, Paul. Good afternoon and welcome everyone to our quarterly earnings call. We're pleased to report good results for the third quarter of fiscal 2023. We take pride in being the most customer-centric organization in our industry, so I'll orient my introductory comments today around our clients. Leah will follow thereafter with details on our financial results. We recently concluded our 23rd annual advisory board meeting with our key insurance clients. In honor of our 40th anniversary as a company, we hosted this event in Northern California, close to our headquarters from which we moved about 10 years ago. It was something of a homecoming for all of us. Every year, we gather in person to solicit feedback from our clients about the opportunities and challenges they face, which in turn informs our service offerings, tech deployments, and capital investment programs. I thought I'd start with some of the key themes that emerged from those discussions this year. The insurance industry continues to experience radical change across a multitude of dimensions, including across the board inflation, as reflected in their rising combined ratios. They and we are observing an apparent reversion to increasing total loss frequency trends. According to CCC, total loss frequency bottomed at 17% or thereabouts in the second calendar quarter of 2022, and has subsequently rebounded to 19% in the first calendar quarter of 2023, the third consecutive sequential quarterly increase. We anticipate the vehicle prices will likely stabilize or soften faster than repair costs will, which will drive total loss frequency to pre-COVID levels and beyond. We see new vehicle prices as a leading indicator for the used vehicle market. Kelly Blue Book data in particular indicates that average retail transaction prices for new vehicles in March of 2023 were below MSRP for the first time in nearly two years. The long-term drivers of total loss frequency, of course, remain unchanged. First, repairs are more expensive and less attractive over time due to increasing accident severity vehicle complexity, labor costs, and rental car costs. And two, 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. Although our U.S. insurance volumes increased 6% or so year over year, we estimate the total loss volumes remain suppressed when compared to compared to historical total loss frequency norms. In the first calendar quarter of 2023 alone, pardon me, in this past quarter alone, if total loss frequency had been at their pre-COVID levels, our insurance volumes could have been 10% more than they were. Another theme that emerged is that our insurance clients continue to experience hiring and retention challenges for their own workforces, which we believe will have them leaning more heavily on trusted partners like us provide additional services, including virtual inspection, loan payoff, title procurement services, among others. Our clients also expressed strong interest in engaging with our image recognition tools and machine learning algorithms to enable better decision-making and, importantly, faster decision-making. For a vehicle that will ultimately be totaled, insurance companies often incur literally thousands of dollars in towing, storage, estimating teardown costs, and appraiser labor, much of which could have been mitigated with streamlined decision-making. Our meetings with our clients also underscored the importance of our global marketplace in providing superior salvage returns to the insurance industry. I'll turn next to our non-insurance business. For several quarters now, we've reported on our progress with our non-insurance customers particularly in the bank and finance fleet and rental segments, which we collectively call blue car. We drove ongoing growth in our third quarter of approximately 7% year over year, despite a still constrained supply base. Likewise, we grew our dealer volume by nearly 5% year over year as well. We view these additional customer segments as examples of our ability to leverage our existing infrastructure to add both mass and velocity to the flywheel of our auction marketplace. Last comment, we've fielded a number of questions already from some of our analysts and investors about our growing cash balance, and I thought I'd address that question proactively here. I'll start with our longstanding position and follow with a more nuanced current view. Our evergreen position is that we take our responsibility as stewards of capital seriously, and evaluate prospective investments with an owner's mindset because we are owners, from Willis Johnson, our founder, to our newest employees who elect to participate in our employee stock ownership program. We prioritize investing in our core business, land and technology in particular. Secondly, we consider strategic extensions that leverage our key capabilities. As is evident from our conservative M&A track record, these opportunities generally must meet a very high bar. And as we have done episodically but very substantially over the years, we ultimately return excess cash flow to our investors and subject to how the tax code evolves, generally in the form of share buybacks. Regarding where we stand specifically today, I do want to emphasize how the strength of our balance sheet empowers and differentiates Copart. In comparison to other participants in our industry, we do not prioritize interest payments, debt pay down, dividends, or massive cost reduction initiatives. We can deploy our resources, specifically our capital and our management bandwidth, to prioritizing the long-term prosperity and satisfaction of our clients. Three simple examples. First, we can continue investing in our owned real estate portfolio which provides strong, durable protection against an inflationary environment and also ensures the sustainability of our service model for the next 50 years. Second, we can provide superior service to our clients in catastrophic events, even when doing so requires substantial capital investments in technology, trucks, land, and people. And third, we can invest in the tech platform and marketing resources that create and sustain our global buyer base. In short, we believe our long-term orientation is in itself a distinct competitive advantage. I'll turn it over to Leah.

Thank you, Jeff. Turning to the quarter, global unit sales increased more than 5% year over year, including an increase of over 4% in the U.S. and nearly 12% internationally. In the U.S., our fee units grew about 5%, primarily due to growth across our insurance business, and our purchase units declined 21%. Internationally, our unit growth came from a mix of fee and purchase units, which increased over 11% and 14% respectively. During the quarter, our U.S. insurance business grew relative to its one- and two-year comps of 6% and 25% respectively. This was primarily due to the continued recovery in driving activity, increasing accident frequency and severity, total loss frequency, and share gain. 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's 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 more cost-effective to deem damaged vehicles a total loss. Turning to our financial results, For the third quarter, global revenue increased 82 million, or nearly 9%, including a 1% or $11 million headwind due to currency. Global service revenue increased 81 million, or nearly 11% for the third quarter, primarily due to higher average revenue per unit and increased volumes. U.S. and international service revenue grew nearly 11% and 9% respectively for the quarter. ASPs were down slightly year-over-year, with U.S. average sale prices down about 1%, compared to an over 4% decline in the Mannheim Index, which ended April at 230.8%. Purchase vehicle sales for the third quarter increased 1 million, or nearly 1%, with U.S. purchase vehicle revenue for the quarter down 27%, and international up 49% for the quarter, During the quarter, our purchased unit activity in the US remained low as we managed our principal unit exposure in a softening vehicle pricing environment. We continue to believe that this portion of our business provides an opportunity for our future growth and is an important enabler for us in new adjacent asset classes and geographies. Purchased vehicle cost of sales grew more than 2 million, or 1.4%, in the third quarter. As a result, purchased vehicle gross profit decreased by 1 million, or approximately 8% during the quarter. Global gross profit in the third quarter increased by about 47 million, or 11%, while our gross profit margin percentage increased by approximately 100 basis points, to 47.3%. U.S. margins increased to 52.2%, and international margins decreased to 25.5%. The year-over-year margin increase on a consolidated basis was driven primarily by vehicle mix shifts in the U.S. towards higher margin consignment units and was partially upset by inflationary impacts to labor and fuel costs and vehicle mix shifts internationally where we had a greater percentage of revenue coming from lower margin purchase units. As noted previously, over the last three years, we have seen pressures from inflation primarily across labor and transportation costs. More recently, we have observed some attenuation in these expenses, particularly around transportation, which was partially driven by reductions to the cost of diesel, which has experienced a 20% decline year over year. In addition, we are constantly seeking to optimize our operational processes by leveraging technology and automation, which we expect will drive efficiency across the organization and help mitigate longer-term cost pressures. Finally, while we experienced increases in labor costs over the last 12 months, we have viewed a significant portion of this as a direct investment in our employees and as an investment to support best-in-class service for our customers. We believe we can continue to increase margins and return on capital over time as we pursue our consistent investment discipline, focusing on our real estate, logistics, and technology assets to ensure we are positioned to scale appropriately to meet the demand of our customers. Turning to general and administrative expenses, excluding stock-based compensation and depreciation. G&A spend in the quarter increased 2 million. I'd like to highlight that last year we mentioned a non-recurring legal expense in Q3. Excluding the impact of this, G&A would have been up 9 million. While G&A can be volatile from period to period, The longer term trends show that we are benefiting from the scale of our corporate infrastructure. Its effect can be observed on the downward trend of our GNA as a percent of revenue, which was 5.1% in Q3. The combination of our strong revenue growth and moderate cost increases drove an increase in GAAP operating income by more than 12% to $419 million for the quarter. Third quarter income tax expense was $90 million, which reflects a 20% effective tax rate. Finally, third quarter GAAP net income increased about 26% to $350 million, or $0.72 per diluted common share. Our global inventory at the end of April increased 4% from last year, and when excluding low-value units like wholesalers and charities, global inventory increased by 7%. That is comprised of a year-over-year increase of over 2% for U.S. inventory, or 5% when excluding low-value units, and nearly 15% for international inventory. Turning to our liquidity and financial position, our liquidity stood at $3.3 billion as of quarter end, which is comprised of $2.1 billion in cash and cash equivalents, and our capacity under our revolving credit facility of over $1.2 billion. Year to date, we have generated operating cash flow of $1 billion, which is an increase of over 16% from the prior year period. In addition, we have invested nearly $347 million in capital expenditures, with over 71% 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 nearly $660 million of free cash flow. Given our strong financial position, we intend on continuing to invest in our business for growth and to meet our customers' needs. These investments include yard expansion, new yard acquisition, logistics, and our technology platform. And as Jeff outlined in detail, 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. And that concludes our prepared remarks. We'd be happy to take some questions.