LKQ Corp (LKQ) 2005 Q3 法說會逐字稿

Welcome to your conference call with your Chairperson, Mr. Mark Spears. Just a reminder that this call today will be recorded. All participant lines will be in a listen-only mode until the question and answer session of the conference. Thank you for using Conferencing Services. Mr. Spears, I’ll turn the call over to you.

Some statements. Some 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 8, 2005, and in other reports filed by us from time to time with Securities and Exchange Commission. (Inaudible) 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, and thanks for joining LKQ Corporation’s Third Quarter 2005 Earnings call. On our call today are two members of our management, Mark Spears and myself. I’m Joe Holsten, the CEO of LKQ. I’ll begin by providing some overview of our performance as well as some qualitative views on our business and our industry. And Mark will provide a more detailed assessment on our quarterly financial results.

Before getting into the company’s performance, I thought it worth noting a few things that took place over the last sixty days. First, obviously, being the fact that now three hurricanes have hit the gulf cost. We feel very fortunate that our facilities in Louisiana and Texas came through with very minor damage. We’ve estimated that the adverse impact in our Q3 revenue from both of the storms that struck during the second quarter was likely around three quarters of $1 million in revenue. And the EPS impact’s likely under $0.01. We’re still evaluating the impact of Hurricane Wilma on our fourth quarter. But I can report that we did not incur any material asset impairment as a result of Wilma.

Second, in September, 2005, we successfully marketed a secondary stock offering that closed on October the 4th of this year, with company issuing approximately $3.2 million more primary shares. Mark will walk through this transaction in a few minutes, its’ impact on our balance sheet and our outstanding shares for the balance of the year.

Third, after our offering closed, we were pleased to see two additional equity research analysts began their initial coverage on our company. One from Raymond James and one from Morgan Keenan, giving us a total of eight research analysts covering the company and who we believe have a very solid understanding of our company and our industry.

Fourth, I’d like to mention that our company was ranked by Forbes Magazine as Number 89 in its listing of the 200 best run small companies, with small being defined as less than $750 million in sales, and we take a lot of pride in getting on Forbes’ list.

And, finally, I see some prankster made a note in my notes that I should comment on the Chicago White Sox winning the World Series as being another recent event.

Let’s look at our quarterly results now. We reported $133.6 million in revenue for the third quarter, which represents 26% growth over the third quarter of 2004. Organic revenue growth was at 11% for the quarter. Our gross margin was 47.1% for the quarter, which is significantly better than the gross margin in Q3 of 2004 of 45.9%. The improved margin was primarily attributable to improved pricing in salvaged cars in both Q2 and Q3, along with the company doing a better job of managing our vehicle backlog in 2005 than we did in 2004.

Our EBITDA margin was 10.4% for the quarter, a 130 basis point improvement, totaled a 9.1% EBITDA margin from Q3 of last year, and our operating income margin improved from 7.5% to 8.6% as well in the quarter. Our net income increased by 45% to $6.6 million for the quarter, and diluting earnings per share increased by 40% to $0.28. We also reported strong operating cash flows in the quarter, which increased by $3.2 million over Q3 of 2004 to almost $15 million in the quarter.

We continue to expand our aftermarket coverage areas. As you know, in February, 2005, we extended our marketing and delivery presence into the northern New Jersey, Philadelphia, and Washington, D.C. marketplace through the Bodymaster acquisition. In late August, we acquired two additional aftermarket businesses for $13.4 million. These two companies have $16.6 million of trailing revenues. Their businesses have six locations with approximately 100 employees, and serve customers throughout the state of Arkansas and markets in Tulsa, Memphis, central Pennsylvania, and the southeastern portion of New York State. Both sets pairing nicely into our distribution networks and will allow us to reach new markets with aftermarket and recycled product.

In terms of other expanse and not activities in aftermarket operations, our aftermarket warehouse in Oakland, California became fully operational during Q3. We’ve previously indicated our plans to open an aftermarket warehouse facility in the greater Chicago area. This facility is now expected to be open to sell parts in the first quarter of 2006. It’s time to use to that facility for distribution of both recycled and aftermarket parts when we open it.

Finally, we opened a warehouse in Webster, Massachusetts, which is south of Boston, and began selling aftermarket parts in that market just last week. So our aftermarket business in now operating out of fifteen regionally located warehouses and locations: Charlotte, North Carolina, Columbus, Ohio, Dallas, Oakland, Philadelphia, Washington, D.C., Atlanta, central Florida and Crystal River, the one in Webster, Mass. I just mentioned, Carlisle, Pennsylvania, Bryant, Jonesboro and Springdale, Arkansas, plus Little Rock and Tulsa.

In August, 2005, the Illinois State Supreme Court overturned the Avery versus State Farm class action suit in favor of State Farm. The court was critical of the lower court’s ruling. The plaintiff subsequently filed a motion for the court to reconsider its decision and the court refused. We now understand that the plaintiffs have filed an appeal to be heard by the United States Supreme Court.

Our aftermarket businesses operate at 29 transfer runs and 313 local delivery routes of the (inaudible). Our recycled parts business operated 55 transfer runs and 364 local delivery routes during the third quarter. In various areas, these recycled part routes also deliver aftermarket product. In total, LKQ has a delivery system approaching about 700 daily local delivery vehicles.

So far in 2005, we have made two recycled business acquisitions. The larger of the two was ANR Auto Parts. It closed on April the 1st of 2005. Pace in South Carolina, this company delivers parts throughout most of South Carolina, and has been integrated very effectively into our mid-Atlantic region distribution system. The 2004 revenue of that business was approximately $11 million. In terms of other potential geographic expansions, we continue to work with a very healthy backlog of acquisition candidates that include both recycling and aftermarket businesses, and I expect that those are additional transactions before the end of 2005.

As we commented in the past, in 2004, we opened three automotive recycling facility Greenfield operations; one each in central Texas, southern Pennsylvania, and southern Louisiana. I’m happy to report that these businesses are progressing nicely as they, as a group, have generated a 34% increase in revenue in the nine months of 2005 over 2004, despite having a slight adverse effect on our current operating margin. We would also note that the revenue gains were achieved in spite of the adverse impact of the hurricanes on our Louisiana start-up.

We acquired approximately 59,300 vehicles in our wholesale recycling business during the first nine months of 2005, which is about 7% more than the number we acquired during the first nine months of last year. The percentage of vehicles that we acquired from salvage auctions in the first nine months remained around 92% of our total incoming product (inaudible).

We discussed on our last call that we had several pilots underway with various retail auto parts companies that supply them with parts. I’m happy to report that the participating parties in these pilots are generally pleased with the progress that we’ve made mutually, and they’ll continue to work with LKQ towards slight expansions of their program.

Our business within insurance carriers continues to grow in terms of the number of carriers we work with as well as the markets that we work with them in. The services we provide include various estimate review services, enhanced recycling or aftermarket part utilization for the carriers, as well as the disposing of their total loss cars to a direct procurement program. While we currently have estimate review programs with twelve different carriers and direct car procurement programs with eight carriers in certain markets, we have numerous growth opportunities with these carriers to expand these programs and in more markets. And, obviously, there are a number of additional insurance carriers in the country we will be marketing to.

We’ve received a number of questions regarding salvaged vehicles in the Louisiana market. We’ve seen estimates that range anywhere from 200 to 500,000 vehicles have been destroyed. Our expectations are that salvage auctions will get the hurricane damaged vehicles, although we believe that those from the heavily contaminated areas of New Orleans will likely be scrapped by the insurance carriers.

As I discussed on last quarter’s earnings call, we continue to increase our sales staff levels for our recycling business, and we’ve done so by an average of 55 people more in Q3 of 2005 than Q3 of 2004. This is a 16% headcount growth with approximately 32 people, or 9% growth coming from acquisitions and 23, or 7%, from organic hiring.

In summary, we believe the fundamentals of the business and our company remains very strong, and LKQ continues to operate a very compelling and successful business model. We provide an attractive value proposition to a wide array of customers and the insurance industry, and our unique position that leverages our inventories of both recycled parts and aftermarket product by having the ability to sell out of either inventory to meet our customers’ needs. We’ve already achieved significant synergies amongst our operating platforms and sales organizations in order to provide for continued sales growth of both our recycled and aftermarket product lines within the lowest possible cost structure. We continue to pursue opportunities to further leverage our existing assets and with the strongest balance sheet we have seen since the inception of our company. The company’s well positioned to take advantage of the many growth opportunities around us.

At this point, I would like to ask Mark to provide a more detailed discussion on our financial results.

Good morning, everyone. Let’s take a look at the tables that’s in our press release and that we have also included a table that reconciles 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. This showed growth in margin percentages.

Looking at our income statement and related tables, our third quarter 2005 revenue was up 26% to $133.6 million from $106 million in Q3, 2004. Our first nine months of revenue for 2005 grew 29.7% to $403.5 million, compared with $311 million for the same period in 2004. Our organic revenue growth was 11.1% for the quarter and 12.3% for the nine months. Our third quarter 2005 gross margin was 47.1% versus 45.9% in the third quarter of 2004. For the first nine months of 2005, our gross margin was 47.1% compared with 46.7% the same period in 2004.

Our facility and warehouse expenses in Q3 grew $3.2 million or 26.4% over Q3 of 2004. The majority of this growth was from our 2005 business acquisition and the full year impact of our 2004 business acquisitions, and that accounted for $2.3 million of the growth or 19.1% expense growth. On a nine month basis, facility and warehouse expenses grew $9.6 million or 27.8% over 2004. Business acquisitions represented $6.9 million of the growth or 19.9% expense growth.

Our distribution expenses for Q3 grew $3.2 million or 25.5% over Q3, 2004, of which $1.6 million or 13% expense growth was due to our business acquisitions. On a nine month basis, distribution expenses grew $10.3 million or 29.4% over 2004, of which $5.4 million or 15.5% expense growth was due to our business acquisitions. Excluding the distribution expense growth related to our business acquisitions, our distribution expenses grew close to 12.5% over Q3 of 2004, while organic revenue growth 11.1%. Related to the organic distribution expense growth, fuel expense for the quarter increased by 51.2% over Q3, 2004, which was primarily related to fuel price increases. In fact, if fuel prices for the companies we owned in the third quarter of 2004 had stayed at the same 2004 price level in Q3, 2005, our organic distribution expense growth would have been close to 8% or lower than our organic revenue growth of 11.1%. For Q3, 2005, fuel expense is approximately 15.1% of our distribution expenses or 1.8% of our revenue.

Excluding the effects of acquisitions, we operated an average of 3% more local recycled delivery routes and 7% more recycled transfer runs in Q3 ’05 compared to Q3 ’04. Also, our subcontracted recycled transfer costs increased 35.5% over Q3 of 2004. Our recycle distribution network enabled us to grow the revenue that runs over our transfer runs by 27.2% from the level of Q3, 2004.

Selling, general, and administrative expenses grew $4.1 million or 28.8% over Q3, 2004, of which $2 million or 13.7% expense growth was due to our 2005 business acquisitions and the full year impact of our 2004 business acquisitions. We had $900,000 in higher incentive compensation expense accruals, and $400,000 in higher insurance premiums and legal claims expense in Q3 of 2005 compared to Q3 of 2004. For the nine months of 2005, these expenses, as a percentage of revenue, improved to 13.6% from 14% for the same period in 2004. On a nine month basis, selling, general, and administrative expenses grew $11.3 million or 26% over 2004, of which $6.2 million or 14.1% expense growth was due to our business acquisitions.

We had $1.3 million in higher incentive compensation expense accruals, and $700,000 in higher insurance and legal claim expense for the nine months of 2005, compared to the same period in 2004. Our selling expenses tend to be fairly variable in nature due to our commissioned inside sales force. Our general and administrative costs are usually less variable in relation to revenue growth.

For the quarter, our EBITDA grew 43.8% to $13.9 million. EBITDA was 10.4% of revenue for the quarter compared to 9.1% in Q3 of 2004. For the nine months, our EBITDA was 11.5% of revenue versus 10.3% for the same period in 2004. Our operating income for Q3, 2005 grew 43.8% over Q3 of 2004, to $11.5 million. Operating income as a percentage of revenue was 8.6% in the quarter, compared to 7.5% in Q3, 2004. For the first nine months of 2005, our operating income improved to 9.8% of revenue compared to 8.7% for the same period in 2004.

Interest expense netted interest income for the quarter increased by $393,000 over Q3 of 2004, to $704,000. We did have higher debt levels in Q3 ’05 due primarily to debt incurred on our 2004 and 2005 business acquisitions, and our interest rates were approximately 2% higher in Q3, 2005. Other income in Q3, 2005, included a pre-tax gain of $335,000 on the sale of equity securities. Our Q3, 2005, pre-tax income grew 47.4% to $11.1 million over Q3 of 2004. As a percentage of revenue, our pre-tax was 8.3% for Q3 ’05 compared to 7.1% in Q3 ’04. For the first nine months of 2005, pre-tax income increased 47.9% to $38.3 million from $25.9 million for the same period in 2004. Our affected income tax rate was approximately 40.6% for Q3 ’05 versus 39.6% for Q3 ’04. For the nine months of 2005, the effective rate was 40.9% versus 40% for the same period in ’04. You may recall in Q2, 2005, income tax expense included $133,000 of stated [ph] adjustments. Had it not been for these adjustments, the nine month 2005 effective rate would have been 40.6%.

Net income for the quarter increased 44.7% to $6.6 million from $4.6 million in Q3, 2004. For the first nine months of 2005, net income increased 45.6% to $22.6 million from $15.5 million for the same period in ’04. Our diluted earnings per share increased 40% to $0.28 a share in the quarter from $0.20 in Q3 ’04. For the first nine months of ’05, diluted earnings per share increased 39.1% to $0.96 from $0.69 for the same period in 2004. Our diluted weighted average common shares outstanding used for EPS purposes was a follows: Q3, 2005, 23.8 million shares versus Q3 of 2004, 22.5 million shares. The first nine months of ’05 were at 23.5 million shares versus the first nine of ’04 at 22.4 million shares. Our diluted weighted average share counts increased by 6% for the quarter and by 4.9% for the nine months over the 2004 comparable period.

Let’s take a look at our cash flow table. We generated $35.3 million in cash from operations during the first nine months of 2005, compared to $20.2 million for the same period in 2004. CapEx, excluding business acquisitions for the first nine months of 2005, was $11.1 million, while cash paid for our business acquisitions during the first nine months of 2005 was $37.3 million. We issued stock related to the exercise of stock options and warrants that resulted in shares issued and net dollar proceeds received that totaled approximately 334,000 shares for $3 million net proceeds in the quarter, and approximately 737,000 shares for $7.4 million in net proceeds in the first nine months of 2005. We issued no stock related to business acquisitions in the first nine months of 2005.

Moving to our balance sheet. On October 4, 2005, we completed our public offering of 3,967,500 shares of our common stock at a price per share to the public of $29. The offering included 3,217,500 primary shares sold by us and 750,000 secondary shares sold by selling stockholders. The number of shares sold by us included 517,500 shares sold pursuant to the exercise of the underwritten over allotment option. We received approximately $88 million in net proceeds from the sale of the shares by us in the offering after deducting underwriting discounts, commissions, and the estimated expenses of the offering.

In looking at our Q3, 2005 balance sheet, on September 30, 2005, you will note we had $55.6 million in debt which included $52 million in debt under our unsecured credit facility with our back group. As of today, our credit facility debt is at zero, as our recently public offering proceeds paid the bank debt off. We also have short-term investments today of about $40 million. We now have borrowing capacity under this bank facility of $135 million. This facility does not mature until June 1, 2010.

Let’s move on to our 2005 earnings guidance. We expect that full year 2005 revenue will be within the range of $542 million to $544.5 million, and that organic revenue growth will be in the low double digits with a 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 $29.2 million to $30 million and diluted earnings per share to be between $1.19 and $1.22. We estimate the weighted average diluted shares outstanding for the full year of 2005 to be approximately 24.5 million shares, and for the fourth quarter to be approximately 27.2 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 our warrants exercised in subsequent periods, and changes in our stock price. Our 2005 guidance does not include the effect of any future business acquisitions. The indicated guidance also does not include the impact of SFAS (ph), Number 123-R, which is the accounting per share base payment. The SEC postponed the implementation of this pronouncement by six months. Recurrently, it would be effective for us on January 1, 2006.

We anticipate that net cash provided by operating activities for 2005 will be in the low to mid $30 million range. We estimate our full year 2005 capital expenditures, excluding what any future business acquisitions may do, to be between $24 million and $29 million. We previously indicated on our last earnings call that the CapEx would be $24 million. Additional amounts are for the purchase of land adjacent to our current recycling facilities. As you can see on our cash flow table, for the first nine months of 2005, we only spent $11.1 million of CapEx of the total full year estimate. While we have run behind to date, we still plan to pick up our spending in this area. Of course, some of these projects are scheduled late in 2005. Some may end up getting pushed into 2006 due to weather and other scheduling conflicts.

I would like to open up floor for Q&A.

Andrea, are you with us? Bear with us for a minute here. We’re trying to get the operator back.

Andrea, are you with us? Hello?

[OPERATOR INSTRUCTIONS]. Mr. Spears, your first question comes from Mr. Scott Stember. Mr. Stember, you have the floor.

Morning, guys.

Morning, Scott.

Joe, you said that the gross margin, if I heard you correctly, was positively impacted by, I imagine, better pricing at auction. Could you talk about what you’re seeing at the prices that you’re paying and the volume as well?

Yes. During the quarter, we saw our average cost of salvage remained really very flat with what we had seen in the second quarter. They were a little higher, maybe 5% higher, than what we had been at in the third quarter of last year. Volumes during the third quarter typically decline a little bit. Most weeks in the second quarter, we’re probably looking a 43,000 to 44,000 vehicles a week. And then third quarter, that generally dips down into very high 30’s to 40,000 vehicles a week, which is what we saw during just about all of the third quarter.

I think the benefits that we are - - we see a contingent of (inaudible) just through the company’s discipline to manage through to a healthy backlog that gives us the opportunity to pay less aggressively if pricing seems to be moving north in the auctions. We’re also in the process during the third quarter of continuing a rollout of the new proprietary bidding tool that we developed internally. That tool is allowing our scouts to assess somewhere between an extra 20% and 30% of vehicles on a daily basis, so we think that’s adding value to our overall procurement and gross margins performance.

Okay. Could you touch on this advance side a little bit? Maybe talk about how, in general, how comps are trailing in October so far and maybe just talk about the demand that you’re seeing right now on the other side of the business.

Okay. On the demand side, certainly we were very pleased with the same sort of sales growth that we saw stay in the very low double digits. So I was very happy with that. There’s been some concern, I think, from some of you whether or not high gasoline price are adversely impacting the business. I think (inaudible) data I’ve seen on that is with fuel consumption may be down somewhere between 2% and 3%, so I think you have to conclude that maybe driving is down by 2% to 3%. We typically had our - - I’ll say, our seasonal lows in September which I think we saw this year coming into October. Mid-October, it seems like the collision side of the business has started to accelerate a little bit in this quarter, with the exception of the hurricane state, was probably a little unseasonably dry. And if we - - we like to assume we’ll see more normal wet weather activity in the fourth quarter that should bring accident rates back up a little bit. That’s what we’ve seen every year and at the moment certainly have no reason to believe that won’t happen again in 2005.

So at this point, it seems that sales are pretty much tracking or your expectations for the fourth quarter, as least, would be relatively similar to the third quarter.

Generally as they move through the quarter, Scott, the revenue per day will start to accelerate. As we get towards the end of October, end of November, you start to see benefits from the fall rains and you start to get some icing in some markets. So if things are true to form, in November and December, our daily sales rates should begin to accelerate.

Okay. And touching on the hurricanes. Hurricane Wilma just went through Florida. Could you maybe just give a little more detail on your exposure there? How many facilities were impacted? And if you could compare it to the minimal exposure that you had due to the last couple of hurricanes, what we could look for?

Okay. Yes, unfortunately, we’re probably a little more in the dark on Wilma at this point. We have two facilities that were slightly impacted. One in Fort Myers, that facility services the market, basically just a little north of Fort Myers to Naples, it’s a fairly small business for LKQ. And no accident impairments of any materiality and a lot of that market has been without power and without phones most of this week. But it feels like that market will recover pretty quickly.

I’m slightly more concerned with the Eastern - - Southeastern Florida business. We operate out of Melbourne, and that plant has responsibility all the way down to and including Dade and Broward Counties. Our facility’s been operational since Tuesday. We had backup generators that we purchased for that facility a couple of years ago. Our phones are operational. Our biggest problem there is that a big piece of our customer base in South Florida really is not operational at this point. There’s still a significant amount of businesses and people without power and without water. And I’m not trying to be evasive, but at this point, you’re guess is probably as good as mine as to when those sorts of basic services get reactivated.

What our assumption is that we’re going to see a couple of pretty sloppy weeks in those markets. And then as we get into late November and December that the volume should start to come through the salvage auctions. Those are, as opposed to Rita and Katrina, the flood vehicles in South Florida are largely going to be fresh water flooded cars as opposed to salt water flooded cars, and so they’ll of interest to us at the salvage auctions. And we will also assume we’ll get some nice acceleration and demand in those markets. So kind of a Reader’s Digest answer would be that October and early November will be pretty sloppy, and we would expect acceleration in December to pretty much offset the losses from October.

Okay. And just two last questions, could you talk about headlights and anecdotally if you’re hearing anything from any shops regarding State Farm coming back to the market - - to using aftermarket?

On the lighting side, probably two comments. Just look at our action crash business because it’s really the only aftermarket business that we owned in both 2004 and 2005. Our headlight sales, third quarter to third quarter, are up marginally 2% to 3%. So we’re still seeing gains there. We’re pretty encouraged by Cappa (ph), I think, began certifying some lighting during the quarter, so I think that’ll be a real plus for helping the whole industry move the dying on the lighting sales.

As far a State Farm, I guess we haven’t heard anything anecdotally from shops. But it certainly seems to be everyone’s expectation that State Farm would be ready to pull the trigger on this pretty soon. It seems like a hurdle keeps coming up. With the latest ones, our understanding is that the plaintiffs decided they are going to see if they can get a hearing with the U.S. Supreme Court. I would assume that State Farm would take no action until the justices make a determination whether they agree to hear the case or not.

Okay. That’s all I have. Thanks.

Thanks, Scott.

Our next question comes from Mr. Jeffrey Williams. Mr. Williams, you do have the floor.

Hi, good morning. This is actually Tony Crustello. How are you guys doing today?

Doing good. How about you?

I’m doing fine. How are you doing Mark? I guess I’m wondering if in terms of the environment, what you’re seeing out there with respect to acquisitions, is it starting to - - it seems like it’s - - not that it hasn’t been competitive, but you’ve got one of your competitors made a recent acquisition on the aftermarket side, and I’m just wondering with respect to multiples or pricing, is that going to result in you having to pay up a little bit more? Or does it then limit the opportunities that you see in terms of expansion plans?

I’ll make the comment that the environment I see right now continues to be the best one that I think we’ve seen we’ve been active, which is a little over seven years. I think we’re blessed with the fact that - - maybe an encouraging aspect is that one of the competitors you’ve mentioned is also a public company. They’re certainly accountable to shareholders and would assume that they’ll keep valuations in check just as we intend to. With valuations, we continue to see in our discussions with people, we think, are very compelling. The company’s well positioned with the strength in its balance sheet, and we would expect to have a very good environment and very good results for our company to continue to grow our top line through supporting it with high quality acquisitions.

Okay. And, geographically, from expansion plans, do you continue to look towards back filling with recycled, and then leveraging that with acquisitions on the aftermarket side?

Yes, we’re certainly looking at both and we’ve talked about a number of holes in the map in the recycling side that we think are really good market opportunities, important markets where we can add to our total network, increase our fulfillment levels, and improve our coverage at salvage auctions. As you may recall, our regional structure or our goal over the next couple of years would be to probably do enough in terms of acquisitions to add a couple of regions. And by doing so, we should be able to shrink those distribution zones, and I think that helps our cost structure as we shrink those distribution zones.

On the aftermarket side, our preferred market entry vehicle continues to be through acquisitions. When we feel probably more flexibility on the aftermarket side to cold start a market if we need to. And I had mentioned that we entered in the open market this year through cold start, and then just last week, the result of the three months of planning and developing warehousing and getting parts on board, we opened a facility just south of Boston. So that will become our hub for aftermarket parts, sales, and distribution in New England. So those markets we looked at and in both of those markets, we felt that we had good opportunities to move into the markets with cold states as opposed to acquisitions. This is going to be another way that we can help keep acquisition multiples in check, if you will.

When you look at your opportunity in the aftermarket business, specifically distribution, and forgive me if you gave the numbers and maybe if you have them, in terms of number of runs and delivery routes for aftermarket versus your recycled during the quarter. And then, also, are you starting to get some benefit there in terms of maybe increasing density - - improving density or increasing utilization on existing routes, and maybe you can run some aftermarket parts in some of your recycled routes that might be going.

I’ll let Mark come back to the route question and how that’s split out. But in terms of the integration, I think we’re - - we have fully integrated the aftermarket distribution in about a dozen of our markets so far. And, yes, absolutely, I think that’s providing some benefits. We saw a lot of those, I think more in the second quarter, start to flow through in terms of the benefits toward our overall distribution costs of being able to deliver some amount of aftermarket product on the existing recycling runs.

Yes, Tony, we’ve got about 313 local delivery routes that’s aftermarket. Okay? And about 364 recycled local routes. About 29 transfer runs that are aftermarket, and 55 transfer runs that’s recycled. That doesn’t mean that some of the 364 recycled trucks are only carrying recycled though. They do carry some aftermarket as well. That’s a hard thing to break out though.

Yes. Okay. And then, I guess, lastly. Just touching on your revenue guidance, I’m assuming the increases wholly related to your acquisition that you made in August, is that fair?

Yes. We made an acquisition in August, and I think we - - two acquisitions, and then we told everybody that was running about $16.6 million a year in revenue.

Right. But I’m assuming that there’s no organic - - a jump in the organic growth rate for the - -

Oh, I’m sorry, no.

It’s primarily related to all acquisitions, is that correct?

Right. Well, the organic growth is still trending, like we said, at low double digits.

Okay. And then do you have an idea if what, if any, impact FAS-124 will have in 2006?

Yes. Back in the service quarter, we ran through that, quite frankly, because we thought it was going to happen July 1. And some of the numbers we put out that it was roughly around $1 million, I believe, a year of net income effect. About $0.04 a share, and that’s options that have already been granted prior to this time, okay? If we grant some more options, and we’re still working with our board on those levels, then obviously that would be on top of that. But they’ve run out of previously issued options. It would be somewhere around $0.04 in ’06.

Okay, great. Thanks, gentlemen.

Thank you.

The next question comes from Mr. Craig Kennison. Mr. Kennison, you now have the floor.

Good morning.

Hey, Craig.

Hey, Craig.

Thanks. The first question is on the aftermarket part business. To what extent are parts available across your entire network? And is there any way to contrast the organic growth rate at facilities that have both products available versus recycled only facilities?

I guess you’re looking for the overlap between product lines at the point.

Sure. The penetration rate, I guess, of aftermarket parts.

We’re clearly less than 50%.

Most of the overlap is east of the Mississippi River there. We don’t have very much west of the Mississippi.

I’d probably look at something in the 35% - - maybe a 35% overlap level. In terms of looking at the same store growth levels, whether or not we’re seeing acceleration markets where we offer both - - let us - - I’d rather just not give you an answer off the top of my head. Let us take a look at that.

That’s fair. And then you mentioned that you have twelve insurance providers on the estimate review service program. Could you maybe indicate of the top five or the top ten insurance companies, what number do you have on an estimate review program?

You mean in number of estimates we look at every day?

No. Just of the top ten providers of auto insurance, how many are in your program and how many are still opportunities?

Those are the major carriers who are in the program, and the ones with the largest market share, State Farm, Allstate, Nationwide and Farmers. Those are the major players who are on our estimate review service.

And would you say that those estimate review services are deployed nationwide for each carrier? Or are there opportunities to deploy further?

There are a lot more opportunities to deploy further. The decisions on those programs are still, by and large, made at the state level.

And then, Joe, if I heard you earlier, you indicated that the cost per vehicle was up about 5% versus last year. Is that on a comparable car?

No, I don’t think I would say that. I would look at that more as a mix issue of the product that we’re buying. It’s just a straight average of total procurement dollars we set out in relationship to the total number of vehicles we’ve bought. Like I said, if we look at second and third quarter, it’s within $9 of each other.

Thank you. And then, finally, do you have any sense at all or have your attorneys provided any guidance with respect to the timeline of the Avery versus State Farm case at the Supreme Court level?

No, they haven’t.

Okay, thanks. And congratulations, again, on a great quarter and an eventful quarter.

Thank you, Craig. I appreciate it.

Okay. The next question comes from Mr. Jerry Marks. Mr. Marks, you do have the floor.

Good morning.

Hi, Jerry.

Hey, Jerry.

Joe, could you remind me what seasonally happens in the months of July, August and September that makes the third quarter so tough from an organic growth standpoint?

Certainly those are the zero tolerance business. Typically, they’re somewhat favorably impacted by adverse weather conditions. Most of the markets, those are the drier months. Certainly rains and wet surfaces tend to bring more accidents. So our third quarter typically is when we see the collision side of our business tighten up a little bit. The mechanical parts remain very attractive and pretty strong in the third quarter. But typically the collision shops see a low plain in their activity for the year between early July and early October.

Okay. And when you’re talking at (inaudible), you’re talking about your gross margins getting - - because of better pricing and better procurement initiatives that you’re doing, I believe that you started to comp up against some of those benefits you start receiving in the fourth quarter of next year. What is the sustainability of these gross profit margin improvements, and do you ever make a strategic decision to try to pass on some of the pricing to your customers to gain market share?

I think I would maintain right now that I think we’ve said we thought our gross margins would remain in the 47% range. I think it would be premature to suggest that we think that we can make a permanent shift in that. I would hate to see anybody adjusting their models for continued (inaudible) function change in our gross margins at this point.

In terms of pricing, we’re typically looking more for price increase opportunities as opposed to price reductions. It’s our belief that we focus on and acquire the best salvage that’s available in the markets. We’ve spent a lot of time making sure that - - ensuring that the salvage we acquire is insurance quality product, and we like to price it accordingly. So I don’t see us - -

One thing, Jerry, be careful. When we say that average costs for cars are up 5%, that doesn’t - - we’re getting a car probably with more parts on it and in better shape. Obviously our margin wouldn’t improve if our - - because we haven’t gone out and raised prices 5%. There shouldn’t be a concern that a 5% increase in average cost per car is going to start losing margin. And, yes, you can see it did not. It actually enhanced margin in this case.

Right. Because it’s primarily just a pass through cost, right?

We see more gross margin dollars being contributed.

Okay. And as you, Mark - - there’s a couple of questions I have for you in terms of - - I noticed that escrow liability on the balance sheet. It’s the first time I’ve noticed that. What is that?

Yes, that’s new. We had a deal we had done back in ’04 where part of the - - in buying the company, we gave our stock. And as part of that agreement, if that person wanted to sell their stock, I believe that over the next two years, we were using that stock as escrow, for example, for any warranties we may have against that company, that prior owner. And we didn’t have claims. What happened was he wanted to sell the stock within two years, he had to then give us the proceeds to hold on that stock, and that’s all that is. He wanted to sell the stock because he had a gain it, and we merely just took his cash and we set a liability up.

And, if I remember, you had mentioned that in your 10-K. Where was that previously being booked?

Oh, no. We didn’t have the cash.

Oh.

For example, we issued stock for the acquisition.

Yes.

And it’s out there. So if he was going sell it, and that was our security to claim that stock back if we had any warranty claims on the deal, which we haven’t. And then in two years, it would expire and the person was free to sell his stock. And in the contract it said if he wants to sell that stock to somebody else in the market, then we lose the escrow there. So, in effect, he had to give us the cash to hold. And then I believe in February ’06, we would then have to give him his cash back.

Okay. So the offset was you got an extra couple million dollars in your cash.

Yes, that’s all. We have cash, and then we had to book a payable to him.

Now, if I heard you correctly, you said SG&A percentage of revenues - - for the numbers we run, they went up. Now it sounded like if you take out that $900,000 in additional compensation and $400,000 in legal, the real comparable numbers 13.6% versus 14%, is that correct? Is that the number, because you drug out a bunch of numbers there.

Yes. Actually, if you took the incentive comp and pull that out, we actually would have had an improvement of 30 basis points in the percentage ’03 to ’05 - - or ’04 to ’05 for Q3.

What was that extra $900,000 incentive comp?

Each quarter, we do projections for the rest of the year, and we have for the executive team and regional VPs and controllers, etc., down the line, we have bonus plans. So in the first part of the year, you’re booking what you think the ultimate bonus on the matrix will be. If you remember in Q3 ’04, we messed up there and didn’t have as much bonus to book. And then you get into Q3 ’05, and it’s been going quite well in ’05. Not only are we hitting our targets, we’re exceeding them, so the bonus accrual needs to be higher. That’s all that is.

And the extra $400,000 in legal?

That’s just a function of premiums and actually, I believe back in 2004, we ended up having a little favorable settlement. I think if you go back and look in our MD&A for that period, it’ll show we actually did better in ’04 than ’03, so ‘05’s more of that. We had no big suit or anything that we lost there. It was more of a function of 2004 being - - having some settlements and then it came out better.

Okay. And when we look at - - you guys beat your expectations or what guided to in the third quarter, you reaffirmed your annual guidance which suggests a little more of a cautious outlook in the fourth quarter. But I think there’s some distortion with the share columns, and Joe was mentioning that it sounded like the collision marker was actually accelerating in the fourth quarter. I’m just wondering what your thought process was in your guidance for the year.

What we’re really doing is giving the Q4 guidance. So looking at Q4, we’re into October here. We saw, as Joe mentioned, the first part of the month soft and then it started picking up, but that’s as we would expect. So we budget it that way and we can look back at prior trends, and November and December really pop up on the revenue per day because you’re hitting that season.

Okay.

That’s all we look at.

(Inaudible) enough in the first quarter that we don’t have any dilutions from the shares we just put out.

But even if I look at it on a net income basis, you guys were running at over 40% in the third quarter, and you’re calling for around for the mid-30ish net income growth in the fourth quarter. I assume there’s just some conservatism in there or it is based upon (inaudible) October or a combination thereof or something.

We actually had a strong - - in 2004, we had a very strong Q4.

Yes.

And a weak Q3. This year, we’ve had a pretty good Q3. We don’t expect a weak Q4, but it’s just laying out - - oh, one other point here. We did pretty well our gross margin in the third quarter. And part of that gets befitted from the backlog, so projecting our gross margin a little bit, we normally do have some decline that second half, and we put a little bit of that in there in gross margin from the seasonality.

And there are no additional acquisitions factored into our Q4 at this point.

Okay, thanks. That’s all I had.

Alright, Jerry, I appreciate it. We’ve gone on about an hour and five, so I think it’s probably time to call it a call. I’d like to thank everyone for joining us on the call today and the continued interest in our company. And we’ll be sending a notice out probably in late December or early January setting up the time and date for our next call.

So thanks, again, for joining us. Have a good day.