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Copart, Inc. (NASDAQ:CPRT)

F2Q09 (Qtr End 01/31/09) Earnings Call Transcript

March 5, 2009 11:00 am ET

Executives

Jay Adair – President

Will Franklin – SVP and CFO

Analysts

Tony Cristello – BB&T Capital Markets

Bob Labick – CJS Securities

Scott Stember – Sidoti & Company

Bill Armstrong – CL King & Associates

Matt Nemer – Thomas Weisel Partners

Craig Kennison – Robert W. Baird

Ivan Holman – RBC Capital Partners

Gary Prestopino – Barrington Research

Edward Hemmelgarn – Shaker Investments

Charles Weissman – Chilton Investment Company

Operator

Good day, everyone, and welcome to the Copart Incorporated second quarter fiscal 2009 earnings call. As a reminder today's call is being recorded. For opening remarks and introductions I would like to turn the call over to Mr. Jay Adair, President of Copart Incorporated. Please go ahead, sir.

Jay Adair

Thank you, Carolyn. Good morning, everyone. It's my pleasure to welcome you all here today. I want to thank you for attending the second quarter call for Copart. Before we start I'll turn it over to Will for just a couple of remarks.

Will Franklin

Thank you, Jay, and good morning. Before we begin our discussion of our second quarter's results I would like to remind you that during this call we will make forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those projected or implied by our statements and comments. For a more complete discussion of the risks that could affect our business, please review the managements' discussion and analysis and the factors affecting future results contained in our 10-Q, 10-K and other SEC filings.

With that, I'll turn the call over to Jay Adair to begin the discussion of our second quarter's performance.

Jay Adair

Thanks Will. Well, again, good morning, everyone. As we discussed in the first quarter when we started to see a lot of these trends take place. We expected back then that volumes would be up, we expected that ACVs would continue to decline, and we've seen that. So just to give you a little flavor, a little feel for what's going on there, basically ACVs for 2008 were roughly the same, meaning that you can go back May, June, July, August, they were roughly the same number, and we started to see that dip after September.

So in October we saw the first decline in ACV values. That continued into November, it continued into December and actually hit the low point in December. It has modestly come up for January, February and March. So it's probably right where it's going to be from what we can see. Obviously, used car values have come back a little more in February. But I think – yes, when we look at ACVs, I think the number is kind of where it's going to be.

I think we're pretty comfortable with that. Obviously, lower ACVs drive volume and we've seen volume up. We've seen a pretty good trend there with respect to increased volumes. Volumes increase inventory for Copart, obviously, as we pick cars up in Q2 and then we sell those cars off in Q3, and we've always said basically we convert cash into receivables in Q2 and then we'll convert the cars into cash in Q3. So we finished the quarter with roughly $22 million in cash and we will finish Q3 – we're talking a month and a half from now, we should be something north of $70 million in cash. That's what we're expecting today from what we can see. So that's kind of volume and ACV related; now we get into returns.

I think this is the exciting part for Copart. We're pretty jazzed up about this. Returns are up for us and I'd say they're up materially, looking at the returns right now, just to give you a flavor for that. Again, returns started to decline from September into October into November into December and they hit the low point in December, as well. Those returns have increased. Average selling prices increased in January, up again in February, up again in March. Looking at where we're currently at compared to our low point, we're up about 10%.

So I think the worst is over, A, but B, more importantly, I think we're outpacing the market. From what we can see that's out there today from talking to industry participants, from talking to clients, it appears the market is relatively flat, and we are hearing that maybe it's up modestly in the first quarter, and so we're excited about that, because we're up significantly and we're looking at that and saying, okay this is good. Obviously, our clients are very focused on returns right now. They're focused on money that they can get for these vehicles and improvements there, and we think we're outpacing the market.

It makes sense to us. We've got a friction-free platform. You open up a browser, you're in the sale. There's no physically attending, there's none of that. So from kind of a gut visceral [ph] perspective it makes a lot of sense to us. From a competitive standpoint it really puts us outside, above, and with a real advantage compared to other players in the industry, not only returns but the strength of our balance sheet, and I think that's a big deal. We're sitting today with no debt. Obviously got a $200 million line that's untapped and the odds are we won't tap it. We'll be finishing April north of $70 million, that's our estimate, and we'll be generating cash again in Q4. So as we sit here and we look, we're the Company that's out there today that has a very strong product, we're the Company today that has a very strong platform and a very strong balance sheet, and so a lot of prospective clients out there today are looking at Copart and seeing if this is an alternative from what they're currently doing.

In addition, we're investing in IT and I think this is important. When you're in an economy like this I think people just tend to pull in their horns and they may not have a choice. If you've got significant debt or you've got significant requirements that you've got to pay you may not have the option of investing in facilities and investing in technology, and we're doing that. We think that by investing in IT and building a lot of new products, like the new web page that we launched, we're going to change the way that we sell vehicles, again. And so you are going to see a lot of improvements, a lot of enhancements in the next six months and a lot in the next 12 months for Copart. Now G&A is up because we've invested in adding so many folks in IT. We were going to actually increase it even more, but as of October we put a hold in on the expansion, as I discussed in Q1. We will not increase the number; however, at the same time we will not be reducing it at this time.

I guess it just basically boils down to the fact that we're not strapped for cash. We've got a lot of ideas, we've got a lot of great improvements to make, and we want to improve the customer experience at Copart. We want to make it a better environment for selling cars and we've just got a lot of things that we – a lot of ideas that we want to invest in, a lot of ideas that we want to bring to market, and so we'll be doing that and I think that's going to drive even further volume. The good news is, as we discussed in Q1, that we've got ample capacity across the organization. We finished the quarter with a $28 million investment in CapEx. That was for some additional land. So as I say to you, on one hand, that we've got ample capacity across the organization that is, in general, for all the stores. Now, if we – as a percentage. If we look out store by store there's a handful of stores that we've got a handful of yards that are nearing capacity and so we bought additional land in those markets. We are sitting on a number of sites, over a dozen sites today that we never discuss. They're mothballed, they're land that we own, it's zoned, it's ready, and if we get additional volume in that market and we run out of space then we'll turn that location on and add it to our network. And so that's, again, why we made some of that investment.

Now looking at Q3, we don't see a lot of investment in CapEx. So our target right now is roughly $5 million for CapEx and that will change if we were to get a major account somewhere and we had to expand a location or develop it. Some of the land isn't developed. We just own the land. It's sitting there and it's a Greenfield waiting to be improved. So we're in that kind of position right now where we've got a lot of capacity, we've got a lot of locations, we can take on new business, we've got great products, we're seeing returns that are up. So we're looking forward to a great, great year, especially considering and comparing to how the US economy is going right now. So I think we're in a good position there.

So that's US. Looking at the UK, just to give you an update on that, we are sitting today with the nation's best network in that market. We are today picking up cars in one day across the nation. That's amazing, because if you go back over two years ago it wasn't uncommon to pick a car up in three, four, five days. So we have gone in there and said, nope, that's not good enough, we're going to be picking them up in 24 hours. We get an assignment today, we pick it up today or we pick it up tomorrow and that reduces, obviously, storage. You've got direct costs of 20 pounds, 25 pounds, 30 pounds a day; sometimes it is 50 pounds a day, that's being billed, especially as you get into some of the London locations. But kind of even on the low end, you're looking at 15 pounds a day storage rate, so you shave that number off by a day or two you're talking about a huge savings for our clients. In addition, we're reducing cycle time, and I think that's a big deal. Obviously always wanting to shrink that and decrease that cycle time across the life of the car.

We recently – the other thing I want to point out, we recently had one of our largest clients switch from purchase to consignment model. This is the second large, large client to do this in the last two quarters. I think this trend is going to continue and it's pretty simple. If you're on a purchase you use the purchase number as the average, so you use that as the average for whether or not you should fix or total the car. I discussed this in the last call. So I won't elaborate too much and if there are questions on it I can explain it again. But in an effort not to kind of repeat things call after call I think most of us on the call understand that if you're averaging a car at 22% that car may be worth 30%, it may be worth 15%. You're not accurately totaling the right car. Sometimes you're totaling a car you should have fixed, and sometimes you're fixing a car you should have totaled.

So what we do is we implement ProQuote, and because we're selling so many cars – we've sold now over 200,000 cars in the UK, obviously, and because we've got such large volumes we can produce real empirical evidence. This is what the cars have sold for recently, this is what your car is worth and now you can factor that into the repair estimate. So because of that we think there's going to be a continued trend to see clients moving off of the purchase model, moving on to a real ProQuote model, where you get the real value on the car, and we'll report as we see further movement in that. Now, with respect to currency conversion, the British Pound to the US Dollar, and how that impacts revenues, I'm going to pass on that. Will will talk about that in his portion, but obviously it did impact us seeing the decline in the pound and the strengthening of the dollar.

And then finally, I just want to announce that we did come to an agreement with Auto Auction Services Corp. They operate the Auto IMS system. We just announced that recently and this is a good thing for Copart, because Auto IMS basically is the electronic link for fleet operators, banks, finance companies, leasing companies. They interact with Auto IMS then Auto IMS assigns the car to the auction. And so we have – obviously we've for years handled finance company cars, repos and leasing companies, and that type of business, but we've had to do it outside of Auto IMS, and now that we've come to an agreement with them, we'll be taking our assignments electronically through them. So literally a bank will be able to click a button on the Auto IMS platform and the car goes to Copart now. So this should drive additional volume for the company. So things look great. We're happy about where we're sitting right now. We think things are going to be doing a lot better going forward, and with that, let me turn it over to Will Franklin, CFO, for an update on the financial side.

Will Franklin

Thank you, Jay. During our second quarter we felt the full impact of the reductions in commodity pricing, the decline in used car pricing, and the strengthening of the dollar, especially relative to the peso on our revenues. These factors led to a decline in the average selling price of the vehicles that we remarket, and, as more than half of our revenue is tied in some manner to the selling price of the vehicle, they have led to a reduction in our revenues per transaction on a sequential quarter basis. On a consolidated basis, revenue for our second quarter was $169.9 million compared to $173.5 million for the same quarter last year, a decrease of 2.1%.

In North America, we generated $138.6 million for the second quarter compared to $137.6 million for the same quarter last year, an increase of $1 million, or 0.7%. The growth came solely from increased volume, as revenue per transaction remained relatively flat. Volume grew despite the reductions in miles driven, which would suggest a reduction in accident rates. We believe the decline in used car pricing has led to higher percentage of cars involved in accidents ultimately being totaled, and growth in our insurance volumes. Units remarketed for the insurance industry represented 83% of total North American volume compared to 81% in the previous quarter and 82% in the same quarter last year. We believe the weaker economy has had a negative impact on volumes from certain non-insurance suppliers. Same-store sales in North America were down 0.8%.

In the UK, revenue was $31.2 million for the quarter compared to $35.8 million for the same quarter last year, a decline of $4.6 million, or 12.8%. The decline resulted solely from the change in the pound to dollar exchange rate, which was $1.49 to the pound in our current quarter, but $2.2 to the pound in the same quarter last year. At the prior-period's exchange rate, revenue would have been $42.2 million, an increase of $6.4 million, or 18%.

In the UK, volume was up 13.5%. In addition, both gross proceeds and the net revenue per transaction were up relative to the same quarter last year. Net revenue is either fees generated for vehicles sold on the agency model or the gross selling price less the cost of the vehicle per unit sold on our own account. We believe this is due to the impact of VB2. VB2 has had a significant impact on the international transactions, as sales to international buyers expressed in gross proceeds has grown from 16% in the same quarter last year to over 22% in the current quarter, an increase of almost 38%.

Revenue from the sales of cars for our own account was $28.3 million and units sold for own account represented 8.2% of all units sold. Our consolidated gross margin percentage remained constant at 39.6% of revenue, as gains in revenue yield in the UK were offset by increased processing cost per vehicle in the US. In the US, we experienced higher subhauling cost as we have not yet recovered all the price increasing, the price increases given to our subhaulers during the period of peak diesel fuel pricing. We have also experienced higher fixed costs, primarily payroll, equipment leasing and facility costs, as we increased our facilities network by six sites over the same period last year.

Operations depreciation expense was $8 million compared to $7.8 million for the same quarter last year. General and administrative costs, excluding depreciation, were $19.5 million compared to $18.4 million for the same quarter last year. Included in G&A costs in the current quarter was the establishment of a reserve for the settlement of a lawsuit of $1 million. The beneficial impact of foreign currency translation rates of $0.6 million was offset by increased costs associated with additional development and network resources and the expansion of our IT system, as we continue to enhance VB2 and our seller interfaces. General and administrative depreciation was $2.2 million compared to $3 million for the same period last year.

Our operating income decreased from $47.2 million to $45.6 million, or 3.5%. Our other income line contains the impact of the impairment of a note receivable of $1.2 million and the loss on the sale of assets of $1.2 million, of which $1 million was the loss on the sale of an airplane in the UK. The note receivable was associated with the sale of the MAG business in 2006.

Fully-diluted EPS was $0.32 per share compared to $0.35 per share in the same quarter last year. Excluding the impact of the note impairment, the loss on the sale of the airplane and the establishment of the reserve for legal settlement, all totaling $3.2 million, diluted EPS would have been $0.35.

Income tax expense for the period was $17 million for an effective tax rate of 38.5%. Our cash was approximately $22.4 million. Relative to our first quarter, accounts receivable, inventory, and vehicle pulling costs all increased as the inventory grew. Accounts payable and accrued liabilities declined primarily due to the timing of payroll-related expenses and certain seller payments.

We continued to have a strong balance sheet with no debt, a current ratio of 2-to-1, and we expect to increase cash significantly during the next two quarters, as we sell off winter inventory. In the quarter we consumed four – excuse me – we consumed $7.6 million from operations. Net income plus non-cash expenses, like depreciation and equity compensation of $40 million, was offset by cash consumed for inventories and tax payments. During the quarter, we made tax payments of over $37 million.

Capital expenditures for the quarter were $27.8 million and we collected $4.7 million from the sale of assets, giving us a net capital outlay of $23.1 million. Finally, during the quarter we repurchased 223,000 shares of our common stock at an average price of $26.93. We have approximately 15.4 million shares remaining on our current share repurchase authorization.

That concludes my comments. At this time, I'll turn the call back over to you, Carolyn, to moderate the question-and-answer portion of the call.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We'll take our first question today from Tony Cristello with BB&T Capital Markets.

Tony Cristello – BB&T Capital Partners

Thanks, good morning, guys.

Will Franklin

Hi. Good morning, Tony.

Jay Adair

Hi, Tony.

Tony Cristello – BB&T Capital Partners

Jay, maybe if you could elaborate a little bit on, you know, you said you're pretty excited about the returns, it's up materially from the low and I'm assuming the low was in December end?

Jay Adair

Yes.

Tony Cristello – BB&T Capital Partners

Why do you think you're so much better than the industry, and do you think what's driving these returns is a sustainable trend?

Jay Adair

Well, I think a couple things impact that. One is we've got – without a doubt in my mind we've got the best international buyer base, but I think without a doubt we've got the best national buyer base. I mean, we sell typically – on an average, if you look state by state, half the cars we sell in a particular state – it's not every state the same, but if you lump them all together, on an average, when we sell a car, one out of every two cars in the state will go to a buyer either in another country or in another state. So it's just – it's a friction-free platform. There's – we're sitting here today, it's 8:25 in California, 11:25 in New York, and the sales are going to kick off at noon, and we could be on the call and doing questions and you open up a browser and you're in the sale and you start clicking the button, you're bidding. That's about as friction free as you can get.

And I think we've got the largest – we've just got such a supply of product and it's so easy to access, and I think that's exactly what's causing the immediate bounce back. I didn't expect – it was dipping – October was kind of the start of this and December was the worst of it and then it starts coming back. I didn't expect it to do this, this quickly, but I'm happy about it, obviously, and I think it's sustainable, yes. But, if tomorrow scrap went to zero or if tomorrow used car prices fell some crazy amount, then I'm sure that would impact us. But if things stay the way they are today I think we're – I think we've seen the worst of it.

Tony Cristello – BB&T Capital Partners

And I'm assuming, then, where you saw – I think Will noted – a minus 0.8% same-store sales in North America for the fourth quarter, if you were to be running a plus 10%, is it fair to assume that that same-store sale then is tracking positive, is that – without giving – I know you don't give guidance or comment on –

Jay Adair

We're talking same-store sales for revenues. Obviously, yes, when the cars sell for more then it's going to generate more revenue. So sure, I would expect – what we're seeing in March, if that trend continues March, April, May, June, July then I would expect that to be an improvement.

Tony Cristello – BB&T Capital Partners

Okay, okay. And when you look at, then, on the yard and fleet side you noted you hadn't really seen that benefit from – on the subhaul or tow because of – haven't really gotten to the height of where you were being impacted last year. So I'm assuming that also has some potential benefits in the coming quarters. But when you look at this quarter you're still able to maintain a pretty good gross margin, even though revenues might not have been where you wanted them to be. Is that a function – and I don't know, I might have missed it. Did you break out what gross margin was in the UK side or the international piece versus what it was in the US and – or in the North America side and is there something that you were able to capitalize on in this quarter?

Will Franklin

No, we don't break that out. We break out the revenues on a regional basis, but after that we report on a consolidated basis. And I made some comments in my part of the call that talked about the increase in revenue yields in the UK, and that being offset by increased costs in the US, and just so happens that those canceled each other out and we arrived at about the same gross margin percentage.

Tony Cristello – BB&T Capital Partners

Okay.

Will Franklin

With respect to diesel, we have recovered some of our diesel cost. There's just more left to recover going forward.

Tony Cristello – BB&T Capital Partners

Well – okay, okay, fair. And is there some benefit that you'll get as well from freed-up tow capacity, in general, just if people aren't rushing out to scrap things those tow companies now are looking for work?

Jay Adair

No, there's plenty of work out there right now because, as we said, volumes are actually up. So I would say the main benefit we're getting right now is that literally six months ago we were looking at diesel prices of – no, maybe it was nine months ago, but we were looking at diesel prices of $4.50 a gallon and so today we're looking at $2.50 a gallon. So the big benefits to say, look, we gave you a raise because of this it's time to look at renegotiating those. Some of that has taken place already. In fact a big portion of that has taken place already and that'll be reflected in the quarter we're in now, in Q3, and some of that we will continue to push. And of course, who knows what fuel prices will do. But I'm saying if the trend stays the way we are today, meaning average what used car pricing is, what the average cost of fuel is, all these factors if they kind of stay where we're at now I think the trend just starts to click up.

And it goes back to what we said in Q1, which is there's more demand today for used parts, i.e., the cars that we sell to the recycling industry, we think there's demand increase there. There's more demand today for used cars, as used car pricing has gone up, so that obviously helps the builders. And, of course, scrap is where scrap was at. So that hasn't changed much. But I think that's exactly why we're seeing an uptick in our volumes and I – I mean in our average pricing, and I think buyers – we've got a great buyer base. We've got a very loyal buyer base and I think they're in here on the product buying more product again. But I think you go back October, November, December, it was kind of – it was a little scary, and I think you had people out there saying, well, let's see what's going to happen. I think we're past that. That was the point I was trying to direct across to everybody on the call.

Tony Cristello – BB&T Capital Partners

That's great. Thanks, guys.

Will Franklin

Thanks, Tony.

Jay Adair

Thanks, Tony.

Operator

And next we'll go to Bob Labick with CJS Securities.

Bob Labick – CJS Securities

Good morning.

Jay Adair

Hi, Bob.

Will Franklin

Good morning Bob.

Bob Labick – CJS Securities

Hi, a couple questions. First I wanted to ask, you elaborated on it a little bit, could you give us a little more detail on the Auto IMS license agreement that you did and the future implications? On their site they say they process roughly four million cars a year. Obviously not all of that's applicable to you, but could you give us a sense of where the market goes and how long it takes to you integrate into Auto IMS, and when we might see some benefits?

Jay Adair

Sure. We do a significant amount of volume for us that is related to banks, repo cars, fleets, and we go out – we've got a sales team, they go out, they meet with the bank. Just to give you kind of the ten second feel on it. They walk in and they would go through the benefits of dealing with Copart and the past was great. We'll go ahead and look at you as an option on our Auto IMS system and we'd have to respond, we're not part of Auto IMS. And we literally just had banks say, then we won't use you. So it was important for us to become part of that network so that now when we walk in they can say, great, we'll just look at you as an option on Auto IMS and we'll say, terrific. And that's what'll be happening, that's the future. I would expect the interface – all the electronic interface that's being built will be done this quarter. So I would think when we – either this month or April it'll be installed and so I would expect by, let's just say May, which is the beginning of the fourth quarter – fiscal quarter that we'd be connected and receiving assignments through Auto IMS.

Bob Labick – CJS Securities

Okay, great, very helpful. And then obviously given the strength of your balance sheet and the – we're projecting $300 million of free cash over the next 18 months, has that helped you in marketing to either insurance or non-insurance customers and should we expect any share gains from that?

Jay Adair

Well, we have had some recent share gains in just the last quarter and, of course, we don't break out quarter-to-quarter what clients we've gained, et cetera, but we have had some recent gains and I think it is an advantage, especially in the world that we're in today. I think if you've got ten figures worth of debt on your balance sheet, people are looking at that and we don't have any debt on our balance sheet. So there's clearly some clients that we've got that have recently communicated their concern to us. The fact that we are strong, we are stable, we're leading the industry in what we do, so I think it is – Bob, I think it is an advantage for us today. Let's put it this way. I wouldn't – I think this is the best way to probably answer the question, I wouldn't be comfortable going out and putting $0.5 billion in debt on Copart's balance sheet let alone a couple of billion dollars in debt on our balance sheet. I'd rather have $200 million or $300 million in cash on the balance sheet in this environment.

Bob Labick – CJS Securities

And then last question, and I'll get back in queue. You mentioned an additional switchover in the UK, two in the last couple of quarters, could you give us a sense of what percentage of, I guess, unit volume is now principal versus agency – you know how that was a year ago – if you pro forma that the switch – when the switch was done?

Jay Adair

It used to be the vast majority and we're getting closer and closer to 50/50 now on the number. So it's a mix. Part of it is clients are switching, as we're talking about, part is where you get the mix of business that you get from different clients, et cetera. So some clients end up signing. It's a much different market than the US. It's very hard to describe, because the way that they sell insurance – we've got a client of ours that just recently overnight grew quite largely because they signed up a new book of business. That kind of thing can occur in that market that really doesn't happen. It's just – it's a different insurance market than the US. But, yes, it's nearing – it's getting closer to 50/50 now than it's ever been, and I think – like I said, I think that trend is going to continue because it just makes sense from a – why would you want to total a car you should have fixed because of an average number? Averages don't work. If you have real evidence you should use it.

Now, there wasn't real evidence before. Before Copart came into the market nobody had a product like ProQuote that was bringing in all the data and showing what the cars are selling for. But we have all that data, that quantifiable data. You can actually see images of the cars, you can see the damage, you can look at what the car sold for, you can compare it to the car you've got and say, okay, that's what that car is worth. And that's obviously the model we use in North America so – and it has been that way for, I don't know, over ten years. So I think that'll – with improvements, of course, with images, that kind of thing. But, yes, over ten years we've had ProQuote and so I think that model will just get stronger and that trend will continue in the UK.

Bob Labick – CJS Securities

Great, thank you very much.

Jay Adair

Okay, thanks, Bob.

Operator

And our next question comes from Scott Stember with Sidoti & Company.

Scott Stember – Sidoti & Company

Good morning.

Jay Adair

Morning, Scott.

Scott Stember – Sidoti & Company

Can you talk about volume? Obviously it was up in the quarter and can you talk about – as we speak right now are you seeing an increase sequentially, or is it just that at a nice steady flow as we speak right now?

Will Franklin

Scott, we really don't comment on what results we're seeing in the current quarter until we talk about the entire quarter on our next call.

Scott Stember – Sidoti & Company

Oh, okay. I was just trying to speak to the fact that with used car pricing actually starting to tick back up whether that's having an impact, but that's fine. Can you talk about –

Jay Adair

It is. I can tell you it is. With used car pricing coming back up it is having an impact, but I think that's not necessarily having an impact in volume, it's having an impact in sale price.

Scott Stember – Sidoti & Company

Got you. And on the international side, international bidders, last quarter you gave a statistic of percentage year-over-year coming from your North American locations, could you talk about that this quarter?

Will Franklin

Sure. As you would expect, it's down relative to the same quarter last year. We're – in terms of units we're about 22% of our total units sold go to international buyers.

Scott Stember – Sidoti & Company

What was it last year?

Will Franklin

It was 28%. And the majority of the change has been a change in buying pattern from our Mexican buyers, as the peso has approached 14 to the dollar.

Scott Stember – Sidoti & Company

As for Europe, you haven't seen a dramatic movement?

Will Franklin

No, we really haven't. I mean, we've seen some impact but nothing to the magnitude that we've seen is in Mexico.

Scott Stember – Sidoti & Company

Okay. And, Will, you said that some of the non-insurance stuff was flattening out a little bit compared to a year ago due to the economy. Could you talk about what piece? Is it the financial side, or is it dealers?

Will Franklin

It's both. It's both, and charities. So it's your franchise independent dealers, your individual consignors and your charities, primarily.

Scott Stember – Sidoti & Company

Okay. And as far as CapEx goes are we still on target? I think you were saying $40 million to $50 million for this year, are you still on target for the targets that you gave last quarter?

Jay Adair

You mean you're talking about $40 million to $50 million for the next three quarters?

Scott Stember – Sidoti & Company

Yes, for the next three quarters. Yes, exactly.

Jay Adair

Yes, because I think for the year, we will end up probably $70 million.

Scott Stember – Sidoti & Company

Oh, okay.

Jay Adair

Yes, I think – do you have the numbers in front of you?

Will Franklin

Yes, what we said is that we – our target is to stay at maintenance CapEx levels, which is between $5 million and $10 million a quarter. Obviously that changes if an opportunity comes up. If we were to find something in Los Angeles that was attractive or in other areas that we needed capacity we would take advantage of it. But right now our target, as we've stated before, between the $5 million and $10 million amount per quarter.

Jay Adair

Part of it, Scott, that – it may make sense or may not, but part of the issue for us is you can imagine when the economy was really high, you walk into a market and say you want to open up a location for Copart and you got everybody and their brother saying that they don't want somebody storing 3,000 wrecked cars next to them. In this environment, cities are much more – and councils are much more apt to give you the proper zoning and allow you to come in now because, obviously, revenues are drying up. So we have to – if there's an opportunity in some of the key critical markets in the country where we know we need to be one day, and we can do it, we're going to do that. It's not projected, but it may come up, that's the point.

Scott Stember – Sidoti & Company

Great. And just lastly, if you could just touch, Jay, on Copart Direct. I know that you guys have launched a new website for it, so the kind of reaction you're getting from that and maybe just talk about some of the results that you've seen?

Jay Adair

Yes, it's a nice little business. It's a profitable book of business. Relatively small for the overall company, but what we're doing currently and what we will be doing are two very different things. We're investing in a lot of technologies and landing pages and things that actually bring volume in on that site, and it really goes part and parcel with some of the improvements we're making on the buy side, too. We're just doing a number of things that will enhance the way we buy and sell vehicles, trying to expand that buyer base, expand that seller base. It's one of those scenarios where, if I'm selling nothing but wrecked Chevrolets I'm not going to get as many buyers as if I sell wrecked Chevys and Fords, and Toyotas. So we take that to the next level, which is we don't just sell wrecked cars, we sell non-damaged vehicles, and that brings in a whole different buyer base, whole different dealer base – buyer base of dealers.

And so we're trying to what we call cross-pollinate that buyer base and do the same thing with Copart Direct. So that we bring in unique products like that that'll be attractive to our buyer base and at the same time improve that experience and improve the amount of vehicles we can sell. So we're doing a number of improvements on the IT side. As I said, landing pages. We'll continue to do that, and I think we'll be seeing some real improvements in how we grow that product. But as we sit right now it's a nice, relatively-small business in the overall size of Copart but a nice book of business, nonetheless.

Scott Stember – Sidoti & Company

Great, that's all I have. Thank you.

Will Franklin

Thanks, Scott.

Operator

And our next question comes from Bill Armstrong with CL King & Associates.

Bill Armstrong – CL King & Associates

Good morning. You addressed this a little bit earlier, but your gross margin was actually up slightly. Your largest competitor yesterday said that their gross margin was down 500 basis points. So I guess the question is, how were you able to keep your gross margins up in this environment?

Jay Adair

Want me to comment or you?

Will Franklin

Yes, our gross margins are relatively flat, and as I've said a number of – I guess twice on my call already, we have seen a beneficial impact on our revenue per transaction from the UK and that mitigated the negative impact on the increase in our cost process cars in the US.

Bill Armstrong – CL King & Associates

Okay, so really it was from the UK, then?

Will Franklin

Yes.

Bill Armstrong – CL King & Associates

And then with towing costs, fuel prices are coming down, you saw, I guess, still on a year-over-year basis in Q2 was higher towing cost per vehicle, do you think we'll see that flattening out in Q3, or will we actually see a year-over-year decline?

Jay Adair

Year-over-year decline in expenses? Did we –

Will Franklin

Bill? Caroline, are we still on line?

Operator

Yes, you are.

Jay Adair

I think we lost Bill. Well, I think –

Will Franklin

Shall we go to the next caller?

Operator

Bill, please press star 1 again.

Bill Armstrong – CL King & Associates

Hello?

Jay Adair

Yes, there he is.

Bill Armstrong – CL King & Associates

Okay. Yes, I guess just the question was towing cost per vehicle, will we see that actually be down on a year-over-year basis in Q3?

Jay Adair

When you go – it's much easier for me to talk sequentially, but when you go year-over-year there's a number of costs, obviously, that increased from payroll on down to the business, so it's not just – when I look at our operating costs it is clearly not just subhauling. There's a huge labor component there and a number of other costs associated with it. So it's rare that our costs actually go down year-over-year on a total or per car basis. I mean, it's possible, but probably not probable. And sequentially we could see an actual decrease just because of the environment that – what's occurring right now with the economy.

Bill Armstrong – CL King & Associates

I see. Okay, thank you.

Will Franklin

Thanks, Bill.

Operator

And next we'll go to Matt Nemer with Thomas Weisel Partners.

Matt Nemer – Thomas Weisel Partners

Hi. Good morning, guys.

Jay Adair

Good morning, Matt.

Matt Nemer – Thomas Weisel Partners

So I first wanted to ask you a few questions on Auto IMS. I'm just wondering, how much of the volume that's running through that site would be sort of not applicable because the cars require a certain kind of reconditioning or there's something else about the nature of the volume that maybe doesn't apply? Do you have any sense for that?

Jay Adair

No. When we go in and meet with a finance institution or bank and talk to them about their business, we usually go in and talk to them about, obviously, the things that just make sense with Copart, and that's your repossessed vehicles that are damaged, your repossessed vehicles that are maybe inoperable, and your repossessed vehicles that are older, something that is, say, five years old. And our goal is to try to get into that book of business, and that piece of the market and then let that – let them experience Copart, the service, and the returns, and let them decide if they want to move the bar up and try later model product. Obviously, Copart every single day sells one-year, two-year-old cars with no damage. It happens every single day. We're doing it today, and so we're never shy of going after that business, but it is easier kind of correlate the benefit to them with Copart's model on the older and the in-op stuff and try to move up the food chain, so to speak.

Matt Nemer – Thomas Weisel Partners

Makes sense. And then in terms of, once you turn this on, is there some volume that hits automatically, or how much is there a selling process, or after you turn it on you have to kind of go back around and meet with everybody and –?

Jay Adair

Well, we – there is – I wouldn't call it a selling but there is an education process of, once you've turned it on you go through every client we've got and say, by the way, we're on this now, you can take this option instead of going outside of the system. And then – that's one piece. And the selling process, I would say, is where you actually go out with clients you've met with in the past that said, when you become part of Auto IMS give me a ring, and you say, hey, we're part of Auto IMS now, let's talk. So I think that'll be – that's kind of first half, second half kind of approach.

Matt Nemer – Thomas Weisel Partners

And in terms of the consignors decision making, how important is location, because it seems to me like you have a much broader footprint than anybody else on IMS?

Jay Adair

Yes, I think location is important. I think capacity is important, the ability to have room to store the cars, obviously, but I think – yes, we're – we've got a great network, and I wouldn't say otherwise, but I wouldn't be selling that as much as I'd be selling the returns and the technology. Do you want to sell in Detroit to a buyer in Detroit, or do you want to open up to a world market?

Matt Nemer – Thomas Weisel Partners

Got it. Then secondly, in terms of the change in international demand, do you have any sense of how much that was driven by actually a reduction in active bidders, or is it sort of bids per bidder, or kind of what's going on on the international front behind the numbers?

Will Franklin

It's kind of interesting, Matt. If you look at the difference in units sold it went from 28% to 22%, but if you look at the difference in value of the product being purchased by international buyers it went from 31% to almost 28%. So that suggests that international buyers are still active and bidding for the higher-value cars, and the lower value cars are staying closer to home.

Jay Adair

Obviously with value of scrap, we had cars that were bringing $500 just for scrap value and those cars today bring $150. So some of that is going to impact your lower-end units and – so as Will just said, they're buying, but they're just buying a more valuable car.

Matt Nemer – Thomas Weisel Partners

And then lastly, I think you mentioned that some of the non-insurance categories were a little bit soft, and charities is obvious, but you also mentioned dealers, and I'm just wondering if there's any implication for that in terms of Copart dealer services. Is that still – obviously the end market is a little weak right now, dealers are hurting, but give us – can you give us an update on CDS?

Jay Adair

Sure. CDS had its best month in February, yes, so we were actually up in that market, but it was definitely – we discussed that with them and they actually commented on the fact that it's harder to get product because there is a demand in used cars right now. A lot of the dealers are getting trades and they're actually saying, I think I might try to sell this trade myself on the lot, because there is a demand for the used car right now. I'm sure that some of the other vendors out there are seeing some of the same type of thing there with respect to the consignments, or the dealer product – the product that comes from dealerships.

But they had a great month, but some of it I think is just the speculative nature of the industry, and we often have buyers that will buy a car from a competitor, bring it over to Copart and sell it. They actually call it flipping the vehicle, where they'll make a profit. Buy it at a competitor, sell it at Copart and make $800 or $900. Some of that business has slowed down a little bit as of the last quarter, and I think it's just because there was a fear, concern, whatever you want to call it, that, am I buying cars that I'm not going to be able to sell, and so it slowed down a little bit. I would expect that to start coming back in the next quarters just because of what we're seeing in some of trends now.

Matt Nemer – Thomas Weisel Partners

Is the – the flipping is, I guess, an indication that – it's the evidence that your returns really are higher. Can you – is there a way to actually go out and market that information? I would think if I'm a consignor and you can tell me that people are actually buying at other auctions and then turning around and selling them at mine the same day that that's a pretty compelling pitch.

Jay Adair

Yes, it is. We've done that and we continue to do that in markets. And absolutely, yes, it's definitely in the past switched clients over to us. So, yes, it works, there's no question. You see your car and you sold it at such and such and you see it sold for $2,000 and it went over to Copart and sold for $2,800 it definitely has an impact on you.

Matt Nemer – Thomas Weisel Partners

Got it. Great, thanks very much.

Jay Adair

Okay, thanks, Matt.

Operator

And we'll take our next question from Craig Kennison with Robert W. Baird.

Craig Kennison – Robert W. Baird

Good morning, guys.

Will Franklin

Hi, Craig.

Jay Adair

Good morning.

Craig Kennison – Robert W. Baird

On the Auto IMS business, could you just talk again about how the mix of vehicles may be different than the typical profile of a vehicle sold? Is it more expensive, is the profit better, for example?

Jay Adair

Yes and yes. So the mix is – they tend to be a better type of vehicle, better quality in terms of average selling price. Obviously the average car we sell is about ten years old, so the average car that you'd sell that comes through Auto IMS is considerably younger than that and the average selling price is considerably higher than our average, and so thus the profit is better on it, as well. So like I said, yes on both points.

Craig Kennison – Robert W. Baird

In terms of the requirement for physical storage, I assume it's the same, but is the cycle time different?

Jay Adair

Yes, the cycle time is a little less because you don't have the storage that you've got associated with damaged cars. So it is – the cycle time is – it's a quicker sell on the vehicle, as well, so it takes up less space in the yards.

Craig Kennison – Robert W. Baird

Over time, if this is successful, would you need a different type of land?

Jay Adair

No, we run these vehicles through the same locations.

Craig Kennison – Robert W. Baird

But they don't require a zoning – a salvage zoning permit?

Jay Adair

No, they don't, but it's – one of the things about running a fixed-cost business is incremental volume, and if we had to go out and open up another hundred sites just for this book of business it wouldn't make sense then.

Craig Kennison – Robert W. Baird

That's fair. And then back on the revenue per vehicle, it sounds like things have firmed up early this year, but on a year-over-year basis, I assume you're still facing a headwind for the next several quarters?

Jay Adair

I would think so, yes.

Will Franklin

That's fair, sure.

Craig Kennison – Robert W. Baird

In terms of that headwind, what you experienced in the current quarter is that a fair indication of what you might expect for the next several quarters, assuming spot rates remain where they are today?

Will Franklin

Well, that's a – yes, if you take those assumptions the reality is there's a lot of uncertainty out in the market; used car pricing, commodity pricing, FX. So for us to sit here and speculate what they're going to do, I think is probably not warranted at this time. I think Jay's comments are probably sufficient in as much as he said that in February we've seen increases in gross proceeds and revenue.

Craig Kennison – Robert W. Baird

If you look at it, volumes were clearly very strong, but it was offset by the revenue per vehicle and the net number was close to 1%. Would you expect going forward that these two numbers would more or less offset one another no matter what the magnitude, given that they're somewhat oppositely correlated to used car prices?

Jay Adair

You're asking will volume offset the decrease in average selling price.

Craig Kennison – Robert W. Baird

Right.

Jay Adair

Okay, the question – it's a tough answer, because if we're looking at volume in December offsetting average selling price in December, the answer is no. But if volume stays at where we're at and the average selling price keeps ticking up the way it is, we don't have to get back to where we were at one time in average selling price. We can actually be less and then they would actually offset. But it's not where we're at today but it may move down – it may move towards that direction.

Craig Kennison – Robert W. Baird

Maybe I would ask this question then, are you surprised that volumes haven't trended lower, given the firming in price you've seen on used car prices?

Jay Adair

Am I surprised they haven't gone lower volume?

Craig Kennison – Robert W. Baird

Right. As used car prices go back up wouldn't you expect to see volume – the gain in volume give back some?

Jay Adair

Well, I wouldn't, not yet, because ACVs are relatively flat. I said on the – in the opening remarks that January, February, and March are up a little bit compared to December, but not what I would call materially, and yet returns are up. So that should – as returns go up, if ACV doesn't follow then we're going to total even more cars.

Craig Kennison – Robert W. Baird

Excellent. Okay, thanks, guys.

Jay Adair

Thanks, Craig.

Operator

And our next question today comes from Scot Ciccarelli with RBC Capital Markets.

Ivan Holman – RBC Capital Partners

Actually Ivan sitting in for Scot. I'd like to focus my first question on the balance sheet. I noticed that receivables increased a little bit – actually rather substantially on a sequential basis and DSOs also popped relative to the first quarter. Going back historically there seems to be kind of a – I guess it's a seasonal trend, could you just shed a little bit of light on why there is that pop in receivables in the second quarter? Is that a typical historical pattern?

Will Franklin

Sure, Ivan. Much of our business is tied to the insurance industry and the supply comes as a result of accidents that are ultimately totaled. Obviously the weather has a large impact on that number, or that volume, and so the inclement weather drives higher volumes and higher inventories. That drives higher receivables and higher vehicle-pulling costs and higher deferred revenue on our balance sheet.

Ivan Holman – RBC Capital Partners

Okay, great, thank you very much. I thought it was seasonal, just wanted to double check. Also, just wanted to verify, now kind of switching gears and moving towards gross margins. Did you say that gross margins might remain flat or decline on a sequential basis looking forward? I just wanted to clarify that.

Will Franklin

Oh, we didn't talk about margins prospectively.

Ivan Holman – RBC Capital Partners

Okay, thank you. Also, as we think about the UK business you mentioned about 50% of that business, or at least approaching that, was moving towards a principal model – sorry, towards the agent model versus a principal model. I know that you guys don't give the breakout, but could you give us an idea at least of what the US domestic margins must have done to offset that, I guess, increase in the UK margins, because they must have come up if the total margins were roughly flat year-over-year. Can you give us just an idea of maybe the pace of the acceleration, just to quantify that just a little bit, a little bit of granularity on that?

Will Franklin

You know, Ivan, I'm not sure what the question is.

Ivan Holman – RBC Capital Partners

Sorry. I was just saying that consolidated margins have remained roughly flat, and you mentioned that the UK business, you guys had signed some more customers who were going towards an agent model. So I'm assuming that those margins tend to be higher and the UK margins historically have been lower than the US. And although you don't give a segmented breakout, could you give us an idea where margins in the US might have slid down a little bit? Could we get just a little bit of detail on that?

Will Franklin

Well, I can't quantify it, because we just address margins on a consolidated basis. I can just say, again, what I've said previously is that our revenue in the US is flat and we've seen increases in our processing costs, primarily because we have higher fixed costs. We have six extra yards and an increase of about 5%, and all that means that we have more employees and we have more loaders and equipment and more facilities costs and we're processing, relatively speaking, the same amount of cars.

Ivan Holman – RBC Capital Partners

Okay. All right, thank you very much.

Will Franklin

Thanks.

Operator

And next we'll go to Gary Prestopino with Barrington Research.

Gary Prestopino – Barrington Research

Good morning, guys.

Jay Adair

Good morning, Gary.

Gary Prestopino – Barrington Research

Jay, I just want to clarify something. Did you say that volumes for the industry were flat in this latest quarter?

Jay Adair

No, I think volumes are up for the industry, which makes total sense. ACVs coming down would generate additional total loss units for the industry. I'm saying my understanding, from what I've learned from speaking to industry participants and clients, et cetera, is that the returns are relatively flat for the first quarter, and I'm simply saying that is not the case for us.

Gary Prestopino – Barrington Research

So volumes were up and returns were flat relative to –

Jay Adair

For the industry.

Gary Prestopino – Barrington Research

And then you would expect, given the seasonality that volumes continue to move up here past Q1, right?

Jay Adair

Yes, volumes are up and returns are flat for the industry, and volumes are up and returns are up for Copart, and we would expect both those trends to continue in the – Q3 and Q4.

Gary Prestopino – Barrington Research

Okay. And then would you say that on price realizations that they kind of move directly with the change in used car prices, or if used car prices were down 10%, is it safe to say that ASPs are going to be down 8% to 10% in a quarter?

Jay Adair

No, because a lot of our cars are sold for recycling and they're going to be sold for parts. So, no, I think that the cars that it impacts is going to be just the builders, and then it doesn't directly correlate to the builder because, obviously, it carries a salvage title versus a used car in the used car market being a clean title. So there's correlation. It's not direct and it only impact cars that are going to be rebuilt.

Gary Prestopino – Barrington Research

Okay. And then lastly, if you can help me out with this, is that if I – you look at your receivables and your vehicle pulling costs, on a year-over-year basis they're basically flat, all right? Now, is something changed there with the mix of cars where you're not having vehicle pulling costs with some of these cars you're taking in, or should I be looking at this on a sequential basis rather than a year-over-year basis?

Will Franklin

I think it's probably better to look at it sequentially, and the difference is, the amount of cost that we capitalize or we put on the balance sheet changes every quarter on a per car basis. For example, we might go from, in this example, $150 to $130, depending on our cost structure. And if that is case then obviously we'd have a movement in those account balances that wasn't relative to the volume.

Gary Prestopino – Barrington Research

So a better measure is to look at this sequentially, then?

Will Franklin

It is, it is.

Gary Prestopino – Barrington Research

Okay. Thank you.

Jay Adair

Thanks, Gary.

Operator

And our next question comes from Edward Hemmelgarn with Shaker Investments.

Edward Hemmelgarn – Shaker Investments

Yes, I just have a couple of questions. One, regarding the UK revenues, if you were doing a – if more of the insurance companies were moving to just a commission model wouldn't that have an impact upon your revenues decreasing?

Jay Adair

Yes.

Edward Hemmelgarn – Shaker Investments

But it didn't have any impact in the second quarter?

Jay Adair

Well, it should have. We had an account that converted Q1, and then we had another one that converted recently, and it could have been Q2, Q3. I'm not exactly sure when that fell. Then what happens is you've got to sell the inventory. So there's going to be some time, some delay, some lag there that takes place. And, of course, if we're comparing Q2 this year to Q2 last year, a lot of things were going on a year ago with integration and conversion that aren't taking place today. So it's really kind of tough to look at them. Today, I think what we ought to be doing is just looking out into Q3, Q4, and then into the first quarter of 2010.

Edward Hemmelgarn – Shaker Investments

Okay, I would just say it was – the comment in your release was that it was the decline in the UK revenue was just due solely to the change in the exchange rate where –

Jay Adair

Well, I think what we were trying –

Edward Hemmelgarn – Shaker Investments

Mostly, but –

Jay Adair

We are trying to illustrate the fact that had the pound been worth what it was worth two years ago – or a year ago they would have generated more revenue.

Edward Hemmelgarn – Shaker Investments

Okay, well, I understand that. Are your volumes – I'm just curious – volumes up in the UK from a year ago?

Will Franklin

Yes, they were up almost 14%.

Edward Hemmelgarn – Shaker Investments

Okay. So there's going to be – you would expect going forward you're going to get higher margins in the UK and then that will be masking, along with the –?

Jay Adair

The trend should be lower revenue, higher margins.

Edward Hemmelgarn – Shaker Investments

Right.

Will Franklin

I just want to make one statement, is that, what we're comparing now is the quarter in which we introduced VB2 in the UK, which was Q2 of last year, and the impact that VB2 has had on, as we pointed out, the international buyer base and we generate higher returns and gross proceeds per transaction because of that. However, the UK has been impacted, just like the US has, recently by commodity pricing and used car pricing. So that would suggest that as we – on a sequential basis revenue per transaction may not grow to that extent.

Edward Hemmelgarn – Shaker Investments

Right, okay. And if you change to a different – if you get more sellers taking advantage of commission then that impacts it, too. That was my only question. Lastly, you indicated that you're picking up cars in the UK now on a 24-hour basis. Do you still – I know you shut down a few of the lots, do you see any expansion in number of lots just to fill in locations if you get an opportunity to buy a good situation?

Jay Adair

That's possible. It's very possible because obviously their real estate market right now is very similar to the US. Prices have come down dramatically and we've got the best network in the country, and everything that I said earlier about the success that we're seeing there, but if a location came up that happened to be perfectly situated, we would make a run at buying it, yes.

Edward Hemmelgarn – Shaker Investments

All right, thanks.

Jay Adair

Okay, thank you.

Operator

And we'll take our last question and it comes from Charles Weissman with Chilton Investment Company.

Charles Weissman – Chilton Investment Company

Hi, thank you. Just a quick – just so I understand how the – how all the pricing and supply issues work, but I understand if used car prices are down and ACV is also down, it impacts returns to a certain degree but wouldn't also increase supply as it comes on negatively impact returns over time?

Jay Adair

Well, if you take it out to the extreme and say, let's say we double volume, which we know won't happen, I would agree with you that you double the amount of cars we're selling in the US in this model it may have a negative impact. But if you're doubling – if you're increasing volumes by 5%, 10%, 15%, 20%, I don't think that's the case. The market is so large that it can absorb those kinds of swings, just like does it every year in the winter time. We can see volumes increase as much as 20% in the winter, and the market is – the buyer base out there, the network of buyers is more than capable of absorbing that kind of volume increase.

Charles Weissman – Chilton Investment Company

Okay. And just another unrelated question. In the UK, is that market – as you have moved it on line is it still primarily a domestic market?

Jay Adair

Primarily, yes. It's over 20% – I think Will said 22% now is being purchased in Europe and other markets, outside of the UK. But, yes, so primarily it is going to be domestic, the same way that the US market is primarily domestic.

Charles Weissman – Chilton Investment Company

Right, okay. All right, thank you.

Jay Adair

Thank you.

Operator

And we have no further questions at this time. I'll turn things back over to our speakers for any additional or closing remarks.

Jay Adair

Thank you, Carolyn. Well, again, we just want to thank you all for being on the call and I appreciate you listening and asking questions, and we look forward to giving an update on Q3. Thank you very much. Bye.

Operator

And that does conclude today's conference. Thank you everyone for your participation.

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Source: Copart, Inc. F2Q09 (Qtr End 01/31/09) Earnings Call Transcript
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