Used and wrecked car wholesaler, reseller, and auctioneerCopart released financial results for its third quarter late on May 27, and sales fell, down for the second quarter in a row. However, profits increased strongly from the year-ago period, jumping more than 40%, while cash and equivalents also increased, and debt fell slightly.
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Good or bad results this quarter? Let's take a closer look.
Growing cash pile
At the end of last quarter, Copart had increased its cash position substantially, entirely through debt. The company ended January with $590 million in cash and equivalents, a $300 million increase from the beginning of that quarter. The company's long-term debt load increased by $400 million over the same period.
As of the end of April, the cash pile had grown to more than $678 million, and long-term debt had actually gone down about $9 million, leaving the company with significantly more liquidity than necessary to operate the business.
When questioned about this on last quarter's earnings call, CEO Jay Adair was relatively vague in his reasoning:
[H]aving cash on our balance sheet is part of our thought process in terms of a fiscally prudent approach to the market. So we think interest rates are very low right now as a company, as a board we are able to borrow debt that goes out 10 years to 15 years before it has to be paid off, and it's cheap, as [CFO] Will [Franklin] gave you the rates earlier. So 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.
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There was some discussion about potential buybacks, but Adair played his cards close to the vest, and it sounds like you can put all that cash under the "flexibility" umbrella for now.
Continuingto drive costs out even as direct sales decline
Copart continues to reduce its operating costs. General and administrative expenses fell 13% to $25.9 million. Normalizing for a $29 million impairment charge last year related to its acquisition of QCSA, total operating expense fell more than $15 million.
While a big part of the total decline in operating expense was related to much lower direct sales, the company's efforts to focus on cost containment is paying dividends.
What about those sales declines?
It's important to understand that Copart derives revenues in essentially two ways: direct sales (cars that it buys and then sells) and auctions of cars for other owners (mostly insurance companies).
This is divided into "service revenues" and "vehicle sales" in the company's earnings statement. The service revenue business has been strong the past couple of quarters, with the revenue decline tied to falling direct sales. Adair addressed this on the last earnings call:
We have become focused on trying to make sure that when we process volume, we make a certain margin for handling cars, and [recently] we are not making enough of a profit. We are exiting that type of business. So, no, we will continue to handle vehicles like that, and you will continue to see that, and I suspect it will grow actually in the future. What we have done right now is made some corrective changes that will bring it down, and then we will come back, but at a higher margin. We are just ... at the end of the day we are not willing to grab market share in a particular segment like vehicles that we are purchasing them and then do it at a low margin.
In other words, the company is refocusing its buy-and-sell business on profitable results, not empty revenue.
It's after market hours on May 27 as I write this, and it's not clear what Mr. Market will do once trading starts, but the bottom line is, Copart management is focusing on what they can control in reducing operating costs and restructuring its car sales business to be more profitable, while preparing for what it can't control by establishing a significant cash cushion.
While history is littered with management's ineffective use of cash burning a hole in their pockets, we have some evidence that Adair and his team can be disciplined with capital, having shown even this quarter that they can drive costs down and improve profits even as the business transitions, and not throwing money at perceived problems. Only time will tell if they can keep it up, but good management starts and ends with prudent capital allocation decisions.
Historically speaking, the odds are probably in their favor. Not a bad place to be if you're an investor.
The article Copart, Inc. Reports Sales and Margins Down, but Profits Up originally appeared on Fool.com.
Jason Hall has no position in any stocks mentioned. The Motley Fool recommends Copart. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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