Good day, everyone, and welcome to the Copart Incorporated Second Quarter Fiscal 20 17 Earnings Call. Just a reminder, today's conference is being recorded. For opening remarks and introductions, I would like to turn the call over to Mr. Jay Adairn, Chief Executive Officer of Copart Incorporated. Please go ahead, sir.
Thank you, Chantal. Good morning, everyone, and welcome to the Q2 earnings call for Copart. With me in the room is Will Franklin, our Executive Vice President and Jeff Liao, our Chief Financial Officer. I'm going to turn it over to Jeff for safe harbor and financial review. Will will give an update on the company and then we'll be happy to answer any questions after that.
With that, Jeff?
Thank you, Jay. I'll start with the Safe Harbor. During today's call, we'll discuss certain non GAAP measures, including non GAAP net income per diluted share, which includes adjustments to reverse the effect of foreign currency related gains and losses on our cash balances and the adoption of an accounting pronouncement regarding the tax treatment of executive stock option exercises. We've provided a reconciliation of these non GAAP financial measures to the most directly comparable GAAP measures on our website under the Investor Relations link and in our press release issued yesterday. We believe the presentation of these non GAAP measures together with our corresponding GAAP measures is relevant in assessing Copart's business trends and financial performance.
We analyze our results on both GAAP and non GAAP basis described above. In addition, this call contains forward looking statements within the meaning of federal security laws, which are subject substantial risks 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 management's discussion and analysis portions in our related periodic reports filed with the SEC. We do not undertake to update any forward looking statements that may be made from time to time on our behalf. Now to the Q2, we continue to base the presentation consistent with what we showed you for the Q1 with non GAAP net income adjusted to exclude the effect of foreign currency related gains and losses on cash balances, as well as the adoption of an accounting pronouncement regarding the tax treatment of stock option exercises.
For the cleanest look at the business, we continue to encourage you to focus on revenue, gross profit and operating income measures. I'll describe in greater detail the currency fluctuations, which affected other income and then in turn net income on a GAAP basis. Starting with the top line, we experienced global revenue growth of approximately 17% year over year for the Q2 from just under $300,000,000 to just under $350,000,000 in the current quarter. We did experience a detrimental year over year currency effect on revenue of approximately $9,500,000 This is due of course primarily to weakness in the British pound relative to the dollar. The pound for the quarter was down 17% year over year.
We did experience global unit sales growth of 18%, consistent across the United States and as well as our international segment. U. S. Unit growth was driven by a combination of factors, principally growth through our existing insurance customers due to driving activity and total loss frequency consistent with themes we've discussed with you in the past as well as account wins and catastrophic weather events. Approximately 3% of our growth was attributable to cat events in the Q2 or for units sold in the Q2 of 2017 in comparison to the 2nd quarter of 'sixteen.
We grew global inventory at 17.7% year over year. A modest portion of this between 1% and 2% is attributable to catastrophic weather events as well. Service revenue growth of 19.1 percent in comparison to purchase car revenue growth of just $200,000 or 0.5 percent, a continuation of the theme we described to you in the past regarding our proactive shift of units away from purchase arrangements to service arrangements when we can so do. We grew gross profit from $124,600,000 in the Q2 last year to 100 and $46,800,000 this year with a slight increase in gross margin from 41.6 percent to 42%. A few notes on average selling prices.
ASPs were up slightly year over year for the Q2, a function really of a few different things. First is we did experience year over year scrap increases of just shy of 40%. That's we cite American Recyclers' crushed car body index averaging their index across the 5 regions. The improvement in scrap rates was offset of course by a much stronger United States dollar, which all else equal can reduce selling prices for cars in our U. S.
Auctions. For example, the USD was nearly 20% stronger this year in this quarter than it was a year ago. Used car value is not a particular driver of change in the quarter. Manheim's index indicates plus or minus flat used car values for the two periods. We did experience an increase in general and administrative expenditures of just over $3,300,000 ex D and A.
Also, G and A was down sequentially versus the prior quarter. We incurred certain adjustments for certain indirect tax expenses, also experienced some modest increases in professional services expenses. Regarding D and A within the general administrative expenditures, we are experiences our increases were due primarily due to assets in information technology that were placed into service as well as changes to certain useful lives of our technology. As we continue to say, G and A will continue to grow on an absolute dollar basis as the size of our business, the complexity of our business increases over time, though with reasonable top line growth rates, we expect to continue to achieve operating leverage. We experienced EBIT growth of just over 18% growing from $92,100,000 for the Q2 last year to $108,900,000 this year.
That's despite a currency related drag of approximately $2,900,000 for the quarter due again to weakness in the British pound. Our net interest expense for the quarter was up slightly from $5,000,000 to $5,800,000 due to a higher funded debt balance offset by somewhat lower drawn rates. The other income line includes a loss of $3,000,000 largely due to currency fluctuations on our cash balances. A year ago, other income was a positive $4,400,000 also due to the same currency fluctuations. GAAP net income for the period grew at 12% from $59,000,000 to 66.1 dollars Non GAAP net income, which I'll walk you through in a little bit greater detail, grew from $55,500,000 to $67,400,000 this year, growth of 21.6%.
The non GAAP net income excludes after tax foreign currency related losses of $2,700,000 in this current quarter and reverses as well the prior year gain of $3,500,000 So that line item alone is a $6,000,000 unfavorable swing, which is adjusted for in our non GAAP net income. Our non GAAP net income also excludes the book tax effect of our adoption of ASU 20 sixteen-nine regarding the GAAP tax treatment of stock option exercise. Our year over year share count has decreased due largely to share buybacks, including the effective share buybacks from tax withholdings for executive option exercises. On balance then, our non GAAP EPS grew at 29% year over year for the 2nd quarter. Let's turn our attention to the balance sheet as well as the cash flow statement.
A few highlights on cash flow. Operating cash flow for the quarter was $81,000,000 a function of increased EBIT offset by AR growth with accounts receivable consuming $45,000,000 of cash. You know already that the accounts receivables are primarily advance charges paid out on behalf of our customers when a lot is picked up. So our accounts receivable tends to grow with the inventory that we have in our yards. We did experience a $32,000,000 reduction in deferred and current income taxes.
You may remember from the prior call that we incurred a large tax bill in effect regarding these stock option exercises by our executives, which effectively prepaid the majority of our federal income taxes for this fiscal year. This $32,000,000 reduction is that cash benefit coming to fruition in the 2nd quarter. The Q2 as you know is customarily our is customarily the quarter in which we build inventory which was the case again this year. Our capital expenditures for the quarter were $54,000,000 of which approximately 80% is for land, development and lease buyouts. Our diluted shares outstanding again decreased from a little north of $124,000,000 to $117,800,000 due largely to share buybacks including open market purchases as well as the effective buybacks for tax withholdings.
With that, I'll turn it over to our Executive Vice President, Will Franklin.
Thank you, Jeff. I'd like to add a few more brief comments and then we'll turn it over for Q and A. The story for the quarter for both North America and the U. K. Is the continuation of the growth in volume driven by market wins, by organic growth within the market and by expansion of our non insurance businesses.
In North America, sales volume was up 18.4% over the same quarter last year and 34% over the same quarter 2 years ago. In the UK, we have similar trends with volume up 15.4% 27.5% over the same quarters in fiscal 2016 and fiscal 2015. In both North America and the U. K, drivers of organic growth are the same and consistent with prior discussions that we've had on this call. We are seeing increases in the car park, increases in accent frequency and of most importance, increases in salvage frequency.
In North America, revenue grew 20.5%, which outpaced the volume growth as revenue per car increased marginally due to higher ASPs and the performance of additional services. While non insurance volume grew, as a percentage of total volume it declined from 19.8% to 17.8%. Growth in non insurance volume came primarily from additional dealer cars. Accommodating the tremendous growth in North America volume while at the same time ensuring that we continue to provide the best service to our sellers and our members has presented opportunities to our operations and our facilities teams. Our facilities teams have been successful in obtaining additional capacity in very difficult environments.
Over the course of the last few years, we have noted the increasing difficulty and the increase in expense of attaining new storage capacity. In the U. S, during the 4.5 year period ending Q2 of 2016, we opened only 3 greenfield yards. In the last four quarters alone, we have announced and opened 10 new greenfield yards. In addition, we have opened 10 sub lots and expanded 16 existing facilities.
During the current quarter alone, we opened 5 yards, 6 sub lots and expanded 5 existing locations, increasing capacity by 4 63 Acres. Even with these additions and expansions, we will need more land to address the expected future growth and to be better prepared to address the sudden storage demands created by catastrophes. Last week, we opened a 162 Acres site in Potobe, Florida. This site will not be operated as a standalone yard at this time, but will serve as standby storage capacity ready for immediate access should a cat occur in the Miami, Tampa or Orlando, Florida areas. A similar strategy has been implemented in North Florida, Louisiana, Georgia and North and South Carolina and is being rolled out in other cat regions.
In the UK and expressed in pounds, our revenue was up 15.5%, very consistent with UK volume growth. In addition to growth in the insurance market, the non insurance volume increased by over 36%. And as a percentage of total volume, non insurance cards grew from 15.4% to 18.2%. However, the change in the pound to USD exchange rate had a severe impact on UK revenue of over $10,000,000 and resulted in a recognized decline in UK revenue expressed in dollars of 3.5%. Overall, our growth of revenue of 16.6 percent was slightly below our growth in volume of 18.3%, primarily due to the detrimental quarter over quarter change in the foreign currency exchange rates.
At the end of the quarter, our North America and our U. K. Inventories were up 19.1% and 4.1% respectively. Global inventory was up 17.7%. On a consolidated basis, our average cost to process each car increased marginally over the same quarter last year.
In normal environments, increased volume meals reductions and average cost to process a car due to greater fixed cost absorption. However, in the current environment, new volume was frequently addressed with new capacity, not idle existing capacity. Further, we incurred extraordinary operating cost associated with temporary leases, additional trucking to move cars between locations after hours and with staffing that was well in excess of our normal operating models. We remain focused on G and A expense and are pleased with our efforts to gain leverage by controlling this growth. While we saw a spike this quarter, it resulted primarily from unique expenses and we expect G and A expense to continue to decline as a percentage of revenue.
Now let me conclude with a final comment. In a business the nature of Copart in which land very specific in nature and very difficult to find is required and where scale is achieved through the construction of new facilities that can take 12 to 24 months, it's very difficult to maintain operational leverage with worldwide growth volume of 33.6 percent over the last 2 years and 18.3% over the last 12 months. Yet in this environment, we expanded our EBIT margin by 2 10 basis points over Q2 of 2015 and 50 bps over Q2 of 2016. And we expect to see better operational leverage as we began to complete our facilities expansion and to process volume growth through the excess capacity that we are currently creating. That concludes my comments.
Shantel will turn the call over to you to manage the Q and A portion of it.
Thank you very much. Ladies and gentlemen, at this time, we would like to open the floor for questions. Our first question will come from Bob Labick, CJS Securities.
Good afternoon. This is actually Robert in for Bob today.
Hi, Robert.
You update us on capacity additions as in how many acres you've added and how many more are to come?
Yes, it depends on what period you're talking about. We have on our board over 60 expansion targets that we're looking at and that's worldwide. And it's impossible to predict exactly the number of acres that those efforts will yield or the timing of those efforts because it's like I said in my remarks, it's very difficult to get a contract on new land. I would expect it to be in the high hundreds of acres within the next 24 months.
That's helpful. And are you able to quantify cat costs in the quarter?
No, not specifically. We still did have remaining cat costs. We did process between 8000, 10000 cat cars during the quarter. But the cat wasn't the sole driver of the increase in cost. It was just the overall volume that affected almost every yard.
Got it. And can you provide us with any update on Germany and Spain with auctions taking place there yesterday and today? What are you learning there?
Yes. So the auctions are test in nature and the results have been very promising. The options are yielding returns that are much higher than the current process employed. What we're also understanding is that we need to have a broader footprint in yards to be able to offer this to the insurance companies in Germany. And so we're somewhat subject to the pace of the expansion of those yards.
Currently, we have 7 yards that we're targeting to open, one of which has already been opened, that's at Hamburg. We have 4 other yards that we're negotiating the contracts on and 2 that we're still addressing the zoning issues. So, like I said, the rollout in Germany will be somewhat subject to our ability to open those yards.
Thank you. That's very helpful. And just lastly from me, typically how long does it take for
the new yards to reach mature margins? There's no any one yard that they're all different. They're all snowflakes. It depends on how much capacity you can ship from other yards. It can be as short as a year and it can be as long as 3 or 4 years.
Got it. Thank you.
Thank you very much. Our next question will come from Ben Bienvenu from Stephens and Company.
Thanks. Good afternoon.
Hi, Ben. Hi, Ben.
I'm curious, you highlighted some of the FX headwinds on the revenue translate from a translational perspective. Are you your volume growth and inventory builds continue to be really strong. I'm curious are you seeing any implications or dampened appetite from a strong dollar from your foreign buyers' appetite to buy vehicles at auctions?
So Ben, I think what I heard you I think probably linked 2 relatively unconnected concepts. The first is that we continue to experience meaningful inventory growth and volume growth and that's a reflection of the factors we've talked about really for a while now regarding driving activity, accident rates and total loss frequency. That appears to be continuing unabated as far as we can tell. The second question you raised, which is the foreign currency effect on our foreign buyers, I mentioned that in my comments as well. That certainly affects the average selling prices for our vehicles.
On balance, we're still flatter up slightly year over year. There are a handful of things that kind of go into that that contribute to the question of ASPs of which foreign currency is 1. The others are scrap, used car values, mix, etcetera. But all else equal, certainly the U. S.
Dollar being 20% stronger year over year versus the Mexican peso for the 2nd quarter does affect ASPs.
Okay. Thanks. And then you highlighted your recent capacity additions in cat prone geographies. We've seen more flooding in California. I'm curious, how has the additional capacity that you've brought online better positioned you in those markets?
And can you give us any sense of what kind of volume is being generated as a function of some of the recent funding activity we've seen out west?
No. In respect to the last question, we really can't give you any kind of guidance on the volume that it will generate. We have opened up 2 new yards in Southern California, which I don't know what we'd do without those. We also have sub lots in the high desert area. So when I talked about the additional cost, what we'll do is we'll use some of the yards in Southern California as marshaling yards.
We'll bring the cars in during the day and during the night we'll load those up on 8 car haulers and we'll take them up to our sub lots up in Palmdale, which once again adds to the significantly adds to the cost of processing the cars.
Okay. That's great. Thanks so much.
Thank you. Our next question will come from Ryan Brinkman, JPMorgan.
Hi, great. Thanks for taking my question. Can you please remind us of the drivers of the seasonal leverage of yard and expense cost as a percentage of revenue as we walk from your fiscal second to fiscal third quarter. The last couple of years you've created leverage these expenses, 13 bps, 300 bps maybe. Should we expect that type of leverage to repeat this year benefiting margin again?
Ryan, I think we just as a general matter, we don't provide forward guidance, but let me provide what I think could be relevant color. So when we receive a unit, we incur the majority of the expenses. We, however, don't recognize most of the revenue until we sell it. So depending on whether the receipt of a given unit crosses receipt and sale of that unit crosses the reporting period, That can cause us to incur the expenses upfront and not recognize the revenue most of the revenue until later. This is all a function of course of GAAP guidelines.
And so in a period like the Q2 in which we received many more units than we sell, we have borne a substantial portion of the cost already for which the units will be sold later. That can explain some of the seasonal fluctuations in our gross margin rate.
That is helpful. Thanks. And then just when you talk about insurance versus non insurance cars, you're not really talking about salvage versus whole car, right? Because I think a large portion of your non insurance cars are actually like non insured salvage cars picked up from junkyards. Is that the case?
I ask because I've gotten some questions today about how you might be negatively impacted by some of the headwinds that Car Auctions Services has discussed regarding fewer dealer consignment sales on the whole car side. And I didn't think you had much exposure there. Are you able to say how large Copart dealer services is now as a percent of your total business?
No, I really wouldn't express it as a percentage, but I will tell you that most of our non insurance cars are truly non insurance cars. They're not salvage cars that came to us through the owner retained process.
So there is some fair amount of exposure there.
Yes. I don't know what you mean by exposure.
I don't know. 10% of your unit volume, I don't know.
Yes. I'm going to jump in just because are you I want to make sure I understand the question or that we understand the question. Are you stating that they are referring to dealer auctions as having slower dealer consignments?
That's right. On the whole car side, there's fewer dealer consignment sales. And I was just wondering, is there well, some clients are wondering, is there implication for your volume from that? How to think about the I think it's small, how to think about the magnitude of your exposure to whole cars being sold by dealers? Because I know you had that Copart Dealer Services business you launched a while back.
Yes. So we won't provide a percentage. We will tell you this that in the last three quarters that number has been growing.
Growing. Okay. So maybe that's one of the reasons they're going. Okay, fine. That's very helpful.
Just last question on the opportunity to repatriate cash back to the U. S. If tax laws were to change. Is that material enough of an opportunity to drive a just growth overseas?
Hey, Ryan, Jay there. The guys can answer that question. I just want to jump in on this point that you're making about the consignments. They're 2 very different types of cars. When you've got a dealer consignment in the whole car world, a lot of those vehicles are coming from franchise dealerships.
And when you've got a dealer consignment in our world, most of those are coming from non franchise dealerships. So they're really not comparative cars. And then to Will's point, besides the fact that that segment is growing, to Will's point, all non insurance then we start to look at institutions and charities and other companies that assign cars and they have absolutely nothing to do with trade ins or insurance.
Okay.
And Ryan to your next question then about cash repatriation, our expected as you note, the majority of our cash is actually held in non U. S. Accounts. Our expectations are to invest and deploy that capital outside the U. S.
If there is a substantial change to the tax code here in the U. S, we of course would reevaluate and consider those parameters as well.
Okay. Thanks for all these answers.
Thank you, Ryan.
Thank you. Our next question will come from Matthew Payne, Gadeli and Company.
Hey, good afternoon. As you speak about gaining additional capacity, in the past you've mentioned also moving into adjacent markets as potential areas of interest. Is this still the case? And where does that fit on your list of priorities?
And what do you mean by adjacent?
Like equipment auctions or even in
more whole
car auction?
The investments you've heard us talk about today are for our core business, Hardstop, as for considering our strength and strategic capabilities and whether they would enable us to extend our franchise into other spaces, that's something we consider over the long term. But nothing you heard us talk about today is relevant for that consideration.
Let me just add to that. We keep waiting or expecting this trend of growth to subside in salvage cars. And I just I got the most recent numbers from ISS, Independent Statistical Services, which is an information provider to most of the insurance industry. And the last quarter that they provided information, which was Q3 of last year, salvage frequency actually went up. We've been expecting that to go down.
And in terms of total claims, on a year over year basis, it's up 3.5%, but in total paid losses, it was up 10%. If you look back 24 months, claims was up 8%, the total paid losses was up 20%. And that's kind of the basis for the increase in the salvage frequency. The cost per pair is growing, accident frequency is growing. And so we're very comfortable with our expansion process as needed to address this expected volume.
That's really helpful. And my second question is for Jeff. You've now been here with the company for a little over a year. Has there been anything that's surprising to you? Or do you view anything at Copart differently now than when you
first joined?
I think of course before you join the company, you just understand so much less about it and what I was able to see from the outside, of course, respected and admired from afar. And now that I'm plugged in and appreciate the complexity of the business and how hard it is to manage the network of facilities, the buyers and while providing outstanding service to sellers, including in cash off times, I think I have a better appreciation for just how hard it is to do
what we do. But in
terms of Copart, no meaningful surprises. I did spend a lot of time with Jay and Will and others before joining the company. So it's been relatively smooth sailing.
Great. Well, thanks
for taking my call and good luck.
Thank you.
Thank you. Our next question will come from Bret Jordan, Jefferies.
Good afternoon, guys.
Hi, Bret. Hi, Bret.
Hey, is there a way to think about capacity utilization? I mean, obviously, you've added a fair amount of acreage in the last 12 months and you're adding a fair amount more. And it sounded like maybe your utilization was too high to be efficient previously. But is there a way that we should be thinking about this relative to the cycle as well because obviously we're having a pretty strong inflow of volume? Is there a point at which you have acreage that would become inefficient if we had a slowdown?
I guess how do you do the math around the incremental real estate decision?
Well, first off, the conversations around expansion aren't that broad. They're generally fairly narrow in terms of geographical regions. So we can't look at our total capacity country nationwide. And there's a lot of factors that enter into what our targets are for the capacity that we need. We've even come with a new comp of the recognize a new phenomenon and that is certain yards are actually get less efficient in their size and we get yards that store 8,000 cars are actually less efficient than the smaller yards.
So that's also part of the consideration. I think the biggest change that we've seen is that previously we tried to operate our yards at 100% or over 100% capacity during the peak season. And now we've decided that that's that creates too much risk for our sellers. And we've changed that model to now we're targeting 85% of capacity during the peak season and 70% of capacity in those areas that are subject to cats. And without answering your question specifically, because I'm not sure how to, these are the drivers that we look at when we're doing going through our expansion processes.
Okay. And then one question on market share. Obviously, there was one insurance company that shifted some share to you guys a year ago. Is anything else changing out there? Or is there anything in the pipeline as far as major RFP activity as we look out?
There's always RFP activity and we compete very aggressively with every other player in the industry. We think we've done very well in the last couple of years and but it's impossible to predict what the next couple of years will look like.
Okay,
great. Thank you, guys.
Thanks, Joe.
Thank you very much. Our next question will come from Elizabeth Suzuki, Bank of America.
Hey, guys. Just a question on operating leverage and efficiency here. Is there a good rule of thumb for the level of ideal revenue growth you would need in order to achieve operating leverage with the capacity you have in place now? Because it seems like if volume growth is too high, you have to add capacity, which is costly. But obviously, if it's too low, you can't leverage your fixed cost.
So what do you think is the sweet spot there for volume growth?
Without a lot of analytics behind it, I would say 8% would be really nice. That gives us time to like I said, it takes a couple of years to get to acquire new capacity. That gives us that would afford us time to do so, especially if we're operating at 85% capacity based on current volume. Elizabeth, I'd say
that the growth is affirmatively good for us. And ultimately, the more we grow, the more we achieve operating leverage over the long term. I think what can create near term noise is surprises or volatility. I mean, if you told me we'd for sure grow at 15% a year forever, we can plan accordingly, hire accordingly, build land accordingly, etcetera, It's that there is some natural volatility in any industry, including ours, that can create spikes if we suddenly have catastrophic weather events and a really busy summer that can cause over time excess sub haul expenses, etcetera. If you had perfect visibility, which we will never have and robust growth that would of course be ideal.
Right. Makes sense. And then just looking at the potential for tax reform, Carr mentioned today that they think a 1% reduction in the U. S. Corporate tax rate would be about a $4,000,000 benefit to their net income.
Have you done any similar sensitivity analysis? Obviously, there could be a lot of moving parts, interest deductibility and other nuance. But just assuming a straight reduction in U. S. Corporate rate, how much of a benefit do you think that would be for Copart?
Yes, I think we're a good question Elizabeth and I think we're not prepared to comment quite as specifically as they did. I would say when we look at the various pillars of the corporate tax reform being contemplated today, big picture they affect both your taxable income, so the base upon which taxes are calculated as well as the rate. We're relatively unaffected on the base side of the equation. We have interest, but we're relatively unlevered. So we're not affected much by interest deductibility considerations.
We do invest capital. So to the extent that we are permitted to deduct those expenditures right away, that could in fact reduce our base. So I think the base for which taxes are calculated is relatively unaffected. We are substantially U. S.
Cash taxpayers however. So if the rate changes that likely does accrue to our benefit. And as that crystallizes and becomes more real, we'll certainly have more specific things to say about it.
Great. Thanks very much.
Thank you, Elizabeth.
Thank you very much. Our next question will come from Gary Prestopini, Barrington Research.
Good afternoon, everyone.
Hey, Gary.
A couple of questions here. In terms of the GAAP tax rate going forward, what should we use? My model I'm looking at from last quarter, I think we had said EBITDA something around 36%. It looks like it came in at 34% this quarter. So what kind of number should we be using on a go forward basis?
So setting aside the topic we just talked about, right, which is a more radical overhaul to the tax code. I think Will said probably 4 to 6 quarters ago, we generally expect 35% to 36% effective rates. And that's still the right long term starting point.
Okay. And then I couldn't write down fast enough, Will. You gave a breakdown of what the global inventory growth was in growth was in the U. K. And U.
S. Could you just repeat that?
Sure. Global was 17.7% and then on a regional basis, North America was 19.1% and the UK was 4.1%.
4.1%. Okay, great. Thanks. And then I'm sorry, was there something else?
No, go ahead. No.
Okay. And then in terms of these temporary standby storage sites that you're putting up, Land is land, obviously, it's going to cost you to do that. But in terms of capital improvements, putting facilities there, do you have to do a lot there besides maybe just putting a fence around the land and maybe putting some gravel there? I mean, do you need to staff it? Do you need to have a physical building on the site?
We do not. In these in our strategy, we won't do much to these. So every yard is unique. The question of whether we fence it to even one is subject to discussion.
If we
don't fence it, that means in times of use, we need to have security. So then it's just a math equation about how many times do you think you'll use it needs security versus the cost of defense. Generally, in these temporary locations they're not temporary, but these standby locations, we'll put in roads, we'll rock some roads and that's about it. So beyond the cost of the land, there's very little capital necessary to put them in a standby state.
Okay. And then the last question as it pertains to what you're doing in Germany, my understanding of that cars were basically owner retained in Germany, was an insurance company retained. So is there prior to doing these auctions and continuing on, is there still some kind of an educational process that you have to with the insurance companies to get them to understand just what you're doing to get them to want to pull the cars and then you've got obviously got to get a buyer base as well, right?
Yes, we have a buyer base. And now I don't think there's really any educational process yet to take place. I think that they are aware of the value that we provide. And I think they're anxious to be able to utilize that value. The holdback is moving one region in the country or one area of the country, which is not attracted to the larger insurance companies.
This is a complete change paradigm to them and a change of process. I'd rather not have 2 processes ongoing at one time. And therefore, they'd like to see our ability to handle their volume more broadly within the country.
Okay.
Thanks.
You're welcome.
Thank you. Our next question will come from Bret Jordan, Jefferies.
Hey, Will. This is just a follow-up to your ISS data. If you could throw that out again the salvage frequency versus total claims. And I guess, is ISS using the similar data that CCC uses from an industry standpoint as they report repairable claims growth?
I believe it is. And this doesn't provide salvage frequency. It provides the drivers to that decision. And so this is more focused on accident frequency. So the numbers I cited were that the number of paid claims on a year over year basis, and this is based on the Q3 of last calendar year, were up 3.5% and on a 2 year period were up almost 8%, while at the same time the paid losses were up 10% 20%.
And I guess I'd also note that accident frequency was reached 6% for the well, I don't know for the first time. I only go back to 2011, it's never been 6%. So the effect of accident avoidance systems and some of the new technology isn't being demonstrated in the numbers, at least at this point.
No. Smartphones are beating accident avoidance technology so far.
So the
takeaway here is claims the percentage of claims that are losses are increasing as a percentage of crashes.
That's correct.
Yes. Thank you. You're welcome, Brett.
Thank you. At this time, we have no further questions in the queue.
I would just add some closing remarks from listening to some of the questions. One is that you may want to look into the use of adaptive headlights and the multiple component bumpers today that exist in the market. There's plenty of research out there that you can find named off CCC and some of the other sources that are out there. But there's no doubt that bumper covers being 3 components and now being 15 components and all the complexity in headlights, headlights are now as high as $5,000 for a headlight coming from the days when they were less than $100 So we're seeing some big increases there. You may want to research on some of the carriers as well because they're reporting that in their claims costs and why their claims costs are up because of that.
That increase in cost is increasing severity and that severity going up causes total loss frequency or salvage frequency as we call it to go up. The other thing that I'm not sure that the analysts maybe understand it, I'm not positive that you fully understand it, is this cost that we have associated with building yards and asking questions about what would be normal. Right now, we've got people in advance of all this growth that are finding locations, developing locations and it takes a number of resources to do that. And then once those yards are ready, we've got to staff them and turn them on completely before we ever assign one car. And so you've got all this cost when you go from adding, I think Will stated, 3 locations over 4 years to 10 locations this year.
And we believe we'll open up in addition in the calendar year we're in another plus 10 or more. So there's a lot of cost that's associated with that. And then once we start to see some normalcy in total loss frequency and then the total losses that are coming in, those yards will have excess capacity. So we don't build those yards for 85% capacity. We'll build those yards for 30% or 40% utilization and a much higher number of capacity so they have room to grow into that.
As Will stated, we want to operate the company at 85% on an average for our location. So these new stores are being built. These new yards are being built with significantly more capacity than that. And so that you're going to see some of these costs. And then finally, I would just mention in addition to all that was the towing component that Will outlined could be a pretty significant component when you're out of space in a market, you may have to shuttle cars.
And we've had a few scenarios like that and that's we're okay with that. We're handling those cars. We're moving them to areas where we have room. And then when we expand, all that cost goes away. So we look at all of this as upside.
We're getting a lot of volume. In the history of my career, I've not seen where the volume increases like this and then goes the other direction. So at some point, this may start to shrink. As Jeff stated, we don't see that currently. But at the point that we start to see volume normalize, we don't think it goes into a negative situation.
So we slow down at that point, the adding of yards. We slow down the expansion of facilities and we process those vehicles as incremental units. So that was it. Just want to add that color and thank you all for attending the call and we look forward to reporting Q3. Thank you much.
Ladies and gentlemen, thank you for your participation. This does conclude today's conference. Have a great rest of your day.