COPART INC quarterly report, Q3 FY2020

Business Context and Reporting Period

Copart, Inc. operates online vehicle auctions and vehicle remarketing services through its VB3 platform. Sellers are primarily insurance companies, while buyers include dismantlers, rebuilders, dealers, exporters and, in some locations, the general public. The company operates in the United States and multiple international markets.

This unaudited Form 10-Q covers the three and nine months ended April 30, 2020, compared with the corresponding periods ended April 30, 2019. The quarter was materially affected by the COVID-19 pandemic, although Copart was generally classified as an essential business and continued operating its facilities and online-only auctions.

Financial Highlights

Metric	Three Months Ended April 30, 2020	Year-over-Year Change	Nine Months Ended April 30, 2020	Year-over-Year Change
Total revenue	$550.4 million	(0.5%)	$1.680 billion	12.0%
Service revenue	$491.6 million	3.8%	$1.489 billion	15.9%
Vehicle sales	$58.8 million	(26.0%)	$190.5 million	(11.0%)
Operating income	$195.1 million	(6.0%)	$610.4 million	16.6%
Net income	$147.5 million	(23.5%)	$534.4 million	22.9%
Diluted EPS	$0.62	$(0.19)	$2.24	$0.42

Reported operating margin was approximately 35.5% in the quarter versus 37.5% in the prior-year quarter, and approximately 36.3% for the nine-month period versus 34.9%. Net margin was approximately 26.8% versus 34.8% in the quarter and 31.8% versus 29.2% for the nine-month period.

Quarterly service revenue increased in both the United States, up 3.6%, and International, up 5.1%. Nine-month service revenue increased 16.7% in the United States and 10.2% internationally.
Vehicle sales declined primarily because international operations shifted from purchase contracts to fee-based service contracts, in addition to changes in vehicle mix.
Quarterly yard operations expense increased 10.1%, while general and administrative expense increased 7.8%. New and expanded facilities increased depreciation and operating costs.
Income tax expense increased to $44.3 million from $11.4 million in the quarter, producing effective tax rates of 23.1% and 5.6%, respectively. For the nine-month period, the effective tax rate was 10.8% versus 15.4%.
Excess tax benefits from employee stock-option exercises reduced tax expense by $8.8 million in the quarter and $86.0 million for the nine months, versus $29.1 million and $34.1 million, respectively, in the prior-year periods.

Cash Flow, Balance Sheet, Debt and Liquidity

Cash and cash equivalents were $306.4 million at April 30, 2020, up from $186.3 million at July 31, 2019. Approximately $72.9 million was held by foreign subsidiaries.
Operating cash flow for the nine months was $651.0 million, up 43.5% from $453.5 million.
Capital expenditures, including acquisitions, were $491.0 million, compared with $260.1 million in the prior-year period. Net cash used in investing activities was $488.8 million.
Net cash used in financing activities was $42.6 million, compared with $382.8 million in the prior year, primarily reflecting the absence of common-stock repurchases.
The company had no outstanding borrowings under its $850.0 million secured revolving credit facility at April 30, 2020. The facility matures July 21, 2021.
Long-term debt and finance lease liabilities totaled $403.7 million on the balance sheet. The company also has $400.0 million of senior secured notes with maturities from 2024 through 2029; their reported fair value was $447.9 million.
Management reported approximately $1.1 billion of liquidity, a consolidated total net leverage ratio of 0.15:1 and compliance with all debt covenants. Minimum liquidity under the debt agreements was $75.0 million.
Working capital increased to $507.6 million from $405.2 million at July 31, 2019. Total assets increased to $3.162 billion, primarily reflecting property expansion and cash accumulation.

Material Changes Versus the Prior Comparable Period

COVID-19 reduced vehicle assignments and processed volume, particularly during the final two months of the quarter, as shelter-in-place orders reduced miles driven and accident frequency.
Management also cited lower auction selling prices at times due to a stronger U.S. dollar, weaker global demand amid economic uncertainty and potential export-logistics challenges.
Copart minimized, but did not materially reduce, operating expenses to maintain employment, support sellers and process vehicles for future auctions. This contributed to quarterly margin compression.
U.S. operations continued to grow, while international vehicle sales declined substantially because of contract mix changes and foreign-exchange effects.
Property and equipment, net increased to $1.838 billion from $1.428 billion, reflecting substantial investment in land, facilities, equipment and software.
The company adopted the new lease standard in fiscal 2020, recording $106.6 million of operating lease right-of-use assets and $109.1 million of operating lease liabilities at April 30, 2020, without a material income-statement impact.
No shares were repurchased under the repurchase program during the nine months ended April 30, 2020. The company had 81.5 million shares remaining under its authorization.

Guidance, Outlook, Commentary and Risks

Copart did not provide specific quantitative revenue, earnings or margin guidance in the filing. Management expects the pandemic to adversely affect revenues in future quarters, with the magnitude and timing dependent on the duration of suspended economic activity, additional outbreaks, governmental responses, miles driven, title-processing operations, economic conditions, vehicle demand and currency movements.

Management believes available cash, cash generated from operations and borrowing capacity will be sufficient to meet operating and working-capital requirements for at least the next 12 months. Potential uses of liquidity include facility investment, technology, acquisitions, working capital, debt repayment, share repurchases and general corporate purposes. No cash dividend has been paid since the company became public.

Key operating risks include lower vehicle assignments, reduced auction prices, changes in accident and total-loss frequency, used-vehicle and commodity prices, foreign-exchange movements and seasonality.
The company depends on a limited number of major vehicle sellers, although no single customer represented more than 10% of consolidated revenue during the nine months.
International expansion exposes Copart to integration, regulatory, political, currency, Brexit, anti-bribery and market-adoption risks.
Online operations create cybersecurity, system availability, data privacy and technology-implementation risks.
Expansion requires substantial capital and may be constrained by zoning, permitting, capacity, acquisition availability and competition.
Environmental liabilities, self-insured claims, tax audits and ordinary-course litigation could create additional costs, although management reported no material pending legal proceedings and does not expect current tax examinations to have a material impact.
Goodwill was $338.0 million. Management reported no material goodwill impairment risk as of April 30, 2020, but adverse economic conditions could change that assessment.

Important Facts for Investors to Verify

Whether COVID-19-related declines in assignments and miles driven persisted beyond April 30, 2020 and how quickly vehicle volumes recovered.
Whether lower international vehicle sales and the shift toward fee-based contracts permanently alter revenue mix, margins and working-capital needs.
The sustainability of quarterly margins given continued facility investment, elevated yard-processing costs and limited near-term expense reductions.
The status of the $850.0 million revolving facility, the 2021 maturity date and compliance with leverage, interest-coverage and minimum-liquidity covenants.
The pace and returns of capital expenditures, including the increase in property and equipment and planned new or expanded yards.
The effect of option exercises and related excess tax benefits on reported effective tax rates, cash taxes and diluted share count.
Potential effects of foreign-exchange volatility, Brexit, economic deterioration, vehicle export constraints and changes in salvage-vehicle demand.
Future goodwill, software and facility impairment assessments if pandemic-related or macroeconomic weakness continues.