LKQ Corp (LKQ) 2005 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the LKQ Corporation earnings conference call. My name is Sarah and I will be your coordinator for today.

[OPERATOR INSTRUCTIONS].

As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to Mark Spears. Please proceed, sir.

Thank you. Before we get started, I just want 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 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, 2006, 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 statements to affect events or circumstances arising after the date on which it was made, except if required by law.

Good morning. Thank you for joining LKQ Corporation's first quarter 2006 earnings call. On the call, today, are two members of management - Mark Spears and myself. My name is Joe Holsten. I am the CEO of the Company. I will provide some high-level overview of our performance, as well as some observations on the business and our industry, and Mark will provide a more detailed discussion of the quarter's financial results.

As stated in our press release, we are very pleased with the Q1 performance of the Company. In many of our markets, we encountered record mild winter weather conditions and the fact that we exceeded prior guidance, we believe, is a strong reflection on the geographic diversity of our Company and the strength of our business model.

We reported $192.1 million in revenue for the first quarter, which represents both the 44% growth over Q1 of 2005 and an organic revenue growth of just over 12%. Our EBITDA margin was 12.4% for the quarter compared to 12.3% in the first quarter of 2005. Had it not been for the low gross margins, our newly acquired aluminum smelter operation and Transwheel purchase accounting, our 2006 EBITDA would have been at 12.7% and Mark will go through an explanation of this in more detail, later, in the call.

Our net income increased close to 44% to $12.1 million for the quarter and diluted EPS increased 16% to $0.22. I might remind you that in early October 2005, we closed on our follow up on stock offering with LKQ issuing 6.4 million more shares and this primarily accounts for the diluted EPS growth rate being that our net income growth rate.

[inaudible] on our March 2 earnings call, we acquired four businesses in the first quarter of 2006, including three recycling businesses. We acquired Michael Auto Parts, located in Orlando, Florida. It serves the professional repair market. This business generated approximately $12 million of sales in 2005. We also acquired two retail business - one near Charleston, South Carolina and one in Port Allen, Louisiana. These two businesses had less than $3 million of combined revenue, last year. Our objective during 2006 is to grow and improve these two businesses and to build their facilities into modern self-service retail facilities. We still expect the effect of these three recycling transaction on our 2006 diluted earnings per share to be insignificant as the two retail businesses will be undergoing significant startup activities. We previously indicated and still expect these three businesses to provide between $0.01 and $0.02 of diluted earnings per share in 2007.

We have been particularly pleased with the integration of Michael Auto Parts into our Florida recycling operations. During this fiscal year, we will be able to close a small distribution hub, eliminate three routes, reduce our buyer workforce, and leverage LKQ's better pricing for ferrous metal and catalytic converters, improving profitability.

As you know, at the end of January, we entered into a new product line with the acquisition of Transwheel Corporation, an aluminum alloy wheel refurbishing and distribution business that had about $28.5 million of revenue in 2005 from the sale and restoration of wheels. Transwheel currently operates from six locations related to wheel refurbishing and/or distribution facilities. In order for Transwheel, in the past, to secure a large number of quality wheel cores to refurbish, Transwheel procured large bulk shipments of used wheel cores, primarily from core brokers. After serving out all the wheels that they could refurbish and had demand for, Transwheel would then melt the unusable wheels in a small aluminum smelter they operate. Smelter is merely used to more economically dispose of the unusable product.

For the two months and the first quarter of 2006 that we owned Transwheel, the smelter's third-party aluminum revenue was $4.4 million at a gross margin of about 6%. Of course, 6% gross margin reduces LKQ's overall gross margin percentage. So while at a very low margin in effect does nothing more in a way than allow Transwheel to more economically obtain a greater wheel core stock than it could procure without the smelter.

As planned, we began to direct all LKQ wheel cores to Transwheel during the rest of 2006 with the addition of the LKQ wheel core that will be evaluating the importance of the smelter operation in light of Transwheel now receiving LKQ's core wheels.

Also related to Transwheel at the end of Q1, you'll note that we have eliminated [inaudible] transfer routes that overlapped with LKQ's existing product transfer truck. We vacated the Transwheel Chicago distribution facility and relocated the Transwheel operations to our Chicago aftermarket location. And as we speak, we're sending refurbished wheel inventory to five LKQ markets and turning on the LKQ name as a supplier of refurbished wheels and shock estimating systems and those five markets, which include Alabama, Northern California, Oregon, Massachusetts, and the New Jersey/New York City markets.

We made good progress in integrating the Fit-Rite aftermarket business that we acquired at the end of 2005 with our other aftermarket businesses where it made sense. In Pittsburgh, we've merged the Action Crash and Fit-Rite businesses together and merged the Fit-Rite Queens, New York location into the LKQ Hunt's Point facility in the Bronx. We merged the Fit-Rite Cherry Hill, New Jersey location into Bodymaster operations, just outside of Philadelphia. And we have combined locations in Newark, New Jersey and Poughkeepsie, New York markets.

In terms of other potential geographic acquisitions, we continue to work with a fairly low-[inaudible] backlog of acquisition candidates that includes both recycled and aftermarket businesses, and we will expect to close on additional transactions during 2006.

In our aftermarket operations, we opened our Chicago warehouse in February 2006 and at the end of the first quarter, have approximately $1.7 million parts inventory in stock or in transit to the 60,000-plus square foot facility. At the end of Q1, we had also aggregated approximately $700,000 of new aftermarket inventory stock at our recycling facilities in Portland, Oregon.

We're pleased our insurance relationships and programs continue to expand during the quarter. In Carrion, Rhode Island, Amica has named us as their preferred vendor for recycled and aftermarket products across the U.S. and are requiring their appraisers to search for alternative parts prior to beginning the repair process.

Our Q4 earnings call, we mentioned the piloting of the new electronic search review process that we are offering to the insurance industry, called LKQ [Lastlook]. While still in the pilot stage with a carrier in three states, initial results are positive and we are now moving to introduce the product to a second carrier, as well. It's also our intent to market LKQ Lastlook directly to the collision repair shops.

We've begun a pilot in Michigan with a national carrier, AAA. It will require several DRP shops to send LKQ repair estimates for all their repairs. They will not be allowed to begin the repair process until LKQ signs off of parts replaced.

The [SmokeSmile] program, now at 50 optimate reviews per day. We do believe the program has potential for expansion.

As we've mentioned on previous calls, we've been in several pilot programs where we supply auto part retailers with recycled and/or aftermarket parts. One of these pilots was the Advance Auto Parts, a leading retailer of automotive aftermarket parts, accessories, batteries, and maintenance items. Advance has approximately 2,900 stores in 40 states. We are apparently in the process with rolling out the supplier arrangement, wherein LKQ will provide recycled and aftermarket products and refurbished wheels to Advance. We will supply these products directly to Advance's stores from our national network of facilities as Advance's customers place such orders for a part. Products will be marketed by Advance under Advance's Right Choice program.

Since we will be in the rollup to startup rollout and training phase of this very new program, we do not expect any earnings accretion during 2006. We are any initial rollout stages and like any new program, communication, product, blind training, the familiarization of the product, and delivering positive experiences that we positively will deliver will be shared in the Advance organization. As Advance has 2,900 stores, we think this will time. LKQ will also need to gradually adjust its procurement in order to achieve better fill rates as a type of product that AAP customers may seek, while at the same time perfecting our historical gross margins. It is our hope and our belief that, over time, we could realize a material amount of sales and profit from this relationship and an annual revenue in the range of $25 million to $50 million could be achievable.

We'd also like to point out that we think it's our national footprint that is main contributor of our ability to obtain programs like the one I just discussed.

At the end of Q1, we operated 34 transfer runs and close to 400 local delivery routes to [perish] primarily aftermarket parts and refurbished wheels and 63 transfer runs in close to 400 local delivery routes that carried primarily recycled parts. In various areas, these recycled part transfer runs and routes also deliver aftermarket products. In total, LKQ has a delivery system approaching 800 daily local delivery routes.

We acquired approximately 32,000 cars in our wholesale/recycling business during the quarter, which was about 30% more than we acquired during the first quarter of 2005. The percentage of vehicles that we acquired from salvage auctions in 2005 accounted for around 93% of our total incoming product flow and we have seen a healthy car availability at the auctions during the first quarter.

We continue to increase our sales staff for our recycle business and we have done so by an average of 53 people more in Q1 2006 compared to Q1 2005. This is a 14% headcount growth with approximately 25 employees coming from acquisitions and 28 from organic hiring. Additionally, we are investing in a technology upgrade program to serve as a base for enhanced growth to better manage call flow and sales productivity with the first phase being new telephone installations, which will provide for new flexibility in call routing and sales staffing.

In summary, we're pleased with our growth prospects and we continue to use a low double-digit organic revenue growth as our operating model. As you could see, we did gain over 12% organic growth during the quarter, we believe, in spite of a very short and mild winter in the Midwest and Northeast areas of the country.

At this point, I would like to ask Mark to provide a more detailed discussion on the Company's financial report.

Thank you, Joe. Good morning, everyone. Let's take a look at the table in our press release. You'll note 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 relating to our income statement. This shows growth in margin percentages. Also note we did have a two-for-one stock split in January 2006 so all our earnings per share amounts are stock price amounts and share counts present a reflective split.

Looking at our income statement and related tables, now, our first quarter 2006 revenue was up 43.6% to $192.1 million from $133.8 million in Q1 2005. Our organic revenue growth was 12.4% for the quarter. Our first quarter 2006 gross margin was 46% versus 46.8% in the first quarter of 2005. As Joe previously discussed, the Transwheel business was acquired, this year, and it has aluminum smelt that operates at a very low margin. In addition, Transwheel performed certain types of refurbishing activities. We were required to write up certain components of their inventory in our opening balance sheet that related to these refurbishing activities and that's required by Financial Accounting Standard No.141, Business Combinations.

The inventory write-up amount was approximately $300,000 with two thirds of that resulting in higher cost of sales in the first quarter of 2006. Accordingly, our first quarter gross margin, excluding the effect of these two items, was 47.1%. Warehouse expenses for Q1 grew $6 million, or 41.8%, over Q1 2005. The majority of this growth was from our 2006 business acquisitions and the full-year impact of our 2005 business acquisitions, which accounted for $4.4 million of the growth, or 30.3% expense growth. Excluding effects of business acquisitions, the first quarter 2006 had increased costs over the first quarter of 2005 related to labor and labor-related cost growth of $0.9 million. This primarily related to increased staff needs as our parts volume continues to grow. In addition, insurance and legal-paying cost, utility cost, and repairs and maintenance cost growth over 2005 was $0.6 million. These costs tend to be incurred more sporadically during the year.

Distribution expenses for Q1 grew $5.8 million, or 41.4%, over Q1 2005 of which $3.2 million, or 22.8% expense growth, was due to our business acquisitions. Excluding distribution expense growth related to our business acquisitions, our Q1 2006 distribution expenses grew close to 18.6% over Q1 2005 while organic revenue growth was 12.4% for Q1 2006.

Related to organic distribution expense growth, fuel expense increased by 37.1% and our subcontracted delivery costs increased by 37.9% for the first quarter 2006 over the first quarter of 2005. Both of these were significantly related to the fuel price increases. In fact, if fuel cost for the companies we own back in 2005 had stayed at a 2005 level, our organic distribution expense growth would have been close to 14%. In Q1 2006, fuel expense and subcontracted delivery costs ran approximately 18.5% of our distribution expenses, or 1.9% of revenue. Excluding effects of the acquisitions, we operated approximately 8% more recycled transfer runs and recycled local delivery routes in the first quarter of 2006 compared to the first quarter of 2005.

[inaudible], general, and administrative expenses grew $7.2 million, or 40.5%, over Q1 2005 of which $4.2 million, or 23.9%, expense growth was due to our 2006 business acquisitions and, of course, the full-year impact of our 2005 business acquisitions. So in the first quarter of 2006 compared to the first quarter of 2005, we had $0.6 million in higher compensation expense accruals related to stock option expense that we had to incur for the first time. We also had $0.4 million in our new long-term incentive plan, or LTIP expense, which was the first quarter we incurred this cost. This new plan is outlined in our proxy statement.

Our selling expenses tend to be fairly variable in nature due to our commissioned inside sales force. Our general administrative costs are usually less variable in relation to revenue growth. For the quarter, our EBITDA grew 44.6% to $23.9 million. EBITDA was 12.4% of revenue for the quarter compared to 12.3% in Q1 2005. Our operating income for Q1 2006 grew 41.3% over Q1 2005, to $20.3 million. Operating income as a percentage of revenue was 10.6% in the quarter compared to 10.8% in Q1 2005.

Remember when I talked, earlier, about the effect on our gross margins in the first quarter of 2006 related to Transwheel's aluminum smelter and the adjustment related to FAS 141 business combination accounting. Without the effect of these two items and the expensing of stock options, our EBITDA would have been 13.1% and our operating income at 11.3% for the first quarter of 2006. So, our primary operations did expand margins over 2005 by 80 basis points on EBITDA margin and 50 basis points on operating income margins.

We had net interest expense in Q1 2006 of $942,000 compared to net interest expense of $554,000 in Q1 2005. This was primarily related to rising interest rates. Other income in Q1 2006 was $806,000 compared to $162,000 in Q1 2005. This increase was primarily related to a $719,000 gain on selling equity securities in Q1 2006. Our Q1 2006 pre-tax income grew 44.3% to $20.2 million over Q1 2005. For Q1 2006, our effective tax rate was 40.2% compared to 40.0% in Q1 2005. Net income for the quarter increased 42.8% to $12.1 million from $8.4 million in Q1 2005. Our diluted earnings per share increased 15.8% to $0.22 in the quarter from the $0.19 in Q1 2005. We reported diluted weighted average common shares outstanding for EPS purposes at 55.5 million shares, Q1 of 2006, versus 45.4 million shares, Q1 2005. In note that our diluted weighted average share count increased by 22.2% for the quarter, which is why EPS growth was only approximately 16%. The large share increase was primarily due to our October 2005 following stock offering of 6.4 million shares plus exercise of stock options and warrants and the increase in our stock price.

Let's take a look, now, at our cash flow table. We generated $4.1 million in cash from operations during the quarter as we invested heavily in inventory. From the end of 2005, we funded an additional $13.5 million in inventory growth with 75% of that related to recycled inventory. CapEx, excluding business acquisitions for the first quarter, was net of $8.6 million. Cash paid for our business acquisitions during Q1 was $29.1 million. During the quarter, we issued stock related to the exercise of stock options and warrants. It resulted in shares issued and net dollar proceeds received to total approximately 1.1 million shares, or $2.3 million, in net proceeds. We issued no stock-related business acquisitions in Q1 2006.

And looking at our Q1 2006 balance sheet, you will note we had $82.9 million in debt, which included $71.0 million in debt under our unsecured credit facility with our bank group. As of April 26, our credit facility debt was $73.5 million. Total [barrings] allowed under this bank facility is $135 million. This facility matures on June 1, 2010. We feel confident this credit facility could be quickly increased when we have a need.

As we indicated on our last earnings call, we expect that 2006 organic revenue growth to be in the low double digits with a balance of the growth being the full-year impact of 2005's business acquisitions, and of course, our 2006 business acquisitions. We expect net income to be within a range of $40.5 million to $42.5 million and diluted earnings per share to be between $0.72 and $0.76. Included in the guidance is an estimated $0.03 per share effect of expense in stock options for the first time.

For the second quarter of 2006, we expect net income to be within the range of $10 million to $11 million and diluted earnings per share to be between $0.18 and $0.20 per share. We anticipate the net cash provided by operating activities for 2006 will be approximately $40 million. We estimate our full-year 2006 capital expenditures related to property and equipment, excluding any needs of any future acquisitions we may do, will be approximately $36 million to $38 million. We estimate that weighted average diluted shares outstanding for the full year 2006 to be approximately 56 million. These share numbers are estimates and assets 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.

I'd like to turn back to Joe and open up for any further comments and questions.

Okay. Thanks, Mark. Just in summary, we believe the Company continues to have a compelling and successful business model, which provides an attractive value proposition to a wide array of customers and to the insurance industry, in particular. We also believe that our Company is in a unique position to leverage our inventory with both recycling parts, recycled parts aftermarket products, and now, refurbished wheels, by adding the ability to sell out of these combined inventories and response to customer requests. We continue to pursue opportunities to further leverage our existing asset investments, our customer base, and to continue to grow through a geographical expansion of our market.

Sarah, if you would open up for questions, we'd like to move to the Q&A portion of our call.

[OPERATOR INSTRUCTIONS].

Please stand by for your first question. Your first question comes from the line of Scott Stember with Sidoti and Co. Please proceed.

Good morning, guys. Could you maybe talk about the two businesses, strength-wise, aftermarket versus the recycled in the quarter?

There was just a little bit of break up at the beginning of that question, Scott. Would you mind repeating it, please?

Yes, no problem. If you could just talk about the breakout, or maybe talk about both businesses. Was that 12% comp evenly spread out between both sides of business?

I'm sorry, yes. We continue to see slightly faster growth in the aftermarket side of the business and that was true in the first quarter. The spread as the aftermarket business has grown to over $40 million in the quarter. The width of that spread is starting to contract a little bit. But, it's certainly fair to say that the aftermarket side of the business continues to grow at a slightly faster pace than the recycling side.

And just going back to the aftermarket, have you guys heard anything, anecdotally, from insurance companies or the body shops that in the wake of the State Farm piece going away, that you're starting to see some increase utilization by insurance companies mass market?

Some of the more recent data we've seen from [Mitchell] would indicate that the aftermarket side of the business continues to grow at share. As a matter of fact, it appeared - the last report I had from Mitchell, and this is a little dated, but it looked like OEM parts had given up about another $0.05 of a percent of market with aftermarket getting a piece of that and recon and recycle, a small piece of it, as well.

Our rate of discussions with State Farm, in particular, indicate to us that they are still evaluating their position in light of their victories in the Court. While State Farm hasn't told us anything, specifically, it certainly remains our expectation that it is a matter of time until they start to write aftermarket products in the repair process.

Okay, and Joe, you had mentioned - I'm not sure if I heard, correctly - about the volume of vehicles that you guys bought at auctions. Did you say that they were down to 30%?

No, it was up 30%.

Oh, okay. I apologize. So, obviously, the activity you guys are seeing at auctions is very robust, right now?

Yes, Q1 activity at the auctions was pretty healthy. It started to diminish a little bit toward the end of March and it pretty much stayed at that level through the first few weeks of April.

Okay, and could you maybe just lastly comment on how things are shaping up in April if the weather, turning back the other way, is helping [inaudible], right now?

Yes, April's off to a start that would be a few percentage points lower than what we saw in Q1. Now, that's fairly normal. If you went back and looked at the last few years, it seems we come out of March, we get a little bit of a wall in April, and by the time we ride into May and June, we could see the momentum swing the other way. And that's exactly what we're seeing, so far, with April running below the Q1 levels. But, if history repeats itself, we should see that momentum swing back upwards in May and June.

That's all I have. Thank you.

Thank you, Scott.

Your next question comes from the line of Tony Cristello with BB&T. Please proceed.

Thanks. Good morning, guys.

Hey, Tony.

I guess one question I had is focused on Transwheel and it clearly seems like the smelter piece costs you about 80 to 100 basis points or so in the quarter. One, is that something that you will consider, at some point, once you see what the throughput is from your core business into that infrastructure?

Yes, it's fair to say we're certainly - we certainly plan to keep our options open relative to the processor. We really didn't come into this with any preconceived notions. The management team has set forth their business case of why they think it's important to the Company. We think there is a chance that LKQ plants and the recycling business and the relationships we have with other recyclers, that perhaps we can deliver the core products that the business needs and we need some time just to let that business phase run its course, here.

And that kind of leads into the next question. How much investment in terms of time and resources and maybe if you can comment on dollars are going to be needed to get Transwheel to a level that it can handle the capacity or the volumes that you can put through that system?

Well, we think that the [inaudible] that investment that exists with Transwheel, today, can probably generate - I'm going to say a 50% increase in the wheel production, per day, and that can be achieved through some pretty simple kind of double shifting, if you will. So, I think there's a significant amount of increased surplus that's available to us, assuming that the demand develops the way that we think it will. If we want to think more than a year down the road on this, if we're pleased with what we're seeing in the business in the Eastern United States, it will probably be our intent to look at putting a production facility up in the Western United States.

I'm assuming when you talk about 50% more throughput, what is the run rate, now? Or what was the run rate when you acquired them, just to give kind of a benchmark?

Yes, their various facilities that aggregated were running, I think, about 800 wheels a day.

Okay. Also, on an annual basis, you're somewhere in the neighborhood of the 30,000 [inaudible]. Have you commented on that before?

We have not. That sounds low.

So, I guess, though, looking at your volume, even if you were to double - double, say was 50 and you went to 100 - if you're buying 100,000 cars a year, you're at 400,000 wheels. So, there's - maybe not all those are usable, but there seems to me that there's a big opportunity in any incremental throughput you have over a relatively fixed base is going to be even more profitable.

I think so and I think our gut instinct tells us that we're going to be able to provide a significant number of those core wheels. You are correct in our vehicle count. Probably 40% -- 35% to 40% of cars on the road are running with steel wheels. Some piece of the alloy wheels, there just isn't any demand for it and that's the equation that we have to work through and better understand over the next couple quarters. Right now, we're very encouraged. Transwheel has been receiving products from the LKQ facilities for a good 45 days, at this point, and they related that the quality of product that they're seeing come in from the LKQ plant.

Okay. And then, I guess, one last thing related to Transwheel - the gross margins - I'm assuming on the core Transwheel business, gross margins are much closer to what your core margins are versus the smelter piece of the side.

Yes, gross margin's probably a little lower. But when you get down to the operating margin, which is what we really look at, taking out the smelter thing that we talked about, taking out the temporary FAS 141 - yes, they're pretty close to us.

Okay. Shifting gears, real quick, to just a few comments on Advance. Do you expect it to sort of be a balance for this year in terms of rolling out and getting up and running and sort of learning what is required, or what's needed, and then you can start to see contribution into 2007? Is that kind of how you're looking at this, right now?

Yes, Tony, I guess that's a pretty fair assessment. It is during the first quarter that's probably actually a minor drag in the Company. We staffed up a call center, hired people, trained internally, gearing up for when the first calls were switched on to us, which only happened, three to four weeks ago. We've seen a nice positive momentum, each week we've been active. While small, we're kind of happy after four weeks, to [inaudible]. Right now, we're annualizing well over $3 million a year in sales, which it being 20 days into it - we think it's not a bad place to be in a fairly low number of stores participating.

So, we try to integrate our training into AAP's planning regional meetings and regional training sessions with their parts pros. So, we'll try to integrate into their schedule and take advantage of those times when their people are together for other training. It's a massive project with 2,900 stores. We think our overlap with Advance is pretty attractive because, obviously, their strength in the Eastern and Central United States, which matches up with our strong suit. We've [inaudible], we've seen about the program and the Advance Auto Parts people play a hard charge and managers. We love the culture. And we couldn't be happier than to be in the positions we're in, to be working with them.

Well, it seems like as this business grows, it can contribute 5%-plus more in terms of sales growth, alone. I mean, I think this could potentially be a very meaningful material piece of business. Is that fair?

Yes, we think so, too. We need time to prove that out. The real question, Tony, in my mind in this [inaudible], we'll have a better understanding after we get a couple quarters under our belt. How much of the revenue that we'll generate through this program is truly incremental revenue to LKQ? And how much of the revenue is something that we would have sold to someone else, anyway? That's the most critical aspect of the real earnings contribution of this relationship.

Alright, great. I'll let have someone else have some. Thank you.

Thank you, Tom.

Your next question comes from the line of Craig Kennison with Robert Baird. Please proceed.

Good morning, Joe and Mark. Could you review the economics of that Advance deal from a margin perspective?

The gross margin line should be really no different than our traditional sales. The upside to the [inaudible] there is would be to the extent of is there an opportunity for us to sell product into the Right Choice program that otherwise might not have sold. If that proves out to be the case, then there could be a small positive impact on the gross margins of the Company, but we need several quarters to really understand. Like I said, whether these are incremental sales or whether this is just product that we were going to sell, otherwise.

There will be some savings at the selling expense line in the Company, as Mark has pointed out. We tend to pay most of our sales reps on a commission rate. These sales - some of these sales will be processed through websites and some of the sales will be processed through an LKQ call center, which in either case should be a slightly reduced selling cost to the Company. I would evaluate programs as maybe a no bad debt expense exposure, which is certainly a plus.

In terms of delivery, the parts we can deliver on LKQ trucks to the AAP stores, we'll do that, so that's really kind of a pretty normal operating cost to the Company. There will be those instances where we will be absorbing freight to ship parts into an Advance Auto Parts store, in which case that could be a minor deduct.

Okay. Thanks for that. And relative to your inventory balance, it grew faster than the pace of sales growth. Is that related to any timing of acquisitions, last year? Or is there something else driving that?

A couple things. Certainly, the Fit-Rite acquisition occurred on 12/31/05, so you've got a pretty big increase that's coming in from their inventory investment, as well as very reliable at year end. Clearly, I would note, as you may recall from last year, during the first 100 or so days of the year, we tend to kind of try to build up our backlog of unprocessed vehicles during the winter months when we think the buying season is more attractive. And we did that, again, in 2006. And we intend, probably as we move into May, that'll go flat. Towards the end of May into early June, it will start to draw down that backlog of unprocessed cars.

And what have you done to control for the margin impact of that backlog, to avoid any surprises on the gross margin line in the third quarters?

Yes, we inventoried that product - all the major components, which we did not do, the first year. We did that a couple years ago. Now, a major component for inventory allows our bidders and buyers to have better visibility of exactly what the part types are that are in backlog so we can avoid any, I'll say, excessive duplications.

And then just moving onto a lawsuit by Ford against some of your competitors. Have you seen any change in demand for aftermarket parts on particular Ford products, related to that litigation? Or is it really unchanged?

I can't say that we have seen any change in demand that would be a function of that litigation.

Great. Thank you.

Thanks a lot, Craig.

Your next question comes from the line of Gary Prestopino from Barrington Research. Please proceed.

Good morning, guys.

Good morning, Gary.

A couple of questions. What are you seeing on the pricing side for the salvage that you're purchasing? Are you seeing normalized costs go up 3% or 4% on the price of the cars due to inflation?

Not quite at that level. They did bump up, a little, over quarters, sequentially. But certainly not at the level you're discussing.

Okay. And then could you elaborate on this Lastlook program and this pilot you're doing in Michigan? Could you just talk a little bit about that?

Yes. Well, there are other electronic parts search engines that are available in the market. We have never been big proponents of those programs because we feel they shortchange the insurance industry and shortchange us because the search engines aren't really - for a lack of a better word, they're not good enough to really identify all of the recycled parts that are available in the repair process. So, we have linked with a third-party software provider who's developed a search engine, if you will, and we're coupling that with some additional phase of review that no one else really provides and that's where we would have someone physically make a fairly quick review of the parts manifest, looking for those parts opportunities that the electronic interchange search just won't find. And by that, I mean things like rocker panels, the crossbeam between the front/rear doors, quarter panels, and sometimes, just assemblies that aren't easily recognized by an electronic search engine.

So, we think that'll be the best product on the market. As opposed to predominately marketing this into the insurance industry, it's our intent to market this heavily to the collision repair shops and provide them tools that will allow them to prove to the insurance - their insurance partners - that they have really the best capability in the market to seek out the alternative parts. We'll be showing all of our parts in the systems, so this is a search engine that can find recon wheels, aftermarket parts, as well, of course, our recycled parts.

And then what about - that was Lastlook, correct? And then what about the pilot with AAA?

That, I believe, is going to move toward a full - kind of full-scale utilization in the Michigan market.

Full-scale estimate review? Okay. And then, lastly, what are you - are you seeing any of the cars coming out of Louisiana, the Gulf Coast, now being - having the ability of being sold? Are they being titled and is there any economic value to some of these automobiles?

Yes, that's a better question for the co-part guys. But from our perspective, there's still a pretty healthy [inaudible], down there.

Okay. Thank you.

Alright. Thanks a lot.

Your next question comes from the line of Bill Armstrong with C.L. King and Associates. Please proceed.

Good morning. I've got a couple of follow-up questions just on the smelter and on the Advance Auto Parts deal. Just to clarify, the $4.4 million dollars in third-party sales - is that from the entire Transwheel business? Or is that just the pillage, or whatever, the melted down aluminum from the smelter?

Yes, that's the third-party revenue of smelter we see, selling the melted aluminum.

Okay, so the actual wheel sales of Transwheel would be in your - there's more, obviously, for that.

Yes.

Okay. Can you tell us what that number was?

We've been trending about $28.5 million a year, so somewhere around 4 or so million dollars. We only had the company two months.

Bill Armstrong; Right, right. Okay.

Not a major change from what they did in '05.

So, I guess it sounds like you're trying to figure out if there's really any value added or any economic value in keeping the smelter in operation.

Yes, I man, the value to us is getting more cores and sorting those out, first. And then, the rest of them, you melt. That's where there's value.

And can you just ship out the cores that you don't need? Just ship them out, as is, to third-party smelters?

No, the ones that we need - we recondition and sell those back to, broadly, the collision repair industry. The ones that we don't need, do not need, those are the ones that are processed through Transwheel's aluminum smelter. So they're melted, formed into a large aluminum [inaudible], and sold back into the automotive manufacturing industry.

Yes, I guess my question was those wheels that you can't use for your recycling business - instead of melting them down, why not just sell them to some third-party smelter operation? Would that make sense.?

You could but you'd probably take - it would probably be less economically advantageous to do that. That's why these guys got the smelter.

Okay. On the Advance Auto Parts - so, Joe, in your initial comments, you mentioned you may have to adjust your procurement practices in order to raise your fill rates. Could you sort of flush that out a little bit? What does that actually mean?

Yes, as I indicated, we're just a few weeks into this so we're getting our first kind of appetite, if you will, of the type of products that we're receiving demand for through the Right Choice customers. So, just as we do with every cost from our wholesale accounts, those requests will be logged into our system and as their buyers are evaluating the value of a damaged vehicle, there may be some parts that we formerly had no demand for, but under the Right Choice program, we do have demand for. But, we'll start to place value on those parts when we bid cars. So, this is just a - it's a process that'll take several quarters for us to understand what the exact part price we're getting requests for. And in some cases, that may lead us to buy a slightly different product mix to meet that demand.

Okay, but you're not talking about paying more just so you can get more -?

Absolutely not. And quite frankly, if anything, the product that we would need to meet the demand from the Right Choice customer base is probably a lower-end and less expensive product than what we buy, today, to supply the needs of the professional collision repair shops.

And the Right Choice customers - these are just individual, do-it-yourself kind of guys?

Bill, they have both a retail component that you just described, but they also have, I think, maybe close to 20% of their business is what they term "commercial business", which you should probably think of as kind of a mom and pop, one or two bay, mechanical repair shop. Their part pros sell to that piece of the customer base. Their demand for products from is most likely going to be engines and transmission.

And so, you're delivery to them would basically be on a just-in-time sort of - they call, they see if you've got the part they're looking for. If you do, you ship it out to the stores, rather than to one of their distribution centers?

Right, we ship it right to the Advance Auto Parts store. That's correct.

Okay. And then, finally, what's the rollout schedule? You just started. They've got 2,900 stores. That's a lot of stores. Are you planning to rollout to all 2,900 stores? Or just some portion? And when do you think that'll be completed?

[inaudible] to have 2,900 stores actively seeking to buy a product from us and run through the cycle, it probably means a couple of visits to maybe three visits, but that's probably the balance of this year.

So, by the end of this year, you figure you should have pretty much full coverage with these guys?

I would hope so. Yes.

Okay. Alright, thanks.

Okay. Thanks, Bill.

Your next question comes from the line of John Lawrence with Morgan Keegan. Please proceed.

Mark, would you comment for a minute on the fuel cost and just sort of break down a little bit the difference of how much of additional runs versus actual pricing of gas would mean?

Yes. If you look at diesel prices, which is really mostly what we run on, they went up about 21%, okay? We kind of track that by area and everything. So, diesel prices went up 21%, Q1 to Q1. We then, on top of that, added another 8% more routes, local delivery routes, and it happened to be 8% more transfer run at the same time but that was added on top of it. And, of course, labor comes up with that, as well. I don't know if that helps you a little bit. That's kind of your price increase for the fuel and a contract delivery that we do. It's 21%.

Okay. Thanks, guys.

Thanks, John.

We now have a follow-up question from Tony Cristello with BB&T. Please proceed.

Hey. Thanks, guys. I just want to follow up one question. This retail opportunity with Advance seems like something that could potentially be used with other retailers if it proves successful. Is that something that you envision?

We'd certainly leave our options open on that. I think, right now, our focus is to engage, as effectively as we can, to the Right Choice program. 2,900 stores appears, on surface, to be an enormous opportunity and I think we just want to do a great job for Advance Auto Parts and prove that we're worthy partners with them in what we think is really a fantastic opportunity for both companies.

Okay. And one other question - there's been a lot of talk of late of [Schnitzer Steel] and Greenleaf and I noticed that they converted, yet two more are in the process of converting two more facilities to their sort of pick-and-pull type format. When you look at that concept versus yours, I mean, there's clearly - it seems like any competitive threat is very minimal, especially as they continue to sort of go in a different direction than you would. Is that something you would agree with?

Yes, I guess I would agree with that. We don't currently see Schnitzer active in the acquisition market. We don't think that the business, today, that they have is - it doesn't - there's not enough density to it to allow for the type of networking of inventory that we're able to achieve. It appears to us, at least on surface, that maybe they're gravitating toward a slightly lower-end product, even at their wholesale stores, than what we tend to buy.

Okay. That's great. That's helpful. Thank you, guys.

Okay, Tony. Thank you.

Well, I'd like to thank everyone for joining us, today, for the call. We'll probably be looking at the last Thursday of July, I'll assume, for our Q2 call. But, we'll certainly put out a formal announcement well in advance of that call. And again, thanks for joining us. I apologize for the delays, upfront, as I know some of you had difficulties getting into the system, so we'll keep working on that to see if we can come up with a little better solution, there. Thanks, again. Have a good day.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.