LKQ Corp (LKQ) 2004 Q2 法說會逐字稿

I'd like to thank everyone for holding, and welcome to your conference call today with Mark Spears. Your line (technical difficulty), but we will have a question-and-answer session. At the time, I'll come on and give instructions. And I will turn the call over to Mr. Spears, and today's call is being recorded. Thanks for using Premiere Conferencing.

Before we get started, I just need to make a comment about forward-looking statements. The statements in this press release and webcast include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our expectations, beliefs, hopes, intentions or strategies. Forward-looking statements involve risks and uncertainties, some of which are not currently known to us. Actual events or results may differ materially from those expressed or implied in the forward-looking statements, as a result of various factors. These factors include the risk factors and other risks that are described in our Form 10-K filed March 24, 2004, and in other reports filed by us from time to time with the Securities and Exchange Commission. We assume no obligation to publicly update any forward-looking statement to reflect events or circumstances arising after the date on which it was made, except as required by law.

Good morning, everybody. Thanks for joining LKQ's second-quarter 2004 earnings call. On the call today are two members of management, Mark Spears, our Chief Financial Officer, and myself. My name is Joe Holsten, I'm the Chief Executive Officer of LKQ.

I will begin by providing a high-level overview of the quarter's performance, as well as some qualitative views on business and industry conditions during the quarter, and Mark will provide a more detailed assessment of the financial results.

We are reporting revenue for the second quarter of $104.9 million, which represents sales growth of nearly 30 percent over the second quarter of 2003. We have continued our historical trend of achieving double-digit same-store sales growth, with 11.4 percent organic growth in the quarter. Our growth from acquisitions added a further 18.1 percent to the top line, and on a year-to-date basis, we are generating about 14 percent same-store sales growth.

In late February, we introduced a second complementary product line within our company, aftermarket parts, through To the acquisition of Global Trade Alliance, which transacts business under the name Action Crash Parts. We continue to make progress in integrating Action Crash into LKQ. To date, we have moved three of Action's operations into LKQ facilities, and we are planning to move two more into LKQ facilities in the next few months.

In July, we signed a lease on warehouse space, totaling approximately 40,000 square feet, on the West Coast as the first expansion of Action into that market. During the second half of the year, Action will begin expanding its local service areas to two new markets in our Southeast region and one market each in our Mid-Atlantic and Northeast regions. We are also continuing to search for warehouse space in the Chicago market.

Early during the second quarter, we completed an acquisition of three facilities in Central America. There are two facilities in Guatemala and one in Costa Rica. This is a follow-on transaction to the self-service business we acquired in the Tampa area in February of this year. Our acquired business base is relatively insignificant today, and was less than $0.5 million of revenue in the quarter. We see these facilities as a future platform to sell the type of product that is currently being scrapped or cored out by our recycled automotive replacement part facilities here in the US. Accordingly, we believe that the investment in this market will allow us to generate additional income from product that has a very low yield today.

In mid-June 2004, we acquired Albert Lea Auto Salvaging, a recycled OEM automotive replacement parts facility located approximately 9 miles south of Minneapolis. The trailing annual sales of this business is approximately $5 million. We are pleased to now have both production and sales in place to better service this important market.

At this point, I'd like to turn to certain of our greenfield expansion opportunities to bring up to date on them. In June, we obtained a lease on a fully permitted dismantling facility between Austin and San Antonio, Texas. During the third quarter, we expect to begin dismantling and warehousing operations at this site, which will be the platform for our entry to the San Antonio market. As a greenfield, we project that this business will operate at a small operating loss for the balance of the year, but we believe this market entry will come at a very nominal cost to our stockholders.

We are also in the process of obtaining property permitted for dismantling operations in Louisiana, and expect to close on the real estate by the end of August. Initially, this property will replace one of our redistribution facilities in Louisiana, but we expect the facility to become operational as a full dismantling and warehousing facility during the fourth quarter of this year. Like the Texas greenfield, small operating losses are expected the first two quarters but, again, should represent important long-term value to our company.

As you may recall, we opened a greenfield facility in southern Pennsylvania in Q2 so that, in total, we plan to open three greenfield operations for this year, which is ahead of our initial plan.

These three development projects are cold starts and, as I said, tend to generate some levels of losses upon opening. The Minnesota and the Central American business acquisitions, when combined with these greenfield startups, are expected to have a neutral impact on our 2004 earnings per share.

Distribution expenses continue to grow faster than other expenses. We continue to invest in our valuable distribution network, which in turn has contributed to double-digit same-store revenue growth for us in this quarter. In fact, in the second quarter of 2004, we increased business that was moved over our transfer network by approximately 33 percent over the comparable period in 2003. We have plans, over the next few quarters, to increase production in warehoused salvaged parts, in order to increase the inventory levels in each of our local markets. Our EBITDA totaled $10.9 million for the quarter or 10.4 percent of sales. This performance reflects a 24.1 percent growth over the second quarter of last year. And finally, our net income for the quarter was $5.3 million, which is nearly a 30 percent growth level over Q2 of last year.

Our earnings per share for the quarter, fully diluted, is 24 cents compared to 25 cents last year. And I will remind you that when comparing our 2004 to 2003 second quarter EPS's, we had the dilution impact of the our nearly issued shares in our Q4 2003 IPO, as well as the impact of the share buybacks that we instituted in early 2003. So in total, our fully-diluted share count was about 34 percent greater in the second quarter 2004 as compared to the second quarter 2003.

Let's turn to procurement for a moment. For the quarter, we acquired approximately 20,800 vehicles from all sources for our wholesale business, which was about 13 percent more than we acquired during the second quarter of last year. The percentage of vehicles that we acquired from salvage auctions in the quarter accounted for about 92 percent of our total incoming product flow.

I'd like to discuss market development activities now, where our focus remains unchanged. We continue to market primarily through the insurance carriers, and secondarily to the collision repair shops and parts installers, in order to attempt to first increase the utilization of recycled parts and then to supply aftermarket parts to the extent recycled parts are unavailable. Our Vice President of Insurance Services continues to work with major carriers, and we are hopeful that additional programs for us to review systems and direct salvaging purchases will continue to be implemented throughout the balance of the year.

Since our last earnings call, we have added two small salvage procurement agreements and several repair order estimate review programs including, first, a direct procurement agreement with a national carrier for cars in St. Louis, Missouri and Fayetteville, Arkansas, for approximately 1,200 cars per year. This agreement started in the beginning of June. In addition, the same carrier is sending LKQ repair estimates for review and LK service areas in Missouri, Arkansas, Kansas, Iowa and Nebraska.

Secondly, a direct procurement agreement with another national carrier for cars in Ohio for approximately 1,000 cars per year has been reached. That's scheduled to begin in early August.

Finally, another national carrier has agreed to staff an LKQ representative to review their repair estimates in the Ohio market for both recycled and aftermarket part opportunities. The process is also scheduled to begin in August.

I was pleased with the salvage business's continued productivity improvements in the sales area, as we were able to achieve our increase in third-party sales while only adding an average sales staff headcount of around 3.8 percent over the second quarter of 2003. While continuing to focus on productivity, we also plan to add 10 to 15 more sales staff in the upcoming months.

Back to GTA, Global Trade Alliance, for one brief comment. For our reported year-to-date results through June 30th, Global Trade Alliance's revenue was $17.2 million, and the related gross margin was 44.3 percent. I believe we are beginning to see some successes in the joint marketing of recycled and aftermarket parts, and leveraging the respective LKQ and GTA customer relationships.

At this point, I'd like to ask Mark to provide a more detailed discussion on our company's financial reports.

Thank you, Joe, and good morning, everyone. Let's take a look at the tables in our press release. Note we have also included a table that reconciles net income to earnings before interest, taxes, depreciation, amortization -- otherwise known as EBITDA.

Looking at our income statement for a moment, our second-quarter 2004 revenue was up 29.5 percent to $104.9 million from 81 million in Q2 2003. Our first six months of revenue for 2004 grew 27.9 percent to 205 million, compared with 160.3 million for the same period in 2003.

Our organic revenue growth was 11.4 percent for the quarter and 14.2 percent for the six months. Our second-quarter 2004 gross margin was 47.1 percent, versus 47.3 percent in the second quarter of '03. For the first six months of '04, our gross margin was 47.1 percent, versus the 47.3 percent of a year ago. Our facility and warehouse expenses for the second quarter improved, as a percentage of revenue, to 11.3 percent versus 11.7 percent for the same period in '03. These expenses grew 24.5 percent in the quarter over Q2 2003, of which 22.5 percent of the expense growth was due to our 2004 business acquisitions.

For the six months of 2004, these expenses as a percentage of revenue improved to 11 percent from 12 percent for the same period in 2003. On a six-month basis, facility and warehouse expenses grew 17.5 percent over 2003, of which 15.4 percent of the expense growth was due to our 2004 business acquisitions.

Our distribution expenses for the second quarter, as a percentage of revenue, grew to 11.2 percent versus 10.7 percent for the same period in '03. Distribution expenses grew 35.7 percent in the second quarter over Q2 2003, of which 21.9 percent expense growth was due to our 2004 business acquisitions.

For the six months of '04, these expenses as a percentage of revenue grew to 10.9 percent from 10.5 percent for the period in 2003. On a six-month basis, distribution expenses grew 33.6 percent over '03, of which 16.3 percent expense growth was due to our 2004 business acquisitions.

The balance of the distribution expense growth was primarily attributable to our continued investment in '03 and '04 in our distribution network. We grew the number of local salvage delivery routes by an average of 9 percent in the second quarter over Q2 '03. We also operated an average of 17 percent more daily salvage transfer runs in Q2 '04 versus Q2 '03. As Joe indicated earlier, the product we transferred between our plants during the second quarter of '04 was approximately a 33 percent increase from that level in the second quarter '03.

Fuel for the second quarter of 2004 as compared to 2003 increased 11 percent, but fuel was not the largest component of our distribution costs. In fact, for Q2 2004, fuel was approximately 12 percent of total distribution expenses.

Selling, general and administrative expenses, as a percentage of revenue, was 14.3 percent for Q2 2004, compared to 14.2 percent in Q2 '03. Selling, general and administrative expenses grew 31 percent in the second quarter over Q2 '03, of which 13.7 percent expense growth was due to our 2004 business acquisitions.

For the six months of '04, these expenses as a percentage of revenue grew to 14.3 percent from 14.2 percent for the same period in '03. On a six-month basis selling, general and administrative expenses grew 28.7 percent over the same period in '03, of which 9.9 percent expense growth was due to our 2004 business acquisitions.

Our selling expenses tend to be fairly variable, due to the nature of our commissioned inside sales force. Our general and administrative costs are usually less variable in relation to revenue growth. However, in the second quarter of 2004 we incurred approximately $900,000, and for the six months, $1.5 million an additional costs related to being a publicly-traded company. These costs include increased insurance premiums on director and officer insurance coverage; additional legal, audit and other fees related to the normal reporting requirements of being a publicly traded company; and also include the newer compliance requirements of Sarbanes-Oxley. We anticipate this level of cost will continue in 2004 at approximately the rate of $700,000 for a quarter.

Our operating income for the second quarter 2004 grew 24.6 percent over Q2 of 2003. Operating income, as a percentage of revenue, was 8.7 percent in Q2 '04 versus 9.1 percent in Q2 '03. On a six-month basis, our operating income for 2004 grew 32.4 percent over 2003. As a percentage of revenue, operating income improved to 9.3 percent in the first six months of '04 from 9 percent in 2003. Interest expense net in 2004 for the second quarter and full six months is lower than 2003 amounts, primarily due to lower debt levels and lower interest rates.

Included in interest expense in the first half of 2004 was about $346,000 of previously paid debt issuance costs that we wrote off in the first quarter of '04 when we terminated our secured credit facility in February 2004.

Our Q2 2004 pretax income grew 32 percent over the same period in '03 to $8.9 million. As a percentage of revenue, our pretax was 8.5 percent for Q2 '04 compared to 8.4 percent for Q2 '03. For the first six months of '04, our pretax income grew 37.8 percent over 2003 to $18.4 million. As a percentage of revenue, our pretax was 9 percent for the first half of the year, compared to 8.3 percent for the first half of '03. Our provision for income taxes was 40.2 percent for the first six months of '04, compared to 39.6 percent for the comparable period of 2003. The difference in rates was due to the changing mix of business in different state income tax jurisdictions.

Net income for Q2 '04 increased 29.7 percent to 5.3 million or 4.1 million in Q2 '03. Net income for the six months of '04 increased 36.2 percent to 11 million from 8.1 million in the first half of '03. Our diluted earnings per share were 24 cents in Q2 '04 versus 25 cents in Q2 '03. As Joe indicated earlier, be careful in looking at this EPS decrease, because the number of shares outstanding actually increased 34 percent when you look at Q2 '03 to Q2 '04. Our diluted weighted average common shares outstanding were as follows. In Q2 '04, we had 22,463,615 shares. In Q2 '03, it was 16,715,982 shares. For the six-month numbers, six months 2004, the diluted weighted average common shares was 22,322,238 versus in 2003 the first half of the year, it was 17,622,601 shares. The six month numbers, it was an increase of 26.7 percent in shares.

You need to know that the number of weighted average common shares outstanding in 2004 versus 2003, it changed for several reasons. One was the 3.6 million share buyback that we did in the first half of 2003, and the bulk of that fell in the second quarter of 2003, and then issued 5 million new shares in our IPO in October 2003. We also issued approximately 187,000 shares in the first half of '04, related to our business acquisitions. Other changes in average diluted shares outstanding relate to the effective change in our stock price and the exercise of stock options and warrants.

Let's take a look at our cash flow table. We generated $8.6 million in cash from operations during the first half of 2004, with 2.8 million coming in Q2. This compares to 10.3 million in the first half of 2003. In 2004, however, we invested in additional inventory of $5 million, where in the first half of '03 it was $400,000 additional investment.

CapEx, excluding business acquisitions, for the first six months of 2004 was $16.2 (ph) million with 9.5 million coming in Q2. This included $11.5 million in real estate acquired during the first six months of '04 that was previously underleased. For Q2, the amount of the 11.5 was 6.8 million. Cash paid for our business acquisitions for the first six months of 2004 was 43.4 million, with 3.8 million coming in Q2.

Stock issued for our business acquisitions for the first six months of 2004 was 187,000 shares, with a value of $3.4 million. In Q2, included in that number, the Q2 portion was 63,000 shares with a value of $1.4 million.

Looking at our balance sheet, you will know we had 42.4 million in debt, which includes 39 million in debt under our credit facility. As of today, our credit facility debt remains at the 39 million.

Let's talk for a minute about earnings guidance for 2004. Including our business acquisitions that we've announced to date, 2004 revenue -- we're keeping our same guidance at $410 to $425 million, net income between $20.6 million and $21.7 million, and diluted earnings per share between 92 to 97 cents. For Q3 2004, we expect revenue to be between $103 and $110 million, net income between $5.0 and $5.4 million, and diluted earnings per share between 22 cents and 24 cents. Using these estimates, our net income growth, Q3 2004 over Q3 2003, is expected to be between 42 and 53 percent. We estimate the weighted average number of diluted shares outstanding for the full year to be approximately 22.4 million, and the third quarter to be 22.6 million. These share numbers are estimates, and as such will be affected by factors such as stock issued in any future acquisitions that we may do, the number of options and warrants exercised in future periods and the changes in our stock price.

We estimate our full-year 2004 CapEx, excluding any future acquisitions, to be around 30 million. However, this includes approximately the 12 million in real estate that we are acquiring under operating leases, 3 million related to new startup facilities, 1.4 million to consolidate our core business in Houston from two facilities to one, and 2 million related to our 2004 business acquisitions.

I'd like to turn it back to Joe for any further comments, and then we will open up for Q&A.

Thanks, Mark. Just in summing up here, first of all, I'd like to note that our company was added to the Russell 2000 index during the quarter, so we are very happy about that.

Secondly, just a comment on the acquisitions we completed in the first quarter of the year. To be brief, I think the acquisitions are performing well. The Action Crash business is expanding as we had planned at the time of the acquisition. I think the management team at Action has been very effective at achieving the cost take-outs that we agreed to early on in the acquisition.

And finally, we're starting to see some slight acceleration in the sales from our Action Crash business. Secondly, I would note that the self-service businesses that we acquired in Florida are also performing as we had expected at the time we submitted our offer. I think it was a good quarter for the Company, as LKQ continues to perform at the revenue and earnings growth levels that we had set forth at the time of our public offering.

That concludes our remarks. We would like to open up for questions at this point.

(OPERATOR INSTRUCTIONS). Scott Stember, Sidoti & Co.

Can you tell me about (ph) about Action Crash, what was the revenue contribution in the quarter?

We said it was 17.2 million for the six months, and I believe it was 5.5 that we had in Q1, so 11.7.

Joe, you alluded to the fact that now that Action is part of the LKQ system. Can you just give some examples or just loosely talk about some of the leverage in sales that you are gaining out of that, now that you have a whole new line of products to market to collision and repair shops?

I think we are seeing it (ph) in two ways, Scott. First of all, in terms of our outside business routes -- I'll just use the Chicago area as an example -- we've had encounters with customers, if you will, who have not shown significant interest in doing business with Action Crash or with LKQ. And the market relationships that the other companies have established over the last few years has opened doors for us to provide both product lines to accounts in the Chicago area. So we are seeing that in other markets, as well as we're starting to market our capacity and capabilities together.

I think, secondly, what I would focus on is that the volume of product that the LKQ sales reps have been able to source from Action and supply into their existing account base has grown every month since January. And we would expect to continue to see that build every month through the balance of the year.

And as far as the guidance for the third quarter and I guess for the remainder of the year, third quarter in particular, I guess the question is, are we seeing or do we expect to see the same types of organic sales trends in the next couple of quarters?

Yes. I think, the second half, I would expect we should be in the same range we were in Q2. I suspect, the fourth quarter, we might inch up a little bit from that. So for the full year, I think we are still thinking kind of a 12, slightly over 12 to -- 12 to 13 percent same-store sales growth.

Craig Kennison, Robert W. Baird.

First question, a follow-up on Scott's question on Action Crash Parts. Was the 5.5 million Q1 revenue a partial quarter's worth of revenue, or the full quarter?

It was partial. It was the full month of March, and a little bit of February.

And it seems as though the mix of greenfields versus acquisitions is more rich in greenfields than we would have anticipated. Does that suggest anything about the prices you're seeing for acquisitions?

No, I wouldn't say so, Craig. The market opportunity that was somewhat unexpected here was the facility in Louisiana. We had originally planned to move into the South Louisiana market through an acquisition. We thought we had somewhat of a reasonable understanding with a seller in the market. He changed the price, and in the meantime, we found a salvage auction property that was on the market that we thought was attractively priced, given the permits. And we decided to use that as our vehicle for market entry, as opposed to acquisition. We are already selling into the market, so we were pretty comfortable with moving into that market, as we already have probably a couple million dollars of business that we are distributing out of our Birmingham facility.

And of the three greenfields that you identified, I don't recall -- did you say they all had permits?

Yes, they do.

Could you comment on the acquisition pipeline as you see it today?

Yes. I would say there are a number of good opportunities in the market. We are negotiating hard on these. We've walked away from transactions where the -- I guess, the way I see it Craig, we're the only ones in the market buying right now. And I think, to guard our shareholder funds appropriately, we should negotiate hard. That's the position we're taking. We continue to have a good backlog that we are working, and I'd say it's a healthy acquisition market right now.

Shifting to the Central American business, I understand it's early, but can you give us a feel for the gross margin and the revenue potential of this opportunity?

I think the revenue potential is fairly significant. These are important markets. The population of Guatemala is almost 14 million people; Costa Rica is almost 4 million. Our facilities are in Guatemala City and San Jose, which combined have populations of about 5 million people. The real opportunity we saw here, Craig, is the small mechanical parts that, quite frankly, are in excellent operating condition for selling to car re-manufacturers. And we have other parts that may not be of insurance quality in the United States that these markets desperately need. They fix everything, and that's the opportunity we saw, to move products that we derive very little money for in the United States. So that's the business plan.

The Coffers (ph), the former owners, had started the business with exactly that same business model, and they sold their wholesale facilities to Greenleaf several years ago. So they effectively -- their supply line dried up when they sold their business. That's what we bring to the table, is to resupply these businesses with product. I guess I would think that the business should be doubling over a three-year period. And I'd say we are too new into this to really make a comment on gross margins as a business. I think we'll make a note on that in the Q3 call, and try to respond to that; I think we'll have a little more history under our belt at that point to make a better comment on the margins.

And shifting to gross margin, some auction companies have noted higher prices or fees. I'm wondering if that is impacting your gross margin at all?

Well, as you can guess, it's something we watch like a hawk. A few comments on the market in general. It does appear to us that the percentage of cars being total loss salvage continues to grow. As a matter of fact, the latest data we saw from CCC suggests that that percentage in the first half of the year had grown to 12.9 percent. So I guess the starting point for me is my belief that there is more product at the auctions for us to compete to buy. We continue to stick to the strong discipline that we discussed during our roadshow and during the post audits. We've changed our business model slightly this year to run with a larger backlog, which we achieved in the first quarter of the year. Now we're bringing that backlog down in the second quarter, and we'll probably bring it down again in the third quarter. So it's my belief that we've been able to mitigate increases by virtue of the fact that we bought more aggressively in the first quarter, which would tend to be one of the better buying seasons.

We continue to believe that -- and obviously, the auction companies have the information, and we don't. So it's a speculation on my behalf. But we continue to believe that a material amount of that increase that the auction companies discussed is likely coming from the sale of the builder vehicles, the rebuildable cars that can be shipped and transported across pretty great distances. As you know, Craig, we compete for parts cars. And while people, our competitors and ourselves, we do move parts cars between states, it's our view that competitors are not buying parts cars to take them out of the country.

Finally just, I guess, comment again -- we buy about 70,000 cars this year through the auction process. We only buy about 12 percent of what we bid on. And I think that's healthy, that we maintain that level. It tells me that we are sticking to our guns and our disciplines, and working hard to protect gross margin percentage that we have as a company.

That's useful. And finally, could you comment on the tone of business in July?

Yes, I will. I think, as I look at our second quarter, we seem to feel some softness in late April and May. And then, we've noted in some new releases (ph) from Allstate and some of the retail parts sellers -- and obviously, we don't think that we really are in their market. But it seems as though there are couple of anecdotal points of evidence out there that other auto parts businesses seem to feel that the second quarter was a little on the soft side. June showed acceleration over the May levels, and our first few weeks of July seem to be tracking exactly where the June revenue performance was.

Gary Prestopino, Barrington Research.

I had to jump off the call for a minute; I may have missed this, but what was the amount of cars that you purchase this quarter?

It's 20,800.

And then, could you go into a little more detail on what you're doing in Central America? Just go into detail as to what kind of parts you are selling down there -- what you're doing?

You did miss that; I'm sorry. The types of parts we're sending down there -- we're sending some interior parts. Seats, in particular, seem to be a highly sought-after items. We are sending a lot of rotating electrical small mechanical parts and pumps. These are parts that we do sell in the US, but some are older product, earlier model year product that we buy. A lot of that product today is going to car re-manufacturers and, quite frankly, being sold for $5, $6, $7 a unit, if even that.

And then, with Action Crash, you said you're going into California with that, with the Company?

That's correct.

And then, you're in the Midwest now. And what other regions are you in?

The major warehousing outlet for Action Crash is Columbus, Ohio. And from that warehouse, the major markets they distribute into are Ohio, Western Pennsylvania, Michigan. They just reach into the Chicago area, and then they have a pretty nice business presence in Kentucky and parts of Indiana.

So from California, you can basically do almost the entire West Coast?

No, I don't think so. The product demands here for delivery are pretty much next-day delivery. So this warehouse is going to be suitable to address the Northern California market, and we may be able to sell into Oregon from this warehouse, as well.

But your plans are to get this thing on a national basis, correct?

That is our planning, and it's probably a three-year process.

Could you tell us what the sales were for Action Crash last year in the quarter, when it was a private company?

Let's try to come back with that off-line. Okay? I'm not sure we have that exact data right here in front of us.

And then a couple more questions. As far as your guidance goes, what bends the needle either way, to the low end or the high end? Is it just sell-through?

Yes, I'd say it's certainly the top line. The gross margins in the second quarter seem to have stayed flowing pretty consistently. Mark talked about some of the going public costs. I think any surprises that we may have had on being a public company -- those are all on the table right now. That's very clear to us what those costs will be on a run rate basis. We are focused on stemming the growth and the distribution costs here, and our plan, quite frankly, to attack that is to increase the availability of parts within the local markets to take some pressure off the intercompany shuttle systems, and to refocus our salespeople to sell into our existing route network, as opposed to continuing to open up more market opportunities. So I think we have to come back to sell-through being the critical item of where we fall in that 92 to 97 cent range.

And lastly, on your cash flow, it looked like your gross cash flow was somewhere north of 14 million? And then it looks like your inventories were up 5 million. Is that a function of the acquisitions, or you just --?

No, the cash flow in here -- like if inventory went up because we bought a company, that's not in here. This is the growth of the inventory, and we made a conscious investment decision to put more inventory on the shelves.

Zach Macado (ph), MCN (ph).

I was wondering if you could talk about the impact on your fulfillment rates that selling aftermarket parts to salvage customers is having in those markets that you are offering it?

The fulfillment rate that we see with Action -- I use the two existing markets where Action has significant warehousing capabilities, so that would be the market surrounding Ohio, and then the market surrounding Charlotte, North Carolina. Both fulfillment rates -- and I'm just talking about the fulfillment rate of selling aftermarket parts -- is approximately 98 percent. That fulfillment rate representing when Action salespeople -- when Action distributes discounts or catalogs with the parts that they have available for sale, that they actually have that part in stock.

But in the salvage business, isn't your fulfillment rate somewhere around 50 percent? And so, I was wondering how much that rate has increased in areas where you are offering aftermarket?

I can't respond to that. I don't know the answer to that, because right now, our information systems will track the fulfillment rate of whether we can -- and you are correct, our not-in-stock percentages in the salvage business are clearly in the mid 30 percent range. What our systems do not track right now is that substitution effect that they are asking about. That's a great question, and something we need to figure out how to track better.

And then, it looks like your facility and warehouse and distribution expenses, as a percentage of sales, was pretty low in the first quarter, and then they jumped up in the second quarter. Was the first quarter an anomaly? Was there something that reduced the expenses?

The facility warehouse expenses quarter to quarter grew -- if you take out the acquisition pace, okay, grew like 2.2 percent Q1 to Q1, and it grew 2 percent Q2 to Q2. I don't follow where you say they went up in Q2. And the thing that happened is we bought some more property, so we got a little benefit there with -- now we've got interest expenses and depreciation, and we've dropped the leases. For the quarter, that was about 150,000 in Q2, plus lease expense because of that.

Does that answer your question? I'm not sure what you are looking for.

It looks like they were both 10.7 percent of sales in Q1, and now they are 11.2 percent of sales.

Oh, okay. Right. What you're looking at is that increase is coming through the companies we bought -- the acquisitions we bought. Okay? And you've got GTA in here for like three months when you only had them for one month in kind of a week or so in Q1. So you're having a changing of mix, not from our salvage business, but we've gotten into some other business lines here, and they carry a little higher rate there. That's what you are seeing on that. I was pulling all that acquisition stuff out, and saying on a quarter-to-quarter basis, our base businesses improved.

So you have got a little leverage if you take the acquisitions up?

Right.

Was there any one-time Sarbanes-Oxley expenses in the quarter?

Yes. Well, let me back up before I say it's totally onetime. Some of the quarters that the Sarbanes stuff falls in, more in Q2. Q3 and Q4 tend to be more flat, but the big thing that is new this year for everybody -- obviously, it's all new to us because we're public, -- but even public companies -- is the Sarbanes-Oxley Section 404 compliance. Okay? And that entails, first, the Company bring together a lot of documents, manuals, flow charts and all kinds of things that then the auditors will test in the fourth quarter. So the consultants we are using on that project -- you really book the expense when they do the work. And a lot of that work is getting -- a big chunk of that is done in Q2, and we finish that up in Q3. So that's what you're seeing like an extra -- we had $900,000 hit in there, and that's really what that piece is.

So you spend 900,000 on Sarbanes-Oxley?

We spent $900,000 on extra stuff that we didn't have last year because we're a public company. Okay? Sarbanes-Oxley was probably 350 or so, okay -- the quarter amount. And 300,000 or so is just our D&O coverage -- we're a public company now, so we are paying a lot more D&O coverage. And that's when you compare Q2 to Q2 now, okay? If you are comparing like Q1 to Q2 for '04, we had about $300,000 more in Q2 than we did in Q1, of our public company costs. And yes, that was primarily the Sarbanes-Oxley 404 consulting work we are having done.

Susan McGarry, Granahan.

Do you have the number for the CCC data for the year prior, something that would respond to the 12.9 percent, I think, that you said?

Yes. That was 11.1 percent in the first -- I'm sorry; that's 2002. It was 11.7 percent for the first half of 2003.

And that's the percentage of collisions that are considered totaled?

That's my understanding, correct.

Craig Kennison, Robert W. Baird.

I want to follow up, Joe, on a comment that you made. And you may not have the answer, but you mentioned that you currently recuperate about $5 to $7 a part when you sell a part to the core market. Do you have any expectation for what you might receive per unit in Central America, even if it's a guess?

At least 5 or 6 times that. It's a significant variance.

John Lawrence, Morgan Keegan.

This is actually Adam Sindler (ph) for John Lawrence. And I apologize if these questions were asked before. Two questions -- first, with regard to when you had both an aftermarket and a collision business in the same marketplace, could you comment a little bit on the dynamics of how the dynamics of that marketplace changed? And secondly, if you made a comment on steel costs and the pressure on the aftermarket business?

Fuel costs?

Steel costs.

The dynamics were, where we have both wholesale salvage and aftermarket parts capabilities in the same market, the first thing we do is look for facility consolidations that we can achieve. We've identified five of those so far, and we probably have a couple more that can be achieved later. Secondly, what we did in the second quarter was to work on our systems to be able to have the availability -- basically have the aftermarket inventory show up on the screens of our salespeople. So when they would see not-in-stock positions on recycled parts, they could hit a kind of a special key that would immediately show the availability of aftermarket parts.

And finally, and what we are working on now is the training of LKQ sales reps and the pricing and the actual selling of the aftermarket parts. Our overall business philosophy is when we have both capabilities in the market, our sales reps are required to attempt to sell recycled product first, and to the extent that recycled product is not available, then they offer aftermarket product. So that's the general battle plan, with the view that as our salespeople are able to fulfill customers' requests on both part types, that that should begin to win more First Call opportunities for LKQ, because of the one-stop shopping capability and our belief that we're really the only company in the United States that provides both lines of alternative parts.

In terms of scrap costs and aftermarket, I guess you're looking at whether or not aftermarket parts are more costly now because of steel prices?

Yes, as a consequence (ph), exactly.

I guess my only comment on that is that, as we looked at the gross margins that we are booking on the aftermarket parts, that they have done, really, very consistent. And they were consistent with the levels that we saw before our acquisitions. I guess, to the extent -- if there have been increases as a result of any growth in steel prices, those are apparently being passed on by higher list prices.

Gary Prestopino, Barrington Research.

You mentioned that you've got a couple of direct procurement contracts with the insurance companies. You also, in the same sentence, talked about one carrier, you are sending the estimates directly to you; is that correct?

That's correct.

How many programs do you have of that nature right now, and what has been the change in that year over year?

Gary, I don't think I could quantify that off the top of my head. We've got some charts on that. That's something we're going to have to come back to you on in a follow-up personal call with you.

Susan McGarry, Granahan.

Mark, do you have any targets in terms of cash flow for the year -- cash flows from operations?

We haven't really put that out. You kind of see how we are tracking to date. At this time, we haven't put out targets for cash flow from operations. We did grow our inventories deliberately the first half of the year. That can kind of give you an idea, when you look at the cash flow statement. We've laid out what the CapEx will be for the full year, but -- I don't really want to get into that right now, because we haven't published those targets.

Gary Prestopino, Barrington Research.

Just another follow-up on the direct procurement with insurance companies. Could you just kind of give us some detail as to how that works, in terms of who selects the cars that go to you? Is it you? Is it the insurance company? Are they late-model cars, newer-model cars?

These can work and a couple of ways, but typically we come to an agreement with the insurance carrier on a model year range that we will accept, and it's our belief that the self-service yards -- for example, in Florida -- that we may be able to accept all. In many cases, the carriers would send us far more product than we can actually manage. So, in those cases, we restrict the volume that we take just to a couple of select markets. And we can either cut these by like a zip code, or in the district offices of the insurance carriers. They have tremendous data on what type of products will they get out of each other districts, and typically what the model year and make of that product is. So we sit down and analyze that type of data, and that's what we use to kind of cut and define the products that we get.

Do you guys set the price, or does the insurance company set the price for you when you have to negotiate from there?

We work those in a couple of different ways. We have some that are pure revenue-sharing agreements, where we pay the insurance carrier based on the total money that is generated from parts and sold off the vehicle, and we have others where we have variable revenue-sharing agreements, such as the cars that sell $7,000 to $8,000 in parts, we would pay a fairly high revenue share. And cars that generate fairly low-dollar part sales, we would provide a very low revenue sharing agreement.

But you are not laying out money initially to purchase these cars? It's my understanding a lot of this is on a revenue share, versus what kind of parts you get off the car?

They are both, but the majority of the ones that we are talking about here are on a revenue-sharing basis.

No more questions at this time.

Thank you, everybody, for calling and thanks for a good set of questions. We've made notes on the items that we said we'd follow up with you on. I apologize that we didn't have everything at our fingertips here, but we'll do our best to get back to you to clarify things that we were not ready to answer this morning.

Thanks again for joining us, and we'll talk to you in about 90 days. Thank you.