LKQ Corp (LKQ) 2006 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the Second Quarter 2006 LKQ Corporation Earnings Conference Call. My name is Jennifer and I'll be your coordinator for today.

[OPERATOR INSTRUCTIONS].

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

Before we get started this morning I need to talk about forward-looking statements, that 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 8th, 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 reflect the events or circumstances arising after the date on which it was made except as required by law.

Okay. good morning and thanks everybody for joining LKQ's second quarter 2006 earnings call. On the call today obviously Mark Spears our CFO as well as myself. I'm the CEO of the company. I will provide some high level overviews of our performance as well as some qualitative views on the business and our industry. I'll also update you on our acquisition work, some of our special projects and work within the insurance industry. Mark will provide a more detailed assessment of our financial results and more specifically Mark will highlight some of the underlining improvements and leveraging our infrastructure. It may not be readily apparent from just a cursory review of our financial statements.

As stated in our press release we are very pleased with the second quarter performance of the company. In many of our markets we encountered record mild weather conditions during the first quarter that continued through the month of May. In fact, sorry the month of April, and the fact that we exceeded prior earnings guidance we believe is a strong reflection on the geographic diversity of our business and the strength of our business model.

We reported $195 million of revenue for the second quarter which reflects 43% total growth over the second quarter of the prior year with organic revenue growth of close to 11%. Our EBITDA margin was 12.1% for the quarter compared to 11.7% in the second quarter of 2005. However the margin improvement was actually even more impressive after taking into account the impact of the low gross margins of our newly acquired aluminum smelter operation and the effect of expensing stock options this year for the first time. Mark will go through an explanation of this in just a few minutes.

Our net income increased by almost 53% to $11.7 million for the quarter and diluted earnings per share increased 31% to $0.21. Remember that in early October of last year we closed with a follow-on stock offering with LKQ issuing 6.4 million additional shares. These newly issued shares primarily account for the diluted EPS growth rate being less than the net income growth rate.

As we discussed on our April 27 earnings call we acquired four businesses in the first quarter of 2006 that included three recycle parts businesses. Those three recycled parts businesses are Michael Auto Parts located in Orlando, Florida that primarily sells and serves the professional or car market, and there were two resale businesses one near Carleton, South Carolina and one in Port Allen, Louisiana that were essentially start ups for us.

Regarding the fourth -- Q1 and acquisition at the end of January we entered 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 or restoration of alloy wheels.

In addition to this wheel refurbishing wheel Transwheel operates an aluminum smelter. We continue to operate Transwheel's smelter and during the remainder of 2006 we will evaluate the importance of the smelter's operation in light of Transwheel now receiving LKQ's wheel [pours]. The smelter's third party revenue was $12.2 million at a gross margin of about 5% for the 5 months that we've owned them this year. Of course the 5% gross margin reduces LKQ's overall gross margin percentage but the smelter is not dilutive to our EPS so while at a very low margin operating a smelter allows Transwheel to more economically obtain greater wheel poured stock than a [temperature] in the absence of a smelter.

We'd now like to update you on our second quarter acquisition accomplishments the first being a West Coast aftermarket distributor by the name of Global Automotive Parts. Global operates out of three warehouses with a combined 70,000 square foot capacity in Los Angeles, Portland and Seattle. In 2005 Global reported approximately $11 million in sales. We will manage these locations as part of our recycled parts businesses in Los Angeles and the Pacific Northwest and by the end of this year this three locations will have increased warehouse space dedicated to after-market product such as they will have a combined total of 110,000 square feet which will enhance the after-market growth opportunities for us in the West Coast as we will have major warehouses to support all four major West Coast population centers.

In the second quarter in early July we also acquired four recycled parts businesses that operate from 10 facilities. These businesses collectively generated $33 million in revenue in 2005. They include first a business in West Michigan, [Denopasal] Auto Parts that operated 3 facilities on a total of 25 acres. Two facilities sell primarily into the retail market and one sells primarily into the professional repair market.

This facility also gives a much needed additional capacity to properly serve the Western Michigan market as our Detroit facility is too distant to efficiently serve that market. The second transaction a business in Tulsa, Oklahoma operates three facilities with a total of 40 acres. Two facilities sells primarily into the retail market and one sells primarily into the professional repair market.

In addition we subsequently acquired a 10,000 square foot warehouse adjoining one of these properties in order to house after-market parts so we recently moved out a stand-alone after-market facility that we leased in northeastern Oklahoma and a combined business in the Tulsa recycled parts business. We believe this transaction will enhance our growth and efficiency opportunities in the Oklahoma market.

The third transaction the business in Houston that operates two facilities with a total of 46 acres that sells primarily into the retail market. As you know Houston is the fourth largest market in the United States and we think this business will complement our existing Houston operations base that works on a 12-acre plot. And which sells primarily into the professional repair market.

And finally the fourth acquisition we [seeded] in early July a business that operates solely outside of Denver on 10 acres and 12-acre facility in Daytona Beach, Florida with both facilities selling into the retail markets. In terms of other potential geographical expansions I would say we continue to work with a healthy backlog of acquisition candidates that include both recycled as well as after-market businesses. But I would expect that our company would close on additional transactions before the end of 2006.

During the quarter we integrated 5 of our after-market branch locations into our recycled parts facilities. Put them under a single manager at each location. This resulted in the reduction of 9 local delivery routes in markets such as Indianapolis, Harrisburg, Pennsylvania, Tulsa, Toledo and Nashville and we continue to identify cost reduction opportunities emerging in our recycled parts and after-market part sales and distribution systems.

Our insurance relationships and programs continue to expand and contribute to the company's growth as well. Our electronic estimate review service offering to the insurance industry LKQ's Last Look is being used in certain markets by two carriers and a third carrier has indicated that they will start to use LKQ Last Look fairly shortly.

We also expanded our manual debt review program with an independent claims manager to go from servicing 2 of their states to servicing 9 of their states in the second quarter. So finally we were working with at least two carriers to receive low-cost cars that supply some minor amount of parts to be sold in the professional repair market and the remainder of the cars to be placed in our retail oriented yard.

Our program with Advanced Auto Parts, which is marketed as the [Right Choice] program continues to more participation by Advance stores. Advance has approximately 2,900 stores in 40 states and to date we have received sales and queries from close to 1,200 of those stores. At this time we are averaging about $85,000 per week in sales or annualizing to $4.4 million. We believe the majority of this volume is being sold to our commercial customers. In August Advance will begin a campaign of in-store commercials on with [one note] posters and counter mat advertising in order to educate more retail oriented customers about the Right Choice product.

As we previously indicated since we will be able to start up a roll out and training phase of this very new program we did not expect any earnings accretion in 2006. As Advance has 2,900 stores we believe the process will take. LKQ will also need to gradually adjustment its procurement in order to achieve better flow rates of the type of product that Advance customers may seek while at the same time protecting our company's gross margins. Then still our hope and our belief that over time with this program we could realize a material amount of sales and profits with an annual revenue in excess of $25 million could be achievable.

At the end of Q2 we operated 35 transfer runs in close to 440 local delivery routes that primarily deliver after-market parts and refurbished wheels, in 64 transfer runs and about 410 local delivery routes that primarily deliver recycled parts. In various areas these recycled part transfer runs and local delivery routes also deliver after-market products.

In total LKQ has a delivery system approaching 100 transfer runs and 850 local delivery routes. We acquired approximately 28,000 cars in our wholesale recycled part business during the quarter which was about 17% more than we acquired during the second quarter of 2005. The percentage of vehicles that we acquired from salvage auctions during the first 6 months of 2006 accounted for about 93% of our total incoming product flow.

We continue to increase our sales staff levels for our recycled parts businesses. We have done so by an average of 23 people more in the second quarter of '06 compared to '05 which is a 6% headcount growth with approximately 19 new sales reps coming from acquisitions and only 1% are from organic hiring.

In summary we're pleased with our growth prospects. We continue to believe we can grow our business organically at a rate in the low double digits. As you can see we grew close to 11% organic revenue growth despite having somewhat of mild weather in April in certain areas of our country.

We have a compelling and successful business model. We believe we provide an attractive value proposition to a wide array of customers and the insurance industry, and are in a unique position to leverage our inventories of both recycled parts, after-market product and now refurbished wheels by having the ability to sell out of these combined inventories in response to our customer needs and their requests.

We also believe that further margin expansion is possible as we continue to seek opportunities to better leverage our investment and facilities and our distribution systems.

At this point I'd like to ask Mark to provide detailed discussion on our financial results. Mark?

Thank you, Joe, and good morning everyone. Let's take a look at the tables in our press release. Note we have also included a table that reconciles net income to earnings before interest, taxes, depreciation and amortization otherwise known as EBITDA. We also added supplemental data schedules related to our income statement that showed growth and margin percentages.

Also note we had a two-for-one stock split in January 2006 so all earnings per share amounts, stock price amounts and share counts presented reflected the split. Let's take a look at our income statement table. Our second quarter 2006 revenue was up 43.4% to $195 million from $136 million in Q2 2005. Our first 6 months of revenue for 2006 grew 43.5% to $387.2 million compared with $269.8 million for the same period in 2005.

Our organic revenue growth was 10.8% for the quarter and 11.6% for the 6 months. Our second quarter 2006 gross margin was 45.2% versus 47.4% in the second quarter of 2005. For the first 6 months of 2006 our gross margin was 45.6% versus 47.1% in the same period of 2005. As Joe previously discussed the Transwheel business we acquired this year has an aluminum smelter that operates at very low margins. In additional since Transwheel performs certain types of refurbishing activities we were required to write up certain components of their inventory in their opening balance sheet related to these refurbishing activities as required by Financial Accounting Standard No. 141, Business Combinations.

The inventory write up amount was approximately $300,000 with two-thirds coming through cost of sales in Q1 and one-third coming through cost of sales in Q2. Accordingly our gross margin would have been 46.9% in Q2 2006 if you exclude the effect of these two items. In fact excluding the effect of these items the 6 months 2005 was 47.1% gross margin and the 6 months for '06 was 47.0% gross margin.

Our facility and warehouse expenses for Q2 grew $5.6 million or 38.5% over Q2 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 $4.3 million of the growth or 29.9% expense growth. Excluding the effects of business acquisitions the second quarter of 2006 had an increased cost over the second quarter of 2005 related to labor and labor-related cost growth of about $0.6 million that's primarily related to increased staffing needs to handle parts volume growth.

Also in this category gains and losses on retirement of property, plant, and equipment for Q2 2006 compared to Q2 2005 differed by $0.2 million. This was due to a 2005 gain on the sale of a facility in Texas. For the 6 months of 2006 these expenses as a percentage of revenue improved to 10.5% from 10.7% for the same period in 2005. On a 6-month basis facility and warehouse expenses grew $11.6 million or 40.1% over 2005.

Business acquisitions represented $8.7 million of the growth or 30.1% expense growth. Our distribution expenses for Q2 grew 4.4 million or 28.6% over Q2 2005 of which $3.3 million or 21.7% expense growth was due to our business acquisitions. Excluding distribution expense growth related to our business acquisitions our Q2 2006 distribution expense grew 7% over Q2 2005 while organic revenue growth was 10.8%.

Our low organic growth of distribution cost in the quarter was helped by 0.3 million of lower insurance cost compared to Q2 2005. For the first 6 months of 2006 these expenses as a percentage of revenue improved to 10.3% from 10.9% for the same period in 2005. On a 6-month basis distribution expenses grew $10.2 million or 34.7% over 2005.

Business acquisitions represented 6.7 million of the growth or 22.7% expense growth. Selling, general and administrative expenses grew $6 million or 32.1% over Q2 2005 of which $4.4 million or 23.7% expense growth was due to our 2006 business acquisitions and the full-year impact of our 2005 business acquisitions. During the second quarter of 2006 compared to the second quarter of 2005 we had about 0.5 million in higher wage and fringe costs, about 0.2 million in higher compensation expense accruals in this category related to stock option expense that we had to incur for the first time in 2006. And we also had about 0.4 million in our new long-term incentive plan or what we call the LTIP expense which was a new incentive plan put into effect in January 2006. This new plan was outlined in our proxy statement.

For the 6 months of 2006 these expenses as a percentage of revenue improved to 12.8% from 13.5% for the same period in 2005. On a 6-month basis selling, general and administrative expenses grew 13.2 million or 36.2% over 2005 of which $8.7 million or 23.8% expense growth was due to our business acquisitions.

Our selling expenses tend to be fairly variable in nature due to our commissioned inside force our general and administrative costs are usually most variable in relation to revenue growth. For the quarter our EBITDA grew 48.1% to 23.6 million. EBITDA was 12.1% of revenue for the quarter compared to 11.7% in Q2 2005. For the 6 months our EBITDA was 12.3% of revenue versus 12% for the same period in 2005.

Our operating income for Q2 2006 grew 49.2% over Q2 2005 to $20.6 million. Operating income as a percentage of revenue was 10.6% in the quarter compared to 10.2% in Q2 2005. For the first 6 months of 2006 operating income improved to 10.6% of revenue compared to 10.5% for the same period in 2005.

A couple of things are affecting margin comparability between 2006 and 2005. First note that prior to 2006 we had no stock option expense in our income statement. It was only in our footnotes to our financial statements. We show stock option expense in our income statement based on where the employee wage costs are incurred.

In total stock option expense for Q2 2006 was $370,000 and for the 6 months was $1.1 million. The expense in 2006 is both in the individual quarters based on investing. We expect the full-year expense will be around $2.5 million for 2006. Second, remember I talked earlier about the effect on our gross margins in the second quarter 2006 related to Transwheels' aluminum smelter and adjustments related to Financial Accounting Standard 141.

For the second quarter without the effect of these two Transwheel items and the expensing of stock options our EBITDA margin would have been 12.7% and our operating income margin at 11.1%. For the full 6 months the EBITDA margin would have been at 12.9% and operating income margin at 11.2%.

So our primary operations did expand margins over 2005, for the quarter by 100 basis points on EBITDA margin and by 90 basis points on operating income margins. For the 6 months by 90 basis points on EBITDA margin and by 70 basis points on operating income margins.

We had net interest expense in Q2 2006 of $1.3 million compared to a net interest expense of 0.7 million in Q2 of 2005 which was related to increased debt levels and rising interest rates as well. Other income in the first 6 months of 2006 was $933,000 compared to $240,000 for the same period in 2005.

This was primarily related to a $719,000 gain in Q1 2006 on selling equity securities. Our Q2 2006 pretax income grew 46.9% to 19.4 million from 13.2 million in Q2 2005. For the first 6 months of 2006 pretax income increased 45.6% to 39.6 million from 27.2 million for the same period in '05. For the first 6 months of 2006 our effective tax rate was 40% compared to 41.1% in the same period of 2005.

Net income for the quarter increased 52.9% to $11.7 million from 7.6 million in Q2 2005. For the first 6 months of 2006 net income increased 48.2% to 23.7 million from 16 million in the same period of '05. Our diluted earnings per share increased 31.3% to $0.21 in the quarter from $0.16 in Q2 2005 and for the first 6 months of 2006 diluted EPS increased 22.9% to $0.43 from $0.35 for the same period in 2005.

Our diluted weighted average common shares outstanding used for EPS purposes was as follows, Q2 2006 at 55.7 million shares versus Q2 2005 at 46.8 million shares. Six months 2006 at 55.6 million shares versus 6 months 2005 at 46.3 million shares. Our diluted weighted share count increased by 19.1% for the quarter and 20% for the 6 months over 2005 comparable periods.

The large increase was primarily due to our October 2005 follow-on stock offering of 6.4 million new shares exercise of stock options and warrants and the increase in our stock price.

Let's take a quick look at our cash flow table. We generated 13.1 million in cash from operation during the first 6 months of 2006 as we invested heavily in inventory. From the end of 2005 we funded an additional 15.4 million in inventory growth with about 75% of that related to recycled inventory.

CapEx excluding business acquisitions for the first 6 months was $16.5 million. Cash paid for our 2006 business acquisitions during these 6 months was $56.3 million. During the first 6 months 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 1.4 million shares or $4.0 million in net proceeds.

We issued no stock related to business acquisitions to date in 2006. In looking at our June 30 balance sheet you will note we 107.5 million in debt which included $93 million in debt under our unsecured credit facility with our bank group. As of July 26th our credit facility debt was at $103 million.

Total borrowings allowed under this bank facility is $135 million and if an accordion option feature is exercised will take that up to $150 million. This facility matures on June 1, 2010. We feel confident this credit facility could quickly be increased when we have the need.

At June 30, 2006 our debt-to-EBITDA ratio is 1.4 times so we generally have only the ability to increase debt capacity for the company. As we indicated on our last earnings call we expect that 2006 organic revenue growth will be in the low double digits with the balance of the growth being the full-year impact of 2005 business acquisitions and our 2006 business acquisitions.

We expect net income to be within a range of $42.7 million to $44.7 million and diluted EPS to be between $0.76 and $0.80. Included in the guidance is an estimated $0.03 per share effect of expensing stock options for the first time. For the third quarter of 2006 we expect net income to be within a range of $8.9 million to $9.7 million and diluted EPS to be between $0.16 and $0.17.

We anticipate that cash provided by operating activities for 2006 will be over $40 million. We estimate our full-year 2006 capital expenditures related to property and equipment, excluding the expenditures of LKQ to acquire businesses will be approximately $41 million to $43 million. This includes approximately $6 million in property and equipment related to businesses we acquired in 2006.

We estimate the weighted average diluted shares outstanding for the full year to be approximately 56 million shares. These share numbers are estimates and as such will be affected by factors such as any future stock issuances, the number of options exercised in subsequent periods and changes in our stock price.

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

All right thanks, Mark, and on behalf of Mark and myself I'd certainly like to thank the people in our company LKQ for their contributions towards such a good quarter. To sum up I would say that I'm very pleased at the momentum in the company now. We love how well-positioned we are as a company and I see LKQ achieving its goals of low double-digit same store sales growth. I see us a company successfully closing accretive transactions which augment our net worth or expand our product offering. It's a company that's sustaining our strong gross margin for 8 years consecutively now.

I see us a company that's realizing increased operating leverage and translating that into expanded profit margin. And finally, I see us a company that enjoys a conservative balance sheet and financial structure which will support our continued expansion plans and growth ambition.

Jennifer, at this time I think we'd like to open up for questions.

[OPERATOR INSTRUCTIONS].

And your first question comes from Tony Cristello with BB&T Capital Markets.

Hi good morning gentlemen.

Thanks Tony.

Good morning.

One I wanted to just touch on the smelter operations and it sounds to me that you might be more inclined to want to keep that piece of business after having a few months under your belt and you were commenting on in the first quarter. And one I wanted to see if that was the case and two on a gross margin basis was the erosion mostly related to the smelter or were you seeing some other things in the quarter pricing or buying that might have impacted the gross margin side of things?

Yes Tony I would first say that we have not changed our opinion one way or the other on whether we'll retain the smelter operation. We're still entirely open minded to that decision and I would suggest we'll probably run up right to the end of the year before we make a final call on that and make sure that we're as well educated and seeing all sides of the equation on that. So we'll continue to work on that. We'll run right through fiscal '07 budget process for the smelter and try and make a decision after we take a close look at what the final budgets look like. In terms of other issues that would be impacting the smelter operation's gross margin I'd say that's really steady as she goes. I think the management team at Transwheel, Transmetco does an excellent job of managing the margin or the spread that they work with on a per pound basis. We communicate that pricing structure to the buyers and even to the LKQ field organizations on a daily basis by I think we're pretty much on top of that game.

Well with -- well core LKQ gross margins were obviously done and I know the smelter has been impacting those. And I'm wondering is much of the erosion related to that or were there some other things in the quarter that also contributed to LKQ's poor gross margins [inaudible]?

Thanks for clarifying that.

Sure.

And we'll let Mark address that.

Yes I mean you can kind of calculate the effect of the smelter but I think you're asking more on recycling and after-market and everything else. They were slightly down from the prior quarter but we have to be careful here. I think we said some -- kind of at the beginning of the year Q4 kind of the winter started a little bit in the end of Q4 and went into Q1 and Q2. So I guess if you pull the smelter out of all this our 6-month margin for '05 is 47.1% and in '06 it was 47.0. And kind of the mix of how that flows between quarters there's just the seasonality that's different year to year there. So nothing in particular. It's [inaudible] to us on the margins.

Okay and then one thing I want to talk a little bit about seasonality because your third quarter is not that typically the most volatile, if you will, quarter that you'll have and there's obviously no winter events that could drive sales. And maybe you've got vacation and some other things disrupting the general flow of accidents. Could you comment a little bit of on that? And has July trends started sort of in line where they should be and going forward as the quarter progresses are you expecting anything, a robust acceleration or do you just need to keep things going as is to kind of get to where you need in the 16 to 17% percentage range?

Yes I mean July has probably been a little slower than we would have liked. It always slows up to some extent and the Fourth of July holiday being on the Tuesday is no help because it kind of gives that longer weekend. But we factor that in our guidance though as well. Yes, you're right. Third quarter is always the weaker question. There's less rain, vacations etcetera or whatever causes that. You can see historically it's not our stronger quarter. But like I said we do our budgets that way as well and we factor July into our projections as well.

We don't see anything super unusual here. I guess we have to just get through the rest of the quarter.

Okay that's great. No fantastic job and I'll let someone else take over. Thanks guys.

Thanks, Tony.

And your next question is from Craig Kennison with Robert W. Baird.

Good morning Joe and Mark.

Hi Craig.

Hi Craig.

The first question has to do with the acquisitions you have consummated to date. I think you've done 9 and 4 of which have been retail self-service and another 2 have a retail component. First, what's driving the emphasis on retail and second what's the margin profile of that type of operation?

I don't know that I would say that we have any faded or [step aside] emphasis to grow the retail business after any other segment. We see the market right now in terms of acquisition multiples in that sector. They're reasonably attractive so that's probably one thing that's led us there coupled with the fact that we're linking a couple of great management teams. The top approach talks about acquiring your businesses in extremely attractive markets. We couldn't be happier than to have the business that we picked up in Houston, Texas.

A fabulous management, excellent operating skills, and they bring lots of talent that will help us improve on the rest of our retail market. We really do love the businesses that bring what we call the combo capability. Companies that have skills and properties that support both the retail and a late model wholesale business model that will always be very attractive to us when we see those opportunities.

We think at some point those market situations will probably allow us to obtain some salvage programs directly with insurance carriers that may be focused more on the lower end of the product chain.

And in terms of the margin profile of that business?

The margins and the retail businesses probably are a little stronger than what we see on the wholesale side.

Next question has to do with the acquisition market. Could you just characterize the current tone of the acquisition market and how you plan to fund future deals, I presume mostly with debt?

Right, first I'd just start off by saying the market is pretty healthy. I reviewed our pipeline and backlog with our Chief Development Officer yesterday and I'd say the list remains healthy and really quite, I think, an impressive mix of both late model wholesale business opportunities, after-market business opportunities that are small as well as a couple more retail operations could be in the list by the end of the year.

But I would not expect the company to close on any further transactions during the third quarter. If they did it would be right at the very end of the quarter. But I would expect us to close on additional transactions before the end of the calendar year.

In terms of funding of transactions yes I would look for the primary funding source to be the company's existing debt facility.

Are valuations about what you'd expect or is there any reason why you might not expect to do anything in Q3 other than normal timing issues?

Yes we certainly have seen absolutely no move on the valuation metrics. They've been very consistent and I think remain reasonably attractive to our shareholders. In terms of Q3 timing we've always said that the acquisitions will probably be a little bit uneven. I don't mind a minor breather here to make sure we're properly digesting what's come on our plate over the last 7 months which has been quite a bit. But given the fact that we wouldn't see anything else closing the third quarter has absolutely nothing to do with valuation metrics.

And then finally your cash flow from operations and capital expenditures before acquisitions have been roughly equal. When do you expect free cash flow to turn more positive and what is the free cash flow profile I guess of a typical mature facility?

Well, we're actually budgeting to come up with a slight amount of free cash flow because we want that business to be able to fund its own organic growth. I guess you're asking if I cut my gross down to like 6% or something you'd have cash coming out all over the place. I mean these businesses generated cash. I think every -- I cannot think of a single recycled company we bought that came with debt so that they are very much cash oriented.

I mean I really don't have a model right now to go through it and tell what it would be at 6% but you could probably look back in our prior years where we have generated a fair amount of cash.

So and the reason that those two metrics are running roughly equal to one another in terms of CapEx and cash flow from operations is because of your growth initiatives?

Yes absolutely. It's in buying land. It's been adding warehousing and racking, that type of thing. We're just uneven every year. I mean this year has been somewhat heavy with that because we wanted to really expand some facilities in some key markets. But yes that's planned and budgeted.

Okay thanks and congratulations on the first half.

Thank you, Craig.

Your next question is from [Gerry Marks] with AutoRetailStocks.com.

Good morning.

Good morning Gerry.

Mark, when you were talking about the distribution expenses did I hear you say that you had lower insurance? Was there are true-up in there?

No I'm not sure you're talking about true-up but basically in our insurance we had some initiatives this year to try to get our insurance costs down. And that included in our [MedicalAir], medical costs along with driver incentive, you know, driver incentive plans etcetera and worker's comp and driver's liability.

We did, I don't know if we mentioned this before, what we did back in August '05 switch our medical program to another program which is now administered and shared with Blue Cross/Blue Shield. Just because we became a bigger company we're able to attract better bids on our business and that's really what's impacting that.

Okay so that $200,000 in savings that you mentioned anniversaries so we won't see that again in the third quarter, correct?

No I think you'll still see improvement on our insurance side over third quarter and into fourth quarter. I mean if things keep going how they've been going under our prior plan you'll still see that.

Okay, Joe I don't know if I heard you correctly but right after when you were discussing your initiatives you mentioned something about testing with two carriers to sell professional parts at retail. Did I hear that correctly?

I think you may have gotten that just a little bit off. I think what I was talking about was not the sales part but what is a program that we call LKQ Last Look. We have developed our own electronic estimate review service. We offer it both to collision repair shops as well as to the insurance companies. The insurance companies can give us either their appraisers or they can instruct their direct repair shops to use LKQ -- Last Look.

So it is our own electronic search engine. We do couple that, if you will, a set of human eyeballs to look at vehicles that are borderline totaled to make sure that some flexibility on pricing or parts decisions might not help save the car. GMAC is one of the main users of this product. GMAC has asked us to all of their direct repair shops use LKQ Last Look, and they've also provided a product to all their internal appraisers.

Yes actually I appreciate the added detailed of GMAC on Last Look but there's some ways -- maybe I'll just follow up with you. I thought I heard you mention something after you talked about how you had signed on potentially a third carrier you followed up by saying that there was another program where you were looking at selling professional parts right after that and you were testing it with two carriers.

It sounds like we should probably follow up on that.

The last question I had with Advance, the $4 million, did I hear you correctly that most of it's going out to commercial customers? I presume the goal is to sell it mostly to their retail customers. What kind of criteria and benchmarks are you putting on this program to make -- to make a decision in terms of whether or not the investment is worth it, that you're penetrating enough retail customers?

Well I think -- the gross margins is program and the operating margin should be pretty consistent with --. But we enjoy selling the -- the primary thing that we'll focus on Gerry is whether or not these are truly incremental sales for LKQ. Over the long run if we're just selling parts through this program that we would have sold anyway then this may not be all that interesting.

We believe that over the next few quarters it will prove out that the majority of the sales will be to a customer base. We likely never would have had the opportunity to have sold to and in many cases it may be parts that we would never have sold in any event. So let's [inaudible] the primary metrics we'll watch. We expected a fairly slow build in the program as we announced last quarter and I think the next real leg up here will be in the third quarter and towards the end of the third quarter as we see the impact of what happens in response to the internal work that Advance is going to contribute into the program now. So far most of the -- I'd say most of the effort to develop the program has come from LKQ's business development people and Advance has been a fantastic partner.

They've put together some really classy internal materials that I'll show on their in-store television. We both -- as they try to educate both their employees as well as their retail customers. So I think after that process is complete and we move into the fourth quarter of the year we'll have a much better appetite for exactly what this program can become.

Okay sounds great. Thanks.

Thank you, Gerry.

Your next question is from Bill Armstrong with C.L. King and Associates.

Good morning, I have two questions. First we had a lot of rain in May and June in the eastern part of the country. I was wondering if that had any positive impact on the supply and demand for collision parts and if you saw that flowing through to your business during the quarter?

Yes I think that's fair to say especially the north east the first three important months of the year for our New England operations were probably a little on the slow side. May was an outstanding month. Actually for the company as a whole but then particular -- we'll have our Great Lakes markets and the east, northeast markets enjoyed a very nice May and June as well.

Okay and then a follow up on an earlier question regarding some of your acquisitions that have added to your self-serve retail capability. Could you talk about any synergies that you may have with some of your existing wholesale salvage businesses especially in the Houston and Florida markets?

Sure one of the probably more obvious things to me is that frequently when I happen to be in our -- some of the retail operations we will see regularly products that those are the retail operations that really doesn't belong there. And by that I mean it's product that it's probably has more utilization and better economic value in a wholesale yard. And this is not necessarily anything by plan but sometimes for lack of a better word you get lucky and you acquire salvage at the retail operations that's really quite attractive to the wholesale business and doesn't necessarily cost a lot of money to acquire.

So certainly to have our eyes open to the abilities to move that product from a retail operation and the wholesale business. We've also been and this has probably been our best success story on this is probably in the Portland, Oregon markets where we also put demos up of our after-market products at the self-service retail yard and that provides a small revenue base that given the fact that there are really no selling costs or any distribution costs associated with those sales are somewhat very attractive incremental revenue bases.

Then there will be markets, the Michigan market I think is probably a fairly good example where we have a self-service business and a wholesale business that operates side by side. While those businesses operate with a separate senior manager the facilities are able to enjoy the benefit of sharing some equipment between operations and certainly back up and spare equipment to be shared between facilities quite easily and in a situation like that.

So the other benefit that I see and I think we'll prove this out in I'll say before the end of the year one of our difficulties with taking product, salvage product directly from insurance carriers has been frequently some of that product might be with older vehicles that we don't have a lot of interest in in our wholesale operations.

Where we can put these programs together where we have both the combination of the wholesale business as well as a retail business that low-end product 2 years we would have had no interest in now we'll probably be very, very happy and very excited to get that type of product in order to push it to our self-service businesses. I think the synergies are probably a little more extensive than first meets the eye.

Right are there -- is there a big difference in how quickly you generate -- you I guess recycle revenue from a retail vehicle versus a wholesale vehicle? I think on the wholesale side you usually get, what is it? Ninety percent of your total revenues in the first 70 days or maybe I've got that backwards but it's similar in retail?

So the retail turns a little faster. Most of our retail yards will probably rotate their product 40 to 60-day cycles.

Okay. Okay thanks.

Thanks, Bill.

Your next question is from Sam Darkatsh with Raymond James.

Thank you. This is actually [Jeff Rideau] calling in Sam's place and taking the call. If we could briefly go back to the weather for a second because for much of the quarter it was actually fairly dry across the country. Can you quantify at all or at least give us directionally what you think the impact of weather was on the organic growth?

I don't think I'd be in a position to do that. The only thing I'd say would just be a guess.

Okay well sticking with the organic growth you were up against a pretty tough comparison in the quarter. Would you expect that to naturally rise the rest of the year? It's going up against easier comps.

I don't think I would want to make that forecast. I think we've said we feel comfortable with low double-digit organic. We've been hitting -- generally we're hitting between 10 and 12% and I'll just add I don't see anything in the cards right now that would suggest we would be outside of that band, bandwidth.

Okay and I actually had one clean up and I apologize if you've addressed this already. But we were expecting the warehousing cost to ramp a little bit faster than they did in the quarter mainly due to the big Chicago warehouse you opened last quarter. Was there anything to offset that opening?

No I'm trying to think the Chicago warehouse, I don't think it's quite started in Q1 [inaudible]. Yes in Q1, nothing comes to mind off hand other than we do watch our costs. I will say maybe overall -- for our cost overall as you know we've mentioned April was a little slow for us so we put in some cost initiatives seeing it wasn't quite as robust as we would have looked. And so we looked at some cost cuts. Other than that and that was over various -- maybe more than cost cuts we looked at not rising cost as fast as some areas. We can react to that when we see some of that so nothing in particular that I can think of that offset the [Ran 1] warehouse.

Thanks a lot.

Thanks Jeff.

Your next question is from John Lawrence with Morgan Keegan.

Good morning guys.

Hi John.

John.

Joe would you comment quickly as you look and you talk about combining some of the -- merging the facilities. Remind us again if you look at those facilities where do you still have those opportunities going forward to the existing infrastructure to really make some [moves] to be able to share some -- there would be some cost there?

Let's say it probably works to fairly easy ones at this point. Of course the Global transaction being fairly recent would still present some possible opportunities there. But by and large the warehousing in the Seattle market will be pretty much stand-alone. We will be merging our cross dock operations for the recycling business into the same facilities being used by the Seattle after-market business.

In the Portland market we'll be able to take -- basically we'll close down Global's existing warehouse and move their product into an existing after-market product warehouse that we had already leased from our Oregon business. And we felt that Global's Los Angeles warehouse was certainly on the small side. We'll be relocating their warehouse to be co-located with LKQ's recycled product warehouse in L.A. That will probably take -- it'll be the end of the year before that gets done and then we should be able to enjoy joint delivery on basically the same distribution trucks out of the Los Angeles market and the after-market business will come under the same management as our LKQ business. So certainly we have -- we have some work and opportunities associated with the Global business.

Okay thanks and just not to belabor that point on the lower retail part of the business but between that and the last look can you just give us a little update on industry conditions, what are the insurance companies seeing and the program you're putting in front of them, what's making them want to come to your -- endorse Last Look? How is that helping net operations your theory of the success factors for that?

A tough question to answer. I guess just in terms of overall trends in the insurance industry it's really pretty much more of the same I think. Some of the carriers are posting some pretty attractive APUs, alternate parts utilization rates, and we see I think a number of carriers who are somewhat in catch up mode to attempt to get to the same levels as those who are -- who have been more successful. I do think the business model we put together of a combination of alternative part types it's gradually, I think, kind of winning over the number of shops and their ability to accomplish a one-stop shopping. I can't say that I any specific data that backs that up other than the fact that we look at the company continually in achieving its same-store sales levels, the 10 to 12% even as the overall footprint of the business continues to expand.

This Last Look is a pretty new product. We're very happy to have really three carriers who will be using that product here over the next half a year. That will give us the ability to capture some data points and probably more effectively market the program in 2007 after we can demonstrate its value.

Okay congratulations Joe.

Thanks John.

[OPERATOR INSTRUCTIONS].

And your next question is from Gary Prestopino.

Hey Joe, Mark.

Hi Gary.

Hey could you just give me the rationale or the benefit to Transwheel of keeping this smeltering operation?

Yes I mean they reason they got into was to be able to bring in more wheels to sort through because they are looking for wheels that are not damaged so bad where they can refurbish them. And to do that they were bringing a lot of wheels so they could then sort through them and pull out the ones that were refurbishable and then get rid of the others without losing money and trying to then to sell to somebody else at less what they paid for it.

So that's why they got into that and it does attract a larger range of wheels coming in. The reason we're still looking to see is to see how many wheels we can generate of the quality. It also increases our inventories out in the field more on this product. And that's why we're trying to wait to the end of the year really to make a decision on that because we don't really like the lower margin business. What we really like is getting the extra wheels to refurbish. And that's why -- that's the purpose of it is to bring in more volume.

Okay and then are you seeing any movement by the insurance companies to kind of use these recycled OEM parts for cars that are say less than 3 years old just to try and save expenses since they've gotten so badly impacted by Katrina, the hurricanes last year?

Gary, I can't say we've seen any movement whatsoever in that area.

Okay all right. Thank you.

All right, thank you.

And there are no further questions at this time.

Just perfect. I'd like to thank everybody for joining our call and we'll do our Q3 call, I think will probably be the last Thursday of October. Obviously we'll be sending out a notice on that and thanks again for your continued interest in LKQ.

Thank you for your participation in today's conference. This concludes the call and you may now disconnect. Have a great day.