LKQ Corp (LKQ) 2006 Q4 法說會逐字稿

Good day ladies and gentlemen, and welcome to Fourth Quarter 2006 LKQ Corporation Earnings Conference Call. My name is Carol and I will be your coordinator for today. [OPERATOR INSTRUCTIONS].

I would now like to turn the call over to Joe Holsten, President and CEO. Please proceed sir.

Before we get started here, I need to talk about forward-looking statements. The statements in this press release and webcast include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our expectations, beliefs, hopes, intentions, or strategies.

Forward-looking statements involve risks and uncertainties, some of which are not currently 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 statement to reflect events or circumstances arising after the date on which it was except as required by law.

Good morning, and thanks for joining LKQ Corporation's Fourth Quarter and Annual 2006 Earnings Call. On the call today are two members of management, Mark Spears, our CFO; and myself. My name's Joe Holsten, and I'm the CEO of LKQ.

I'll begin by providing some high level overview of the performance of the business as well as some qualitative views on the business and the industry. Then, Mark will go into a more detailed assessment of the financial results for the quarter and the year.

Let's look at our results now. As stated in our press release, we are very pleased with the 2006 performance of our company. We reported $204.5 million in revenue for the fourth quarter, which represents 42% total growth over the fourth quarter of 2005 and organic growth of 11%.

Our EBITDA margin was 10.7% for the quarter compared to 11% in the fourth quarter of 2005. You might remember from our last call that we now incur the impact of the low gross margins from our aluminum smelter operation that was acquired in early 2006 as well as the effect of expensing stock options this year for the very first time.

Without those two items, we would have reported an 11.3% EBITDA margin. And Mark will go through a more thorough explanation of that in just a few minutes. Our net income increased by over 23% to $10.2 million for the quarter, and diluted earnings per share increased by 20% to $0.18.

Let's take a moment and walk through our business acquisitions. As you may recall, we acquired nine businesses in the first three-quarters of 2006. This included three recycled parts businesses that had about $15 million of revenue in 2005, the first of which was Michael Auto Parts, located in Orlando, Florida that primarily serves the professional retail market. And the next two were retail businesses, on near Charleston, South Carolina and one near Baton Rouge, Louisiana that were basically start-ups for us.

As you know, at the end of January 2006, we entered a new product line with the acquisition of Transwheel Corporation, an aluminum alloy wheel refurbishing and distribution business at about $28.5 million of revenue in 2005 from the sale or restoration of wheels.

At that time, we saw strong potential synergistic contributions from the refurbished wheel business and an ability to leverage our sales and distribution systems, and that vision has indeed come to fruition.

In addition to this wheel refurbishing business, Transwheel operates an aluminum smelter. The smelter's revenue was $28 million at a gross margin of approximately 7.1% for the 11 months we owned them this year. We made the decision to sell the smelter, provided that we could obtain a buyer who would agree to allow us to sort and retain the cores for those wheels with refurbishing potential.

We have been unable to do so, and accordingly have decided to keep the smelter in order to ensure a steady stream of wheel cores that we need to continue to grow the business. While a 7.1% gross margin does reduce LKQ's overall gross margin percentage, the smelter's financial performance continues to be accretive to the company's 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 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.

During the third quarter, we merged the Global Portland and the Global Seattle business operations into our recycled parts warehouses and businesses. At the end of the year, we merged the Global Los Angeles business into our Los Angeles recycled parts business by moving into a new warehouse space where the two businesses will be co-located.

These three markets now have warehouse space dedicated to aftermarket products with a combined total of 110,000 square feet. This should enhance the aftermarket growth opportunities for us on the West Coast, because we own major warehouses to support all four West Coast major population centers.

In the second quarter, in early July, we also acquired four recycled parts businesses that operate ten facilities on 133 combined acres. These businesses generated $33 million of revenue in 2005 and include a business in western Michigan that operates three yards with 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 us much needed capacity to more fully service the western Michigan market, which previously has been fully served by our Detroit facility.

Next, the business in Tulsa, Oklahoma that operated three facilities with a total of 40 acres, two of these facilities sold 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 those properties to house aftermarket parts. We believe this acquisition will enhance growth and efficiency opportunities for us in Oklahoma.

Next, we acquired a business in Houston that operates two facilities with a total of 46 acres that sells primarily into the retail market. Houston is the fourth largest market in the U.S. We think this business will complement our existing Houston operations that are based on a 12-acre facility and sells primarily into the professional repair market.

And finally, a business that operates a facility outside of Denver with 10 acres and a 12-acre facility in Daytona Beach, Florida, both of these facilities sell into the retail market as well.

During the fourth quarter and through to date, we have closed on three additional businesses with trailing annualized revenues of about $12 million. These include first, [Seigel Industries], an aftermarket parts distributor with approximately 26 employees who operate three aftermarket warehouses located in Denver, Colorado; Gray, Tennessee; and Greensboro, North Carolina. We have since transferred Tennessee and Greensboro operations into our existing aftermarket businesses, and eliminated some overhead and [ROM].

The second acquisition to report today is Northern Lights, a head and taillight refurbishing company, has 36 employees and operates out of a facility near Grand Rapids, Michigan. While currently a very small business, we believe the majority of our vast quantity of light cores can be refurbished back into high quality replacement lights that can be sold to our collision repair customers.

This business, Northern Lights, provides us with the know-how and the technology to refurbish used lighting products and will be producing about 200 lights per day by the end of the quarter.

The third acquisition we're announcing today is Potomac German, a recycling business that serves the professional repair market. Potomac German has 26 employees and operates on two recycling properties totaling 13 acres, one being in Frederick, Maryland and the other in St. Augustine, Florida. These operations have historically specialize in Mercedes Benz and BMW vehicle products.

Our insurance relationships and programs continue to expand and contribute to the growth of the company as well. Our electronic ultimate review service offering to the insurance industry called LKQ Last Look continues to be used in certain markets by three insurance carriers today. We are also piloting with a body shop chain for their use of the system as well, which would make it easier for them to buy 100% of their alternative parts from LKQ.

As we indicated last quarter, we have been trying to attain several carriers to directly provide us with low-cost cars that would provide some parts to be sold into the professional repair markets with the remainder of those cars being placed into our retail-oriented operations.

For the fourth quarter, we received 400 of those low-cost type vehicles from one carrier in the Midwest, and another carrier is interested in a similar program in the Northeast.

Next, we have completed a pilot with another carrier relating to obtaining wholesale cars directly from them in six different markets. We believe this program will move to a longer-term supply agreement, which could generate 150 cars per month for us later during 2007.

Through December, we completed a full nine months with the Right Choice program. It's our program with Advanced Auto Parts. We are now averaging 1,000 inbound calls per day into our call center, which has been dedicated to the Right Choice program.

We are on a current revenue run rate of close to $9 million and believe this will continue to grow. Advance has an in-store campaign that kicks off in March. This campaign will include a series of six in-store commercials along with [Glen Depeltier's counter mat] collateral material and advertising and funding newspapers that reach every market they serve.

In addition, we will pilot a supplemental in-store counter person incentive. This pilot will be in the Midwest region to gather feedback before launching on a nation-wide basis later in the year.

At the end of Q4, we operated approximately 36 transfer runs and 400 local delivery routes that carry primarily aftermarket parts and refurbished wheels and approximately 64 transfer runs and 400 local delivery routes that carried primarily recycled parts.

In various areas, these recycled part transfer runs and routes also deliver aftermarket parts. In total, LKQ has a delivery system of approximately 100 transfer runs and 800 daily local delivery routes.

We acquired approximately 111,400 cars in our wholesale, recycled parts businesses during 2006. The percentage of vehicles that we acquired from salvage auctions during the full year 2006 accounted for about 94% of our total incoming product flow. On a full-year basis, we acquired approximately 14% more wholesale vehicles than in 2005.

We continued to increase our sales staff for our recycled part business, and we have done so by an average 50 people more in Q4 2006 compared to Q4 of 2005. This is a 12% headcount growth with approximately 30 people or 7% coming from acquisitions and 20% or 5 -- 20 people or 5% growth from organic hiring.

In summary, we are very pleased with our growth prospects. We continue to believe we can grow our business organically at a rate in the low double digits. In this quarter, we reported 11% organic growth, and for the full year, close to 12%. But, 2006 was our eighth consecutive year of double-digit, same store sales growth.

We believe we have a compelling, successful business model as we have migrated our company's operating model to be the nation's only major supplier of a broad line of alternative repair parts to the professional repair industry.

We believe we provide an attractive value proposition to a wide array of customers in the insurance industry and are in a unique position to leverage our inventories and recycled parts aftermarket products and refurbished wheels by having the ability to sell all of these combined inventories in response to customer requests.

We also believe that further margin expansion is possible as we continue to seek opportunities to better leverage our investment and facilities, distribution systems and to find incremental value in the parts on each vehicle that we process.

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

Thank you Joe, and good morning everyone. Let's take a look at the tables that are in our press release. A 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 two-for-one stock split back in January '06, so all our earnings per share amounts, stock price amounts, and share counts presented reflect the split.

Looking at our income statement and related tables, our fourth quarter 2006 revenue was up 42.1% to $204.5 million from $143.9 million in Q4 of '05. Our revenue for the full year 2006 grew 44.2% to $789.4 million compared with $547.4 million for the full year '05.

Our organic revenue growth was 11.2% for the quarter and 11.6% for the full year 2006. Our fourth quarter 2006 gross margin was 44.8% versus 46.9% in the fourth quarter of 2005. For the full year 2006, our gross margin was 45.3% versus 47.1% in 2005.

As Joe previously discussed, the Transwheel business we acquired in early 2006 has an aluminum smelter that operates at very low margins to LKQ's primary businesses. In addition, 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 Number 141, Business Combinations.

This inventory write-up amount was $300,000 with all of it coming through cost of sales in the first half of 2006. Accordingly, our gross margin would have been 46.3% in Q4 2006 and 46.7% for the full year 2006 if you exclude the effect of these Transwheel items.

Our facility and warehouse expenses for Q4 grew $7.4 million or 46.2% over Q4 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 $5.5 million of the growth or 34.3% expense growth.

Excluding the effects of the business acquisitions, the fourth quarter of 2006 had increased costs over the fourth quarter of 2005, primarily related to labor and labor-related cost growth of $1.1 million. This related to increased staffing needs to handle parts volume growth.

For the full year 2006, facility and warehouse expenses as a percentage of revenue improved to 10.9% from 11% in 2005. For the full year of 2006, facility and warehouse expenses grew $26.2 million or 43.6% over 2005. Business acquisitions represented $20.6 million of the growth or 34.3% expense growth.

Our distribution expenses for Q4 grew $3.7 million or 22.8% over Q4 2005, of which $2.7 million or 16.3% expense growth was due to our business acquisitions. Excluding distribution expense growth related to our business acquisitions, our Q4 2006 distribution expenses grew 6.5% over Q4 of 2005.

For the full year of 2006, distribution expenses as a percentage of revenue improved to 10.1% from 11.2% in 2005. For the full year 2006, distribution expenses grew $18.6 million or 30.3% over 2005. Business acquisitions represented $12.7 million of the growth or 20.6% expense growth.

Selling, general, and administrative expenses grew $7.3 million or 37.4% over Q4 2005, of which $4.7 million or 23.8% expense growth was due to our business acquisitions. During the fourth quarter -- the fourth quarter of 2006 compared to Q4 2005, we had $1.1 million in higher wage and fringe costs.

We also had $800,000 in higher compensation expense accruals related to stock option expense that we had to incur for the first time in 2006. We also had $600,000 in our new long-term incentive plan, which was a new incentive plan put into effect in 2006. This plan was outlined in our 2006 proxy statement.

For the full year 2006, SG&A expenses as a percentage of revenue improved to 12.9% from 13.6% in 2005. On a full-year basis, SG&A expenses grew $27.7 million or 37.2% over 2005, of which $18.3 million or 24.6% 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 while our G&A costs are usually less variable in relation to revenue growth.

For the quarter, our EBITDA grew 38.4% to $21.8 million. EBITDA was 10.7% of revenue for the quarter compared to 11% in Q4 of 2005. For the full year 2006, our EBITDA was 11.5% of revenue versus 11.4% for the same period in 2005.

Our operating income for Q4 2006 was 38.3% over Q4 2005 to $18.4 million. Operating income as a percentage of revenue was 9% in the quarter compared to 9.2% in Q4 2005. For the full year 2006, our operating income improved to 9.8% of revenue compared to 9.7% for the same period in 2005.

A couple of things that were affecting margin comparability between 2006 and 2005, first note that prior to 2006, we had no stock option expense on our income statement. It was only in our footnotes 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 Q4 2006 was $900,000, and for the full year 2006 was $2.4 million. The expense in 2006 is booked in the individual quarters based on actual vesting.

Second, remember when I talked to you earlier about the affect on our gross margins in 2006 related to Transwheel's aluminum smelter and Financial Accounting Standard 141 adjustment related to Transwheel. For the fourth quarter, without the affect of the Transwheel items and the expensing of stock options, our EBITDA margin would have been at 11.3%, and our operating income margin at 9.6%. For the full year 2006, EBITDA margin would have been at 12% and operating income margin at 10.3%.

So, our primary operations did expand margins over 2005 for the quarter by 30 basis points on EBITDA margin and 40 basis points on operating income margin; for the full year by 60 basis points on both EBITDA and operating margin.

We had net interest expense in Q4 2006 of $1.7 million compared to net interest income of $66,000 in Q4 2005. The prior-year interest income was related to our Q4 2005 secondary equity offering.

Other income in the full year of 2006 was $1.5 million compared to $628,000 for the same period of 2005. This increase was primarily related to a $719,000 gain back in Q1 2006 on selling equity securities.

Our Q4 2006 pre-tax income grew 26.9% to $17 million from $13.4 million in Q4 of 2005. For the full year 2006, pre-tax income increased 40.9% to $72.8 million from $51.7 million for the same period in 2005.

For the full 2006, our effective income tax rate was 39% compared to 40.2% in the same period of 2005. Remember back in Q3 of 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 full year 2006 effective tax rate would have been at 40%.

Net income for the quarter increased 23.4% to $10.2 million from $8.3 million in Q4 of 2005. For the full year 2006, net income increased 43.7% to $44.4 million from $30.9 million in the same period of 2005.

Our diluted earnings per share increased 20% to $0.18 in the quarter from $0.15 in Q4 of 2005. For the full year 2006, diluted earnings per share increased 27% to $0.80 from $0.63 for the same period in '05.

Our diluted weighted average common shares outstanding used for EPS purposes were as follows -- Q4 2006, 56.2 million shares versus Q4 of 2005, 54.6 million shares. For the full year 2006, we were at 55.8 million shares versus the full year 2005 at 48.7 million shares.

Our diluted weighted average share counts increased by 2.9% for the quarter and 14.6% for the full year over 2005. The large annual 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 look at our cash flow table now. We generated $52.4 million in cash from operations during 2006, which included the effect of investing $8.7 million of additional inventory. Half of the inventory growth related to aftermarket. CapEx, excluding business acquisitions for 2006, was $36.2 million. Cash paid for business acquisitions was $73.5 million.

During 2006, we issued stock related to the exercise of stock options and warrants that resulted in shares issued and dollar proceeds received that totaled approximately 1.9 million shares for $13.4 million in proceeds, which includes the latest tax effects. We issued no stock related to business acquisitions in 2006.

In looking at our December 31 balance sheet, you will note, we had $100.4 million in debt, which included $86 million in debt under our unsecured credit facility with our bank group. As of February 26, our credit facility debt was at $97 million. Total borrowings allowed under this bank facility are $135 million.

And if an accordion option feature is exercised, it could go to $150 million. This facility matures on June 1, 2010. We feel confident this credit facility could be quickly increased. At December 31, 2006, our debt to EBITDA ratio was only 1.1 times, so we assume we have significant ability to increase our debt capacity.

Let's take a look at our 2007 estimates. We expect that 2007 organic revenue growth will be in the low double digits with the balance of the growth being the full-year impact of 2006 business acquisitions and our 2007 business acquisitions closed to date. We expect full-year 2007 net income to be within a range of $53.5 million to $56.5 million and diluted earnings per share to be between $0.95 and $1.00

For the first quarter of 2007, we expect net income to be within a range of $14.2 million to $15.2 million and diluted earnings per share to be between $0.25 and $0.27. We anticipate that net cash provided by operating activities for 2007 will be over $55 million.

We estimate our full-year 2007 capital expenditures related to property and equipment, excluding the expenditures of LKQ to acquire businesses, will be between $45 million and $50 million. This does include approximately $5 million related to capital we planned in late 2006 on projects that became delayed.

We estimated the weighted average diluted shares outstanding for the full-year 2007 to be approximately 56.5 million. These share numbers are estimates, and as such, will be affected by factors such as any future stock issuances, the number of our options, exercise in subsequent periods, and changes in our stock price.

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

Let's -- Mark, let's just go right to Q&A.

Thank you, sir. [OPERATOR INSTRUCTIONS] Your first question comes from the line of Bill Armstrong with C.L. King. Please proceed.

Good morning. I have a couple of questions. On the light refurbishing business, I guess could you describe how a light gets refurbished. Is it a light that -- where the element is damaged? Or, is this just a cosmetic refurbishing? What kind of units would we be talking about? And what's the dollar market opportunity?

Sure. The ultimate strategy here is for us to improve the yield from the product that we already predominantly at the gross margin line and to leverage the sales and distribution network as a company and to grow our customer satisfaction. The -- essentially, the core lights, damaged lights will come in from LKQ facilities.

These may be lights as minor damage to the tabs in particular, or you may notice on some older cars that the lenses of the headlights become milky in color. These are sorted. Those lights that cannot be refurbished, we may remove certain piece of those -- pieces of those to be used in reconditioning other lights.

But, the broad business there is to clean, buff, clear-coat with a UV paint. And then, kind of the unique piece of the technology of Northern Lights is their ability to use injection moulding to reproduce tabs and moulds that have been broken off lights so that would otherwise be discarded.

We're orienting the business right now toward about 200 lights per day. That is not the capacity of the facility. At 200 lights per day, this would be a little over a $6 million a year business with very impressive gross margins and operating margins.

Once we've reached that level, we'll reassess the market and the demand for the product to see if we should move to multiple shifts and a higher volume. In terms of the total demand for lighting, these lights, in our view, would be selected -- be given preference over aftermarket products.

And certainly due to the nature of their pricing, should be given preference over a new OE light. So, we're -- really the addressable market is the total OE recycled and aftermarket light business, which is kind of in the $1 billion range.

Are there other companies with these capabilities that can refurbish lights?

This is -- the company we acquired is basically coming on as start-up. As a matter of fact, the first couple of quarters, we would expect a loss at the pretax line because of the start-up nature of the business and our acquisition cost. We're not aware of anyone who's doing this on any significant scale and would expect to be the clear market leader -- well, I would guess we're probably the clear market leader today.

Wow, okay. I was wondering if you could talk about the impact of weather? It looked like in November and December we had very mild weather conditions. And then, January and February, we had winter -- more seasonable winter conditions. Did that have a negative impact on Q4? And conversely, did the bad weather -- is that helping out Q1?

Yes, good question. I chose not to put the weather report into my script this morning. I think everyone's read enough volumes about record warm temperatures in December, record warm temperatures in January and all the kind of ancillary discussions about global warming that seem to accompany those. Obviously, I think even on our last call, we indicated that the fourth quarter auction environment was not as robust as we would have preferred.

And I'd ask you to keep in mind that the weather conditions can impact two aspects of the company. One is supply, because if we're in kind of moderate weather conditions or unseasonably warm that we experienced in December and January, that reduces the amount of product that the salvage auction pools where we obtain a majority of our salvage product.

And then, it also obviously reduces the demand for product, not only from the collision repair market, but we believe the cold weather and extreme cold weather will actually create more demand for some of our mechanical parts.

So, to get to the short answer to your question, when we came into 2007, it was our view that the majority of our shops had a very nominal amount of backlog. It would be my belief, and of course it's hard to document this, but certainly our December results were modestly impacted.

Keep in mind that revenue for the fourth quarter net only another 2.5 or $3 million that probably would have kicked in another penny per share. So, it doesn't take a lot of revenue loss in a quarter to kind of knock the results down by a type of quick penny.

Clearly, the -- these weather conditions, especially in The Great Lakes area and New England continued throughout January. January was a soft month for us. I'm happy to report today that February is progressing quite nicely, and in particular, the second of the month is accelerating very quickly.

With the number of weather events that we have seen in a number of markets, and I'll say markets that are very important to LKQ, it's certainly my belief that should bode well for a very improved auction environment. And I would expect March to be a very robust time for the company.

Okay, great. Just two other quick ones, the -- you've now owned the smelter operations for over a year -- or for just about a year now. So, can we expect the gross margin impact to now [poised]?

Maybe, I'll leave that one to Mark. But, it would be my intention that this is the last time you'll hear about the smelter on this call.

Yes. We will have the smelter for 11 months in '06 and 12 months in '07. So, you're not going to see the ongoing impact of the margins on that.

Okay. And then, one more question, I guess for Mark, I think you mentioned earlier you acquired 111,000 wholesale vehicles. If I back into Q4, it looks like that means you actually acquired fewer vehicles in Q4 than you did a year ago? Is that correct?

Yes, that's correct.

Okay. How is that possible if you had 11% organic growth and you also had a larger number of facilities?

Well, we did grow the total number of vehicles, I think, 14% year-over-year. So, we'd like to build up backlog. We don't like to be forced. Well, we're going to have to buy all the vehicles anyway this week or two. So, keep in mind, the vehicles coming through the auctions in October and November are wrecked in the third quarter. And the prices are going to be higher. So, that's how it's possible.

Right. And we do dismantle off a backlog. That doesn't mean that that's the numbers of cars that we dismantled.

I see. Got it, okay. All right, thank you.

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

Hi, good morning. Actually this is [Rae Chow Chow] for John Lawrence. All our questions have been answered. Thank you.

Thank you. Thanks for calling in.

Your next question comes from the line of Bill Gibson with Nollenberger Capital. Please proceed.

Actually, I think my question that I wanted to zero in on, which was fourth quarter gross margins was answered as well, in that's the result of fewer cars being auctioned and higher prices being paid. Is that correct, Mark, in addition to Transwheel?

No. No, not really. If you go back and look at it historically, the Q3 and Q4's gross margins are a little less sequentially. I think -- and I don't think the wholesale side didn't really hurt us unexpectedly or anything on the gross margin. We do have some self-service operations. We did see the pricing go up on those cars, but we also saw the revenue go up.

And like when steel pricing goes up, that does tend to give us -- it gives us good gross profit dollars. We just don't want to go backwards there, but the percentage, it gets skewed a little bit.

The other thing to note is, our aftermarket business has been growing very nicely. If you kind of look at some of the numbers, you saw the aftermarket business grew over 75% Q4 to Q4. And that's acquisitions and organic.

Yes.

And as we continue to have very strong organic revenue growth on the aftermarket side of the business as well. As we get into new markets with the start-ups to gain business, we do have a little light gross margins on that. So that's, I'd say, the self-service and the aftermarket, high growth there, probably makes up all of the gross margin for the Q4 difference, Q4 to Q4.

Good. So, I want to --.

After you pull out the Transwheel stuff, obviously.

Yes. Yes. So, on an annual basis in '07, do you think we're close to 2006 levels?

Yes, I believe so.

Good. Thanks, Mark.

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

Okay, thank you both. Just regarding -- following up on that smelter question, the way we do the math is, gross margin was about 200 basis points lower, but a good majority of the was the smelter. I'm just having a hard time figuring out what the remainder of the gross margin shortfall is all about.

Okay. It's a smelter -- it -- when I stated the gross margins, that was without the smelter, the 46.3. So, it was about a 60 basis point decline after you've -- pull out the smelter.

Quarter to quarter.

Half of it's after -- a lot of growth in the aftermarket side. We're growing the aftermarket organically quite a bit faster than the recycle side. And to grow and to do start-ups and to do that, we saw a slightly lighter margins than we would. That's half of it. We are talking 60 basis points here.

So, I don't want to get too carried here. But, we've grown aftermarket 75% quarter to quarter. Part of that would be acquisitions as well that we brought in there as well. And they come in with different margins as well.

So, the other half would be self-service. Again, we're talking maybe 30 basis points here. Self-service, when the scrap price goes up, we pay more for the cars. Now, keep in mind, we're talking like $200 cars here. Okay?

So, as that goes up, we pay more for the cars. We protect our gross profit, but you can have margin erosion there from a percentage standpoint. Again, it's not a big number. Like I said, that's probably about half of the gross margin in the quarter.

Actually, that's very helpful. Thank you. And then, with respect to previous guidance, which said over the course of a year or several years, you would hope to expand overall operating margin in the neighborhood of 75 basis points per year. Is that still a reasonable target for your company?

Yes. I've always said 50, 70 basis points. That it -- when we do acquisitions, and that includes putting in some acquisitions. And you never exactly where those will come in. I think that's a safe number.

Okay. And then, shifting into the light remanufacturing business, which is a very promising business, I think. Are you concerned at all that you may be just cannibalizing sales of generic or aftermarket sales?

No, absolutely not. The beauty of this product line for us is that this is product that we would typically be throwing away. It would be crushed in the vehicles most likely. So -- and it's our view that, especially on later model cars, most of the shops are going to tend to use new OE product, so I think that's really the competitive edge that we have here.

If there's some cannibalization here, I think it would be highly negligible and far more than offset by virtue of having this type of quality product at this price availability for the professional repair market. We've had enough discussions with the insurance people already and their engineers who write the estimates that they like what they're getting.

And thank you. With respect to the litigation environment, especially with respect to the Ford case, are you more or less inclined to pursue acquisitions in the aftermarket business?

Let's say, our appetite for acquisitions in the aftermarket industry is as good as it has been for the last couple of years. Since our last call, we have had an opportunity to probably more thoroughly assess the impact of the handful of parts in question and have certainly drawn the conclusion that they represent a very immaterial portion of our business.

Moreover, I think we remain convinced that ultimately, this decision climbed its way to the Federal Court, and as we look at the precedence of former decisions by the Federal Courts, it's our view that those courts are going to invalidate these patents and when they have the opportunity to do so.

Excellent. And finally just with respect to State Farm, again, any word from that organization with respect to aftermarket parts?

No.

That's what I thought.

Actually, it does mark color on that for you Craig. But, they're about as fightless on that as the Defense Department is on some of their things, so no signals one way or the other.

Okay, thanks Joe.

Thank you, Craig.

Your next question comes from the line of Sam Darkatsh with Raymond James. Please proceed.

Good morning Joe, good morning Mark.

Good morning.

Hi, Sam.

Most of my questions have been answered. These are more just clarification questions. You mentioned that your aftermarket acquisition appetite is healthy. Have you seen the expected multiples of those business owners looking to sell, perhaps come in a little bit given the ITC issue? Or, there hasn't been change in their thoughts as well?

I would say no change in their thoughts as well, Sam.

Your -- Mark, you mentioned the 75% aftermarket growth on a year-on-year basis. Could you give a sense of what the organic growth was?

I would say that's close to the higher teens.

And for the year?

About the same.

And would you suspect that that mix continues in '07 where aftermarket out-performs recycled to a certain extent?

Yes. We would certainly expect that. That's what our budgets and business plans reflect.

Okay. And final question, the CapEx at 45, $50 million, I think -- I guess the difference between on a year-on-year basis is that $5 million push-ahead. What are you expecting to spend the capital on?

It's primarily growth CapEx. Replacing CapEx is somewhere around $8 million, so it's a pretty good-sized project. I kind of don't want to go geography by geography, maybe for competitive reasons.

But, there's quite a few plants we're expanding the warehousing, putting in more racking. Some of our plants as they get bigger and bigger, we have troubles with the loading docks. You start -- you keep growing, let's say 12% a year.

And four years down the road, none of the trucks can get up to the warehouse, so that's primarily what a lot of that is. And there is some land purchases in there as well that we think we can get done that are adjacent property.

If we look a few years out, are we still going to be at this level of CapEx? Or, when does it begin to ramp down?

Well, keep in mind, our [flightsman] CapEx is only about $8 million. So, the question is if we're going to grow 12% organically, that -- take four years and you've just grown 50%. It's -- so, I'd say it's a little heavy this year, and you'll probably see some slightening of that.

But over a longer period of time, I kind of -- I think if you go back and see what we've done for the last three or four years, you do have to support your growth with more warehouses and racking.

So, keep in mind, there's not really much in the way of delivery trucks in there, because we do lease those on operating leases. But, I'd probably say on average, it could come down. We do have quite a few big projects in there this year. We've got one project alone that's about $6.5 million at one plant. It's a pretty massive expansion. And that's not an average sized project.

I apologize. There is one last question. The acquisitions that you made in this quarter, are they generally speaking, company average EBITDA margins? Or, how should we look at the margins of the acquired businesses?

Certainly Eagle and Potomac German would be company average EBITDA margins. And then, Northern Light, as I indicated is -- they had a very modest amount of business. So, I'd look at it almost as a start-up.

So, for the $12 million in sales, for all intent and purposes, it's essentially company average margins?

I would say that if you add all three up in '07, you don't have a lot of accretion. The start-up -- yes for the other two, but the little start-up is burning some cash in growth a little bit in '07.

Okay, thank you much.

Your next question comes from the line of Shawn Boyd with Westcliff Capital Management. Please proceed.

Good morning, just a few questions here. Did I hear that the Right Choice program with Advance Auto Parts contributed $9 million in '06?

No, the program was currently annualizing at about $9 million in revenues.

Okay. So, that's a run rate?

That's the run rate as of the month of February.

Okay. And can you give us the number for the contribution in '06?

We had nine months of that. If you're looking for an exact number, you should probably call back in to Mark, but --.

Yes. I don't have that with me. The way it gets booked, we've got to pull some special reports on it. We monitor that, but I didn't bring that in. We started out -- what was the length?

It's probably around $5 million, yes.

Okay.

If you want a more exact number than that, we'll get one for you.

Yes. Okay. Not, that's fine for now.

It started really in April. It really started going the last week of March of '06.

Got it. Got it, so you basically had --.

And it's been growing quite a bit.

Well, that's where I was going to go next. In terms of what you're thinking on that into '07 and '08, can you give us a rough feel?

A lot of that unfortunately, really depends I think on the kind of aggressiveness of our partner in the program. We think we had product to support certainly higher sales figures that what we see today. And what's going to drive this is going to be the aggressiveness of the -- at the store level of the 3,000 stores out there who have access to the product.

We've -- I think we've said on former calls that this has to viewed more as a marathon than a sprint as we continue to train and retrain store people on the product availability and qualities of the product.

Okay. But, it is in all stores at this point?

It is available to all stores. I can't say that 100% of their stores are participating.

Got it, okay. Just some notes I had was from previous calls I believe was 25 to 50 million potentially after a full roll out. But what you're saying is your participation levels certainly impact that.

Yes our expectation levels are certainly less than that, as of today, if we're talking three to five years out, I still don't think that something in the $25 million a year range is a silly number if we have good participation from their source and as we continue to strengthen our product line.

Okay. Joe, let's go to a different topic for a second. When we see the acquisitions that you all do, and some of the comments on this call in particular have made me think about the start ups and some of the smaller acquisitions, should we be thinking about you're not bringing on the full amount of revenue? In other words, maybe there's on average 10% of the business is non-core or something that you're not going to emphasize.

So if you acquire a business doing $20 million in revenues, and I'm just making this up, but if you acquired a business doing $20 million that we should really think about that LKQ contribution once its ramped being, I don't know, 90% of the $20 million? Or should we really be just using the full amount? How should we kind of model these in as we go?

You just say maybe they were selling products that we're not interested or different kinds of customers maybe.

That's right, I mean at this point you guys have done so many acquisitions I'm just betting you've got a much better feel for exactly how much you're going to be able to keep and really go.

I understand your point now. That would be a very high number, certainly when we do our due diligence in acquisitions we've become I think fairly adept at being able to identify a customer who might go away. For example when we acquired Transwheel a year ago it was very clear to us that the product that Keystone was buying from Transwheel would disappear and effect it then.

Sure.

So we factor that in our modeling and fortunately in the Transwheel case we've been highly successful at more than replacing the revenue that went away. So I guess I'll just answer the question by saying we're very cognizant of the issue, we factor it into the returns that we base our offers on and so far I think we've been pretty accurate on being able to assess if and when we actually incur some revenue slippage.

Generally it's more than made up almost immediately because of companies coming into our network, the benefit they get from being able to acquire product from other LKQ facilities and being able to increase their ability to say yes. Whatever sales may dissipate because of competitive reasons, at least it's my opinion, we replace those very quickly.

Okay. And so with the acquisitions in '06 in particular, has there been any kind of a delayed ramp on those as they have contributed to the company? In other words, is there any sort of a little bit of a pent up demand that we might see here in the first half of the year as those really are fully incorporated into the LKQ system?

Oh the recent transactions, you're asking if there's going to be some acceleration in revenue growth from the deals we've done in the last 8, 9 months, is that really your question?

Yes, really the '06 acquisitions.

I can't say anything that's going to result in a spike. I think our expectation is that the deal flow for 2007 will be in line with some of our historical patterns. Last year we closed on a total of 10 deals, we've closed two so far this year. While they're small, I am happy to report that the pipeline's in very good shape.

My personal confidence level in being able to average a couple deals per quarter is extremely high. While we can't really speculate on the size of the deals, our recent experience the last two years would suggest that we'll supplement the organic growth of the company with enough deal flow to achieve about a 20% top line growth for the year. And I certainly can't see any reason as of today that we would not repeat that level of performance for 2007.

You'd supplement the organic by 20% a year?

We'll supplement the organic growth with enough deal flow to achieve a total top-line growth of at least 20%.

Oh I see, okay. The margin pick up, I understand the impact of the smelter and the other issues that you mentioned on the previous questions, the only I just want to make sure in terms of calibrating the margins as we go forward, the pick up is basically off of '06 levels on the gross margin and operating margin line?

The pick up, I'm not sure I follow your question. Are you saying that you think '07 margins will be pretty close to '06?

No. What I'm trying to clarify here is, I understand what the margins would have been without the smelter. But the smelter is going to be part of ongoing operations, so as we model the company forward I'm assuming we need to think about the '06 margins and if we assume any expansion from there, that's where we need to start, not the 46% gross margin?

Oh correct. I'm sorry, yes because [we'll have it again] in '07, yes.

Okay. And just last thing, in terms of your total revenue base now, the mix between recycled and aftermarket percentage?

Yes I think we put in there about 24% was aftermarket in wheels. We kind of combined those two. They're very much related, you're even infill some of your refurbished wheels with aftermarket wheels, replicas, so that is like right at 24% of '06.

Okay. And so with that higher growth in the aftermarket, I understand the mix shift issue there, but the operating margin's expanding 50 to 75 basis points a year, would we expect to see a little bit of that in the gross margin line to slowly see these gross margins come back up?

That's hard to tell because most of our products still comes from auctions, its cars and it kind of depends how much stuff is coming through the auctions at a given time. So we try to tell people going forward I wouldn't put anything on gross margin going up, our real leverage is the operating costs as we continue to grow our plant and put more volume through the plants. I mean that's really where our leverage is.

Okay. Okay thank you very much.

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

Hey good morning, guys, how are you doing?

Good, Gary, how about you?

Hi, Gary.

Most of my questions have been answered, but Joe, could you just give us your year-over-year additions to your aftermarket and recycled sales staff?

Sales staff?

Well your sales people.

You want that on the aftermarket side?

I think you're focusing on when we talked about the inside sales people, the recycled side.

Right.

We'd indicated earlier we grew the headcount 12%.

Yes we're up a total of 50 -- 30 of them were from acquisitions and 20 were new hires or, if you will, organic growth. So if you're asking us to break that out into product lines, we're going to have to come back to you on that. I don't know that off the top of my head.

With Northern Lights you said you're going to do about 200 lights per week, what do you estimate is the capacity there?

I'd say its 200 lights per day and total capacity would be maybe almost double that. That's just with this single facility, I wouldn't reflect on this as a high capital intensive product line. The real value here is that we have the core products and being able to seize that easily and move it to this facility gives such an enormous amount of leverage and advantage over anyone else who might choose to enter into this product line, as well as the sales and distribution capability that we have in place today.

And quite frankly that's why this individual I believe sold to us. He was having difficult finding the cores and he didn't have the sales and distribution system. He had a great product, he just didn't have a good quality way to obtain the cores and to move it to market, and we solved that problem for him on day one.

Is it safe to assume that, even though you're adding value to a damaged light, you pretty much have to charge what you would charge for a good recycled OEM light to the repair shops in terms of pricing?

Absolutely. We will price these as a A-quality insurance quality part. It'll be price of a discount to a new OE light.

So, the real value for this comes in the fact that if you have a car that has some damage to the headlights, you pay your price for the car. That factors into that damaged headlight and you can then refurbish the light and make an increment above what your cost would be. Is that a correct assumption?

Absolutely. Yes it is.

Yes and of course when you sell any of these lights to a shop you try to get their core back too as well, unless it's obliterated.

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

Thanks. Good morning, gentlemen.

Hi, Tony.

Hi, Tony.

I guess a couple questions, Mark, on this part of the call, and I just want to address the facility warehouse cost line item. You some deleverage there and I think you noted that part of it was related to the acquisitions you made during the quarter. Was that a significant part?

Let's see here, for the quarter we had a total of, organically it grew about 11.9% and like our organic revenue, which is a little higher than we normally would do on an annual basis. I guess on order on an annual basis it grew 9.3%, which is a little bit more the norm. And the biggest in there was we added some labor as we got into the busy season, some headcount, some people.

And one thing to keep in mind, especially in facility and warehouse costs, it's not real linear with revenue, it's more of a stair step where you have to go into plants and add some more staffing and then you kind of sale off of that a little bit.

But I would not read this to mean all of a sudden all leverage is gone from facility and warehouse expense, you'll see us get into Q1 and Q2, there will be leverage coming back there. But labor jumped up on us there and it was somewhat deliberate, we actually got hurt last Q4 because we didn't have enough labor and the market and weather changed on us pretty quick and some other areas, so that's what that is.

It grew 46.2%, if you broke that down between acquisition and organic, the bulk of it was acquisition, 34.3% expense growth was acquisitions and 11.9 was organic.

Okay. All right that's good, that's helpful. When you look then at your mix of business mechanical versus the sort of salvage in general in terms of the sheet metal and the crash parts, is that still sort of around a 45% mix?

And then second, when you look at it from an organic growth standpoint in 2006, which the industry itself for automotive repair suffered and was relatively soft, is there an opportunity to see some acceleration this year just because the operating environment was fairly unfavorable in 2006?

Yes as far as the mix, I really can't imagine there's been any measurable shift in the mix of the crash parts versus mechanical. And Mark's nodding his head, yes that's correct. I did find it interesting, Mitchell came out with their most recent report period just within the last couple days and they're actually reflecting that the collision industry grew 4.4% in 2005 and of course the majority of those costs are parts.

And I think they also mentioned that over the last five years the collision industry has averaged 5.7% per year growth. So I was a little surprised by those numbers, I would have expected them to be probably much softer than that.

But coming off what would appear to be a bit of a soft year and I'll say a favorable experience year for the collision repair, for the insurance industry, yes would you would think there could be some nice upside in 2007 in terms of volume and activity in the repair side of the business.

When you look at your organic growth, are you growing the mechanical side of the business at the same organic growth rate that you're seeing on the crash parts side of the business?

Yes I think you'd have to conclude that those growth levels are very similar.

Okay. And I guess the last item, when you look at your Transwheel, what utilization rate is that facility running at now? You're starting to leverage up a little bit and get more throughput and I think last we talked you were probably around 50% or so and so there's certainly some upside to get more utilization out of that location?

Yes we're probably running at about I'd say about 75% capacity today and that doesn't include the further upside of being able to add more shifts. So I've been very pleased with the pace of growth there, we're about one year old into the business now, as I indicated earlier, we've can easily more than replace some of the volume that defected very early on that we expected, in fact we replaced it much quicker than we had expected.

The LKQ sales people are now accounting for about 25% of all of the sales of the Transwheel product, so that integration is working I think very nicely as we start to populate the field inventories with more of the Transwheel product.

And we have pretty ambitious plans in terms of adding I think about 7 or 8,000 wheels to the field inventories during the first half of 2007. So it's been a very, very nice transaction for us, we're really thrilled with it and it's accomplishing everything we had expected when we wrote the check.

When you look at that business, I mean it's a very good business for you, is there opportunity to expand that business organically without having to go out via acquisition? Or do you have to acquire someone that has sort of an existing smelter operation to make it work for you?

If we expand that business we'll do it to a cold start. We've got all the people who have the skills to open up a new facility, the capital requirements to do so is not that extensive and we will certainly be evaluating the West Coast for a possible start up of a wheel refurbishment plant.

And like I said, we'd do that internally. There are no special permits, zoning probably isn't really even an issue, so the cold start fees now that we have the systems down and we've got the people in place, it should not be that difficult to do.

Okay and one last question, say you're seeing around 300,000 wheel cores a year that are good enough to maybe remanufacture, how many of those right now are being sent through the Transwheel operation?

You mean wheels from the LKQ?

Yes from your existing operations from vehicles that you buy at auction too. Before, you'd obviously sell those in bulk to someone.

We send all of our wheels to the Transwheel facility.

So they're getting everything now?

They're getting everything.

So they're no longer buying outside or are they still buying outside?

They're still buying outside as well.

Okay. Great, thanks.

Thanks, Tony. We have time for one more question. We've gone well past an hour, so let's take a final question if there is one.

Okay, sir. We have a follow-up question from the line of Bill Armstrong with C.L. King. Please proceed.

Just a quick follow-up, I noticed that you're combining the replacement parts revenue and the wheel refurbishing of 53.7 million, could you just give us a breakout between the aftermarket and the wheel refurbishing revenues?

Yes, the wheel for the quarter was about 8 million.

Okay, so aftermarket is about what, 46 million?

Yes. We're kind of combining those because they start melding together and they mean less and less when you start also selling some of the aftermarket type wheels. Yes, the aftermarket was -- the wheel was 8.2 and the aftermarket was 45.3, if I'm reading my writing correctly.

45.3?

Yes well 8.2 was the wheel and you can just back out, we've got it in the press release, I can't tell if it's 45.5 or 45.3 my writing's so bad.

Okay thanks, that's helpful.

Okay.

All right, Bill, thanks. Thank you very much and I'd like to thank everyone for calling in and staying with us on such a long call. I appreciate your continued interest in the company and I'll say we'll talk to all of you in about 60 days when we report on our progress for the first quarter of 2007. Thanks again.

Thank you for joining in today's conference, you may now disconnect. Good day.