LKQ Corp (LKQ) 2005 Q2 法說會逐字稿

Thank you everyone for holding, and welcome to your conference call with Mr. Mark Spears. I want to remind everyone that your phones are in a listen-only mode. And that I will come on later in the conference -- and instructions for the question-and-answer session. And also the call will be recorded today. And Mr. Spears, you have the floor, and thank you for using Sprint.

Thank you. Before we get started, I need to talk 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 know 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 8, 2005 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, thanks for joining LKQ's second-quarter 2005 earnings call. On our call today are two members of management, Mark Spears and myself. I am Joe Holsten, the CEO of LKQ. I will provide some high-level overview of our performance, as well as some qualitative views on the business and our industry. And Mark, our CFO, will provide a more detailed assessment of our financial results.

We reported a record $136 million in revenue for the second quarter, which represents 30% growth over the second quarter of 2004. We were extremely pleased with our organic portion of revenue growth, which was almost 15% for the quarter. Our gross margin was 47.4% for the quarter, which is slightly better than the gross margin in Q2 of last year of 47.1%. This improved margin was primarily attributable to improved salvage pricing of cars in Q1 and Q2. But we also slightly improved our aftermarket parts margins as well.

Our EBITDA margin was 11.7% for the quarter, a 130 basis point improvement over the 10.4% EBITDA margin from Q2 of last year. And our operating income margin improved from 8.7% to 10.2% as well in the quarter. Our net income increased by almost 43% to $7.6 million for the quarter, and diluted earnings per share increased by over 37% to $0.33 per share.

We also reported strong operating cash flows in the quarter, which increased by $6.4 million over the second quarter of last year to $9.1 million. We are extremely pleased with virtually all aspects of the quarter, as we exceeded our internal goals for revenue, operating margins and net income. We generated consolidated aftermarket parts revenue for the quarter of $19.4 million, which was slightly below our Q1 2005 revenue of 20.3 million. We had anticipated a seasonal decline. Reflecting the confidence we have in our business model of combining recycled and aftermarket parts offerings to our customers, we decided to geographically expand our footprint of market service with aftermarket parts.

As we previously discussed on our last call, we acquired Bodymaster, an aftermarket parts business on February 1st of this year for $15.5 million net of acquired cash. This business serves the Philadelphia; Washington, D.C.; New Jersey and Maryland markets out of its two locations -- one outside of Philadelphia and one outside of Washington, D.C. Bodymaster recorded $19.5 million in revenue in its fiscal 2004.

This past quarter, we successfully integrated Bodymaster's sales and inventory management processes into our own operating systems. We recently expanded our marketing and delivery presence into the northern New Jersey marketplace, and the initial response has been very positive.

In terms of other expansion activities in our aftermarket operations, our aftermarket warehouse in Oakland, California is expected to be fully stocked in mid-August. We previously indicated our plans to open an aftermarket warehouse facility in the greater Chicago market in early Q3. We do have a site location locked up, but its opening will now likely be in mid to late Q4 due to some delays in getting through all the building and fire inspections and permits that we require. We still plan to use that facility for distribution of both recycled and aftermarket parts upon opening.

In Q2, we increased our aftermarket inventory investments at our LKQ recycled facilities in Atlanta and Crystal River, Florida and plan to increase the inventory investment at our Massachusetts recycling facility in the second half of the year. With these additions, our aftermarket business is now operating out of eight regionally-located warehousing facilities of varying sizes in Charlotte, North Carolina; Columbus, Ohio; Dallas, Texas; Oakland, California; Philadelphia/Pennsauken, New Jersey area; Landover, Maryland, which is Washington, D.C.; Atlanta; and Crystal River, which is central Florida.

Our aftermarket business operated 22 transfer runs and 256 local delivery routes of its own. And our recycled parts business operated 55 transfer runs and 371 local delivery routes during the second quarter. In various areas, these recycled part routes also deliver aftermarket parts. So in total, LKQ has a delivery system of over 600 daily local delivery trucks today.

One aftermarket part types that we carry and sell is automotive aftermarket head lighting, which is approximately 14% of our aftermarket parts revenue or about 2% of LKQ's total consolidated sales. As we have discussed on these calls before, several insurance companies have stopped writing headlamp aftermarket lighting because Kappa indicated four model types of aftermarket headlamp lighting may not meet required specifications. In particular Allstate, State Farm, GEICO, USAA, and AAA are not currently writing aftermarket headlamp lighting. Despite this, we continue to see no revenue declines in our aftermarket headlamp lighting. And we understand that two major lighting manufacturers are working with Kappa to begin certifying lighting part types, which should bring some of these carriers back into writing the product again.

Today, the aftermarket manufacturers have not raised prices, despite rising steel prices. In the past, they waited until the OE manufacturers would raise prices. We do not believe the recent decision by China to allow its currency to devalue slightly -- will have any impact on our aftermarket margins.

Turning to our main product line, our recycled parts operations. As we previously reported, we have also expanded our market presence through an acquisition in Q2. Our second 2005 acquisition was A&R Auto Parts. It closed on April 1st. A&R is an automotive recycling business based in South Carolina between Spartanburg and Greenville. A&R delivers parts throughout most of South Carolina. This business acquisition positions LKQ into new markets and will integrate very effectively into our mid-Atlantic region's distribution system to share inventory between LKQ markets. The 2004 revenue of this business was approximately $11 million.

In addition, on April 26th, we acquired a small self-service retail operation in Memphis, Tennessee. This brings the total number of retail self-service businesses to nine. Given the small revenue base of this Company is currently operated -- it is not expected to have any material impact on our 2005 earning.

In terms of other potential geographical expansions, we continue to work with a healthy backlog of acquisition candidates and would expect to close on additional transactions in 2005.

As we have commented in the past in 2004, we opened three automotive recycling facility greenfield operations in central Texas, southern Pennsylvania, and southern Louisiana. While two of these facilities have been open approximately 1 year, these are progressing nicely, despite having a slight adverse effect on our operating margins and facility and warehouse costs in particular.

We acquired approximately 24,000 damaged vehicles in our wholesale business during the second quarter, which was about 16% more than we acquired during the second quarter last year. The percentage of vehicles we acquired from salvaged auctions in the first half of 2005 accounted for around 92% of our total incoming product flow.

Our working relationships with insurance carriers continue to be healthy, including the growth of providing various estimate review services to enhance recycled or aftermarket part utilization for the carriers. We also continued to expand the volumes under our current direct car procurement programs with insurance carriers. In addition, we are currently negotiating with several new geographical areas to begin taking cars directly from the carriers and additional OEM as well.

As I discussed on last quarter's earnings call, we continue to increase our sales staff levels for our recycled business. And we have done so by an average of 77 sales reps, more in Q2 2005 compared to 2004. This is a 23% headcount growth with approximately 16% of the growth coming from acquisitions and 7% from our own internal hiring.

In summary, we believe the fundamentals of the business and our Company remain very strong, and that LKQ continues to operate a very compelling and successful business model. We provide an attractive value proposition to a wide array of customers and to the insurance industry, and we are in the unique position to leverage our inventories of both recycled parts and aftermarket product by having the ability to sell out of either inventory to satisfy our customers' needs. We have already achieved significant synergies among our operating platforms and sales organizations in order to provide for continued sales growth, as both our recycled and aftermarket products within the lowest possible cost structure. And we will continue to pursue opportunities to further leverage our infrastructure and asset base.

At this point, I'd like to ask Mark to get into a more detailed discussion on the Company's financial results.

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 to reconcile net income to earnings before interest, taxes, depreciation and amortization -- otherwise known as EBITDA. We also added supplementary data schedules related to our income statement that shows some growth and other margin percentages.

Looking at our income statement and related tables, our second-quarter 2005 revenue was up 29.7% to $136 million from 104.9 million in Q2 '04. Our first 6 months of revenue for 2005 were 31.7% to $269.8 million compared with 205 million for the same period in 2004. Our organic revenue growth was 14.6% for the quarter and 12.9% for the 6 months. Our second-quarter 2005 gross margin was 47.4% versus 47.1% in the second quarter of 2004. For the first 6 months of both 2005 and 2004, our gross margin was 47.1%.

Our facility and warehouse expenses for Q2 grew $2.7 million or 22.9% over Q2 2004. The majority of this growth was from our 2005 business acquisitions and the full year impact of our 2004 business acquisitions, which accounted for $1.9 million of the growth or 15.7% expense growth. Included in the quarter for this expense category is a $163,000 pre-tax gain on the sale of a warehouse as a result of consolidating business activities from two locations down to one. For the 6 months of 2005, these expenses as a percentage of revenue improved to 10.7% from 11% for the same period in 2004. On a 6-month basis, facility and warehouse expenses grew $6.4 million or 28.5% over 2004. The business acquisitions represented $4.6 million of the growth or 20.4% expense growth.

Our distribution expenses for Q2 were $3.7 million or 31.2% over Q2 2004; of which 1.4 million or 11.8% expense growth was due to our business acquisitions. For the 6 months of 2005 and 2004, these expenses as a percentage of revenue were 10.9%. On a 6-month basis, distribution expenses grew $7.1 million or 31.5% over 2004; of which, $3.6 million or 16.1% expense growth was due to our business acquisitions. Excluding distribution expense growth related to our business acquisitions, our distribution expenses grew close to 19.5% over Q2 2004, while organic revenue growth was 14.6% for the quarter. Related to organic distribution expense growth, fuel expense for the quarter increased by 40.8% over Q2 2004, which was primarily related to fuel price increases. In fact, if fuel costs for the companies we own in Q2 2004 had stayed at the same level in Q2 2005, our organic distribution expense growth would have been 14.7% or very close to our organic revenue growth. For Q2 2005, fuel expense is approximately 13.7% of our total distribution expenses.

Excluding effects of acquisitions, we also operated an average of 9.4% more daily recycled transfer truck runs in Q2 '05, and our subcontracted recycled transfer services increased 34.4%. Our distribution network enabled us to grow the revenue that runs over our transfer runs by 24.4% over the Q2 2004 volume.

Selling, general and administrative expenses grew $3.7 million or 24.5% over Q2 2004; of which, $1.8 million or 11.9% expense growth was due to our 2005 business acquisitions and the full year impact of our 2004 business acquisitions. We had $300,000 in higher incentive compensation expense accruals and $300,000 in higher insurance and legal claim expense in Q2 2005 over Q2 2004.

For the 6 months of 2005, these expenses as a percentage of revenue improved to 13.5% from 14.3% for the same period in 2004. On a 6-month basis, selling, general and administrative expenses grew $7.2 million or 24.6% over 2004; of which, $4.2 million or 14.3% expense growth was due to our business acquisitions.

Our selling expenses tend to be fairly variable in nature due to our commission inside sales force. Our general and administrative costs are usually less variable in relation to revenue growth.

As Joe mentioned earlier, we continue to expand our operating margin in the quarter. For the quarter, our EBITDA grew 46% to $16 million. EBITDA was 11.7% of revenue for the quarter compared to 10.4% in Q2 2004. For the 6 months, our EBITDA was 12% of revenue versus 10.9% for the same period in 2004. Our operating income for Q2 grew 50.9% over Q2 of 2004. For the 6 months, our EBITDA was 12% of revenue versus 10.9% for the same period in 2004.

Our operating income for Q2 grew 50.9% over Q2 2004 to $13.8 million. Operating income as a percentage of revenue was 10.2% in the quarter compared to 8.7% in Q2 2004. For the first 6 months of 2005, operating income improved to 10.5% of revenue compared to the 9.3% for the same period in 2004.

Interest expense for the quarter increased by $460,000 over Q2 2004 to $735,000. We had higher debt levels in Q2 2005 due primarily to debt incurred on our 2004 and our 2005 business acquisitions. Our Q2 2005 pretax income grew 47.6% to $13.2 million over Q2 '04. As a percentage of revenue, our pretax was 9.7% for Q2 2005 compared to 8.5% for Q2 '04. For the first 6 months of 2005, pretax income increased 48.1% to $27.2 million from 18.4 million for the same period in 2004. Our effective income tax rate was approximately 42.2% for Q2 2005 versus 40.2% for Q2 2004.

However, in Q2 2005, net tax balance sheet accounts of $133,000 were adjusted; that represented a 1% effective rate increase for the quarter. These were various state-related adjustments and included the effect of Ohio phasing out their corporate income tax and phasing in a gross receipt tax over the next 5 years. That legislation just occurred several weeks ago in Ohio.

For the first 6 months of 2005, the effective rate was 41.1% versus 40.2% for the same period in 2004. Again, the 2005 rate includes the 133,000 of state adjustments. Had it not been for these adjustments, the 6-month 2005 effective rate would have been 40.6%. We estimate the second half of 2005 to be around a 40.6% overall tax rate.

Net income for the quarter increased 42.7% to $7.6 million from 5.3 million in Q2 2004. For the first 6 months of 2005, net income increased 46% to $16 million from $11 million in the same period of 2004.

Our diluted earnings per share increased 37.5% to $0.33 in the quarter from $0.24 in Q2 2004. For the first 6 months of 2005, diluted earnings per share increased 40.8% to $0.69 from $0.49 for the same period in 2004. Our diluted weighted average common shares outstanding used for EPS purposes were as follows -- Q2 2005 at 23.4 million versus Q2 2004 at 22.5 million shares, 6 months 2005 at 23.2 million shares versus 6 months '04 at 22.3 million shares. Our diluted weighted average share count increased by 4.1% for the quarter and by 3.8% for the 6 months over 2004 comparable periods.

Let's take a look at our cash flow table. We generated $20.4 million in cash from operations during the first half of 2005 compared to 8.6 million for the same period in 2004. CapEx excluding business acquisitions for the first half of 2005 was $6.5 million. Cash paid for our business acquisitions during the first half of 2005 was $24 million. We issued stock related to the exercise of stock options and/or warrants that resulted in shares issued and net dollar proceeds received that totaled approximately 370,000 shares and $3.8 million net of proceeds in the quarter and approximately 460,000 shares and $4.4 million on net proceeds in the first 6 months of '05. We issued no stock related to business acquisitions in the first half of 2005.

In looking at our Q2 2005 balance sheet, you will note we had 56.5 million in debt, which included $53 million in debt under our unsecured Credit Facility with our bank group. As of today, our Credit Facility debt is at $50 million. As we previously reported, we amended our bank credit agreement effective June 1, 2005. The amendment increased our total borrowing capacity from $100 million to $135 million and extended the maturity from February 2007 to June 1, 2010 and also modified certain other terms.

We expect that full year 2005 will be within a range of $539 million revenue to $542 million revenue. And that organic revenue growth will be in the low-double digits, with the balance of the growth being the full year impact of 2004 business acquisitions and our 2005 business acquisitions made to date. We expect net income to be within a range of $28.1 million to $28.8 million, and diluted earnings per share to be between $1.19 and $1.22.

For the third quarter of 2005, we expect revenue to be between $134 million and $135.5 million; net income to be between $5.9 million and $6.3 million; and diluted earnings per share to be between $0.25 and $0.27. We estimate the weighted average diluted shares outstanding for the full year 2005 to be approximately 23.6 million shares and for the third quarter to be approximately 23.7 million shares. These share numbers are estimates and as such, will be affected by factors, such as any future stock issuances, the number of our options and warrants exercised in subsequent periods, and changes in our stock price.

In our previous guidance discussed on April 28, 2005, we had estimated weighted average diluted shares outstanding was to be 23.1 million for 2005 compared to that 23.6 million we had just updated. Our updated 2005 diluted earnings per share guidance for the full year would have been higher by $0.03 had the earlier share count guidance not changed. Our 2005 guidance does not include the effect of any future business acquisitions. The indicated guidance also does not include the impact from SFAS Number 123R, Accounting for Share-Based Payment. The SEC postponed the implementation of this pronouncement by 6 months. Accordingly, it would be effective for us on January 1, 2006.

We anticipate that net cash provided by operating activities for 2005 will be in excess of $25 million. We estimate our full year 2005 capital expenditures, excluding any future business acquisitions we may do, to be about, approximately $24 million. We previously indicated on our last earnings call that CapEx would be $19 million. The additional 5 million is for the purchase of land adjacent to our current recycling facilities, acceleration of recycling facility construction projects and assets for planned aftermarket geographical expansions.

As you can see on our cash flow table for the first half of 2005, we only spent $6.5 million for CapEx of the total 24 million full year estimate. While we have run behind the date, we still plan to pick up our spending in this area. Of course, if some of these projects are scheduled late in 2005, some may end up getting pushed into 2006 due to weather and other state schedulings' conflicts.

I would like to turn it back to Joe for any further comments and then open up for Q&A.

Okay, Katie, if you are on, would you please open the system for questions?

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

Could you maybe talk about the businesses individually aftermarket versus recycled OEM as far as the strengths? That would be from a sales basis.

I am trying really -- could you maybe just explain a little bit more?

Just in general, from the comp of 15% organic growth that you saw, was there any particular strength in any one area -- meaning, was aftermarket as strong as the OEM side?

I'm sorry; that is very clear. Yes, we are seeing a little stronger organic growth on the aftermarket side, which I think we would all expect. First of all, we are growing off a smaller base. And secondly, we are expanding the replacement parts aftermarket parts into existing LKQ markets. So you are absolutely correct. We are seeing our aftermarket parts' organic growth in the low 20% range in the second quarter, which still left us with very healthy same-store sales growth in the recycled parts side.

And as far as the auction activity that you are seeing right now?

Second quarter was very healthy. In many weeks, we saw 43, 44,000 vehicles at the auctions that we attend. Seasonally, we see that come off a little bit in the third quarter. Last couple of weeks, total car counts have been in the high 30,000 range. That's pretty normal. But right now, I would say it is a pretty healthy environment.

Okay. And in general, could you talk about the demand side of the equation right now -- how you equate what you are seeing?

The second quarter was obviously pretty robust. The same-store sales growth or our organic growth for the Company, as we indicated, was very close to 15%. Going into July, business the first few weeks of July has softened up a little bit from the activity levels we saw in June. That is normal. It isn't anything that we are concerned about at the moment. But certainly, the forecast that Mark has provided for the third quarter would assume that we would see some strengthening as we move into August and September. And that is typically what we have seen in our number of years in the business.

So if you were to look at July, what you are seeing so far in the year-over-year basis still running at more historical ranges, which would be in the, I guess, the low-double digit range?

I have not looked at that, Scott. I just benchmarked it to really what we were seeing on a weekly basis in June. And we have just tiered off a little bit.

Sean Boyd (ph).

Good quarter. Just a couple quick questions for you. In terms of the third quarter, should we expect the growth margin to dip as it did last year? End of your third and fourth quarter, I guess, how should we look at that?

We certainly would not expect the gross margin to decline as much as it did in the third quarter of last year. I don't know if you were on our calls in 2004, but we think we had overbuilt our backlog in 2004, and we ended up correcting that in the third quarter and partially into the fourth third. We think that is behind us. We think we've managed that issue appropriately in 2005. You will likely see some decline in the Q3 gross margin compared to Q2. But as I said, I would not expect it to be of the magnitude that we experienced in 2004.

And on the operating expenses running 51 million a quarter at this point, is there -- obviously, additional acquisitions change that number. But at the current run rate, is there anything significant that is going to move that up or down?

We tend to see a little bit of increases as we get -- sequentially as we get into the next quarter. Some of our insurance plans renew with employees, medical and that type of thing. You can almost look at prior trends on that. There's a seasonality to that as well.

And just longer term, let's get away from the quarters 1 second in terms of the margin. What are you -- at this point, you are 10% operating margin, so what are you gunning for kind of longer term say 2, 3 years out?

We have set internal goals typically to increase our EBITDA margin, operating margin by close to 1 point per year. We find that sometimes that will get diluted by new businesses that we bring into the Company or by our greenfield operations, which we still think are good uses of our capital to grow our Company. But our internal targets for the existing business, typically, we get in the budget season is about 1 point per year.

And on the organic growth, with that accelerating 15% in this quarter versus 13% for the first half, is it correct to just assume that is primarily from the aftermarket piece layering on now?

The aftermarket parts helped it a little bit. But the recycled piece of the business is still in the 13 -- a strong 13% same-store sales growth. As Mark said, we do see the variations by quarter, so we'd still like to think in terms of 2005 kind of a low-double digit level.

And I know you guys have said in the past that you think that the -- capturing that "lost aftermarket" -- not lost but the orders in the aftermarket's business that you couldn't fill before that that might take kind of a 3-year timeframe. Given what is going on, any chance we are going to see that a little bit faster than that? Or do you still think it is a 3-year haul?

Well, before too long, we are going to have one of those 3 years behind us. Yes, I think I would stay with our original time schedule. We are still a couple of years out.

On the acquisitions, can you give us any flavor for anything you're looking at anything at, anything you would expect in the back half? How is the cone out there? Are you still seeing a lot of deals? How does that look?

Yes, I would say the pipeline in terms of the quantity of projects and good quality projects that are on the table is as good as I have seen. We obviously don't get every deal done that we go after. Sometimes, we get a month or two invested into something we think will get down, and then you just can't get to the right price. My hat is off to our acquisition team. I think they negotiate fairly and hard.

Anyway, the pipeline, as I said, I think it is as good as I have seen it in quite a while.

And just one last little detail, the free cash flow -- I just want to make sure I heard you correct -- you are expecting full '05 free cash flow or operating cash flows at 25 million?

Well, actually, I said in excess of 25 million. That is kind of like the bare minimum.

And your CapEx is going to be 24 million for the full year?

And the reason I don't peg exactly 25 is -- we actually tried to invest in some inventories towards year end, where we open warehouses up or build a salvage inventory a little bit going into the winter months. We are not going to overpay for stuff on the salvage side. Like last year, I ended up with a little more cash flow from operations than I thought. It's possible that could happen, but I feel comfortable saying it's going to be over 25.

Okay, great quarter; thank you.

Kenneth Gray (ph).

Bill Gibson, Nollenberger Capital Partners.

Just a question on the competitive front on acquisitions. Is anybody new shown up? Are you pretty much still the only game in town in terms of being a national acquirer out there?

I'd really have to look at probably a few different business models to answer that. In terms of the self-service businesses or the yards that are capable of being self-service businesses, Schnitzer Steel has done -- very active in the market, drawing their business. And a couple regional players or scrap metal processors are beginning to dabble in that side of the industry a little bit. Obviously, in the aftermarket side, Keystone has -- and I'm sure it will continue to be active on the deal front.

In terms of our primary business line, the recycled parts side of the business, I am not aware of anyone who is actively buying companies other than us.

And just to follow-up a little bit on what Sean was talking about in terms of your 3-year plan on aftermarket and salvage. Can I get you to maybe give me a baseball analogy in the sense of -- and I'm looking at also the demand side as people get used to calling you as a one-stop shop -- what inning are we in?

Probably the second.

Second inning?

Yes, we still have a lot of work to do to get -- especially on the aftermarket side -- to get our Company into the estimating systems and on the estimates. Keystone obviously has a very significant lead over our positioning on that today. And there's nothing that is rocket science there. It is just time, marketing, building relationships and getting the job done.

Gary Prestopino, Barrington Research.

Couple of questions -- you mentioned that salvage pricing improved in this quarter. Is that a function of pricing in the overall market went down year-over-year or did not grow as much as you expected? Or did you guys -- I believe last year, you had some issues with overbuying and paying a little bit too much. Could you kind of clarify that?

As you can see, our margins expanded. That was part of the buying. That doesn't mean we would hit the markets -- to hit the auctions and they're all rock bottom pricing -- that's not what we mean by that. We focused our car mix a little bit and added some additional lower end cars from a pure dollar standpoint. But there seemed to also be cars available; the auctions seemed to have cars. And the cars we were looking for, we were able to get what we wanted in our margin requirements.

So it wasn't any kind of trend in the industry that you're seeing where the pricing is actually starting to -- growth is starting to slow or come down?

No, they were your average salvage costs was what we paid for vehicles -- was really very consistent with what we've seen in the last few quarters. One thing we are doing internally is we are working on proprietary bidding tools that will allow our people in the field to assess more products in the time they have at the auctions.

Can you maybe give us some insight into any technology initiatives you are possibly doing with your buyers to kind of increase productivity, lower the costs of getting those guys out in the field and buying and looking at cars? Anything you can shed light on there?

Yes, we have a product underdevelopment as we speak. We are kind of enhancing that product on a monthly basis. It's not ready for full rollout across LKQ. We believe the advantages of the tools will allow all of our field scouts to assess probably 20% more vehicles in a day than they have been able to do historically.

A lot of product comes into the auctions really at the last minute that gets released for being auctioned -- will allow our people in the field to respond to all the products at the auction as opposed to simply what was available the day the scout went through. And I suspect it will take some of the manual errors out of the process as well.

Can you elaborate on what exactly you're doing? Or does it have to wait until it gets rolled?

We are using, developing little handheld systems that will have the database, if you will, automating the thinking process. We had a governance group in Akron doing -- for the last couple of years.

And then, in terms of your geographic expansion for both sides of the business -- I know you kind of back end filling the recycled -- but can you talk a little bit about where you might be wanting to back end fill recycled as well as where your next step in the aftermarket parts would be?

The recycled side, certainly, I think the East Coast still holds a number of business opportunities that are fairly high in my radar screen. And on the aftermarket side, I think our next step will be into New England.

And there after, you're looking in -- where, in the Rocky Mountain area?

Yes, the real weakness obviously in terms of our botch (ph) almost both sides of the business is in the western half of the U.S. We certainly enjoy the ability to network our businesses in the East Coast -- Bodymaster and Action obviously had nice footprints here. It has been an ideal market for us to kind of learn how to bring our businesses together to work most effectively.

And then the last question, with your share account, the numbers you gave us for Q3, in order to get to about a 23.6 million average share count for the year, it looks like you are going to have to come in somewhere around 24.5, 24.6 million shares in Q4. Is that about right, Mark?

Yes, you have to get in here and run through the thing. Our stock price effects us as well.

So we are looking at almost potentially from Q2 to Q4 an additional 1 million shares in the share account, and that's basically due to options being in the market--?

No, no, no. It's not through options being exercised. As our stock price goes up, that puts more of the options in the money, and the treasury stock method starts running that up. That doesn't necessarily mean anybody is going to exercise. I have no way of knowing who is going to exercise and which one is going to exercise.

So as putting that in the model, as well as the ones that came in Q3 is -- over an average period of time. Then, all of a sudden, boom, they flop into the next period. You can kind of do the math. You've got some weightings here. And I gave you Q3, so you can tell exactly how strong the EPS is in that period. I think we said -- it's 25 to 27. But the numbers I gave you, you can calculate exactly Q3 and then you've got the full year there.

Bill Armstrong (ph).

I have a few questions. You mentioned July business softened a little bit versus June. Is that just a normal seasonal lull?

Absolutely. We have seen it every year.

Any impact from some of these early hurricanes that we have seen in the South? I think you had some impact a year ago. I was wondering if you were seeing anything so far.

No, not really. Certainly, I can't say that we have seen any more robust auction environment than -- even in the panhandle of Florida to be quite honest with you. I would say at this point, really no impact on the business up or down.

In terms of the aftermarket business, what was the gross margin there in the second quarter?

Really fairly consistent with where we have been if we just looked at the two main aftermarket businesses that we bought, the Action and Bodymaster. They are really very consistent with what we have seen in the prior quarters.

So in the 44%, 46% range?

We also had aftermarket revenues that are being generated by the LKQ facilities on top of that. We have had some slight improvement on the aftermarket margin. We decided going forward not to break that out for competitive reasons. This quarter, we improved both on the salvage and a little bit on the aftermarket as well. It kind of feels as we go forward here, for competitive reasons, we shouldn't be breaking those two out.

Could you also tell us the number of vehicles purchased both for the wholesale business and for the self-serve business?

The second quarter, we bought through all sources, we acquired about 24,000 vehicles for the -- what I will refer to as the wholesale fleet model recycled business. And our self-service business, we acquired about 14,000 vehicles.

And then finally, in terms of your goal to expand operating margins by about 100 basis points a year, what are we talking about -- 2, 3, years, 4 years? And what would be the main drivers in allowing you to do that?

We are looking at kind of 1 point per year. I think we will continue to get more leverage on the G&A side of the business, as well as our facility and warehouse costs. The other area where I would see us gaining leverage would be with the aftermarket parts sales and our ability to incorporate the delivery of some of those parts into existing LKQ routes.

Craig Kennison, Robert W. Baird & Co.

This is Craig. I'm sorry; I did not recognize my name there. Congratulations on your quarter. First question has to do with your average cost per vehicle, did you give that number?

We did not, but it is essentially flat with where we were about a year ago. It's still right in the middle $1,600 range in the raw cost of the vehicle.

And the actual number of salespeople?

377.

Is that internal only?

That includes our business development people as well -- I mean our outside sales reps.

That's helpful. And relative to your generic part business, that has clearly provided some revenue synergies. I am wondering if you can give us some sense of the average dollar per order this year versus last year at this time when you did not have much of that business.

We are going to have to get back to on that. I'm not prepared to answer that right here.

Fair enough. You indicated that you've got some technology to improve the number of vehicles that you look at. Would that also increase your bid rate -- the number of vehicles on which you bid?

Yes, it would. That should be one of the outcomes of that is that we would be bidding probably a few percentage points more of the vehicles at the auctions (multiple speakers).

So do you have your bid rate and win rate for this quarter?

That has really been pretty consistent. We still see on a weekly basis that we bid -- actually, it's kind of up to about 30% now in terms of the percent of the auction that we assess and bid. And what we bid, we are still running about 12%.

In the past, you've talked about strategies to distribute product through some alternative retail channels. Any update to that strategy?

Yes, we started a pilot in late in the second quarter with a national retail chain. There about 20 some stores in the pilots. We have to date not seen what I always consider material revenues to come from the pilot, but they seem happy. It is clear to me that working with the retail chains, there will be a fairly long curve. I think LKQ is well-positioned to work with the retail chains.

What we have seen to date is that the turnover in the retail chains is pretty significant. Even during our pilot, when we go back to stores for the second visit for follow-up training, the same people are not there who were there on the first go around. But any costs with having a broad national network in the major markets, it does provide us with the resources and the people on the ground that we can do the follow-up training at the retail stores -- would be necessary. So it is slow going, Craig, but long term, I am pretty encouraged about what it could do for our Company.

Joe, could you describe a framework of that business model? In another words, I assume you are keeping the inventory, and they call you, and then you share the revenue. And what is margin profile; that sort of thing.

Yes, you are right. There is no intent to have them to warehouse our products. We make it -- the access to us can be either Telephonics or we will have our products -- ultimately, it will be available for them to see online. Not all of the retailers truly have a good online capability -- probably move more to a kind of a set price -- a family price, if you will and leave the ultimate market pricing decision to the retailer.

Is there a concern at all that if that were to be particularly successful and become a large percentage of your revenue that that margin mix might be inferior to your broader portfolio?

That would be a nice thing if it became that significant piece of our revenue. I don't know that I could come to that conclusion today. Still, a lot of the product I think that we would be selling here -- our concern here is to make sure that we are not creating channel conflict for LKQ. The customer base here is largely going to be a DIY retail customer; it's probably not our customer today. And the real golden piece of this -- if it works -- is that we would be making sales here that ordinarily those parts, we would not be selling at all.

So it's a different SKU almost?

Yes, it would be a different SKU, if you will.

Would an example be, and I'm guessing, maybe a rearview, which you may not sell in the wholesale market?

Yes, it could be something like that or even some of our small rotating electrical -- because the market for the small rotating electrical parts is -- really moves away from the recyclers to the retail chains.

And then, if you have a minute, maybe review some of your international strategies. I think a year ago, you looked at Central America. Maybe update us on the progress there? Thank you.

Yes, Central America, we are -- the business there is not a significant piece of our operations. I think from the time we acquired the businesses, we have probably expanded our business base by a little over 20%. We continue to focus on -- I will say product that probably would not sell in the United States, we containerize that and ship it to the three stores we have in Central America. Seats and tires and wheels would be some of the higher demand product that we send down.

Monitoring situation, certainly kind of watching the profit margins. As we get to the end of this year, we will probably reassess whether or not we should consider a fourth market in Central America.

George Day (ph).

One question regards to the seasonality of the aftermarket parts. In the second quarter, it declined slightly from the first quarter, while the savage parts actually grew sequentially. So I am just trying to understand the dynamics here. Thank you.

Two things -- one, we did buy an $11 million ongoing business in South Carolina that was a recycled business, and that was in for the whole second quarter per. We did not buy an aftermarket business in the second quarter. We did buy one in the first quarter, but they came on February 1, so it was more of a piece of acquisition growth there.

But also you have to remember in the recycle business, we are kind of selling to two markets. We are selling collision repair parts to body shops, and we are selling mechanical parts to repair shops. And those seasons aren't exactly the same in a lot of our markets. So you tend to have a little more drop in the aftermarket in the slower seasons than you would on the recycle side. For example, bad weather doesn't really affect the mechanical parts sales.

I see. So if you back out the acquisition on the salvage part side, the salvage part actually also had a sequential decline in second quarter vis-à-vis first quarter?

I think what Mark is saying is that the collision parts of the sheet metal --

Would decline --

Would have declined a little bit, but that was, if you will, somewhat offset by the sale of mechanical parts. I think we've -- go one more question if there is one.

Bill Armstrong.

Right, just a follow-up on the mechanical parts, I assume that most of that is paid for by the car owner and it's not covered by insurance. So if that is the case, how do you I guess increase your share in that business versus new OEM parts?

The majority of the motor/transmission sales are not insured repairs. We do sell -- our larger customers are typically extended warranty companies. So indirectly, that is a form of insurance. But you grow that piece of the business in two ways. One is having the products; we pride ourselves in terms of the vehicles that we targeted in acquisitions. We target lower mileage products. We thinked (ph) in a lot of our competitors. So we think that makes our motors and transmissions in particular more attractive to customers.

And secondly, just old fashioned shoe leather on the street, meaning the dealerships and parts installers and running our business with good quality product that is a solid warranty and standing behind the -- and warranting what you sell.

So with the extended warranty business, is that mainly through shops that are part of a new car dealership franchise?

No, not really. The extended warranty company, AIGA, Fidelity that sell -- big extended warranty companies. We sell a lot of products back to them in order for them to be able to fulfill the extended warranty period.

So you are selling direct to them?

In some cases, yes.

In some cases, we sell to a shop that's then being made by the --

Reimbursed by them.

Is there a push from the extended warranty companies similar to the other mainline auto insurance companies to lower costs via aftermarket and recycled parts?

We have watched that go up and down. When their margins are strong, they don't tend to -- I will say manage the utilization, the recycled parts quite as closely. As their market gets more competitive, we tend to see them step back in and use more recycled product in the repair process.

What phase are we in right now in terms of that?

I would say their margins are pretty good right now.

So they are not really pushing it that hard?

No, not as hard as we've seen in some years that we've done assets.

All right, thanks.

Everybody, thank you for joining the call. We appreciate your continued interest in our Company and learning more about our business. And we will be talking to you probably the last week of October for our Q3 earnings call. Thanks again.