LKQ Corp (LKQ) 2006 Q3 法說會逐字稿

Good day ladies and gentlemen and welcome to the third quarter 2006 LKQ Corporation's earnings conference call.

My name is [Angela] and I will be your coordinator for today.

At this time, all participants are in a listen-only mode. We will be conducting a question and answer session towards the end of today's conference.

[OPERATOR INSTRUCTIONS]

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

And now, I would like to turn the presentation over to your initial host for today's call, Mr. Mark Spears, Chief Financial Officer. Please precede, sir.

Thank you. Good morning.

Before we get started I need to talk about forward-looking statements.

The statements in this press release and web cast 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 statement to reflect events or circumstances arising after the date on which it was made except as required by law.

I want to turn it over to Joe Holsten, our CEO now.

Okay, good morning. Thanks for joining LKQ Corporation's third quarter 2006 earnings call.

On the call today are 2 members of management, Mark Spears, our CFO, and myself. My name is Joe Holsten. I am the Chief Executive at LKQ.

I'll begin by providing some high level overview of our performance as well as some qualitative views on the business and our industry. Then Mark will provide a more detailed assessment of the financial results of the Company.

As stated in our press release, we are very pleased with the Q3 performance of the Company. We reported $197.7 million in revenue for the third quarter, which represents 48% total growth over the third quarter of 2005 and organic revenue growth of 12%.

Our EBITDA margin was 10.8% for the quarter compared to 10.4% in the third quarter of 2005.

We believe the margin improvement is 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 over 58% to $10.5 million for the quarter. And diluted earnings per share increased by almost 36% to $0.19.

I ask you to remember that in early October 2005 we closed on a follow-on stock offering with LKQ issuing 6.4 million new shares. This primarily accounts for the diluted EPS growth rate being less than the net income growth line, growth rate.

As we discussed on our July 27 earnings call, we have acquired 9 businesses in the first 3 quarters of 2006. This included 3 recycled parts businesses that had about $15 million of revenue in 2005; one being Michael Auto Parts located in Orlando, Florida that primarily serves the professional repair market. And 2 retail businesses, one near Charleston, South Carolina and one near Baton Rouge, Louisiana that were essentially start-ups for us.

As you know, 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, to add about $28.5 million of revenue in 2005 from the sale or restoration of wheels.

In addition to this wheel refurbishing business, Transwheel operates an aluminum smelter. The smelter third party revenue was $19.9 million and gross margin of approximately 6.7% for the 8 months that we owned them this year. And obviously a 6.7% gross margin reduces LKQ's overall gross margin percentage. But I would note that the smelter's financial performance is accretive to our earnings per share.

During the second quarter we acquired a West Coast aftermarket distributor by the name of Global Automotive Parts. Global operated out of 3 warehouses with a combined 70,000 square foot capacity in Los Angeles, Portland, and the Seattle area.

In 2005 Global reported approximately $11 million in sales.

During the third quarter this year we merged the Global Portland and Global Seattle business operations into our recycled parts businesses. In November we plan to operate the Global Los Angeles business as part of our Los Angeles recycled parts business by moving into new warehouse space where the 2 businesses will be relocated.

By the end of the year these 3 markets, Los Angeles, Portland, and Seattle, will have warehouse space dedicated to aftermarket product with a combined total of about 110,000 square feet, which we will believe will enhance the aftermath of growth opportunities for us on the West Coast, as we will have major warehouses to support all 4 West Coast major population centers.

In the second quarter and in early July we also acquired 4 recycled parts businesses that operate 10 facilities. These businesses generated $33 million of revenue in 2005. And they include a business in Western Michigan that operates from 3 facilities with a total of 25 acres, 2 facilities sell primarily into the retail market. And one sells primarily into the professional repair market.

This facility also gives us much needed capacity to more fully serve the Western Michigan market, which previously has been solely served by our Detroit operations.

Also a business in Tulsa, Oklahoma that operates 3 facilities with a total of 40 acres, 2 facilities selling primarily into the retail market, and one selling primarily into the professional repair market.

In addition we subsequently acquired a 10,000 square foot warehouse, adjoining one of these properties to house our aftermarket product for the Tulsa market.

A business in Houston was also acquired that operates 2 facilities with a total of 46 acres that sells primarily into the retail market. Houston is the fourth largest market in the United States. We think this business will compliment our existing Houston operations that are based on a 12-acre facility selling into the professional repair market.

The final transaction is a business that operates a facility outside of Denver with 10 acres, our initial entry into the Denver market and a 12-acre facility in Daytona Beach, Florida with both facilities selling into the retail market.

As I indicated on our Q2 earnings call last July that we probably would not close on anymore deals in Q3. We have acquired a large amount of business in the first, or in the last 12 months, larger than we would normally project on an annual basis.

In fact for the 9 months ended September 30 our revenue growth from business acquisitions is 33.2%.

In terms of other potential geographical expansions, we are continuing to staff acquisition candidates that include both recycled parts and aftermarket businesses. And would expect to close on additional transactions before the end of 2006.

Our insurance relationships and programs continue to expand and contribute to our growth as well. Our electronic ultimate review service offering to the insurance industry, which we call LKQ Last Look, is now being used in certain markets by 3 insurance carriers.

And we're looking at modifying this program to make it easier for our own sales staff to review requests more efficiently.

As we indicated last quarter, we have been trying to get several carriers to directly provide us low cost cars that would supply some parts to be sold into the professional repair market. And the remainder of the car being placed in the retail oriented locations.

I'm happy to report that several weeks ago we began receiving cars at a rate of about 250 per month under this type of arrangement with a large national carrier.

We have been piloting with another carrier to whom, to obtain wholesale cars directly from them in the pilot market. That carrier has since expanded this program. And in the fourth quarter this program will be expanded into 5 additional states. We estimate this could generate approximately 160 cars per month for us.

Our program with Advance Auto Parts, which is marketed as the Right Choice Program, continues to see more participation by Advance stores.

Advance Auto Parts has approximately 3,000 stores in the U.S. throughout 40 states. And to date we have received sales inquiries from 2,250 of those stores. And have sold at least one item to nearly 2,200 different stores.

At this time we are averaging around $117,000 per week in sales, which is annualizing at a little over $6 million.

That represents 38% increase over the level we reported to you 3 months ago. In August Advance began a campaign of in-store commercials. Along with window posters and counter mat advertising, along with supplemental newspaper ads in their major markets to educate more retail oriented customers about the Right Choice product.

As we previously indicated, since we will be in the start-up rollout and training phases of this new program, we do not expect earnings accretion in 2006. As Advance has 3,000 stores in the U.S., we believe this process will take considerable time.

We will also need to gradually adjust our procurement in order to achieve better fill rates for the type of product that Advance customers may seek while protecting our existing gross margins.

The store hope and our beliefs over time with this program we could realize material amount of sales and profits, and than annual revenues approaching $25 million could be achievable.

At the end of Q3 we operated 35 transfer runs and over 400 local delivery routes. This carries primarily aftermarket parts and refurbished wheels. And 54 transfer runs and about 400 local delivery routes that carry primarily recycled parts.

In various areas these recycled part transfer runs and routes also deliver aftermarket parts. So in total LKQ has a delivery system approaching 100 transfer runs and over 800 daily local delivery routes.

We acquired approximately 24,000 cars in our wholesale-recycled parts business during the quarter, which is about 18% more than we acquired during the third quarter of 2005.

The percentage of vehicles that we acquired from salvage auctions during the first 9 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. And we have done so by an average of 54 persons more in Q3 2006 compared to the third quarter of last year. This is a 14% growth in headcount with approximately 8% of the growth coming from acquisitions and 6% of the growth coming from organic hiring.

In summary, we're pleased with our growth prospects and we continue to believe we can grow our business organically at a rate in the low double digits. And in this quarter, as I noted earlier, we recorded approximately 12% organic growth. And for the 9 months organic growth is closer to 12% as well.

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

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 supplementary data schedules related to our income statement that showed growth and margin percentages.

Also note we had a 2 for 1 stock split in January 2006. So all earnings per share amounts, stock price amounts, and share counts presented reflect a split.

Looking at our income statement related tables; our third quarter 2006 revenue is up 47.9% to $197.7 million from $133.6 million in Q3 2005. Our first 9 months of revenue for 2006 grew 45% to $584.8 million compared with $403.5 million for the same period in 2005.

Our organic revenue growth was 12.2% for the quarter and 11.8% for the 9 months.

Our third quarter 2006 gross margin was 45.2% versus 47.1% in the third quarter of 2005.

For the first 9 months of 2006 our gross margin was 45.5% versus 47.1% in the same period in 2005.

As Joe previously discussed, the Transwheel business we acquired this year has an aluminum smelter that operates at very low margins compared to LKQ's primary businesses. In addition since Transwheel performs certain types of refurbishing activities, we were required to write up certain compliments of their inventory in an opening balance sheet related to these refurbishing activities, which is required by financial accounting standard number 141 called Business Combinations.

The inventory write-up was approximately $300,000 with all of it coming through cost of sale in the first half of 2006.

Accordingly our gross margin would have been 46.7% in Q3 2006 and 46.9% in the first 9 months of 2006 if you exclude the effect of these 2 items.

Our facility and warehouse expenses for Q3 grew $7.2 million or 47.3% over Q3 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 $6.4 million of the growth or 42.1% expense growth.

Excluding the effects of business acquisitions, the third quarter of 2006 had increased cost over the third quarter of 2005 primarily related to labor and labor related cost growth of $0.3 million. This related to increased staffing needs to handle parts volume growth.

For the first 9 months of 2006 these expenses as a percentage of revenue improved to 10.8% from 11% for the same period in 2005.

On a 9-month basis facility and warehouse expenses grew $18.8 million or 42.6% over 2005. Business acquisitions represented $15.1 million of the growth or 34.2% expense growth.

Our distribution expenses for Q3 grew $4.7 million or 29.7% over Q3 '05, of which $3.3 million or 21.1% expense growth was due to our business acquisitions.

Excluding distribution expense growth related to those business acquisitions, our Q3 2006 distribution expenses grew 8.6% over Q3 '05 while organic revenue growth was 12.2% for Q3 '06.

For the first 9 months of 2006 these expenses as a percentage of revenue improved to 10.3% from 11.2% for the same period in 2005. On a 9-month basis, distribution expenses grew $14.9 million or 33% over 2005.

Business acquisitions represented $10 million of growth or 22.2% expense growth.

Selling, general, and administrative expenses grew $7.1 million or 38.7% over Q3 '05 of which $5 million or 27.1% expense growth was due to our 2006 business acquisitions and the full-year impact of our 2005 business acquisitions.

During the third quarter of 2006 compared to the third quarter of 2005, we had $0.3 million in higher sales promotions, $0.9 million in higher wage and fringe costs, $0.2 million in higher compensation expense accruals related to the stock option expense that we had to incur for the first time in 2006.

We also had $0.4 million in our new long-term incentive plan or LTIP expense, which was a new incentive plan put into effect in 2006. This new plan was outlined in our prior proxy statement.

For the 9 months of 2006 these expenses as a percentage of revenue improved to 12.9% from 13.6% for the same period in 2005.

On a 9-month basis selling, general, and administrative expenses grew $20.3 million or 37.1% over 2005 of which $13.7 million or 24.9% expense growth was due to our business acquisitions.

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

For the quarter, our EBITDA grew 54% to $21.4 million. EBITDA was 10.8% of revenue for the quarter compared to 10.4% in Q3 2005. For the 9 months our EBITDA was 11.8% of revenue versus 11.5% for the same period in 2005.

Our operating income for Q3 '06 grew 55.8% over Q3 '05 to $17.9 million. Operating income as a percentage of revenue was 9% in the quarter compared to 8.6% in Q3 2005. For the first 9 months of 2006 operating income improved to 10.1% of revenue compared to 9.8% 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 statements. It was only in our footnote to our financial statements.

We now show stock option expense in our income statement based on where the employee wage costs are incurred. In total, stock option expense for Q3 2006 was $372,000. And for the 9 months was $1.5 million.

The expense in 2006 is booked in the individual quarter based on vesting. We expect the full-year expense will be around $2.4 million for 2006.

Second, remember when I talked earlier about the effect on our gross margins in 2006 related to Transwheel's aluminum smelter and the adjustment related to financial accounting standard 141.

So for the third quarter, without the effect of the Transwheel items and the expensing of stock options, our EBITDA margin would have been at 11.1% and our operating income at 9.3%. For the 9 months EBITDA margin would have been at 12.3% and our operating income margin at 10.5%.

So our primary operations did expand margins over 2005 for the quarter by 70 basis points for both EBITDA and operating income margins, for the 9 months by 80 basis points on EBITDA margin, and by 70 basis points on operating income margin.

We had net interest expense in Q3 2006 of $1.8 million compared to net interest expense of $0.7 million in Q3 '05. This was primarily due to an increase in levels and rising interest rates.

Other income in the first 9 months of 2006 was $1.2 million compared to $601,000 for the same period in 2005. This increase was primarily related to a $719,000 gain back in Q1 2006 on selling equity securities.

Our Q3 2006 pre-tax income grew 46.3% to $16.3 million from $11.1 million in Q3 2005. For the first 9 months of 2006 pre-tax income increased 45.8% to $55.9 million from $38.3 million for the same period in 2005.

For the first 9 months of 2006 our effective tax rate was 38.8% compared to 40.9% in the same period of 2005.

During Q3 2006 we booked a tax benefit of $688,000 primarily related to the statutory closing of certain prior tax years. Had it not been for this reversal, our Q3 and 9-month 2006 effective tax rate would have been 40%.

We expect our Q4 2006 effective tax rate to be 40%.

Net income for the quarter increased 58.4% to $10.5 million from $6.6 million in Q3 '05. For the first 9 months of 2006, net income increased 51.1% to $34.2 million from $22.6 million in the same period of 2005.

Our diluted earnings per share increased 35.7% to $0.19 in the quarter from $0.14 in Q3 2005. Without the $688,000 tax benefit, our EPS would have been $0.17 for the quarter.

For the first 9 months of 2006 diluted earnings per share increased 27.1% to $0.61 from $0.48 for the same period in 2005. Our diluted weighted average common shares outstanding used for EPS purposes were as follows. Q3 2006, 55.9 million shares versus Q3 '05 at 47.7 million shares. For the 9 months 2006 it was at 55.7 million shares versus 9 months '05 at 47 million shares.

Our diluted weighted average share count increased 17.3% for the quarter and 18.7% for the 9 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 warrant, and the increase in our stock price.

Let's take a look at our cash flow table.

We generated $30.8 million in cash from operations during the first 9 months of 2006. From the end of 2005 we funded an additional $11.9 million in inventory growth with 60% of that related to aftermarket inventory.

CapEx, excluding business acquisitions for the first 9 months was $24.4 million. Cash paid for our 2006 business acquisitions during the quarter - I'm sorry - during the first 9 months was $68.1 million.

During the first 9 months we issued stock related to the exercise of stock options and warrants that resulted in shares issued and dollar proceeds received that totaled approximately 1.7 million shares for $11.2 million in cash proceeds, which includes related tax effects.

We issued no stock related to business acquisitions to date in 2006.

In looking at our September 30, 2006 balance sheet you will note we had $109.2 million in debt, which included $94 million in debt under our unsecured credit facility with our bank group. As of October 25, our credit facility debt was at $93 million.

Total borrowings allowed under this bank facility are $135 million. And if an accordion option feature is exercised, could go to $150 million.

This facility matures on June 1, 2010. We feel confident this credit facility could quickly increase when we have the need. At September 30, 2006 our debt to EBITDA ratio is 1.3 times. So we certainly have significant ability to increase our debt capacity.

As we indicated on our last earnings call, we expect that 2006 organic revenue growth will be in the low double digits with a balance of the growth being the full-year impact of 2005 business acquisitions and our 2006 business acquisitions.

We expect full-year 2006 net income to be within a range of $43.7 million to $44.7 million. And diluted earnings per share to be between $0.78 and $0.80. Included in the guidance is an estimate of $0.03 per share effect that expensing stock options for the first time.

We anticipate that net 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's acquired businesses, will be approximately $41 million.

This does include approximately $6 million related to property and equipment purchases made subsequent to our ownership of businesses we acquired in 2006.

We estimate the weighted average diluted shares outstanding for the full-year 2006 to be approximately $56 million.

These share numbers are estimates and as such will be affected by factors such as future stock issuances, the number of our options, exercise in subsequent periods, and changes in our stock price.

We anticipate that in late February 2007 we will announce our 2006 fourth quarter and annual financial results as well as our 2007 financial guidance.

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

All right. Thanks, Mark.

Just to sum up here, we do believe that the Company LKQ continues to have a highly compelling and model. We provide an attractive value proposition to a wide array of customers and to the insurance industry.

And we believe our Company is in a unique position to leverage our inventory to recycled product, aftermarket parts, and refurbished wheels by having the ability to sell out of these combined inventories in response to our customer request.

We also believe that further margin expansion is possible as we continue to seek opportunities to better leverage our investment and facilities and distribution systems. And as the Company continues to enjoy solid opportunities for revenue expansion through same-store sales growth coupled with acquisitions.

At this time, Angela, we'd like to open up for Q&A.

[OPERATOR INSTRUCTIONS]

Gentlemen, your first question will come from the line of Sam Darkatsh with Raymond James. Please proceed.

Good morning, gentlemen. This is actually [Jeff] calling in for Sam. He was unable to take the call.

Hey, Jeff.

I just have a couple of quick questions.

First off, you touched on the distribution expense. And as a percentage of sales it looks like it's running I guess about 100 basis points lower than it has in the past.

I was wondering if you could maybe talk about the cause of that a little bit. I don't think we've seen this kind of leverage in that expense in the past.

Yes, I think you've got to be careful and kind of go back to what I talked a little bit on the organic growth. Organically, distribution costs increased year-over-year 8.5%.

In Q2 it had increased 7% with the main difference being there back on the Q2 call we talked about a little improvement in insurance costs for the period.

So we're tracking pretty well there. Year-to-date it's 10.8%. You have to be a little careful when you look at the overall relationships there. Some of the businesses we've bought as we got into Q3 were the retail businesses. And they don't really run distribution. It's more of a retail operation.

So that's probably why you see the quarter itself showing more. Cause you're looking at the whole financial statement rather than just the organic side.

Okay. And then in the SG&A, what kind of leverage should we be looking for going forward in that line item?

In that category there's a little more selling than G&A. And we've always selling expenses tends to grow not far off from what the revenue grows.

G&A should have a fair amount of leverage there. Year-to-year we look at 3, 4, 5%, somewhere in that level in the G&A.

Keep in mind this year you've got stock option expense in there for the first time. And you've all got the LTIP in there as well. So you're not showing quite the same leverage.

Okay. And then just a couple of more. In Q4 are you expecting any favorable benefit from the snowstorms that we've been seeing up in the Northeast, the blizzard in Buffalo in particular?

Yes, I'd say it's a little early to be altering any of our forecast for Q4 based on any weather events of the last week.

Okay. And then just lastly, on your last call you talked about examining ownership of the Transwheel smelter. Have you made any progress on that evaluation?

Yes. That evaluation continues to be in progress. And if our timing is the same as we had indicated in the past that we believe we'll make a firm decision on that by the end of this calendar year.

Okay, thank you. That does it.

Thanks, Jeff.

Gentlemen, your next question will come from the line of Tony Cristello with BBT Capital Markets. Please proceed.

Hi, thanks. Good morning.

Hey, Tony.

A couple of questions, one wanted to just comment. When you look at this quarter year-over-year to last you were benefit last year by an earlier winter. The seasonally weakest quarter that you just finished you had great organic growth. You were even started a little bit sluggish, if I can recall.

Would you say that you're off to at least a little bit better start this quarter? Or because you had such a strong quarter last year maybe it's just in line with your expectations?

I would unfortunately say that the shock filter starter is probably a little on the sluggish side, too. We've, unfortunately, we've done these calls. This is the third time in a row where we've started the quarter and indicated that the first few weeks of the quarter are a little on the slow side.

Yes, it's nothing. We don't think that the business won't kind of recover from over the balance of the quarter. It's a material variance from what we expected.

As we are coming into - this may sound a little silly - but Daylight Savings Time changes seem to have an impact on the accident frequencies. And that's coming up this weekend.

Deer season is upon us and again, as silly as that my sound, that does seem to create a significant number of accidents and repair jobs in a number of the Midwestern and New England states.

So, yes, I think the guidance that Mark gave for the year would reflect the fairly robust fourth quarter with continued good gains over the fourth quarter of 2005. And I certainly don't see anything over the first 25 days, 26 days of the quarter that would suggest we won't achieve those goals.

Okay. When you look at then the seasonality of your core business, is the wheel business any different from a seasonality standpoint? I mean can you just talk a little bit about that and where the peaks of that business versus sort of off-peak months might be?

Tony, I think I'd look at the recon wheel business in just the same way I would as the crash part side of the business as differentiated from mechanical part side of the business.

It's going to be subject to the same I think seasonality trends of those months with typically more wet weather, either rainfall or snow or ice. You're probably going to see.

Your aftermarket business now over 20% of your mix. Do you see what's going on with Ford and the ITC issue with Keystone? While you're not named in that, there are broader reaching implications should that be ruled unfavorable to Keystone.

I'm just wondering if, Joe, you may have any thoughts or comments about the big picture. And sort of one I'm assuming your business with Ford on the aftermarket is probably not a major component certainly on the F-150, at least the newer models because your average age is a lot older.

But just any thoughts you might share with us on that with respect to [Cappas] sort of pulling out on that business right now.

Yes, first of all I should be clear. We did receive a letter from Ford this week that I'm assuming must be somewhat similar to the letter that Keystone claimed that they received.

And the letter related to certain patents and patent applications of Ford. We obviously take anything like that seriously and we've asked our inside and outside counsel to assess the claims that are made in the letter by Ford. That analysis is ongoing as we speak.

The thing that, the conclusion that I would be happy to share with the group this morning is that our kind of quick review of the list of parts and products and the model years, the vehicles involved, is that the vast majority of those part types don't even have aftermarket product being produced.

And we're very comfortable to state that the parts at issue would constitute an immaterial part of our aftermarket parts revenue. And obviously it would be an even more material in relationship to the Company's total revenue mix.

Okay. All right.

And one last question, when you look at the Advance business, good growth from last quarter. Some of that obviously related to Advance's push on the marketing side.

Can you talk a little bit just about the mix of product initially? And then maybe where the mix of product is now relative to Advance getting a little bit more promotional on pushing the salvage?

Yes, I think the initial sales we saw in the program were almost all mechanical and largely motors and transmissions.

As our salespeople spent more time in the stores with the Advance people and thanks to the infomercials that Advance has put into their stores, we're starting to see a more diverse product line being sold. And the aftermarket product sales have certainly increased over what we saw in the first quarter.

But here we're starting to see brain boxes of sell to the system, spindles, and some small rotating electrical parts. And even more body parts are starting to sell.

So it's, we continue to look at the program as a marathon. We love the fact that we have this relationship with Advance and they're real standup people. We're highly confident that they'll continue to take that promotional program internally and we'll be right there with them with a lot of our business development people continuing to work with their 3,000 stores on a regular basis.

Okay, great. Thanks guys, nice quarter.

Thank you, Tony.

Gentlemen your next question comes from the line of Bill Armstrong with CL King Associates. Please proceed.

Thanks, CL King.

Your facilities and warehouse expense looks like it was roughly flat as a percentage of sales. And I thought that would be an expense option that you normally would be able to leverage.

Yes, Bill, a couple of things there. You got to keep in mind a lot of that comes through with the acquisitions we did. Again, we did quite a few acquisitions and there was a fair number of them that were in that retail bracket.

In a retail bracket, most of it's cost and then facility and warehouse expenses. It's not in distribution costs. They don't have salespeople running around or anything like that.

Maybe I reference you back to when I talked about growth of the 7 warehouse costs. On an organic basis, they actually were fairly low for us in the quarter. Organically they grew 5.2% year-over-year.

And I think that's what you're seeing. And the top line answer that looks like we should have had leverage. But we did have leverage organically. It's just the acquisitions getting layered in.

Okay. And has there been any change to your sales commission structure this year?

Yes, generally each year we do raise the bar a little bit on the commission structure. Although I cannot say that we did that in every single LKQ location. I'm comfortable to say that a majority of our regions certainly either took the commission structure down by probably a quarter of a point or had a slightly higher threshold for salesman to earn the top level.

We've also introduced various requirements for salespeople to have to sell a certain mix of their revenue to be both aftermarket products as well as recycled parts. Otherwise there could be a slight downward adjustment to their commissions.

And we'll, probably in '07 we'll see similar trends from the Company where we would again make a slight raising of the bar, if you will.

Okay. And then finally on the smelter revenues, I guess I would have thought that revenues might have been more since your presumably flowing a lot more wheels through the Transwheel operation. And therefore smelter should be getting more.

Should we be looking at sort of 7 or $8 million per quarter run rate on the smelter going forward or does that ramp up?

Well, the smelter like we said, it's not a main part of our business. And it's pretty close to max capacity.

So the only thing changing there for the most, only to squeeze a little bit in more. But the only thing that's really going to change there is the pricing.

So like I said, we're not at the current time looking at putting another smelter in. So that's why you're not seeing volume growth really.

Okay. So if - so what are you doing with all those wheels then that you can't use?

Well the flow we're coming in with, we're pulling more out. I mean bigger wheels that we brought in are mostly coming from LKQ plants. That's the more volume.

And so we get better return out of those wheels. I mean the ratio of wheels good to bad is much better on the LKQ ones.

Okay. Okay, thanks.

Thanks, Bill.

[OPERATOR INSTRUCTIONS]

Gentlemen, your next question will come from the line of Craig Kennison with Robert W. Baird. Please proceed.

Mr. Kennison, your line is open.

Okay, thank you. Sorry about that.

Congratulations on the quarter.

Thanks, Craig.

A couple of competitive related questions. First of all it looks like Ford is beginning to sell some damaged parts. Is that a threat to you?

I guess over the last 6 or 7 years I think we've seen various programs come from a number of the OE manufacturers. They tend to be short-lived. And I guess I can say from my interaction with our salespeople in the field locations, I certainly can't say that that's cannibalizing any of our sales at this point.

And also Amazon announced they're going to sell auto parts online. Is that either a threat or possibly even an opportunity for you down the road?

We're currently evaluating that as a possible opportunity for us. It's very; we're very early into that assessment. But, yes, we're taking a look at that as a possible avenue to move additional product.

Is there any discussion with that organization? Or is it too preliminary to disclose?

Too preliminary to disclose.

Okay. We've seen fuel costs come down significantly. How material is that to your business and should we see some benefit?

You'll probably see it a little more in the fourth quarter. That really started in September. Let me throw out a number here for everybody.

We had in Q3 our truck fuel expense in what we call subcontractor delivery costs that we do, which kind of tracks with fuel as well. It was about 22% of our total distribution expenses. And it's about 2% of revenue.

So again, just a reminder that 2% of our revenue, we like to see fuel costs come down. But it's not like it's a major.

Okay. That's a helpful metric.

I doubt you have any news on State Farm but I'll ask anyways.

Same answer as last quarter, no new news.

Okay. And then final question just what's your internal thinking regarding free cash flow generation? It looks like you generate or you spend in capital expenditures, growth capital expenditures, about as much as you generate.

Should that continue sort of philosophically for the next several years as you continue to grow?

Yes, I think our philosophy has been internally with our budgeting and everything is to generate some level of free cash flow. Okay?

We want to self-finance our organic growth. And we've been able to do that kind of from day one here.

We did have some little extra CapEx this year as we talked about. And you may have noted that we dropped our CapEx projection a little bit. There was a few more projects. We had up to $43 million in our priority. I think now it's around $41.

Just some projects we wanted to get done this quarter and it ended up getting pushed into early next year.

So it's still our, we showed you the growth. We like that double-digit organic growth. We want to re-invest but we don't want to take on more debt or have to do more equity for that. We want to take on more debt and equity at times in our future related to the acquisition growth.

Great. Thanks, guys.

Thank you, Craig.

Gentlemen, your next question will come from the line of Eric Glover with Canaccord Adams. Please proceed.

Thanks. Nice quarter, guys.

Thanks, Eric.

Just a couple of questions here. In terms of the quarter itself, was there a particular strength you saw in any certain markets? Or would you describe it as broad based?

I think I would have to say it's fairly broad based performance. I can't really think of any geographical market or product line that kind of weighed heavily or more heavily than we would have expected.

Okay. And then maybe more specifically on your retail oriented businesses, could you just comment on how that segment of the market is doing for you?

We've been fairly pleased with it. The kind of the one aspect of that piece of the business is with high scrap prices, it does tend to attract a lot more people in to compete for product.

Our view has been that we should be able to sustain profitability at consistent levels in that business by managing the spread of what we're paying for cars in comparison to the value of course in scrap. And certainly we had a good handle on the average parts prices that we'll sell per vehicle.

But that would probably be the only minor negative that I could comment on that for that. Business line over the last few months with the tight scrap prices has made the buying market a little more competitive.

Okay. And then just looking at your aftermarket parts business. Looks like revenue has been down sequentially over the past few quarters. Just wondering if there's anything going on there in particular?

Eric, that's just the normal seasonality. And you'll see that pop back up in the fourth quarter. In fact we've been seeing our aftermarket revenues, they've been strengthening every week for probably the last 6 weeks in a row.

Okay, great. Thank you.

Thanks a lot, Eric.

[OPERATOR INSTRUCTIONS]

Gentlemen, your next question will come from the line of Gary Prestopino with Barrington Research. Please proceed.

Good morning, guys.

Hi, Gary.

Most questions have been answered. But Joe, you mentioned that you're getting 250 cars per month direct from a large national carrier. And you've got another contract for 160 million per month, 160 per month. Is that correct?

That's our best estimate.

That's - the one was 160 per month is literally just being saved as we speak.

Okay, the question I would have to you is, you had mentioned this in the past, that taking more cars in has always been an issue just in terms of the amount of space you have at your facilities. Realistically, how many cars per year can you take directly from the insurance companies?

I wouldn't say we're anywhere close to a saturation point. We're hitting about, around 7% year-to-date of our product coming in from non-pool sources.

Would I be comfortable saying that we could take that up into the low teens? Yes. But that's probably what I would perceive as a max level for us.

And quite frankly we probably wouldn't want it to be any more than that. There are a lot of advantages to being able to pick and choose the vehicles from the auctions.

And is there any cost differential on these vehicles when you get them directly from the insurance companies? Obviously you're not paying a salvage fee.

Gary, our effective goal is to try to essentially split the auction costs with the insurance carrier. So in theory we would split that 50, 50 with an insurance carrier.

Thanks.

Thanks a lot, Gary.

And gentlemen, at this time I show no further questions within the queue. I'd like to turn the call back over to you for your closing remarks.

Okay, perfect. Thank you one and all for joining us again. And we'll be getting the date out for our year-end call. And as Mark said, we'll provide our 2007 earnings guidance at that time.

Have a great day.

Ladies and gentlemen, this concludes our presentation. You may now disconnect. Thank you and have a wonderful day.