IAA (2020 - Q4)

Good morning and welcome to the IAA Inc's Fourth Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Arif Ahmed, Vice President, Treasury. Please go ahead. Arif Ahm

Thanks, Chad. Good morning, everyone and thanks for joining us today for IAA's fourth quarter fiscal 2020 earnings conference call. Speaking today are John Kett, Chief Executive Officer and President and Vance Johnston, our Chief Financial Officer. After John and Vance have made their formal remarks, we will open the call to questions.

Thanks Arif. Good morning and thank you all for joining us for our fourth quarter and fiscal year-end earnings call. Arif, Vance and I are in two different locations today, so please bear with us particularly when we do the Q&A. But let me just start out to, to recap to say that 2020 was an unprecedented year would be an understatement. The challenges of the pandemic have tested us all personally and professionally. And I want to start by just saying how proud I am of the IAA team, and how they rose to meet these challenges. Our top priority throughout and continues to be the health and safety of our employees, customers, and suppliers. We were pleased to be in a position very early on in the pandemic to help our partners respond through products and solutions such as inspection services, and title services that help providers remotely manage their workforce safely and efficiently without human contact. At the same time, we also executed against our priorities, delivering an improved experience for our buyers and sellers, primarily through the accelerated rollout of our digital auction, and digital only auction platform. We also made great strides launching new products, services, tools, and functionality.

Thanks, John and good morning, everyone. I just want to spend a few minutes providing some more detail and color on our results for the year and fourth quarter. I will focus my discussion today on our non-adjusted on our adjusted non GAAP results. And just touch on some key highlights. Please see today's press release for more details on our financial performance and on our methodology when calculating non-debt results. Performance improved sequentially as we moved past the peak impact of the pandemic earlier in the year, capped by a strong fourth quarter that saw a return to revenue growth. As we continue to benefit from the strong revenue per unit trends, as well as improved trends in assignments and units sold. For the year, we saw a decline of 3.7% in consolidated organic revenue, and a decline of only 2.2% organic adjusted EBITDA, which we feel really good about considering where we are at in late March and the unknown impact of COVID-19 on our business. As John mentioned, and we have previously discussed we benefited from higher revenue per unit, which we believe is largely driven by our efforts to accelerate buyer digital transformation and expand our global buyer network, among other things, and did a really good job managing costs during the pandemic. We generated free cash flow for the year of $240.2 million, which increased 18.5% versus the prior year despite the revenue decline, and we benefited from improved working capital. We ended 2020 with liquidity more than double the level at the end of the prior year. Before I review the key financial highlights of our Q4 performance, a brief housekeeping note. As you likely saw in our press release beginning of the fourth quarter results, we will now be breaking out revenue and cost of sales by vehicle sales, as well as service revenue given that vehicle sales now represent greater than 10% of our consolidated revenues.

Yes, thanks. Good morning, guys. Congrats on the quarter. And thanks for taking your questions.

Good morning, Dan.

I want to start on a bit of a higher level one, you guys have been online all day for roughly nine months now, how execution gone. But more specifically, how has the international penetration gone? Have you seen success growing an international buyer base relative to your original expectations? And then I don't know if you've spoken this out before. But could you share what percentage of your U.S. vehicles are sold overseas today?

It’s Vance. So let me start with the execution and the implementation. It went extremely, extremely well. We had really no sort of hiccups of any significance. A couple of things here and there that we needed to correct them. We corrected them really quickly. But I think our technology team, as well as our implementation team did a really good job of implementing it and again, on an accelerated basis implementing it. So I think, really no issue there. And I think we're seeing it, and we're seeing the results of it operational. We talked about the savings, but we're also seeing it in terms of our buyer engagement. And what buyers are doing? They like the new platform. They like the interaction -- they like to interact our new marketing platform. And so I think, it's it really has been a success. In terms of international buyers, as I've talked about in my prepared remarks. Early on, there was disruption during the pandemic as it first came about. But we're really happy with growing our international buyer base by 40%. That is really successful given what's happened in 2020. And we knew that we had a good plan, not just with the platform, but with our digital marketing efforts. So I'm not surprised that we grew up. But I'm just -- I'm really pleased with the results in terms of growing our international buyer base. In terms of the percentage of vehicles that lead the country. I don't think we've, Vance, correct me if I'm wrong. I don't think we've disclosed that publicly.

That's right, John. We haven't updated that anytime recently.

And, and again, Vance, there is some hazard in -- because many of our domestic buyers turn around and export it, we don't necessarily know what they're doing with the vehicle. So to put a hard number on it would be difficult regardless. But we're really pleased with what's happened with the international buyer.

Yes. That makes a lot of sense. And I guess, as a follow up to that, 40% growth, is the big headline number. John. How much more room do you think there is in front of you to continue growing that? Are we anywhere near maturity? Or is there still a long runway of either existing countries or a new country that you could sell into to continue growing that base and driving revenue per unit higher?

Yes, great. Yes. We do see continued what we call white space in terms of the international buyer. We still think there is areas to further penetrate the countries we're already in, and there are still additional markets that we think we can find buyers. And again with -- what we've put in place, we're confident we're going to be able to find them in a pretty efficient way.

Great. And then, last one from a bit of housekeeping. We've heard a lot of commentary on freight costs, both ground freight and maritime overseas shipping, becoming real inflationary here. Are you guys experiencing that today? Was that in the fourth quarter at all? And then how should we think about those factors from a cost perspective as we head into 2021?

Vance, do you want to take a crack at that one?

Yes, sure. So Dan, we haven't seen anything today. We've kind of inflationary spending. I mean, where -- as you're probably aware, buyers purchase our cars, they typically arrange for the transportation of those vehicles to their location. We are working on some things that we feel really good about in those areas. But regardless, the buyer will be taking on that cost. We haven't really heard or seen anything from our buyers that suggests that that's an issue for them. And in fact, if you look at our proceeds per vehicle and what type of revenue per unit. And kind of the increase as we talked about earlier and international buyers would suggest that they're getting -- they're doing that quite well and they continue to bid on a number of vehicles and bid higher and buy more vehicles. Does that helps?

Awesome. Thanks so much for color, guys, and best of luck.

Thanks, Dan.

Thank you, Dan.

The next question comes from Gary Prestopino with Barrington Research. Please go ahead.

Good morning all.

Good morning, Gary.

A couple of things here. John, you mentioned in your comments that I guess the total loss ratio was up 120 basis points to 21.5% in Q4. And then 130 basis points. I didn't quite get what that percentage -- raw percentage number was it? Was it 20%? Or higher or lower?

That was for the full year, Gary. And Arif do you. I don't have that number in front of me what it was for the full year. But we certainly have it, Gary. We can get it for you.

Yes. That's fine. That's something you can get to me. Is there any chance now that you're breaking out your revenues that you can give us an idea of the unit declines and increases on fee-based vehicles versus purchased vehicles?

So unit - so Vance do you want to . Yes. Please.

Yes. Gary, that's not something that we're necessarily disclosing at this point in time.

Right.

But obviously, with what you saw with the increase in vehicle sales, if you consider that -- if you think about, obviously, revenue per unit has gotten higher as we talked about. So if you're thinking a quarter-over-quarter comparison with the fourth quarter of 2020 versus the fourth quarter of 2019, that clearly would have been a factor. But also, you would have good performance on volume. As we talked about kind of service revenues, obviously, the primary factors we've alluded to in our prepared remarks is that is really, really strong revenue per unit has been the primary factor and that offset volume declines.

Okay. Are you going to give us some kind of historical data on this breakdown between service fees and vehicle sales when you file your Q for a modeling purposes on a quarterly basis?

I think what we'll be providing is similar to what's been provided in the earnings release, which is going to be just the fourth quarter and the full year. So that's what as we file our Q. And then obviously, going forward we would expect that we would continue to break those out. And then you'll see that on a quarterly basis, Gary?

Okay. And then on what -- I don't have this in front of me. I wrote it in a report way back. But of the three elements of the margin expansion plan that still need to be completed, which one will if any will be scheduled to be completed this year, John?

Well, Gary, I think we provided over a multi-year period, and we're going to be making progress on all of them. So in terms of completed, I don't know that we are going to complete any one of them. But I think, we're going to continue to attack them over the next couple of years. Vance is that fair?

Yes. That's fair. I mean, if you -- Gary, if you go back and you look at the plan that we rolled out in March of 2019, I think we did give some sense of timing as it related. We did get some sense of time as it related to each of those. And some of those go on for a little bit longer than others, right? So towing optimization, for example. And what we're saying right now is that, we're making really good progress. And we feel good about things and we're on track with the timing and benefits.

That's fine. I mean, I was really trying to get at as you did the digital transformation not much quicker. And I was thinking and maybe there will be some things have been going better than expected, and you may be able to wrap up some of these things as we go forward. Alright. And then lastly, in terms of the impact of these elements of your transformation, is that going to be more of an impact on the gross margin side or the operating margin side as we go forward?

John, you want to take this one?

Yes. go ahead, Vance.

Yes. So Gary, the vast majority, almost all of it is going to be on the gross margin line. Because if you think about buyer digital transformation, that is kind of revenues and as cost -- that you know, cost of going away from previously running live auctions, and then pricing is clearly a gross margin line item. And then towing -- the cost of towing hit cost of services. So that is a gross margin item as well. And branch, process improvement, efficiency, once again, those costs, field costs are primarily, almost all those will be kind of hitting the gross profit line as well.

Okay. Thank you very much, guys.

Hey, Gary, the total loss is 20.5 for the full year, okay?

Okay. Thanks Arif.

Sure.

The next question comes from Bret Jordan with Jefferies. Please go ahead.

Hey, good morning, guys.

Hi, Bret.

When you think about the vehicle sales being up 47% year-over-year, is there a strategic shift where you're really sort of focusing on using that strategy to gain share. And you talked about one international provider switching to the purchase model. How much of that single customer was the 47%?

So I'll let Vance answer the second part of if we're going to say. But that's not a strategy to -- it is purchase contracts are much more prevalent in the UK and a little bit in Canada. But it's not something that we're using in the insurance market in the U.S. to try and change. We like the consignment model for a lot of reasons and our customers do too. So we do see opportunities to buy vehicles in some, particularly non insurance markets and we are going to continue to focus on that, but it's a relatively small part of our mix.

Right. And the 47%?

Yes. Bret, that's obviously, it was a significant factor, which is why we kind of alluded to it, but we're not going to break them out in terms of the percentage where the dollar is related to that. But it -- we would only mention if it was a significant factor.

Okay. And then one question, I guess, sort of housekeeping. On land acquisition, you commented the CapEx had a more significant piece there. Could you sort of carve that out for us and maybe talk about your strategy going forward in land purchase?

So I'll start and Vance certainly weigh in. But yes, I mean, I think as we've said, as we've defined our own capital allocation, we're -- as we look at real estate, we are going to be looking at the best economic returns. If buying land, that we believe that's a better deal. And we think there's strategic a strategic need for land in a particular geography that we think has a really long term value. We'll look at buying. But if the returns are favorable, we'll continue to lease. So it's really a -- it's just having the option to use both levers to procure properly.

Okay, great. Thank you.

Thanks, Bret.

Thanks, Bret.

The next question will be from Stephanie Benjamin with Truist. Please go ahead.

Hey, good morning, everybody.

Hi, Stephanie.

Good morning, Stephanie.

I was hoping you could talk a little bit about how assignments trended throughout the quarter. Just I think there's a lot going on in the fourth quarter just given increased COVID restrictions, the holidays, and you talked a little bit about how -- the start of January held up. But any additional color you could give would be helpful? Thank you.

Vance, you want to pick that?

Yes. More happy to take that. Good morning, Stephanie. So what we saw really in terms of assignments to think about vehicle miles traveled first assignments and then unit sold that really, those trends had come up a lot from the second quarter continue to sequentially improve in the third quarter and improved in the fourth quarter. But obviously started to get a little bit more stabilized in the fourth quarter is what we saw. And there wasn't anything that was abnormal, really, is it relates to the holiday period, per se, other than the normal kind of seasonal fluctuations that we would typically see. So that's the way I would describe it. Now, obviously, there was probably some more vehicle miles traveled as it related to traveling to see relatives and things of that nature versus flying that normally would be. But in terms of our results, we didn't necessarily, seeing anything that was abnormal -- abnormally more than what we would typically see in terms of seasonality.

Got it. That's helpful. And this is a follow up. Can you talk a little bit about what you're seeing right now in terms of your inventory levels? I believe that was a little ended the year down? And may be how you would characterize it? Thank you.

Yes. So, yes, no, I think if you think about what's happened -- what happened in 2020, is that we had obviously the decline in assignments and volume that John spoke about that kind of hitting a trough in mid April, and then climbing back from then from that, and with that inventory came back as we got more assignments. Obviously, we sold through things as well. And we were able to -- as we got more assignments, we had more vehicles in inventory and ended the year kind of slightly down from 2019, which I think all things considered is a pretty good place to be as we enter into 2021. And so -- and we're seeing certainly in kind of the end of the first -- at the end of second quarter and somewhat in the second quarter, we saw a little bit more than the impact on conversion rates, and we're starting --,we've seen that stabilize as well. So I think we feel good about where the inventory sit now.

Great. Thank you so much.

The next question will be from Bob Labick with CJS securities. Please go ahead.

Good morning and congratulations on excellent execution.

Thank you, Bob.

Hi. So I wanted to just follow-up a little on the total loss frequency that you discussed. Obviously, it's been rising. But with the significant increase in auction return, which was driving your ARPU that we can see. Do you think there's more room for total loss frequency to increase? Do you think it's kind of in concert with the auction returns? Or do you think that they've gone out of whack a little bit I guess, is the question?

So I think, we've obviously seen this trend over a seven, eight-year period where total loss frequency has continue to climb for a lot of reasons. And we've talked about many of those. The complexity of vehicles, repair costs, average age of the fleet, or the car park continues to age. So I think all those things have contributed to total loss frequency. And I think auction returns, there is -- it's a somewhat separate discussion, although, obviously, there is some relationship. But I think auction returns are more driven around the just the demand side for parks, as well as what we've done to broaden the buyer base to bring more eyeballs and clicks to our platform. I think that's driving up the value of the assets. Now our insurance company is going to adjust their behavior based on what they're seeing returns possibly. But I think I think the longer term trends that we've seen in total loss frequency are somewhat independent of what we've seen with auction returns.

Okay. Got it. Great. And then just real quick, I guess my follow up question. Could you discuss your priorities for your free cash flow, obviously, very strong free cash in 2020. And I would expect very strong free cash flow in the coming year, as well. And just give us a sense of how you're prioritizing the reinvestment of the cash?

I'll start and Vance please jump in. But again, we've laid out a disciplined capital allocation around using our free cash flow to invest in the highest return projects, whether that's buying land or it's investing in SG&A, or it's returning money to shareholders. Those are all obviously, different things we do. Pay down debt, obviously, would be another use of that. But I think we're going to continue to just be very disciplined about it. And we're looking at all of those potential avenues for deploying our free cash. Vance, anything you want to add to that?

Yes. I would just add that. Obviously, we've been in the pandemic. We like many others have been prudent with cash. We've been fortunate that we've been able to, one, generate a lot of free cash flow, certainly in 2020. We invested that back in the business. And we're strategically on key growth initiatives, technology, things of that nature, some land purchases, because we thought that we need to continue to do that. Throughout this, I think we've done that and done that well. And like as we move forward, as John alluded to, our overall philosophy hasn't changed, which is that we're looking to allocate capital to the highest return opportunities that we see. And we are going to be very, very disciplined and continuing to do that. I think initially, once we get more clarity and what line of sight as we kind of come out of the pandemic then we'll be opening things up even more. But we've continued to invest back into our business, which will be the primary area of funding growth initiatives, because we do believe there are a lot of high return growth opportunities and kind of deploying capital back into the business. And that'll be the primary focus along with land and then we'll look at a variety of other opportunities as well. And as we end the year out that it won't continue to come down, but we're comfortably within kind of a leverage target that we had set out at the time of the sales .

Got it. Super. Okay. Thank you very much.

Yes. Thank you.

Thank you. The next question comes from Craig Kennison with Baird. Please go ahead.

Hey, good morning. Thanks for taking my question. It's been helpful call. Vance. wanted to ask about interest expense, it was lower due to floating rate debt. Would you consider fixing that rate with the risk that we could see rates move higher here?

We're looking at different option. That is pretty low. I'm sorry, that rate is pretty low that we have. But we are looking at some different options that we see out there, evaluating those right now. So that could be one of then, but nothing more than that say at this point in time.

Thanks. And I appreciate, reluctance to give guidance. We're trying to build the model and there are so many inputs that could go in different directions. It's hard. But if we just isolate ARPU trends, which have been exploding on the upside. How big a drag would it be if ARPU backs off just because of price? Clearly, you have some drivers are pretty that are beyond just supply/demand dynamics. But if we see that supply.demand dynamic even out a little bit and ARPU drops or normalizes. How big a drag is that? How sensitive is your model to that dynamic?

Let me kind of start with the last piece of it. I mean, at the end of the day there is really kind of two primary drivers on the model, primarily because you have a big -- such a big portion of a cost or variable in the tow cost and things of that, that are directly related to per unit basis. So the two primary factors are assignments and volume sold and then revenue per unit driven by proceeding and then also fees. And so, I think in that regard it is impactful. As we've seen, as its moved on the upside, it's been very impactful. And if it look to go down, it would be impacted as well. But I think in terms of what we're seeing, it's interesting because I think there's a macro level impact factors which are things like supply, demand and balance and also used car prices. And when we came out of the -- went into the pandemic and we saw everything and then we saw revenue per unit balance really high kind of come to really high levels in the second quarter before demand assignments have recovered, we saw, okay, maybe some portion of that is due to supply demand and balance. And what we've seen since then is indeed assignments and volume sold has recovered, not fully but largely almost kind of below but largely recovered where it was pre-pandemic. And revenue per unit has still remain really, really high. And so, some slight adjustments have come down a slight bit, but really its remain at those kind of very high level. So that would suggest that supply/demand is probably not as big of a factor or may not be much of the factor at all. Now use car, elevated use car prices, we don't know the degree. We do think intuitively that, that make sense that would have an impact and all things considered equal, if somebody can sell their car that they buy for more than they're willing to pay more for that, right? We talk about that quite a bit. But I think, what we believe that the largest drivers have really been the things that we've done internally going to an all digital auction format, buyer digital transformation, growing out the interact platform with 360 view feature tour and all the tools that we're providing buyers. And then the expansion of our global buyer network. We think that its tough to kind of talk about it in degrees. But we think that a large part of it is due to bad and we do believe that's sustainable over a period of time.

Thank you. And thanks for sharing that growth and international buyers that helps explain things. Thank you.

Thanks, Craig.

Thanks Craig.

And the next question will come from Chris Bottiglieri with Exane. Please go ahead.

Hey, guys. Thanks for taking a question. One of the follow-up first on the international buyer growth, its pretty impressive number. Can you give us some context for what that metric looks like say over 2019, 2018 in terms of growth rate, obviously, in addition to current, but interesting to hear kind of how that accelerated to historical trends?

Yes. Chris, its kind of something we've talked about specifically, but we had a robust international buyer base in 2018 and 2019. We've just move really again through the efforts that we talked about this morning and I've been talking about around the new platform as far as our digital marketing and SCO work, we've really accelerated. And so, yes, it is strong growth. But it was a pretty solid base from which to grow.

Okay. And then I'm really impressive SG&A control this quarter. You should have that -- if I remember correctly, you said that car shared service agreement expiring in a couple quarters. I think it was two years. Is that correct? Can you remind us what that means for expenses? And then, in totality how should we think about SG&A growth next year? It'd be helpful.

Vance, do you want to take that.

Yes. Happy to take that. So yes, Chris, you are correct. There is a transition services agreement with car that was put in place in time to spend. That rolls off and is no longer effective as of the end of the second quarter of 2021. And so, we'll have a half year where we'll continue to pay someone out for transition services fees. As we've also talked about in previous calls, we have -- we really did a nice job of getting basically everything on our platform and building up all the functions we needed. And so effectively at the end of 2019, we were really no longer for all intents and purposes, there was no need or been no longer using cars as a support function. But there was a continuation of fees. We were able to kind of work with them and reduce some of those fees, although we have not disclosed those publicly. But to the degree that there are still fees that were paying, which there are -- those will roll off at the end of the second quarter. Related to SG&A going forward, what I would say is that on the positive side, we'll have only a half a year of the transition services fees that will be impacting us. We will as we go back to a more normalized divide if that's the case, and we think it will be more of a normalized environment at some point in the year, than we would expect to have a little bit more discretionary spending, travel things of that nature. Although, there are things that we plan to kind of as we change our model we've learned during the pandemic, that will be things that we'll no longer do. But we would expect to have some more discretionary spending in the year than maybe we did certainly in 2019, provided we go to a global turn back to a normal environment. And then we have public company compositions and costs that we put in place in 2019. I'm sorry, in 2020. And we're most of the way there as we stand there. There's only a few kind of minor things. And so -- but some of those will end verse -- will have an impact a full year impact in 2021, because we would have hired certain positions throughout 2020. So that's how I would describe the factors driving SG&A as we head into 2021.

That's really helpful. Thank you for the clarity.

Thanks, Chris.

Ladies and gentlemen, this concludes your question and answer session. I would like to turn the conference back over to John Kett for any closing remarks.

Thanks, Chad. Again, thank you everyone for your attention and for your support of IAA. We look forward to continuing to update you on our progress in future quarters. Have a great day.

Thank you, sir. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.