UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 

COPART, INC.

(Exact name of registrant as specified in its charter)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

YES         ý            NO          o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

YES         ý            NO          o

 

Number of shares of Common Stock outstanding as of June 8, 2005: 90,241,091

 

 

Copart, Inc. and Subsidiaries

 

Index to the Quarterly Report

 

April 30, 2005

 

Description
PART I – Financial Information
Item 1 - Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Acquisitions and New Operations
Critical Accounting Policies and Estimates
Results of Operations
Liquidity and Capital Resources
Factors That May Affect Future Results
Item 3 – Quantitative and Qualitative Disclosures About Market Risk
Item 4 – Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Changes in Internal Controls
PART II – Other Information
Item 1 – Legal Proceedings
Item 6 – Exhibits
Signatures

 

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Part 1 Financial Information

Item 1 Financial Statements

 

Copart, Inc. and Subsidiaries

Consolidated Balance Sheets

(in thousands)

(Unaudited)

 

		April 30, 2005			July 31, 2004
ASSETS
Current assets:
Cash and cash equivalents		$	243,903		$	5,720
Short-term investments		—			172,600
Accounts receivable, net		94,348			81,633
Vehicle pooling costs		24,849			23,966
Prepaid expenses and other assets		7,195			5,437
Property and equipment held for sale		48			3,755
Total current assets		370,343			293,111
Property and equipment, net		275,550			257,667
Intangibles, net		2,131			2,941
Goodwill		115,549			112,691
Land purchase options and other assets		6,642			6,613
Total assets		$	770,215		$	673,023
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities		50,421			44,080
Deferred revenue		12,742			9,721
Income taxes payable		10,116			3,819
Deferred income taxes		5,564			5,438
Other current liabilities		141			165
Total current liabilities		78,984			63,223
Deferred income taxes		7,960			6,355
Other liabilities		1,263			1,182
Total liabilities		88,207			70,760
Commitments and contingencies
Shareholders’ equity:
Common stock, no par value - 180,000 shares authorized; 90,220 and 90,076 shares issued and outstanding at April 30, 2005 and July 31, 2004, respectively		269,681			267,276
Accumulated other comprehensive income		308			95
Retained earnings		412,019			334,892
Total shareholders’ equity		682,008			602,263
Total liabilities and shareholders’ equity		$	770,215		$	673,023

 

See accompanying notes to consolidated financial statements.

 

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Copart, Inc., and Subsidiaries

Consolidated Statements of Income

(in thousands except per share amounts)

(Unaudited)

 

		Three months ended April 30,						Nine months ended April 30,
		2005			2004			2005			2004
Revenues		$	130,426		$	116,618		$	344,550		$	300,720
Operating costs and expenses:
Yard and fleet		61,947			58,053			170,863			159,659
General and administrative		11,672			10,515			29,989			27,224
Depreciation and amortization		9,054			7,652			24,254			23,133
Total operating expenses		82,673			76,220			225,106			210,016
Operating income		47,753			40,398			119,444			90,704
Other income (expense):
Interest income, net		1,217			338			3,034			924
Gain (loss) on sale of fleet equipment		(67		)	(773		)	(50		)	1,155
Other income		776			591			2,778			1,869
Total other income		1,926			156			5,762			3,948
Income before income taxes		49,679			40,554			125,206			94,652
Income taxes		18,774			15,590			48,079			36,881
Net income		$	30,905		$	24,964		$	77,127		$	57,771
Basic net income per share		$	.34		$	.28		$	.86		$	.65
Weighted average shares outstanding		90,179			89,373			90,127			89,296
Diluted net income per share		$	.33		$	.27		$	.83		$	.63
Weighted average shares and dilutive potential common shares outstanding		93,100			91,974			92,931			91,236

 

See accompanying notes to consolidated financial statements.

 

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Copart, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)

 

		Nine Months Ended April 30,
		2005			2004
Cash flows from operating activities:
Net income		$	77,127		$	57,771
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		24,254			23,133
Deferred rent		87			(53		)
Gain on sale of property and equipment		(697		)	(1,012		)
Deferred income taxes		1,731			2,430
Write-off of land purchase options		—			1,150
Changes in operating assets and liabilities:
Accounts receivable		(12,527		)	(12,733		)
Vehicle pooling costs		(768		)	(1,067		)
Prepaid expenses and other assets		(1,787		)	(1,043		)
Accounts payable and accrued liabilities		6,312			8,929
Deferred revenue		3,022			181
Income taxes		6,958			13,893
Net cash provided by operating activities		103,712			91,579
Cash flows from investing activities:
Purchase of short-term investments		(341,020		)	(111,355		)
Sale of short-term investments		513,620			62,360
Purchase of property and equipment		(42,171		)	(51,030		)
Proceeds from sale of property and equipment		5,520			16,628
Purchase of net current assets in connection with acquisitions		(303		)	(154		)
Purchase of goodwill and intangible assets in connection with acquisitions		(3,059		)	(686		)
Net cash provided by (used in) investing activities		132,587			(84,237		)
Cash flows from financing activities:
Proceeds from the exercise of stock options		1,082			2,609
Proceeds from the issuance of Employee Stock Purchase Plan shares		661			698
Repurchases of common stock		—			(10,723		)
Net cash provided by (used in) financing activities		1,743			(7,416		)
Effect of exchange rate changes on cash		141			(28		)
Net increase (decrease) in cash and cash equivalents		238,183			(102		)
Cash and cash equivalents at beginning of period		5,720			5,391
Cash and cash equivalents at end of period		$	243,903		$	5,289
Supplemental disclosure of cash flow information:
Interest paid		$	1		$	3
Income taxes paid		$	39,390		$	20,558

 

See accompanying notes to consolidated financial statements.

 

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Copart, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

April 30, 2005

(Unaudited)

 

NOTE 1 – General:

 

Nature of Business

 

Copart, Inc. (the “Company”) provides vehicle suppliers, primarily insurance companies, with a full range of services to process and sell salvage vehicles through auctions, principally to licensed vehicle dismantlers, rebuilders, repair licensees, used vehicle dealers and exporters.  Salvage vehicles are either damaged vehicles deemed a total loss for insurance or business purposes or are recovered stolen vehicles for which an insurance settlement with the vehicle owner has already been made.  The Company offers vehicle suppliers a full range of services that expedite each stage of the salvage vehicle auction process and minimize administrative and processing costs.  The Company generates revenues primarily from auction fees paid by vehicle suppliers and vehicle buyers as well as related fees for services such as towing and storage.

 

Basis of Presentation

 

In the opinion of the management of the Company, the accompanying unaudited consolidated financial statements contain all adjustments, necessary to present fairly the financial information included therein.  These consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2004 filed with the Securities and Exchange Commission.  The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

 

Use of Estimates

 

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and reported consolidated results of operations during the reporting period. Estimates are used for, but not limited to, vehicle pooling costs, allowance for doubtful accounts, goodwill, income taxes and long-lived assets. Actual results could differ from those estimates.

 

NOTE 2 – Net Income Per Share:

 

There were no adjustments to net income in calculating diluted net income per share.  The table below reconciles basic weighted shares outstanding to diluted weighted average shares outstanding (in thousands):

 

		Three months ended April 30,				Nine months ended April 30,
		2005		2004		2005		2004
Basic weighted shares outstanding		90,179		89,373		90,127		89,296
Effect of dilutive securities - stock options		2,921		2,601		2,804		1,940
Diluted weighted average shares outstanding		93,100		91,974		92,931		91,236

 

Options to purchase 43,500 and 151,000 shares of common stock at a weighted average price of $23.77 and $21.79 per share were outstanding during the quarters ended April 30, 2005 and 2004, respectively, and 63,000 and 1,591,400 shares of common stock at a weighted average price of $23.48 and $17.69 were outstanding during the nine months ended April 30, 2005 and 2004, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares.

 

Note 3 - Short-term Investments: 

 

Short-term investments consist of federal, state and municipal securities with readily determinable fair market values and original maturities in excess of three months.  Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities

 

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represent the investment of cash that is available for current operations.  The Company’s investments are classified as available-for-sale and accordingly are reported at fair value, with unrealized gains and losses reported as a component of shareholders’ equity.  Unrealized losses are charged against income when a decline in the fair market value of an individual security is determined to be other than temporary.  Realized gains and losses on investments are included in interest income.

 

As of April 30, 2005, the Company had no short-term investments as all short-term investments, consisting principally of AAA rated auction rate securities, were converted to cash prior to the end of the quarter.

 

Short-term investments consist of the following (in thousands):

 

 

NOTE 4 – Goodwill and Intangible Assets

 

The following table sets forth intangible assets by major asset class as of the dates indicated (in thousands):

 

 

Aggregate amortization expense on intangible assets was $0.3 million and $0.4 million for the three months and $1.0 million and $1.2 million for the nine months ended April 30, 2005 and 2004, respectively. The average life of the covenants not to compete is approximately five years.  Estimated amortization expense for each of the five succeeding fiscal years is as follows (in thousands): 

 

 

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The change in the carrying amount of goodwill is as follows (in thousands):

 

Balance as of August 1, 2003		$	109,114
Goodwill acquired during the period		3,635
Acquisition adjustment		(58		)
Impairment adjustment		—
Balance as of July 31, 2004		$	112,691
Acquisition adjustment		—
Goodwill acquired during the period		2,858
Impairment adjustment		—
Balance as of April 30, 2005		$	115,549

 

NOTE 5 – Stock-Based Compensation:

 

The Company accounts for its stock-based employee compensation plans using the intrinsic-value-based method prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations, as allowed under SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) (as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (“ SFAS 148”).  Accordingly, compensation cost is measured as the excess, if any, of the fair value of the Company’s stock at the date of the grant over the price the employee must pay to acquire the stock.  Options granted to consultants and other non-employees are accounted for at fair value.

 

Pro forma information regarding net income and net income per share is required by SFAS No. 123, and has been determined as if the Company had accounted for options granted under its plans using the fair value method.  For these purposes, the fair value of options issued under the plans was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions: no dividend yield, volatility factor of the expected market price of the Company’s stock of 0.40, a forfeiture rate of 0.08, a weighted-average expected life of the options of five years and a risk-free interest rate of 3.7% and 3.3% for fiscal 2005 and 2004, respectively.  The weighted average fair value of options granted was $6.79 and $5.19 for the three months ended April 30, 2005 and 2004, respectively and $4.82 and $3.62 for the nine months ended April 30, 2005 and 2004, respectively.  For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options vesting period. The effects of applying SFAS No. 123 in this pro forma disclosure are not necessarily indicative of future results.

 

8

 

For purposes of pro forma disclosures under SFAS 123 and SFAS 148, the estimated compensation expense related to option grants to employees that would have been recognized during the three and nine months ended April 30, 2005 and 2004 is deducted from net income.  The Company’s pro forma information related to option grants to employees as calculated in accordance with SFAS 123 and SFAS 148 is as follows (in thousands):

 

		Three months ended April 30,						Nine months ended April 30,
		2005			2004			2005			2004
Net income, as reported		$	30,905		$	24,964		$	77,127		$	57,771
Add: Stock-based employee compensation expense included in reported net income, net of related tax benefits		—			—			—			—
Deduct: Stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects		(462		)	(592		)	(1,608		)	(1,571		)
Pro forma net income		$	30,443		$	24,372		$	75,519		$	56,200
Net income per share:
Basic – as reported		$	0.34		$	0.28		$	0.86		$	0.65
Basic – pro forma		$	0.34		$	0.27		$	0.84		$	0.63
Diluted – as reported		$	0.33		$	0.27		$	0.83		$	0.63
Diluted – pro forma		$	0.33		$	0.26		$	0.81		$	0.62

 

NOTE 6 – Common Stock Repurchases:

 

In February 2003, the Company’s Board of Directors authorized the Company to repurchase up to nine million shares of its Common Stock. The repurchases may be effected through solicited or unsolicited transactions in the open market or in privately negotiated transactions. No time limit has been placed on the duration of the share repurchase program. The repurchases will be made at such times and in such amounts, as the Company deems appropriate and may be discontinued at any time.  As of April 30, 2005, the Company had repurchased a total of 3.7 million shares at a weighted average price of $8.49. The Company did not repurchase any shares during the nine months ended April 30, 2005.  The Company repurchased a total of 1.0 million shares at a weighted average price of $10.974 during the fiscal year ending July 31, 2004.

 

NOTE 7 – Segment Reporting:

 

The Company’s two operating segments, salvage auction and public auction, are aggregated into one reportable segment given the similarities of economic characteristics between the operations represented by the facilities and the common nature of the products, customers and methods of revenue generation.

 

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NOTE 8 – Depreciation and amortization:

 

The following table shows the components of reported depreciation and amortization (in thousands):

 

		Three months ended April 30,						Nine months ended April 30,
		2005			2004			2005			2004
Yard related depreciation and amortization		$	8,011		$	6,714		$	21,238		$	20,354
General and administrative related depreciation		1,043			938			3,016			2,779
Depreciation and amortization		$	9,054		$	7,652		$	24,254		$	23,133

 

Included in depreciation expense for the three months ended April 30, 2005 is a $1.4 million cumulative adjustment, related almost entirely to prior years, to record certain leasehold improvements over the shorter of the related lease term or the estimated life of the assets.

 

NOTE 9 – Comprehensive Income:

 

The following table reconciles net income to comprehensive income (in thousands):

 

		Three months ended April 30,						Nine months ended April 30,
		2005			2004			2005			2004
Net income, as reported		$	30,905		$	24,964		$	77,127		$	57,771
Other comprehensive income (loss):
Foreign currency translation adjustments, net of tax		55			(13		)	213			(28		)
Total other comprehensive income		$	30,960		$	24,951		$	77,340		$	57,743

 

Note 10 – Reclassifications:

 

The Company’s consolidated balance sheet as of July 31, 2004 reflects the classification of $172.6 million of auction rate securities as short-term investments.  This reclassification was also reflected in the Company’s consolidated statements of cash flows for the nine months ended April 30, 2004.

 

Note 11 – Recent Accounting Pronouncement:

 

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS 123R (Revised 2004), Share-Based Payment, which requires that the compensation cost relating to share-based payment transactions be recognized in financial statements based on fair value. The Company currently discloses pro forma compensation expense quarterly and annually.  Upon adoption, the pro forma disclosures previously permitted under SFAS 123 will no longer be an alternative to financial statement recognition. The provisions of SFAS 123R are effective as of the beginning of the first annual reporting period that begins after June 15, 2005.  The Company is currently evaluating the method of adoption and the effect that the adoption of SFAS 123R will have on its financial position and results of operations. The Company does not anticipate the adoption will have a material impact on its consolidated financial statements.

 

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Note 12 – Legal Proceedings:

 

The Company is involved in litigation and damage claims arising in the ordinary course of business, such as actions related to injuries, property damage or handling or disposal of vehicles.  Among this litigation is a lawsuit filed in Massachusetts against the Company which purports to be a class action on behalf of persons whose vehicles were disposed of by the Company as abandoned vehicles, which the claimant contends were disposed of without complying with state laws. 

 

The Company is also involved in various governmental and administrative proceedings primarily relating to licensing and operation of our business.  The Company provides for costs relating to these matters when a loss is probable and the amount may be reasonably estimated.  The effect of the outcome of these matters on the Company’s future results of operations cannot be predicted because any such effect depends on future results of operations, the amount and timing of the resolution of such matters.  While it is not feasible to determine the outcome of these matters, management believes that any ultimate liability will not have a material effect on the Company’s financial position, results of operations or cash flows.

 

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ITEM 2-                MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue” or the negative of these terms or other comparable terminology.  The forward-looking statements contained in this report involve known and unknown risks, uncertainties and situations that may cause our or our industry’s actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements.  These factors include those listed under the caption “Factors That May Affect Future Results” beginning on page 19 of this report and those discussed elsewhere in this report.  We encourage investors to review these factors carefully.

 

Although we believe that, based on information currently available to Copart and its management, the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.  You should not place undue reliance on these forward-looking statements.

 

Overview

 

We provide vehicle suppliers, primarily insurance companies, with a full range of services to process and sell salvage vehicles through auctions, principally to licensed vehicle dismantlers, rebuilders, repair licensees, used vehicle dealers and exporters.  Salvage vehicles are either damaged vehicles deemed a total loss for insurance or business purposes or are recovered stolen vehicles for which an insurance settlement with the vehicle owner has already been made.  We offer vehicle suppliers a full range of services that expedite each stage of the salvage vehicle auction process and minimize administrative and processing costs.  We generate revenues primarily from auction fees paid by vehicle suppliers and vehicle buyers as well as related fees for services such as towing and storage.

 

We process salvage vehicles principally on a consignment method, on either the Percentage Incentive Program (“PIP”) or on a fixed fee consignment basis.  Using either consignment method, only the fees associated with vehicle processing are recorded in revenue.

 

For the three months ended April 30, 2005 and 2004, approximately 69% and 65%, respectively, and for the nine months ended April 30, 2005 and 2004, approximately 68% and 65%, respectively, of the vehicles we sold were processed under PIP.  The increase in PIP percentage is due to a contract change for dealer cars from fixed fee to PIP.  Those vehicles not sold under the PIP program were processed under fixed fee agreements.

 

Due to a number of factors, including the timing and size of new acquisitions, market conditions, and acceptance of PIP by vehicle suppliers, the percentage of vehicles processed under these programs in future periods may vary.

 

Our revenues consist of salvage fees charged to vehicle suppliers and vehicle buyers, transportation revenue and purchased vehicle revenues.  Salvage fees from vehicle suppliers include fees under PIP agreements and fixed fee programs where we charge for title processing, special preparation, storage and selling.  Salvage fees also include fees charged to vehicle buyers for purchasing vehicles, storage and annual registration.  Transportation revenue includes charges to suppliers for towing vehicles under fixed fee contracts.  Transportation revenue also includes towing charges assessed to buyers for delivering vehicles.  Purchased vehicle revenues are comprised of the price that buyers paid at our auctions for vehicles processed that we own.

 

Costs attributable to yard expenses consist primarily of operating personnel (which includes yard management, clerical and yard employees), rent, yard maintenance and security, contract vehicle towing, insurance,

 

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equipment maintenance and repair, and costs of vehicles sold under purchase contracts.  Costs associated with general and administrative expenses consist primarily of executive, accounting, information technology development and data processing, sales personnel, human resources, professional fees and corporate marketing expenses.

 

During fiscal 2004, we converted all of our salvage vehicle auction facilities to an Internet based auction-style model using our Virtual Bidding Second Generation (“VB²”) Internet sales technology.  This process employs a two-step bidding process.  The first step, called the preliminary bid, allows buyers to submit bids up to one hour before a real time virtual action begins.  The second step allows buyers to bid against each other, and the high bidder from the preliminary bidding process, in a real time process over the Internet.

 

We believe the implementation of VB² across our salvage operations has increased the pool of available buyers for each sale and the added competition has increased the amount buyers are willing to pay for salvage from us. We also believe it has improved the efficiency of our operations.  For the quarter ended April 30, 2005, sales of vehicles to buyers outside the state where the vehicle is located accounted for 48% of total vehicles sold; 26% of salvage vehicles were sold to out of state buyers and 22% were sold to buyers out of country.  For the quarter ended April 30, 2004, sales of vehicles to buyers outside the state where the vehicle is located accounted for 43% of total vehicles sold; 26% of salvage vehicles were sold to out of state buyers and 17% were sold to buyers out of country.

 

The period-to-period comparability of our operating results and financial condition is substantially affected by business acquisitions and new openings made by us during such periods.

 

Acquisitions and New Operations

 

We have experienced significant growth as we have acquired or opened nineteen vehicle auction facilities since the beginning of fiscal 2003.  All of the acquisitions have been accounted for using the purchase method of accounting.

 

As part of our overall expansion strategy of offering integrated service to vehicle suppliers, we anticipate acquiring and developing facilities in new regions, as well as the regions currently served by our facilities. As part of this strategy, in fiscal 2005 we acquired a new facility in Lexington, Kentucky and we opened new facilities in Strongsville, Ohio; Ocala, Florida; Knoxville, Tennessee and Loganville, Georgia.  In fiscal 2004, we acquired new facilities in or near Eugene, Oregon; Cleveland, Ohio and Anchorage, Alaska and opened new facilities in or near Toronto, Canada and Helena, Montana.  In fiscal 2003, we acquired new facilities in or near Pittsburgh, Pennsylvania; Reno, Nevada and Richmond, Virginia and opened new facilities in or near Springfield, Missouri; Corpus Christi, Texas; Ft. Pierce, Florida; Rancho Cucamonga, California; Richmond, Virginia and Albany, New York.  We believe that these acquisitions and openings strengthen our coverage as we have 113 facilities located in North America and are able to provide national coverage for our suppliers.

 

We seek to increase revenues and profitability by, among other things, (i) acquiring and developing new salvage vehicle auction facilities in key markets, (ii) pursuing national and regional vehicle supply agreements, (iii) expanding our service offerings to suppliers and buyers, (iv) increasing revenue and profitability at our public automobile auction facilities and (v) expanding the application of VB² into new markets.  In addition, we implement our pricing structure and merchandising procedures and attempt to effect cost efficiencies at each of our acquired facilities by implementing our operational procedures, integrating our management information systems and redeploying personnel, when necessary.

 

Critical Accounting Policies and Estimates

 

The preparation of consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent

 

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assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to vehicle pooling costs, allowance for doubtful accounts, goodwill, income taxes and long-lived assets. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:

 

We recognize revenues, which generally consist of salvage fees charged to vehicle suppliers and buyers, at the date the vehicles are sold at auction.  No provision for returns has been established, as all sales are final with no right of return. When we bill suppliers under fixed fee contracts for various services which may include tow fees, storage, title processing and various other salvage fees prior to the vehicles' sale at auction, we defer the revenue until the vehicles are sold.

 

We defer, in vehicle pooling costs, certain yard expenses associated with vehicles consigned to and received by us but not sold as of the balance sheet date. We quantify the deferred costs using a calculation that includes the number of vehicles at our facilities at the beginning and end of the period, the number of vehicles sold during the period and an allocation of certain yard expenses of the period. The primary expenses allocated and deferred are certain facility costs, labor, transportation, and vehicle processing costs. If our absolute costs and apportionment of those costs between warehousing and sales activities change, then yard expenses could increase or decrease correspondingly in the future.  These costs are expensed as vehicles are sold in the subsequent periods on an average cost basis.

 

We maintain an allowance for doubtful accounts in order to provide for estimated losses resulting from disputed amounts billed to suppliers or buyers and the inability of our suppliers or buyers to make required payments. If billing disputes exceed expectations and/or if the financial condition of our suppliers or buyers were to deteriorate, additional allowances may be required.

 

We evaluate separately the impairment of goodwill of our salvage and our public auction operating segments, annually by comparing the fair value of the operating segment to its carrying value. Future adverse changes in market conditions or poor operating results of an operating segment could result in an inability to recover the carrying value of the investment, thereby requiring an impairment charge in the future.

 

We evaluate the realizability of our deferred tax assets on an ongoing basis.  Generally accepted accounting principles require the assessment of the Company’s performance and other relevant factors when determining the need for a valuation allowance with respect to these deferred tax assets. The Company’s ability to realize deferred tax assets is dependent on its ability to generate future taxable income. Accordingly, the Company has established a valuation allowance when, in certain taxable jurisdictions, the utilization of the tax asset is uncertain.  Additional timing differences, future earning trends and/or tax planning strategies may occur which could warrant a need for establishing an additional valuation allowance.

 

We are required to estimate income tax provisions and amounts ultimately payable or recoverable in numerous jurisdictions.  Such estimates involve significant interpretations of the Internal Revenue Code of 1986 and various foreign, state and US income tax regulations, which are inherently very complex. Resolution of income tax treatments in individual jurisdictions may not be known for many years after completion of any fiscal year.

 

We evaluate long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable but in no event less than once each year.  Recoverability of assets is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset.  If the estimated undiscounted future cash flows change in the future, we may be required to reduce the carrying amount of an asset in the future.

 

We are partially self-insured for certain losses related to general liability, workers’ compensation and auto liability.  Our liability represents an estimate of the ultimate cost of claims incurred as of the balance sheet date.  The estimated liability is not discounted and is established based upon analysis of historical data and actuarial estimates.

 

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While we believe these estimates are reasonable based on the information currently available, if actual trends, including the severity of claims and medical cost inflation, differ from our estimates, our results of operations could be impacted.

 

Results of Operations

 

Three Months Ended April 30, 2005 Compared to Three Months Ended April 30, 2004

 

Revenues were approximately $130.4 million during the three months ended April 30, 2005, an increase of approximately $13.8 million, or 12%, over the three months ended April 30, 2004.  The increase was due to increased vehicle sales volume, on which fees are generated, new service revenue and higher fees resulting from increased auction proceeds per vehicle.  The increase in gross proceeds per vehicle (the gross sales price of the vehicle at auction) yields higher revenue per car as buyer fees and certain seller fees, including those sold under the PIP program, are based on the gross proceeds per vehicle and generally increase as gross proceeds per vehicle grow.  We believe the increase in proceeds per vehicle was the result of the introduction of VB², which allows more buyers to participate in the auctions.  Existing facilities contributed approximately $11.6 million of the revenue growth and new facilities in or near Cleveland, Ohio; Strongsville, Ohio; Anchorage, Alaska; Ocala, Florida; Knoxville, Kentucky; Lexington, Kentucky and Loganville, Georgia, contributed approximately $2.2 million of revenue growth.

 

Yard expenses were approximately $61.9 million during the three months ended April 30, 2005, an increase of approximately $3.9 million, or 7%, over the three months ended April 30, 2004.  Yard expenses increased due principally to the cost of handling increased volume and the additional costs associated with seven new yards.  Yard expenses decreased to 47.5% of revenues during the three months ended April 30, 2005, as compared to 49.8% of revenues during the three months ended April 30, 2004.  Yard expenses decreased as a percentage of revenue due in part to the generally fixed cost nature of Copart’s business.

 

General and administrative expenses were approximately $11.7 million during the three months ended April 30, 2005, an increase of approximately $1.2 million, or 11%, over the three months ended April 30, 2004.  The increase was primarily due to increases in software development costs, technology hardware leasing costs, telecommunication costs and information technology payroll costs, mainly associated with the development and deployment of VB², cost relating to Sarbanes-Oxley compliance and general corporate expansion.  General and administrative expenses remained unchanged at 9% of revenues during the three months ended April 30, 2005 and 2004.

 

Depreciation and amortization expenses were approximately $9.1 million during the three months ended April 30, 2005, an increase of approximately $1.4 million, or 18%, over the three months ended April 30, 2004.  The increase in depreciation expense resulted from a $1.4 million cumulative adjustment, related almost entirely to prior years, to record certain leasehold improvements over the shorter of the related lease term or the estimated life of the assets.  The cumulative adjustment is not considered to have had a material impact on the Company’s prior or current period financial statements.

 

Total other income was approximately $1.9 million during the three months ended April 30, 2005, an increase of approximately $1.8 million, from the three months ended April 30, 2004.  The increase was due primarily to an increase in interest income of approximately $0.9 million due to higher interest rates and a higher average cash balance. In addition, the Company recognized a loss on sale of fleet equipment of $0.07 million, a decrease of $0.7 million over the three months ended April 30, 2004.  The sale of the equipment is associated with the Company’s decision to replace its company owned trucks with subhaulers for its towing services.  Other income, which consists primarily of rental income and gain on the sale of non fleet assets, increased approximately $0.2 million and was due primarily to a $0.2 million gain on the sale of equipment.

 

Our effective combined federal, state and local income tax rates for the three months ended April 30, 2005 and 2004 was approximately 37.8% and 38.4%, respectively.  The effective tax rate in the current quarter reflected the company’s updated forecast of its fiscal 2005 overall effective tax rate.

 

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Due to the foregoing factors, we realized net income of approximately $30.9 million for the three months ended April 30, 2005, compared to net income of approximately $25.0 million for the three months ended April 30, 2004.

 

Nine Months Ended April 30, 2005 Compared to Nine Months Ended April 30, 2004

 

Revenues were approximately $344.6 million during the nine months ended April 30, 2005, an increase of approximately $43.8 million, or 15%, over the nine months ended April 30, 2004.  The increase was due to increased vehicle sales volume, new service revenue and higher fees resulting from increased auction proceeds per vehicle.  The increase in gross proceeds per vehicle (the gross sales price of the vehicle at auction) yields higher revenue per car as buyer fees and certain seller fees, including those sold under the PIP program, are based on the gross proceeds per vehicle and generally increase as gross proceeds per vehicle grow.  We believe the increase in proceeds per vehicle was the result of the introduction of VB², which allows more buyers to participate in the auctions.  Existing facilities contributed approximately $39.7 million of revenue growth and new facilities in or near Cleveland, Ohio; Strongsville, Ohio; Anchorage, Alaska; Ocala, Florida; Knoxville, Kentucky; Lexington, Kentucky and Loganville, Georgia, contributed approximately $4.1 million of revenue growth.

 

Yard expenses were approximately $170.9 million during the nine months ended April 30, 2005, an increase of approximately $11.2 million, or 7%, over the nine months ended April 30, 2004.  Yard expenses increased due principally to the cost of handling increased volume and the extra costs associated with seven new yards. Yard expenses decreased to 50% of revenues during the nine months ended April 30, 2005, as compared to 53% of revenues during the nine months ended April 30, 2004.  Yard expenses decreased as a percentage of revenue due in part to the generally fixed cost nature of Copart’s business.

 

General and administrative expenses were approximately $30.0 million during the nine months ended April 30, 2005, an increase of approximately $2.8 million, or 10%, over the nine months ended April 30, 2004.  The increase was primarily due to increases in software development costs, technology hardware leasing costs, telecommunication costs and information technology payroll costs, mainly associated with the development and deployment of VB², cost relating to Sarbanes-Oxley compliance and general corporate expansion.  General and administrative expenses remained unchanged at 9% of revenues during the nine months ended April 30, 2005, and April 30, 2004.

 

Depreciation and amortization expenses were approximately $24.3 million during the nine months ended April 30, 2005, an increase of approximately $1.1 million, or 5%, over the nine months ended April 30, 2004.  The increase in depreciation expense resulted from a $1.4 million cumulative adjustment, related almost entirely to prior years, to record certain leasehold improvements over the shorter of the related lease term or the estimated life of the assets.  The cumulative adjustment is not considered to have had a material impact on the Company’s prior or current period financial statements.

 

Total other income was approximately $5.8 million during the nine months ended April 30, 2005, an increase of approximately $1.8 million, or 46%, from the nine months ended April 30, 2004. During the nine months ended April 30, 2005 the Company recognized a loss on sale of fleet equipment of $0.05 million, a decrease of $1.2 million over the nine months ended April 30, 2004.  The sale of the equipment is associated with the Company’s decision to replace its company owned trucks with subhaulers for its towing services.  The more profitable trucks were sold in the prior year.  Interest income increased approximately $2.1 million due to higher interest rates and a higher average cash balance.  Other income, which consists primarily of rental income and gain on the sale of non fleet assets, increased approximately $0.9 million and was due primarily to a gains on the sale of real property and equipment.

 

Our effective combined federal, foreign, state and local income tax rates for the nine months ended April 30, 2005 and 2004 was approximately 38% and 39%, respectively.  The decrease is due to certain adjustments and estimates affecting the overall effective state tax rate and deductible and non-deductible items.

 

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Due to the foregoing factors, we realized net income of approximately $77.1 million for the nine months ended April 30, 2005, compared to net income of approximately $57.8 million for the nine months ended April 30, 2004.

 

Liquidity and Capital Resources

 

Historically, we have financed our growth through cash generated from operations, public offerings of common stock, the equity issued in conjunction with certain acquisitions and debt financing.  Cash and cash equivalents increased by approximately $238.2 million from July 31, 2004 to April 30, 2005, mainly a result of changes in short-term investments and operating activities.  Our liquidity and capital resources have not been materially affected by inflation.  During the winter months, most of our facilities process 10% to 30% more vehicles than at other times of the year.  This increased seasonal volume requires the increased use of our cash to pay out advances and handling costs of the additional business.

 

As of April 30, 2005, we had working capital of approximately $291.4 million, including cash and cash equivalents of approximately $243.9 million.  We invest substantially all of our cash balances in AAA rated auction rate securities.  Auction rate securities are principally variable rate securities tied to short-term interest rates with maturities on the face of the securities in excess of 90 days.  Auction rate securities have interest rate resets through a modified Dutch auction, at predetermined short-term intervals, usually every 7, 28 or 35 days. They trade at par and are callable at par on any interest payment date at the option of the issuer. Interest paid during a given period is based upon the interest rate determined during the prior auction. Although these instruments are issued and rated as long-term securities, they are priced and traded as short-term securities because of the liquidity provided through the interest rate reset.  These auction rate securities were converted to cash prior to the end of the quarter.  Our primary source of cash is from the collection of sellers’ fees, buyers’ fees and reimbursable advances from the proceeds of auctioned salvage vehicles.

 

We believe that our currently available cash, cash equivalents and short-term investments, cash generated from operations and borrowing availability under our bank credit facilities and equipment leasing lines will be sufficient to satisfy our operating and working capital requirements for at least the next 12 months.  However, if we experience significant growth in the future, we may be required to raise additional cash through the issuance of new debt or additional equity.

 

Operating Activities

 

Net cash provided by operating activities increased by $12.1 million to $103.7 million during the nine months ended April 30, 2005 when compared to the same period in fiscal 2004, due to the profitability of the company and to the timing of routine changes in working capital items. The increase in net income came in part due to increased revenue due to growth in vehicle sales volume, new service revenue and higher fees resulting from increased auction proceeds per vehicle. 

 

Investing Activities

 

For the nine months ended April 30, 2005, we purchased approximately $341.0 million in short-term investments.  These purchases were offset by the sale of $513.6 million of short-term investments.  We typically invest our cash in auction rate notes with ratings of AAA.

 

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Capital expenditures (excluding those associated with fixed assets attributable to acquisitions) were approximately $42.2 million and $51.0 million for the nine months ended April 30, 2005 and 2004, respectively. Our capital expenditures are related primarily to opening and improving facilities and acquiring yard equipment.  We continue to expand and invest in new and existing facilities in order to handle increased volume and standardize the appearance of existing locations.

 

During the nine months ended April 30, 2005, we used cash for the acquisition of an operation in Lexington, Kentucky, which had an aggregate cash cost of approximately $3.4 million.  During the nine months ended April 30, 2004, we used cash for the acquisition of an operation in Eugene, Oregon, which had an aggregate cash cost of approximately $0.8 million. 

 

Financing Activities

 

In February 2003, our Board of Directors authorized us to repurchase up to 9 million shares of our Common Stock. The repurchases may be effected through solicited or unsolicited transactions in the open market or in privately negotiated transactions. No time limit has been placed on the duration of the share repurchase program. The repurchases will be made at such times and in such amounts, as we deem appropriate and may be discontinued at any time.  As of April 30, 2005, we had repurchased a total of 3.7 million shares at a weighted average price of $8.49.  We accounted for the repurchase of our Common Stock by charging Common Stock for $31.2 million.  We have not repurchased any shares in fiscal 2005.

 

Lease, Purchase and Other Contractual Obligations

 

The following table summarizes our significant contractual obligations and commercial commitments as of April 30, 2005 (in thousands):

 

Payments Due By Period

 

Contractual Obligations (1)		Total			Less than 1 year			1-3 years			3-5 years			More than 5 years
Capital Leases		$	12		$	9		$	3		$	—		—
Operating Leases		$	112,978		$	24,129		$	35,944		$	23,298		$	29,607

 

Amount of Commitment Expiration Per Period

 

Commercial Commitments (2)		Total			Less than 1 year			1-3 years		3-5 years		More than 5 years
Letters of Credit		$	10,800		$	10,800		—		—		—

 

(1)   Contractual obligations consist of long-term debt and future minimum lease payments under capital and operating leases, including off-balance sheet leases, used in the normal course of business.

 

(2)   Commercial commitments include primarily letters of credit provided for insurance programs and certain business transactions.

 

Credit Facilities

 

On February 23, 2001, we entered into a credit facility with our existing banking syndicate.  The facility provided by Wells Fargo Bank, Fleet National Bank and U.S. Bank National Association consists of an unsecured revolving reducing line of credit in the amount of $60 million that matures in 2006. As of April 30, 2005, we had available $49.2 million under this facility, after taking into account $10.8 million of outstanding letters of credit. We

 

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are subject to customary covenants, including the following financial covenants: 1) ratio of funded debt to earnings before interest, taxes, depreciation and amortization (EBITDA); 2) profitable operation; 3) leverage ratio and 4) interest coverage ratio.  We are in compliance with all covenants.

 

Factors That May Affect Future Results

 

We depend on a limited number of major suppliers of salvage vehicles.  The loss of one or more of these major suppliers could adversely affect our results of operations and financial condition, and an inability to increase our sources of vehicle supply could adversely affect our growth rates.

 

Historically, a limited number of vehicle suppliers have accounted for a substantial portion of our revenues. In the second quarter of fiscal 2005, vehicles supplied by our two largest suppliers accounted for approximately 12% and 8% of our revenues, respectively.  Supplier arrangements are either written or oral agreements typically subject to cancellation by either party upon 30 to 90 days notice.  Vehicle suppliers have terminated agreements with us in the past in particular markets, which has affected the pricing for auction services in those markets.  There can be no assurance that our existing agreements will not be cancelled.  Furthermore, there can be no assurance that we will be able to enter into future agreements with vehicle suppliers or that we will be able to retain our existing supply of salvage vehicles.  A reduction in vehicles from a significant vehicle supplier or any material changes in the terms of an arrangement with a substantial vehicle supplier could have a material adverse effect on our results of operations and financial condition.  In addition, a failure to increase our sources of vehicle supply could adversely affect our earnings and revenue growth rates.

 

Our strategic shift from live salvage auctions to an entirely Internet based sales model presents new risks, including substantial technology risks.

 

In fiscal 2004, we converted all our salvage auctions from a live auction process to an entirely Internet based auction-style model based on technology developed internally by us.  The conversion represents a significant change in the way we conduct business and presents numerous risks, including our increased reliance on the availability and reliability of our network systems.  In particular, we believe the conversion presents the following risks, among others:

 

•      Our operating results in a particular period could be adversely affected in the event our networks are not operable for an extended period of time for any reason, as a result of Internet viruses, or as a result of any other technological circumstance that makes us unable to conduct our virtual sales.

 

•      Our business is increasingly reliant on internally developed technology, and we have limited historic experience developing technologies or systems for large-scale implementation and use.

 

•      The change in our business model may make it more difficult for management, investment analysts, and investors to model or predict our future operating results until sufficient historic data is available to evaluate the effect of the VB² implementation over a longer period of time and in different economic environments.  For example, the shift to VB² has in recent periods had a favorable effect on yard expenses and an adverse effect on general and administrative expenses.  Results to date are still preliminary, however, and it is difficult to predict the long-term effect of our VB² initiatives on operating results, particularly to the extent we are required to make additional commitments and devote additional resources to developing and improving our proprietary technologies.

 

•      Our increasing reliance on proprietary technology subjects us to intellectual property risks, including the risk of third party infringement claims or the risk that we cannot establish or protect intellectual property rights in our technologies.  We have filed patent applications for VB² in the United States, the Netherlands,

 

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and Europe.  Our patent application with the U.S. Patent and Trademark Office was rejected, but we intend to continue to prosecute the patent.  We believe we have a legitimate basis to assert that a patent should be issued, but we cannot provide any assurances that patents will actually issue or that, if issued, the patent could not later be found to be unenforceable or invalid.

 

Our results of operations may not continue to benefit from the implementation of VB² to the extent we have experienced in recent periods. 

 

We believe that the implementation of our proprietary VB² auction technologies across our salvage operations has had a favorable impact on our results of operations by increasing the size and geographic scope of our buyer base and increasing the average selling price for vehicles sold through our auctions.  VB² was implemented across all our salvage yards beginning in the third quarter of fiscal 2004.  We do not believe that we will continue to experience improvements in our results of operations at the same relative rates we have experienced in the last year.

 

In addition, we are presently implementing VB² in our public auction facilities.  We cannot predict if, or to what extent VB² will have a favorable impact on these operations.  Differences between our salvage and public operations, in particular the relative importance of inspecting the vehicle being auctioned, may result in our experiencing a relatively less favorable impact on our public auctions than we have experienced in our salvage auctions.

 

Failure to have sufficient capacity to accept additional cars at one or more of our salvage yards could adversely effect our relationships with insurance companies or other suppliers of salvage vehicles.

 

Capacity at our salvage yards varies from period to period and from region to region.  For example, following adverse weather conditions in a particular area, our yards in that area may fill and limit our ability to accept additional salvage vehicles while we process existing inventories.  We regularly evaluate our capacity in all our markets and, where appropriate, seek to increase capacity through the acquisition of additional land and yards.  We may not be able to reach agreement to purchase independent salvage yards in markets where we have limited excess capacity, and zoning restrictions or difficulties obtaining use permits may limit our ability to expand our capacity through acquisitions of new land.  Failure to have sufficient capacity at one or more of our yards could adversely affect our relationships with insurance companies or other suppliers of salvage vehicles, which could have an adverse effect on our operating results.

 

Factors such as mild weather conditions in the United States can have an adverse affect on our revenues and operating results as well as our revenue and earnings growth rates.

 

Mild weather conditions in the United States tend to result in a decrease in the available supply of salvage vehicles because traffic accidents decrease and fewer automobiles are damaged.  Accordingly, mild weather can have an adverse effect on salvage vehicle inventories, which would be expected to have an adverse effect on our revenue and earnings and related growth rates and could have an adverse effect on our operating results.  Conversely, our inventories will tend to increase in poor weather such as a harsh winter or as a result of adverse weather-related conditions such as flooding. During periods of mild weather conditions, our ability to increase our revenues and improve our operating results and related growth will be increasingly dependent on our ability to obtain additional vehicle suppliers and to compete more effectively in the market, each of which is subject to the other risks and uncertainties described in these sections.

 

The salvage vehicle auction industry is highly competitive and we may not be able to compete successfully.

 

We face significant competition for the supply of salvage vehicles and for the buyers of those vehicles.  We believe our principal competitors include other vehicle auction companies with whom we compete directly in obtaining vehicles from insurance companies and other suppliers, and large vehicle dismantlers, who may buy salvage vehicles directly from insurance companies, bypassing the salvage auction process.  Many of the insurance companies have established relationships with competitive auction companies and large dismantlers.  Many of our competitors may have greater financial resources than us.  Due to the limited number of vehicle suppliers, the absence of long-term contractual commitments between us and our suppliers and the increasingly competitive market environment, there can be no assurance that our competitors will not gain market share at our expense.

 

We may also encounter significant competition for local, regional and national supply agreements with vehicle suppliers.  There can be no assurance that the existence of other local, regional or national contracts entered into by our competitors will not have a material adverse effect on our business or our expansion plans.  Furthermore, we are likely to face competition from major competitors in the acquisition of salvage vehicle auction facilities, which could significantly increase the cost of such acquisitions and thereby materially impede our expansion objectives or have a material adverse effect on our results of operations. These potential new competitors may include consolidators of automobile dismantling businesses, organized salvage vehicle buying groups, automobile manufacturers, automobile auctioneers and software companies.  While most vehicle suppliers have abandoned or reduced efforts to sell salvage vehicles directly without the use of service providers such as us, there can be no assurance that this trend will continue, which could adversely affect our market share, results of operations and financial condition.  Additionally, existing or new competitors may be significantly larger and have greater financial and marketing resources than us; therefore, there can be no assurance that we will be able to compete successfully in the future.

 

Because the growth of our business has been due in large part to acquisitions and development of new salvage vehicle auction facilities, the rate of growth of our business and revenues may decline if we are not able to successfully complete acquisitions and development of new facilities.

 

We seek to increase our sales and profitability through the acquisition of other salvage vehicle auction facilities and the development of new salvage vehicle auction facilities.  There can be no assurance that we will be able to:

 

•      continue to acquire additional facilities on favorable terms;

 

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•      expand existing facilities in no growth regulatory environments;

•      increase revenues and profitability at acquired and new facilities;

•      maintain the historical revenue and earnings growth rates we have been able to obtain through facility openings and strategic acquisitions; or

•      create new salvage vehicle auction facilities that meet our current revenue and profitability requirements.

 

As we continue to expand our operations, our failure to manage growth could harm our business and adversely affect our results of operations and financial condition.

 

Our ability to manage growth is not only dependent on our ability to successfully integrate new facilities, but also on our ability to:

 

•      hire, train and manage additional qualified personnel;

•      establish new relationships or expand existing relationships with vehicle suppliers;

•      identify and acquire or lease suitable premises on competitive terms;

•      secure adequate capital;

•      maintain the supply of vehicles from vehicle suppliers; and

•      compete successfully in the public automobile auction sector.

 

Our inability to control or manage these growth factors effectively could have a material adverse effect on our results of operations and financial condition.

 

Our annual and quarterly performance may fluctuate, causing the price of our stock to decline.

 

Our revenues and operating results have fluctuated in the past and can be expected to continue to fluctuate in the future on a quarterly and annual basis as a result of a number of factors, many of which are beyond our control.  Factors that may affect our operating results include, but are not limited to, the following:

 

•      fluctuations in the market value of salvage and used vehicles;

•      the availability of salvage vehicles;

•      variations in vehicle accident rates;

•      buyer participation in the Internet bidding process;

•      delays or changes in state title processing;

•      changes in state or federal laws or regulations affecting salvage vehicles;

•      changes in state laws affecting who may purchase salvage vehicles;

•      our ability to integrate and manage our acquisitions successfully;

•      the timing and size of our new facility openings;

•      the announcement of new vehicle supply agreements by us or our competitors;

 

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•      severity of weather and seasonality of weather patterns;

•      the amount and timing of operating costs and capital expenditures relating to the maintenance and expansion of our business, operations and infrastructure;

•      the availability and cost of general business insurance;

•      labor costs and collective bargaining;

•      availability of subhaulers at competitive rates;

•      acceptance of buyers and sellers of our Internet-based model deploying VB², a proprietary Internet auction system;

•      current levels of out of state and foreign demand for salvage vehicles may not continue;

•      the introduction of a similar Internet product by a competitor; and

•      the ability to obtain necessary permits to operate salvage auction facilities.

 

Due to the foregoing factors, our operating results in one or more future periods can be expected to fluctuate.  As a result, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as any indication of future performance.  In the event such fluctuations result in our financial performance being below the expectations of public market analysts and investors, the price of our common stock could decline substantially.

 

New accounting pronouncements or new interpretations of existing standards could require the Company to make adjustments in our accounting policies that could adversely affect our financial statements.

 

The Financial Accounting Standards Board, the Public Company Accounting Oversight Board, the Securities and Exchange Commission, or other accounting organizations or governmental entities issue new pronouncements or new interpretations of existing accounting standards that require us to reconsider our internal accounting policies and procedures.  To date, we do not believe any new pronouncements or interpretations have had an adverse effect on our financial condition or results of operations, but future pronouncements or interpretations could require us to change our policies or procedures. Moreover, we continually review our critical accounting policies in light of the accounting literature and changes in our operations. 

 

Government regulation of the salvage vehicle auction industry may impair our operations, increase our costs of doing business and create potential liability.

 

Participants in the salvage vehicle auction industry are subject to, and may be required to expend funds to ensure compliance with a variety of U.S. or Canadian, federal, state, provincial and local governmental, regulatory and administrative rules, regulations, land use ordinances, licensure requirements and procedures, including those governing vehicle registration, the environment, zoning and land use.  Failure to comply with present or future regulations or changes in interpretations of existing regulations may result in impairment of our operations and the imposition of penalties and other liabilities. At various times, we may be involved in disputes with local governmental officials regarding the development and/or operation of our business facilities. We believe that we are in compliance in all material respects with applicable regulatory requirements.  We may be subject to similar types of regulations by federal, provincial, state, and local governmental agencies in new markets.  In addition, new regulatory requirements or changes in existing requirements may delay or increase the cost of opening new facilities, may limit our base of salvage vehicle buyers and may decrease demand for our vehicles.

 

The operation of our auction facilities poses certain environmental risks, which could adversely affect our results of operations and financial condition.

 

Our operations are subject to federal, state, provincial and local laws and regulations regarding the protection of the environment.  In the salvage vehicle auction industry, large numbers of wrecked vehicles are stored at auction facilities and, during that time, spills of fuel, motor oil and other fluids may occur, resulting in soil, surface water or groundwater contamination. Environmental issues resulting from fuel spills, oil spillage, or similar problems are also present at our public auction facilities.  In addition, certain of our facilities generate and/or store petroleum products and other hazardous materials, including waste solvents and used oil.  We could incur substantial expenditures for preventative, investigative or remedial action and could be exposed to liability arising from our operations, contamination by previous users of certain of our acquired facilities, or the disposal of our waste at off-site locations.  Environmental laws and regulations could become more stringent over time and there can be no assurance that we or our operations will not be subject to significant costs in the future.  Although we have obtained indemnification for pre-existing environmental liabilities from many of the persons and entities from whom we have acquired facilities, there can be no assurance that such indemnifications will be adequate.  Any such expenditures or liabilities could have a material adverse effect on our results of operations and financial condition.

 

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If we experience problems with our providers of fleet operations, our business could be harmed.

 

We rely upon independent subhaulers to pick up and deliver vehicles to and from our auction facilities. In addition, our failure to pick up and deliver vehicles in a timely and accurate manner could harm our reputation and brand, which could have a material adverse effect on our business.  Further, the increase in fuel cost may lead to increased prices charged by our independent subhaulers, which may significantly increase our cost.  These costs may not be passed on to our sellers or buyers.

 

We are partially self-insured for certain losses.

 

We are partially self-insured for certain losses related to general liability, workers’ compensation and auto liability.  Our liability represents an estimate of the ultimate cost of claims incurred as of the balance sheet date.  The estimated liability is not discounted and is established based upon analysis of historical data and actuarial estimates. While we believe these estimates are reasonable based on the information currently available, if actual trends, including the severity of claims and medical cost inflation, differ from our estimates, our results of operations could be impacted.  Further, we rely on independent experts to assist us in establishing the proper amount of reserves for anticipated payouts associated with these self-insured exposures.  If these experts provide guidance based on erroneous assumptions, use models mathematically flawed or otherwise provide advice that is inaccurate or unrepresentative, then it could have an adverse impact on our results of operations.

 

Our executive officers, directors and their affiliates hold a large percentage of our stock and their interests may differ from other shareholders.

 

Our executive officers, directors and their affiliates beneficially own, in the aggregate, approximately 23% of our common stock as of April 30, 2005.  If they were to act together, these shareholders would have significant influence over most matters requiring approval by shareholders, including the election of directors, any amendments to our articles of incorporation and certain significant corporate transactions, including potential merger or acquisition transactions.  In addition, without the consent of these shareholders, we could be delayed or prevented from entering into transactions that could be beneficial to us or our other investors.  These shareholders may take these actions even if they are opposed by our other investors.

 

We have a shareholder rights plan, which could affect the price of our common stock and make it more difficult for a potential acquirer to purchase a large portion of our securities, to initiate a tender offer or a proxy contest, or to acquire us.

 

In March 2003, our board of directors adopted a shareholder rights plan, commonly known as a poison pill.  The poison pill may discourage, delay, or prevent a third party from acquiring a large portion of our securities, initiating a tender offer or proxy contest, or acquiring us through an acquisition, merger, or similar transaction.  Such an acquirer could be prevented from consummating one of these transactions even if our shareholders might receive a premium for their shares over then-current market prices.

 

If we lose key management or are unable to attract and retain the talent required for our business, we may not be able to successfully manage our business or achieve our objectives.

 

Our future success depends in large part upon the leadership and performance of our executive management team, all of whom are employed on an at-will basis and none of whom are subject to any agreements not to compete.  If we lose the service of one or more of our executive officers or key employees, in particular Willis J. Johnson, our Chief Executive Officer, and A. Jayson Adair, our President, or if one or more of them decides to join a competitor or otherwise compete directly or indirectly with us, we may not be able to successfully manage our business or achieve our business objectives.

 

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Compliance with new rules and regulations concerning corporate governance may be costly and time consuming.

 

The Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, requires, among other things, that companies adopt new corporate governance measures and imposes comprehensive reporting and disclosure requirements, sets stricter independence and financial expertise standards for board and audit committee members and imposes increased civil and criminal penalties for companies, their chief executive officers and chief financial officers for securities law violations. In addition, the Nasdaq National Market, on which our common stock is traded, has adopted additional comprehensive rules and regulations relating to corporate governance. These laws, rules and regulations will increase the scope, complexity and cost of our corporate governance, reporting and disclosure practices, which could harm our results of operations and divert management’s attention from business operations. These new rules and regulations may also make it more difficult and more expensive for us to obtain director and officer liability insurance and make it more difficult for us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee.

 

In the event we are unable to satisfy regulatory requirements relating to internal controls, or if these internal controls over financial reporting are not effective, our business and our stock price could suffer.

 

Section 404 of Sarbanes-Oxley requires companies to do a comprehensive and costly evaluation of their internal controls. As a result, during our fiscal year ending July 31, 2005, we will be required to perform an evaluation of our internal controls over financial reporting and have our auditor publicly attest to such evaluation. We have prepared an internal plan of action for compliance, which includes a timeline and scheduled activities with respect to preparation of such evaluation. Our efforts to comply with Section 404 and related regulations regarding our management’s required assessment of internal control over financial reporting and our independent auditors’ attestation of that assessment has required, and continues to require, the commitment of significant financial and managerial resources. While we anticipate being able to fully implement the requirements relating to internal controls and all other aspects of Section 404 in a timely fashion, we cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations since there is no precedent available by which to measure compliance adequacy. If we fail to timely complete this evaluation, or if our auditors cannot timely attest to our evaluation, we could be subject to regulatory investigations or sanctions, costly litigation or a loss of public confidence in our internal controls, which could have an adverse effect on our business and our stock price.

 

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ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Our principal exposures to financial market risk are interest rate and foreign currency risk.  Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio of marketable securities.  As of April 30, 2005, our cash and cash equivalents consisted primarily of funds invested in money market accounts, which bear interest at a variable rate.  During the course of the quarter we invested substantially all of our cash balances in AAA rated auction rate securities, which also bear interest at a variable rate.  Due to the average maturity and nature of the Company’s investment portfolio, we believe a sudden change in interest rates would not have a material effect on the value of our investment portfolio. As the interest rates on a material portion of our cash, cash equivalents and short-term investments are variable, a change in interest rates earned on our investment portfolio would impact interest income along with cash flows, but would not materially impact the fair market value of the related underlying instruments.

 

Our exposure to foreign currency risks relates to our operations in Canada, which have not been significant.  We do not hedge our exposure to the Canadian dollar.  We do not use derivative financial instruments for speculative or trading purposes.

 

ITEM 4 - CONTROLS AND PROCEDURES

 

(a)           Evaluation of Disclosure Controls and Procedures.

 

Our management evaluated, with participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q.  Based on this evaluation, our management, including our Chief Executive Officer and our Chief Financial Officer, concluded that our disclosure controls and procedures are effective to ensure that material information we are required to disclose in reports that we file or submit under the Exchange Act, as amended, is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

 

(b)           Changes in Internal Controls.

 

There were no changes in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

ITEM 1 – LEGAL PROCEEDINGS

 

We are involved in litigation and damage claims arising in the ordinary course of business, such as actions related to injuries, property damage or handling or disposal of vehicles.  Among this litigation is a lawsuit filed in Massachusetts against us which purports to be a class action on behalf of persons whose vehicles were disposed of by us as abandoned vehicles, which the claimant contends were disposed of without complying with state laws. 

 

We are also involved in various governmental and administrative proceedings primarily relating to licensing and operation of our business.  We provide for costs relating to these matters when a loss is probable and the amount may be reasonably estimated.  The effect of the outcome of these matters on our future results of operations cannot be predicted because any such effect depends on future results of operations, the amount and timing of the resolution of such matters.  While it is not feasible to determine the outcome of these matters, management believes that any ultimate liability will not have a material effect on our financial position, results of operations or cash flows.

 

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ITEM 6 - EXHIBITS

 

(a)           Exhibits

 

31.1	Certification of Willis J. Johnson, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of William E. Franklin, Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Willis J. Johnson, Chief Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of William E. Franklin, Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

	COPART, INC.
	/s/ William E. Franklin
	William E. Franklin, Senior Vice President and Chief Financial Officer (duly authorized officer and principal financial and accounting officer)
Date: June 8, 2005

 

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