Interview Transcript

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

I have a fund and we own Copart, so am always interested in learning more about what it's like working with them and your thoughts about the future of that industry, how things are changing and their competitive position. The best place to start is to talk about your background as you have 20 years of experience.

I spent 20 years with CarMax in the used space, almost all on the operations side. Everything from running locations to doing multiple grand openings, working at a regional level across 20 to 24 locations at any time with oversight on those. I was involved in many special projects and initiatives, everything from cosmetic, mechanical and quality standards to service drive, customer service execution and the logistical side of the omnichannel offering.

What is omnichannel?

Omnichannel at CarMax was their answer to Carvana, Shift and Vroom, all the online-only used cars. They allowed customers to start online, transition to in-store then back online, or start in-store and transition to online, or do it in only one place. That gave customers the ability to choose how their purchase experience occurred. They did a lot of back-office work around logistics, creating a hub and spoke and delivery at store to customers. Prior to CarMax, I spent 10 years in the tire, battery and related services industry at a company which was eventually bought by Sears. There, I had both store-level and district-level roles and also worked on special projects.

I left CarMax and jumped on board with a company owned by Copart focused on ADAS technology and I worked as their director of operations, then also took over the mobile division, which I scaled from 8 to 33 markets in six months. Some of that was through acquisition but also through strategic planning. If we were in Houston and Dallas, we went after San Antonio, and from Austin we went to El Paso. I was involved in everything from staffing, equipment, strategy and the customer aspect. I also operated a call center during that time and developed scale around how to schedule calibrations and other mobile services, effectively turning that into a solid revenue stream for the company.

My notes say you were a big customer of Copart while at CarMax?

CarMax used to buy parts from Copart. CarMax lived with a mindset of Like Kind Quality and LKQ is one of Copart's big competitors. That meant you were always looking for the dismantlers and salvage lots to find a part which still had usable life, to save money and pass along the quality to the customer. During my time with CarMax, one of the initiatives I was a part of was to test the in-store provider network where they brought in NAPA, Advance and AutoZone, so I worked with all three formats, to understand how that worked and how they became a preferred vendor for us. We also used Copart and others for reconditioned parts.

LKQ is also a customer of Copart.

Awesome.

With CarMax, how did that work with buying parts? I assume they're not buying used cars on the online platform and doing it themselves?

No, they would work through the network to get parts through Copart to be able to use the parts on the vehicles. Instead of buying the whole car, you wanted a specific part. Many times, you're looking for what I call hard parts, items like fenders, doors or wheels which don't always have technology wrapped up in them. We would go to Copart or LKQ because we had confidence in them and didn't have to worry about doing any bench tests on components.

Was that all done online?

Yes, predominantly online or the old-fashioned way; using the phone. Very rarely, would we send somebody to a facility to pick up the part, but occasionally, if you had a heat case where you needed that part right away, maybe a customer was on the other side of that, then yes you would run over to a lot and pick that part up and run it back over.

For that service, you used Copart and LKQ; were there others?

Those were the primary ones due to their reputation. If you had an issue, you always knew you could take it back and they would work with you. You weren't stuck with a part that said it fit a 2015 but it only fit up to a 2014.

What were some of the differences between dealing with Copart and LKQ?

The biggest difference we noticed was LKQ were tailored more towards walk-in customers, so they stripped parts further back. With doors for example, if all you needed was the interior components, they would strip it down so you didn't have to buy the whole door. That was one advantage with LKQ, but the flip side is that, often, you would buy one part and realize you needed others. Sometimes you wish you bought the whole door for $100 extra, because, in the process of doing the repair, you broke something or realized there was a part missing due to a previous repair.

You worked in the auto diagnostic business; how does that tie in with Copart and accidents or how does that work?

The biggest tie in I saw was the ability to work with DRPs and insurers and become a trusted partner by doing the scans. asTech® has proprietary information where they basically scan the device using the internet. You can have a technician in Texas scanning a car in California, or a Californian technician scanning a car in New York. As a result, you are able to give the customer reports both pre and post-repair to validate that everything was done.

Initially, your focus is around the ADAS technology, but by scanning that car you can see all the trouble codes which are present, which is critical in the repair collision industry because repairing a car back to standard is huge for the customer and gives them peace of mind. You tell the shop which components they need to replace and ensure a sensor is re-calibrated or replaced. You can give them a detailed view of the vehicle without them removing any panels. They may have a damaged bumper but, before removing it, they want to know what else to order, as opposed to consistently reordering because that takes time. The insurance industry wants the car repaired as quickly as possible because they are tying up a bay at the shop and the customer is in a rental.

When we worked with a shop, they knew we were part of Copart so there wasn't necessarily a selling aspect where asTech® said they should use Copart. We simply told them these are the parts they will need and make sure to use a reputable provider who guarantee their parts. Sensors and other components need to meet standards for the insurance company and DRPs don't want to lose their status, so they stay within parameters. Becoming an approved DRP vendor leveraged the partnership between asTech® and Copart.

Is DRP the Direct Repair Program?

Yes.

Were your customers for asTech® just body shops?

Not just the body shops; it expanded while I was there. When I came on board, they were heavily focused on both standalone collision body shops and those within OEMs and dealerships, but there was some transition and we had some new people coming in. I was one of two new directors of operations who came in, along with several folks on the sales side. There was also a big push to drive scans into the rental car segment, and Enterprise came on board with a large contract. Every time an Enterprise vehicle was damaged and sent for repair, it would get a pre and post-scan from asTech® and that vertical started to grow.

Another vertical we saw growth with and which was partly driven by the expansion of mobile, was getting onto the service drive at OEM dealerships with our scan technology. We could identify trouble codes which would help them save time, because we had the ability. If you charge $99 to do a scan, and the technician at the dealership makes $35 an hour, they may bill two or three hours to that car to do the same work asTech® did in under 30 minutes. It made more sense for dealerships to move in that direction and there was the ability to come out with the mobile right behind that scan and do the repairs, which was a savings to dealerships. The dealership agreed because it didn't tie up their tech who could then do an unskilled job. The scanning and technology side of vehicles is fairly specialized and your average technician does not have the skill or the patience to do some of those repairs. Diagnostic work is tedious.

Could you describe how a scan works?

Most people have probably seen this when they go into an auto parts store with a battery issue and the counter person will come out and hook up a little tool to the OBD2 port, which is kind of an oversized USB for your car. There are several different technologies whose scan tool will go through all the on-board computers and look for alpha numeric codes. There are books or databases embedded within the scan tools and you learn what the codes mean. That will tell you where to look or what sensors potentially failed, so you can diagnose the car.

If you see it's an oxygen sensor, most cars have four and the scan tool will tell you which one. They will tell you what’s wrong with it and give you all sorts of other data, as well. That allows a tech to fix it more quickly versus simply plugging and playing with different sensors. It also allows you to validate because codes will often set in cars, which is similar to computer. If you get an error code when you start your laptop or a 404 error when you go to a website, it's a time out error and there are simply things you can do like clearing the computer cache. It's that simple with a car and, sometimes, the scan tool will allow you to do that quickly. An asTech® technician will reach out to the shop to check the asTech® device is plugged in and the car is in the on position and you have these lights showing, after which they remotely dial into unit through the internet using Wi-Fi technology, to scan it with a database of scan tools for that particular vehicle, which then spits back all the information.

How long does that take?

10 minutes, which includes ensuring they're set up, scanning and giving the report.

Wow.

Unless there's a connectivity issue which occurs 7% to 10% of the time. It may stretch to 15 or 20, but it's rare for it to go beyond 20 minutes. Automotive repair, whether it's mechanical or collision, is all done based on flag hours or booked time. Mitchel, CDK and Reynolds and Reynolds are companies who have developed systems for tracking repairs and doing the invoicing but, more importantly, being able to say this repair is worth this much time to the technician or the shop.

If a repair takes two hours to do and you can do it in 20 minutes, the shop just made significant money, so it's all about efficiencies. When you hear the word efficiency in automotive, that's the difference between what the booked time pays and the actual time it took. That is the concept asTech® and others in the remote diagnostic world are banking on, being able to save you time while providing you that resource using somebody with ASC or even OEM manufacturer certifications.

Would you scan a car which has been totaled?

It's not uncommon, as mechanically and cosmetically totaled are different things.

That's what I was thinking.

So the answer is yes, you would. If you're trying to ensure you're getting the value for the vehicle, there are no bad reasons to scan a car. A pre-scan will tell you what is wrong and a post-scan will tell you what you did or didn't get right. I'm not sure we scanned cars which ended up getting totaled, but most of the time, that scan was done ahead of the decision to total it. There could also be a decision to total it down stream, so it's a great question you asked. If you do a post-scan and find another error code and you need an ECU or a body control module, either you cannot get it or it might be too costly, so the insurance company decides to total it.

I was wondering if it's even involved in that decision; it could be.

Absolutely.

You mentioned other diagnostic companies doing the same as asTech®; are there many competitors or are there several big leaders?

One that jumps out as the biggest is AirPro Diagnostics out of Florida.

AirPro?

AirPro is a solid company and probably the largest competitor for asTech®. asTech® have done a nice job of partnering with many big people. They have an alignment with Gerber Collision & Glass as well as Safelite. There are many small to mid-tier players, such as Caliber Collision who are Dallas based and recently acquired one whose name escapes me. There are several here in the Dallas Fort Worth area that have spun up over the years because they are former asTech® people who have gone out and started on their own. There are many who are either in a startup phase or still scaling and moving forward.

How do they differentiate from each other? Is the technology relatively basic and everyone has the same tech and it's a matter of relationships with Safelite and Copart, or are there other aspects of the technology which are vastly different?

The technology, for all intents and purposes, is the same with a few differentiators. Doing mobile service on your lot is a differentiator, whether at a dealership or collision center, as you are providing them with another way to make money by using a third party. Many smaller entities go into that mobile space because it becomes too costly for the bigger ones due to the overheads they have to commit. They have to park technicians in shops who are not always kept busy, whereas with a moving van you can schedule appointments throughout the day.

The down side to that is when your first appointment takes six hours instead of two. Now you have to reshuffle multiple appointments for that day, and if you booked out a few weeks, it quickly becomes a mess. Calibrations are also a differentiator. All the sensors which play a role in collision avoidance, your ADAS technology, have to be calibrated any time certain components are removed. If you remove the front or rear bumper, some manufacturers need you to recalibrate airbag sensors. LIDAR, RADAR, cameras and lasers are used to sense emergency braking, lane departure, collision avoidance and adaptive cruise control. Even your camera systems use that to gauge how far you have to back up or pull into a parking space. Calibration can be done static or dynamic, at the shop or even over the phone, similar to scanning internet mode. That technology is very costly but it makes it easier and faster to do. AirPro have something called Auggie, which mounts on the windshield and does the majority of calibrations on the vehicle. I don't know if it has become quite the game changer yet, but they released that in the past six to 12 months, and it seems to be getting some traction.

I want to talk about the impact of technology on repairs and accident rates; how has adding all this extra technology on cars impacted repairs?

Accident rates and the cost of those repairs has gone up, due to the technology required becoming more expensive. It's not like computers where the price decreases. Scan tools and Auggie require software programming, whose cost has increased over 15 years. CAFE laws – which encompass Federal fuel and emission laws and California has their own – result in manufacturers making their cars lighter, so many vehicles don't have spare wheels. Taking that out of the car helps them get closer to the weight, but if the car breaks down, the cost of getting the car to the shop increases, so there are things we don't think of that do it.

Over time, we've moved away from ladder frame to unibody vehicles which have crumple zones. Once a crumple zone is compromised, it's done, but unfortunately the industry repairs them. The marks from frame machines are different today than they were even five years ago, and it's very hard to find that damage, meaning there is lots of hidden damage out on the road. That has driven insurers and repairers to make questionable repairs to avoid replacing cars, which continue to get more expensive. That is driven by both the technology in the cars and the technology used to make them, and somebody has to get paid for that.

Margins are razor thin in the car business. Instead of 10% to 20%, you only make 1% to 3% on a used vehicle sale. Even on new vehicles, those margins are not much higher than 5% to 7%, on a good day. There is a lot of F&I money available, but those aren't profit out of the vehicle. It costs so much to fix that car because you have to make so many parts available, and if those parts don't get used, that is total obsolescence and you lose all that investment, so a balance has to be struck. It will probably get worse before it gets better, which has to do with EV technology and ADAS, which are both aimed to save lives. Emergency braking or lane departure, all those cool little features that newer cars have, and when you rent one, you're like, why is my seat rumbling?

Yes, or the steering wheel takes over and doesn't let you go over lanes.

Yes, or suddenly it flashes brake on the dashboard and automatically brakes. Those things scare the heck out of us but they are there to save our life. The short time I was with asTech®, it really hit me because I had been seeing the cost of repairs increase at CarMax. Today, I have many rental car customers and talking to them I understand that same thing, which is EVs and all that technology is going to get worse, because not everybody can afford an EV or fossil fuel vehicle today with all that technology. The majority of cars on the road don't have ADAS, so if two cars arrive at an intersection but only one has ADAS, the damage to both cars will still be catastrophic. The only real value of ADAS is for that car. EVs have fewer mechanical parts, but there's still a tremendous amount of electronics and technology in there, so the cost of repair will remain high because those things aren't cheap.

It will come down to the availability of technicians and OEMs sharing their technology to aftermarket repairs and insurance companies. Will they be able to force the OEM’s hand to make all that information available? Currently, if an EV rolls into CarMax with an issue their technicians cannot repair, that car goes back to the OEM dealership for repair, whether it's under warranty or not. There is a phrase in the industry which sounds a little cliche, which is ‘don't touch the orange wire’, which is the big power cable for the battery pack, because if you touch that, it will kill you. Every CarMax technician goes through training on EVs and it says, if anything in the book tells you to touch this orange wire, the car goes to the dealership.

Those things will continue to keep repair costs high, because if you're a third-party repair center, who is billing an hour to a car, your door rate is $125. At an OEM, it's north of $200, which is in an average city, not New York, L.A., Chicago or Atlanta. L.A. door rates at OEM are probably in the 300s. Those things have an impact on the repair cost to anyone trying to fix a vehicle, whether it's a collision center, automotive repair service center or an OEM. asTech® and other players in the space are able to scale that so that if they can scan 1,000 cars at this rate, they pay back for that investment, and that is very easy to do.

With repair costs going up so much, I imagine it's pretty easy to total an EV?

With supply and demand impacted by Covid and dealership lots getting bigger and used car vehicle prices going to all-time highs – even more than new cars – that forces the hand of the insurers to no longer total it because they cannot find customers a replacement vehicle. From a customer service lens, will they feel good about cutting an $80,000 check to their insurer, knowing they cannot buy that same car because there aren't any out on the market, versus repairing it, even though the cost of repair is more than they would want it to be. Loss ratios will drive many decisions, and those loss ratios continue to go up. With Covid and the supply chain issues we've seen over the past 24 months, there is no sign of it improving; in fact, it has worsened over the past 90 days. You will see more claims done than cars totaled because the insurers will have to fix the cars as they are not going to have any choice.

There are so few cars out there that, suddenly, the cars themselves become very valuable, so to total it becomes more difficult because you can more repairs if the value of the car is high, versus the value of the car reducing then it's easy to total.

I recently had a conversation with a friend who is still in the used car space. We spent time together at CarMax in the early 2000s and were both in North Carolina, opening several stores, and we had a bunch of Daewoos. We had been working with a corporate initiative on, do we collect all the Daewoos we can and turn them into our loaner fleet? The thought was, yes, because now their value is tanking and they're not very reliable, but if we have a whole fleet of them and store them somewhere, we can simply take parts from them as we need them. But the decision was no because, from a customer service lens, not many customers who bought a Mercedes or BMW would be thrilled getting a Daewoo as a loaner.

The big challenge today is, how to balance all these peaks and valleys in the car business. You see a bunch of cars hitting the market which all get bought up, whether used or new. Then the inventories get depleted and values are driven up again. That drives up repair costs if fewer cars are available. Copart buys vehicles from many different avenues but if they are no longer running through the sale for scrap, and instead used car retailers like CarMax and Carvana are holding onto those cars and putting more money into them to make them a vehicle to sell, so they can acquire one more customer, that takes a car out of Copart's inventory.

It's also the accident rate itself and miles driven; it's all these variables.

The acquisition of ADESA by Carvana is a big move because it gives them a resource of vehicles to repair and recondition. Everybody initially thought this was so they can recon cars, but it's not solely that. It basically gives them a bone yard, if you will, to where, if their car is at that auction and they feel they can harvest parts from it, they will. That could potentially take Copart out of the mix, but I don't know if they're savvy enough quite honestly. Anybody in the financial space can do the math on that but it definitely changes the game. There are also rental car players who have been buying used cars to re-fleet after de-fleeting.

What do you think about the possibility of Copart selling used cars?

That would be a smart move because Copart have a good image in the industry and everybody sees them in a positive light. They are not seen as a salvage yard or dismantler but a parts supplier. The minute somebody sees you as a dismantler, they think of a wrecking yard with cranes and cars going to the smasher; they don't think of how it drives the repair industry by giving more fair pricing to consumers. Everybody thinks CarMax and Carvana are huge and have this unbelievable market share but they don't; they're sub 10% market share. That pie in the used car industry is huge, a small 5% to 10% sliver of that is several billion a year, so if it was me, I would jump all over it, because it's not hard to get into that space.

What other trends do you think are important or have been significant?

There will probably be more M&As in the used car space. Watching from the sidelines and having been in the industry, I'll tell you in my eyes what I saw happen. 20 years at CarMax, Carvana starts coming on the scene and everybody was like, who cares? I said we need to care but they were like no; it's simply DriveTime 2.0. But it was different. DriveTime is focused on sub-prime customers whereas Carvana is focused on a prime customer. They have all the UX and UI to go for the prime customer, and did. CarMax underestimated what Carvana could do, and only when CarMax realized it was a problem, they put in the omnichannel play. I still think CarMax is a great company, but they reacted five years too late. If they reacted sooner, Carvana would not be where they are today. They burnt a lot of cash over the years and I think the investors would have said no if CarMax implemented a better plan sooner.

There are two others in the space which I think are acquisition worthy. Vroom stay on the sidelines and are not very big but they get some press. Several key CarMax players went over there years ago and they have done a nice job redefining what they do and got an alignment with Manheim. If you do some homework, it's pretty easy to find they went into partnership for reconditioning which was a smart move. Without them buying Manheim or Manheim buying them, it gives them a synergy where they can feed off of the supply in the Manheim lots to help fuel their inventory. That is probably an acquisition worthy company and will not acquire anyone as they don’t have the financials to do it. They are also publicly traded.

Another publicly traded one is Shift, out of the Bay Area, who spent time and money on technology. They also pulled in several CarMaxers over the years to help them scale and do great things. They just completed a merger in the last 90 days which created some turmoil over there, so I still think they're in the same boat, but their model is really good. The only challenge I see with them is having enough in the war chest to keep going, or needing mergers to fuel growth.

The last one isn't an M&A look but they have been on the acquisition trail for quite a while, and no one realizes some of this is fueling their huge growth, and that is Sonic Automotive. The North Carolina Smith family, also the owners of NASCAR, own Sonic Automotive Group, who own EchoPark. They released their quarterly report last week with strong numbers on both sides of the house. Sonic has done a nice job with acquisitions over the past 24 to 36 months, building and scaling EchoPark.

What is EchoPark?

EchoPark is Sonic's used-only, similar to CarMax where they started with brick and mortar. Their first location was in the Denver metro, then they added two or three locations. They went for the sub-prime customer in San Antonio, with several location openings, one of which was a sub-prime focus and the other was the traditional prime focus in the used space. Over the past few years, they have started to scale. They also got several CarMax folks who had some tenure and strength and brought them in at VP and director levels to put in structure and process on the operational side, which is helping them scale. CarMax is a heck of a training company and get accolades every year for their training. It's a very easy pond to fish from for employees, because there is tons of talent there.

They train people, then other companies take them.

Yes, I've fished there several times since I left and converted 90% of people. EchoPark is primed and ready to go and if you look at their financial reports, they're looking to spin it like Circuit City spun CarMax. They are hesitant and I think they are trying to figure out whether to acquire a Shift or Vroom and convert them to give them more of an online presence. They have the brick-and-mortar presence and are scaling the online, but they have a unique offer where they say they will always be within $3,000 of KBB.

Do they promise to be within $3,000 of the Kelly Blue Book?

Yes, they're never going to be more than $3,000 over what Kelly Blue Book says. They are growing their customer base month over month, and are doing it in two ways. One is through organic sales, but they are also doing it through acquisition. They acquire used points for dealerships and turn them into EchoPark locations, which saves on building a facility. Instead, they simply remodel, rebrand and bring in that EchoPark, which is simple for them. CarMax built these huge buildings, and still do. They buy land, erect a building, sell it to a real estate investment trust and lease it back. EchoPark are looking for acquiring, whereas Shift and Vroom are probably more the ones to acquire. Carvana has a great model which everybody has tried to copy – even CarMax did – but I cannot figure out how Carvana can burn through so much money and still have people pouring money into them. It's a lot of cash burn.

Yes, there's a lot of moving parts to this industry.

CarMax has been in this space for almost 30 years, the first seven or eight of which they were owned by Circuit City, who had a cool story. Circuit City wanted to create another business and it was either cars or furniture. At the time in that Eastern Seaboard, Carolinas and Virginia, Heilig-Meyers was huge, so they realized there was no point going after furniture as they would get crushed, so chose to go into used cars. They slowly acquired a lot of talent and their second CEO was the first person hired at CarMax, Folliard, who was a used car guru from Florida. They also brought in people from other areas of the automotive space and retail, then scaled it.

If you look at what they've done and how they've grown that business, everybody thinks they must have half the market because they've been in this space a long time, but they don't. If you read their annual report, they only have 10% to 12%. People don't consider the amount of individual sales or private party transactions, as there is not a great way to account for those, other than Automotive News and other trade publications you can pull some data from. Small mom-and-pop car businesses litter the landscape. If you drive through any suburban or urban area, you will go past three to four of them in a 10-mile drive. That's where all the market share is; private party and all those independent lots.

I appreciate all your thoughts; lots of interesting things to think about.