LKQ Corp (LKQ) 2011 Q3 法說會逐字稿

(Operator Instructions.) It is now my pleasure to introduce your host, Mr. Joe Boutross, Director of Investor Relations for LKQ. Thank you. Mr. Boutross, you may begin.

Good morning, everyone, and thank you for joining us today. This morning, we released our third quarter 2011 financial results and provided our updated guidance for 2011. In the room with me today are Joe Holsten, LKQ's Acting Chairman and Co-Chief Executive Officer, Rob Wagman, President and Co-Chief Executive Officer, and John Quinn, Executive Vice President and Chief Financial Officer.

Joe, Rob and John have some prepared remarks, and then we will open the call for questions. In addition to the telephone access for today's call, we're providing an audiocast via the LKQ Website. A replay of the audiocast and conference call will be available shortly after the conclusion of the call.

Before we begin with our discussion, I would like to remind everyone that the statements made in this call that are not historical in nature are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We include 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. We assume no obligation to update any forward-looking statement to reflect events or circumstances arising after the date on which it was made, except as required by law.

Please refer to our Form 10-K and other subsequent documents filed with the SEC and the press release we issued this morning, for information on potential risk. Hopefully, everyone has had a chance to look at our 8-K, which we filed with the SEC earlier today. As normal, we are planning to file our 10Q in the next few days.

And with that, I am happy to turn the call over to Mr. Rob Wagman.

Good morning, and thank you for joining us on the call today.

We are pleased with the results we reported this morning. Diluted earnings per share from continuing operations in Q3 were $0.33, an increase of 32%, as compared to $0.25 for the third quarter of 2010. Please note that the third quarter 2011 diluted earnings per share results included a $0.01 charge for restructuring and acquisition costs.

Revenue reached a record $784 million in the quarter, an increase of 29% as compared to Q3 2010. Total organic revenue growth for the quarter was 11.1%, and 12.3% for the first nine months of 2011. Organic revenue growth for parts and services for the quarter was 7.6%, and 8.8% for the first nine months of 2011.

This continued organic parts and services growth is a result of the broadening of our product line offerings and the ongoing optimization of our regional distribution network, as we continue to integrate newly-acquired companies into the system.

This has also resulted in continued improvement in our operating expense leverage. Although we continue to face the headwinds of higher cost of salvage, higher gas prices, and the continued pressure on miles driven, we announced today that we have adjusted our organic same-store sales growth range to 7% to 8%, versus our previous guidance of 6% to 8%. In addition, we changed our earnings guidance, which John will cover shortly.

As mentioned on previous calls, the Company continues to implement pricing initiatives in our salvage operations to offset some of the operating pressures we are facing. I am also happy to report that we have realized sequential gross margin improvements of our salvage operations, in part as a result of these initiatives.

In our wholesale parts division, demand for LKQ's recycled parts remained strong during the quarter. Organic revenue growth of recycled parts and services was 8.4% for the quarter. Recycled parts revenue growth from acquisitions was 15.7% for Q3.

In the first nine months of 2011, our recycled parts business grew organically 10.1% compared to the same period in 2010. During the quarter, we purchased 57,000 vehicles for dismantling by our wholesale operations, which is a 15% increase over Q3 2010.

As anticipated on our Q2 call, there was a healthy volume of cars at the auction in Q3. With on-hand product and maintenance of our existing rate of vehicle acquisition, we should have sufficient inventory to continue to grow our recycled parts operations. We are also seeing good growth in our wholesale vehicle salvage as well as our heavy duty truck operations.

Turning to aftermarket, our aftermarket refurbished revenue increased 25.4% for the quarter, with an organic growth rate of 6.9%, a sequential increase from Q2 2011. This healthy growth rate can be partially attributed to the availability of more certified parts entering [the] system as well as the maintenance of generally robust inventory levels, allowing us to reach the higher end of our traditional in-stock rates. Aftermarket and refurbished revenue from acquisitions grew 18.3%.

Lastly, on October 6, the Company became the first certified automotive parts distributor under the new NSF International Automotive Parts Distributor Certification program. This NSF program requires formal corrective action to complaints and an immediate recall plan if and when necessary.

To earn certification, LKQ was required to demonstrate effective record systems and inventory tracking systems to track orders and parts through the supply chain. We are pleased to be the first participant in this program, and NSF has nearly 1,000 parts already certified and a similar amount currently in the process of evaluation for certification.

And with that, I'd like to turn the call over to Joe Holsten to talk about other aspects of our business and our most recent acquisitions.

Turning to our self-service retail businesses, during the third quarter we acquired 90,000 lower cost self-service and crush-only cars, as compared to 75,000 in the third quarter of 2010, an increase of 19.5%.

We saw the cost of these cars rise about 37%, similar to the second quarter. Part of the increase in the cost of these cars is a result of higher scrap prices. This business is performing well and continues to present a long-term growth opportunity for our Company.

In our heavy duty truck operations, during the third quarter, we purchased roughly 1,600 units for resale or parts, as compared to only 1,100 in the third quarter of 2010. We continue to build out this business, as indicated by three heavy duty truck acquisitions we closed in the quarter, which added locations in California, Washington, Montana and Oregon. These acquisitions highlight our focus on establishing a national network over the next few years.

In addition, the focus of establishing a national network was validated by a recent agreement we signed with Navistar to manage their used and surplus parts facility in Marshfield, Missouri. LKQ's heavy duty business will manage the receipt, the storage and the sale of Navistar's surplus and obsolete parts.

In addition to the heavy duty acquisitions, I'd like to touch on other development efforts that we completed during the quarter. We purchased three wholesale salvage businesses with locations in California, Idaho and Minnesota. We added to our cooling parts business with the acquisition of a distributor in North Carolina. We picked up two self-service businesses, one in Texas, and the other in California, and lastly we acquired one engine remanufacturing business in the state of Washington.

In addition to our development efforts during the quarter, on October 3 the Company announced the acquisition of Euro Car Parts, the largest automotive aftermarket parts distributor in the United Kingdom. The acquisition of Euro Car Parts represents an important strategic step for LKQ. It has always been our goal to acquire the best companies in our respective markets. Euro Car Parts represents that type of Company in the UK, with its impressive track record of growth, its excellent distribution network and its strong management team. Euro Cart Parts provides an ideal entry point to Europe for LKQ.

And lastly, the Company announced that Donald F. Flynn, the founder of our Company and the chairman of our Board, passed away on October 10. Again, on behalf of our employees and shareholders, I'd like to thank and acknowledge Don for his vision, his wisdom and his dedication to our people and our shareholders.

Given Don's passing, in the interim, I will act -- be the Acting Chairman of the Board, pending the Board of Directors electing a permanent replacement for Don.

At this time, I'd like to ask John to provide some details on the financial results for the quarter.

Rob has already given you a breakdown of the major year-over-year revenue changes, so I'll just supplemental what he said with a few other data points.

For Q3, our total organic revenue growth was 11.1%, and we had an additional growth of 17.6% from acquisitions. Rob mentioned that the Q3 2011 organic growth for parts and services was 7.6%. Other revenue, which is where we recorded our scrap commodity sales, was up 53.3%. Approximately 32.5% of this was organic growth, as commodity prices were higher on a year-over-year basis, and because we had higher volumes of scrapes and cores. 20.7% of that increase was a result of acquisitions.

In Q3, 2011, revenue from our self-service business was $76 million, or 9.7% of LKQ's total revenue. Approximately 30% of this revenue was part sales included in recycled and related products, and 70% scrap and core sales included in other revenue.

Our acquisition revenue growth was driven by the 15 deals we did in the last half of 2010 and the seven deals we did in the first half of 2011, and the 10 deals we closed in Q3 this year. The Q3 impact on revenue from acquisitions was approximately $107 million.

Gross margin for the third quarter of 2011 was 42.6%, which was down 40 basis points from the 43% in the same period 2010. On last quarter's call, I mentioned that we believe we've anniversaried, if you will, the increase in the cost of salvaged cars at auction. Scrap prices and the cost of products in the self-service line of business are still higher year-over-year, so that continues to put pressure on gross margin percentages. But, we believe we maintain gross margin dollars on that revenue.

Year-over-year, in Q3, we're still seeing some impact on gross margin percentages from lower margin aluminum furnace operations we acquired in Q3 last year. But, we've now hit the anniversary of that deal, so it'll no longer be a factor in year-over-year. We did see a small, negative impact of about 10 to 20 basis points from the AkzoNobel business.

It's probably taking a moment to add a few comments on the sequential gross margins. Gross margins increased slightly from 42.4% in Q2, 2011, to 42.6% in Q3, 2011. It's fair to say that the quarter unfolded much like we described in the last earnings call. The cost of cars and scrap prices were relatively stable, so there were limited impacts from those two factors.

We had an extra two months of AkzoNobel, so that was a slight drag on gross margins sequentially, but we're starting to see the impact of some of the pricing programs we've been discussing the last few quarters. We believe that these programs are part of the reason we saw gross margins improve sequentially.

We continue to see improvements in our facility and warehouse distribution and SG&A expenses. In total, these three items fell, year-over-year, on a quarterly basis, from 30.7% of revenue to 29.8%. I mentioned last quarter that this improvement is partly just a function of math, because the higher commodity prices drive higher other revenue without any corresponding increase in most of these costs, but also reflects the continued leverage of the business.

Year-over-year, our distribution costs were up from 8.5% of revenue to 8.7% for the quarter, as the impact of higher fuel costs continue to impact that line item. Distribution costs did improve slightly sequentially, following 9.1% of revenue in Q2, 2011, to 8.7% of revenue in Q3, as we saw fuel prices retreat from their highs earlier this year.

I mentioned on our last quarterly call that we expect to have some ongoing restructuring costs related to acquisitions, and on the October 4 call I mentioned that we'd incur some costs during Q3 related to the Euro Car Parts acquisitions. These costs were a total of $2.9 million for the quarter and are broken down in a separate line item in the income statement as restructuring and acquisition-related expenses.

Operating income is $85.5 million for Q3, 2011, compared to $65.2 million in Q3 of last year, an improvement of $20.3 million, or 31%. Net interest income of $4.8 million was $2.3 million favorable to Q3 last year. This improvement is partly -- excuse me, is primarily due to lower interest rate being paid as a result of our new credit facility and lower swap costs, partially offset by higher boring levels. Our effective boring rate was 3.17% in Q3 2011, compared to 4.92% in Q3 2010. Our effective tax rate was 38.7%.

On a reported basis, diluted earnings per share from continuing operations was $0.33 in Q3, 2011, compared to $0.25 in 2010. The impact on EPS of the restructuring costs and the costs we wrote off in conjunction with the ECP acquisition was approximately $0.01, after tax. Excluding these two items, EPS from (inaudible) over the reported $0.25 for the same period last year.

Cash flow from operations was $159 million, compared to $145 million in 2010, an improvement of $15 million. The primary driver of the improved cash flow was improvement in net income of $26 million. Offsetting the higher income were higher levels of working capital, particularly the impact of accounts receivable. There were an additional $17 million use of cash, compared to 2010, and additional investments in inventory, which were the incremental $7 million higher use of cash.

During the quarter, we spent $85 million in cash on acquisitions, bringing our year-to-date total to $181 million. Through nine months, we also issued 1.1 million shares of stock related to the exercise of stock options and equity compensation, but that resulted in $13 million of cash, including related tax benefits.

At the end of the quarter, debt was $633 million, and cash and cash equivalents were $45 million. We mentioned in our October 3 press release that we amended our credit facility to increase our capacity by $400 million to $1.4 billion. Under this new facility, as of quarter end, we had borrowings of $618 million and approximately $35 million of letters of credit that are backstopped by the facility, leaving $740 million of availability for borrowing under the credit facility, including the $200 million under the delayed term loan facility -- delayed draw term loan facility.

We did make a draw under the facility to fund the ECP acquisition of approximately $326 million. In early October, after taking into account the ECP funding, we had $414 million of capacity of -- available, including the delayed term loan availability.

Turning to guidance, you'll note, in our press release, we revised much our guidance. Given our year-to-date parts and services growth of 8.8%, we've raised the full-year estimate from 6% to 8%, to 7% to 8%. In Q4, we expect to see a slowdown in the organic growth because of more difficult year-over-year comparisons. As we noted previously, Q4 2011 has one less selling day than Q4 2010.

We raised our EPS and net income guidance for the year. Our revised EPS guidance is a range of $1.38 to $1.43. The new range for income from continuing operations is $204 million to $212 million. I wanted to point out that the revised guidance includes the $0.02 we incurred on the debt refinancing in Q1 and also includes the expected positive impact of ECP. This guidance excludes restructuring, integration and deal costs. Based on the acquisitions we completed to date, we expect we could incur approximately $1 million of these costs in Q4 2011.

We'll just take a moment to discuss some of the things that could impact us in Q4. Bill costs did improve a little, sequentially, since last quarter, but we're still seeing negative year-over-year miles driven. Further decline in miles driven could lower the number of accidents and, hence, our volume.

You'll recall, in Q1, when commodity prices were rising, we mentioned a positive $0.02 impact to our earnings. We also mentioned that, if prices fell, there'd be a risk that we could give up that gain. In Q3, we saw scrap steel commodity prices were essentially flat to Q2. However, at this point, we are seeing some softness in the commodity markets, with some forecasts of scrap prices dropping from between $20 and $60 per ton. A decline in scrap steel prices would impact our other revenue category, and we estimate, for every $10 decrease in average scrap price, compared to Q3 2011, would decrease our other revenue by approximately $5 million.

In our guidance, we've built in an assumption there. A diluted earnings per share will be negatively impact by falling commodity prices of $0.01 to $0.02 per share in Q4. This loss occurs because of the timing difference between when we buy cars and when we sell the scrap. If commodity prices do fall, we would expect to be able to buy cars cheaper, going forward. So, this isn't a long-term impact, but it does impact the quarter when prices fall.

We've also seen the auction environment fairly stable. Although we paid approximately $1,960 per vehicle at the salvage operations last quarter, which was up from $1,870 we paid in Q2, the mix of cars we bought in Q3 was slightly better. So, although we paid more for the cars, we expect them to part out for more. So, sequentially, we don't anticipate much impact on our gross margins from the scrap -- excuse me, from cost of salvage.

I've already mentioned that we have one less selling day in Q4 2011, compared to Q4 2010, so that's going to cause a bit of a drag in the organic growth and on earnings.

And the revised EPS and guidance includes the impact of Euro Car Parts for Q4. I just wanted to make it clear that the guidance that we gave on October 3 for accretion, due to ECP, of $0.15 to $0.18 for 2012, was incremental earnings to 2012 over what we would otherwise have without ECP, including the impact of ECP at Q4.

Our accounting teams are working through the UK/US GAAP differences and how other companies apply those. ECP includes their national warehouse costs as part of the facility costs, whereas we include those as part of our cost of goods sold. When we described ECP's 2010 gross margin as 44%, that was on the basis of their chart of accounts and their application of GAAP.

Using our chart of accounts, that margin would likely be a little bit lower. We're still working through the accounting. At this point, it's our expectation that the impact would be less than 100 basis points to our Q4 gross margin.

Just to be clear, this is simply moving cost from one line item to another, and in no way impacts the net income or accretion we expect from ECP. Our guidance for cash flow from operations, of approximately $195 million, did not change, and the full-year guidance -- we continue to expect our capital spending to be between $85 million and $95 million. We're seeing a little less capital spending domestically, and that's being offset by some additional spending, as we continue to -- the aggressive buildout of the UK footprint.

I know many of our listeners are working on their 2012 projections. Our field is currently working on their detailed estimates. In the next two months, Joe, Rob and I will be traveling the country to [review] those plans, after which we'll be presenting the consolidated results to our Board. Until that work is completed, we're not really in a position to speak meaningfully in any detail regarding 2012, but we expect to share our thoughts with you on our Q4 earnings call in a few months.

Well, I'll summarize by saying that we were pleased with the way the quarter ended. Organic growth continued at the high end of our range for both aftermarket and recycling, [putting up] respectable numbers. We saw our gross margin start to improve a bit over Q2, 2011.

Scrap, fuel and the cost of salvage were all reasonably stable. We saw our operating leverage coming back, with our operating margins expanding year-over-year and sequentially. We saw our deal flow very strong, with 10 deals in the quarter, and of course, the potentially transformational Euro Car Parts deal being completed earlier this month.

Thanks to our improving credit profile and the support of our banks, we ended the quarter with liquidity to complete that transaction and still have over $450 million of cash and other availability for future deals. So, it's nice to see everything firing on all cylinders.

And with that, operator, we'd like to open the phones to question, please?

Thank you. (Operator instructions.) Nate Brochmann, William Blair & Company.

Good morning, there, everyone. Great quarter.

Good morning, Nate.

Hey, wanted to talk a little bit about -- we talk about the impact of miles driven, and certainly we know that that's a little bit of a headwind on the business. What's the offset for your business as the average age of cars goes up, and people are keeping the cars longer and the amount of repairs on that? How do you think about the balance between those two dynamics?

That's a good question, Nate, because I think we certainly -- as cars get older, they obviously are going to require more repairs. And I think, as people -- as cars age, they're more likely to look for alternative sources of parts.

Well, the headwind in that same scenario, though, is that people, as the cars get older, may tend to drop their insurance coverage a bit, where it's not fully insured. And then, as, certainly as cars get older, they're more likely to total.

So, on the mechanical side of our business, it's a good thing. Obviously, as those parts start to wear and be replaced, we're in a great position. Of course, this is not just a US phenomenon anymore. It's now the same for us in our England operations, where we are selling those type of components regularly.

The good news is that, obviously, the repairs become greater as the cars get older. The only bad side of that, I would say, would be the collision side of our business, where cars who carry less insurance are more likely to total. But, overall, it's not a bad thing for LKQ. That's for sure.

When you combine that with the miles driven being down, do you think, net-net, it's a neutral? Or, net-net, miles driven, it's a little bit of a greater impact than the benefit from the age going up? How do you think about how those two balance themselves out?

I think it's more of a neutral. I think it's -- obviously, people will spend more as the cars get older. Newer cars require less repairs. So, I think it's -- at best, it's (inaudible). Worst, it's a neutral and maybe slight uptick, considering that people will put more money into those cars rather than replace them.

Also, is -- you guys require more of -- kind of what I'll call different services or different categories, in terms of the cooling or the paint, etc.? As you're getting into that, and you're integrating those business, how much overlap, in terms of your distribution network, are you able to leverage in terms of better density?

Yes, the best thing I can do is give you a great example, and that's with the Akzo acquisition back in May. We actually closed late May. They had 40 locations. We had slated to close 30 of them. 10 were going to standalone, because there weren't any operations close.

We've already closed 27 of them. They have moved into our buildings, we are shuttling their parts on our existing trucks. Delivery trucks are the same ones that are going to those shops. So, the answer to your question is, there's pretty immediate gains that we can realize by putting these smaller niche companies.

And the same goes with the cooling. The last couple coolings deals we have done, they are all fully integrated into our warehouses, where that was applicable, and the merchandise was riding on the existing trucks that were already going to those shops.

Thank you very much. Appreciate it.

Thanks, Nate.

Tony Cristello, BB&T Capital Markets.

First question. I think it was in John's prepared remark -- you talked a little bit about the organic growth and the tough comparison you have and the -- from the fourth quarter of last year. If I recollect, you had an even tougher comparison in the third quarter, and you put up a pretty solid number.

So, I'm just wondering, is there something you're seeing to the start of this quarter that's giving you a bit of pause? Or is it just conservatism? Or is it something with respect to the acquisitions and some of the integration that makes you a little bit more cautious?

The biggest impact's probably going to be the [one less selling day], actually.

So, nothing --?

I don't think that the acquisition revenue's going to be reported as acquisition revenues. It doesn't really impact the organic growth, per se. I don't think we're seeing, really, any changes in the dynamics of the business. And miles driven can -- we still continue to see negative miles drive year (inaudible) as far as respect to that.

Okay. If I look, then, at the acquisitions you've -- in addition to Euro Car, you talked about some more heavy duty. Can -- maybe, Joe, can you give us an update on the heavy duty side of the business? Where the trajectory is now on that revenue run rate? And are you getting any more traction with building that parts database to springboard to the next level?

[I think] our weekly sales have moved up more in the $1.5 million, $1.6 million range. Periodically, we'll post up a couple million a week. So, absent any other transactions, I would guess the business will probably budget around $100 million of revenue for 2012. We're pleased with having put $100 million a year business on the books, here, over the last two, three years, with good margins.

Our buildout in the West is really in pretty good shape, with the recent transactions. (Inaudible) in Southern California and then we'll be looking in the New Mexico market, West Texas, and then we'll really be in excellent shape West of the Mississippi. We've got a couple of cold starts planned on existing LKQ properties to better leverage our existing asset base.

When that's done, our real attention will turn to the Northeast, in terms of being pretty close to having a national footprint. The visibility of the parts (inaudible) does keep improving. As you can guess, that's taking some time, in terms of getting good parts descriptions in the systems and the commonality in the database, but several times a week, now, we're seeing situations where the salespeople are able to sell out of each others' inventories and complete a customer's needs. I think it'll really make buying significantly easier for our foreign buyers to tap into a database or make one trip into the country and kind of hit all their needs.

Maybe the short answer to the question is we think the original business model and philosophy we had to invest in the business is holding to be very true. We probably want to get a little more structure in place before we start aggressively marketing for fleet -- taking entire fleets of vehicles. We've done that on a couple of occasions and found that we really need just a little more muscle before we can really effectively handle large fleet dispositions.

But, that's -- I think we're certainly close, and I would think, this time next year, we'll be pretty actively going after fleet managers and trying to manage the disposition of trucks they're taking out of service.

You've been very inquisitive collectively in various -- not only with Euro Car in Europe and the heavy duty and the smelter and the coolant. I'm wondering is, if we look at your business today, how much embedded cost and infrastructure and integration are sort of compressing the margin, so to speak? And is there a particular quarter or time period when you -- we should think you start to really see that unwind?

Then, it's fully integrated, and you start to, then, really maybe get a stair-step, if you will, in terms of your margin expansion?

Tony, it's John. I don't -- Rob mentioned the AkzoNobel deal, where we, within two quarters, have taken out 27 of the 30 locations that we think we're going to get out of the total 40 locations we bought.

We're pretty good at getting the early hits out. The longer-term impact -- I just fall back to where we've always said, is that the things like putting more -- being able to ultimately get warehouses that are collocated between the aftermarket and the salvage product line and share the delivery routes a little bit more, those things just take time over -- as the leases come up and as the properties become available.

That, really, is just sort of the long-term view that we've always said, which is operating income expansion of 40 to 60 basis points or 40 to 50 basis points through -- putting more product through the same warehouses, putting more products through the same distribution network.

I don't think that there's a -- we haven't identified a huge amount of latent costs that are, if we stopped growing through acquisitions, would suddenly come out of the system, I don't think. It's more of just a continuous improvement-type philosophy, I think.

Okay. Maybe one last quick question on that, then. Is it still fair to assume that gross margin sequentially improving? You're into the fourth quarter, the smelter's anniversary and, maybe, for the first time, you see gross margin on a year-over-year basis improve as well?

In my prepared remarks I hit on a couple of those things that couple impact it. Let me just run through those again for everybody. The salvage -- the cost of salvage, really, has been pretty stable, so I don't think that that's going to impact as much.

But, we are seeing some forecasts, and we've seen a little bit of spottiness in some of our markets. Not nationwide yet. We have seen a little bit of softening in commodity prices in some of our markets. So, that -- just like we mentioned in Q1, that we had a couple of $0.01 benefits from a rising commodity environment, if commodity prices do end up falling for the quarter, that's going to hit the gross margin a little bit.

The other thing I just try to give everybody a heads-up on is that ECP -- in our presentation on October 4, we talked about them having a 44% gross margin in 2010. That was on the basis of their chart of accounts and their interpretation of UK GAAP.

We're going to through the integration right now in mapping their chart of accounts to ours. It looks like they've got some costs that are facility costs on their financial statements that we would -- we, on our chart of accounts, include in the cost of goods sold. So, there could be an impact. We think it's less than 100 basis points, but it could impact our gross margin, moving those costs up into costs of goods sold from facility and warehouse costs.

You haven't seen this yet, so -- but, that's coming in Q4, and I just want to give everybody a heads-up on that. So, those two things could be a little bit of a drag on Q4.

Thank you.

Tony, I'll just add one last thing, that obviously the pipeline is still active and there'll be more deals likely coming as well, that will have an impact as well --.

Right.

Going forward.

I guess on the gross margin, on the (inaudible), the -- some of the (inaudible) programs we've been executing, we continue to tweak those and try to move those along. The things that we did in Q2 -- or, excuse me, that have impacted Q3 I don't anticipate those stopping. We're going to continue to work on that.

Thank you.

Thanks, Tony.

Scott Stember with Sidoti & Company.

Can you maybe talk about the cadence of pricing during the quarter? We're seeing used car valuations starting to come in. Maybe just talk about why you spoke to the gross margin already for the fourth quarter to general trends from procurement standpoint, going forward?

Yes. Obviously two sides of that salvage environment. We'll talk about the salvage first, Scott. The options are very robust in terms of inventory. We did predict that last quarter, with all the flooding that happened and the volumes are up substantially.

The good news for us is our backlog remains strong. Probably one of the strongest we've seen going into the winter season. So, hopefully we'll be a little more selective on our purchases and allow us to do some better buying.

But, the cost -- let's just talk a little bit more about the margin. The cost does remain high, as John mentioned in his prepared remarks, but we are digging deeper into every single car, and it is time to pay off at the gross margin line. As John mentioned, some of the activities we have going on, in terms of looking for alternatives to get more funds into the system by offsetting distribution costs, etc.

In terms of used car prices, you're right. The Manheim Index, in September, was 3.4% lower than a year ago. However, it's still really high in comparison. I think it's going to take a little bit more time to get a little bit -- it has to come down a little bit more before we see any kind of meaningful relief at the action. Don't really anticipate much help there in the short term.

In terms of the pricing we're doing, in terms of the pricing of the product, once it's in the system, we -- as John mentioned, we're continuing to work on the pricing optimization. We track OE prices revenue to what they're doing. They are still averaging, consistently, 1.5% to 2% increases, so we tend to fall right on their heels. When they raise, we're right behind them. That's providing us a little bit of relief.

Our deviation work that we -- controlling our reps from deviating from the price continues, as I mentioned, the CEs we're adding to help us. Fuel is certainly helping. We feel confident that gross margin is certainly turned -- bottomed out and likely turning in the right direction.

Just one last point on the gross margin. We talked about sequential gains, but in the last year and-a-half, we've announced over 30 deals. If you took two of them out, the paint deal and the smelting deal, actually our margins are up year-over-year as well, if you just remove those two deals. Everything's heading in the right direction, as far as we're concerned.

Right. Maybe just talk about -- we've seen some of the reports that aftermarket parts, in particular, are taking share from OEM parts. Could you maybe talk about how that's benefiting your business? And just frame that out a little?

Yes. We only get annual results from the estimating Company as to what's happening to the APU trend, so we don't have that figure yet. However, one thing that is silver lining for our industry is that we know many of the carriers who have reported their earnings already had a tough Q3, mainly from all the flooding and the cap loses that they sustained.

Tremendous pressure on them to continue to increase -- decrease their cost through increased APU. Obviously, we continue to win more and more parts into the system. The interesting -- I did mention, in my prepared remarks, about the certification programs. There are just some stats here that are just amazing.

CAPA has been in business now for over 25 years, and they have 4,300 parts -- certified parts in the program. NSF, who's a little over a year old, has a total of 951 parts already in the system, with 1,000 pending. A lot of certified parts coming into the system and adding to our ability to sell more and more parts to the (inaudible) [repair].

So, getting more inventory, more parts that the insurance companies are demanding, and the fact that they still have a high demand level for those parts. So, really good news there as well.

All right. And the last question -- could you maybe talk about how the government business is doing? I know you guys rolled it out a couple of quarters ago.

Continuing to plug along in that. Our government affairs division is actually helping us [open some] doors at the state and federal levels. Really just plugging along. Nothing heroic to report, unfortunately, but steady growth is occurring every single quarter.

Got you. That's all I have. Thank you.

Rob, I just want to -- I think you mentioned the Manheim Index. It's up year-over-year, but it's down from the peak.

Correct.

Craig Kennison with Robert W. Baird.

Before I ask a question, let me just offer my best to the LKQ family on the loss of Don.

Thank you.

Thank you, Craig.

The first question had to do with the 10 acquisitions you closed recently. Do you have a sense of the revenue impact for that in 2012?

I don't think we're in a position to talk 2012. Just -- we talked about $107 million of acquisition impact in Q3. We're probably looking on -- for, cumulatively, all the acquisitions we've done, probably $80 million impact on Q4, excluding the ECP deal. We talked about ECP being an incremental $120 million to $125 million, so we're probably around $200 million sequential impact from acquisitions.

Can you comment, maybe, on the trailing 12 month revenue of the businesses that you acquired?

I don't think we've got that handy.

I can move on. Next question. Joe, the acquisition pipeline, can you just comment on the nature of that pipeline? What valuations look like? And what your overall appetite is for debt? And how you want to finance those acquisitions?

I'll start. This is Rob. Joe can jump in if he's got anything to add on that. The acquisition environment is -- remains strong and very active. I've long said that this is a family-owned business industry, where it appears the kids are not as interested in running the parents' business anymore. So, the deals continue to flow quite nicely.

I just want to talk about the Q3 deals, because I know it's pretty indicative of how they're going to move forward here. We had 10 deals. We had three salvage, two self-service, one aftermarket, three HD and one reman. Really spread out nicely across our entire portfolio. That does not include ECP in that -- in those numbers.

The best part about the spreading of that-- those acquisitions across our portfolio is it allows for balanced integration. I mean, no one team is going to be stressed to bring 10 into their own organization. So, it allows for quick integration and the ability to get the benefits realized pretty quick.

For full service -- [let's talk] about each division separately. The full service will continue to look at strategic tuck-ins. This past quarter, we acquired locations in Sacramento and Minneapolis/Saint Paul, immediate distribution opportunities in cities that we were servicing from hundreds of miles away. They bring -- we continue to look for key markets with great management.

One thing that we're starting now -- it's kind of new to our business models, what I dub a tweener opportunity. Not really a self-serve, not really a full serve, [as] a car in the middle between $900 and $1,300 that we kind of bypass, picked up here and there, for both of our full service and self-serve. We're going to focus on that, going forward in 2012, to open up a whole new line of business for us, potentially.

Still looking at distressed opportunities. Those still exist where the families have just had enough, and it's time to call it quits.

As far as the UK, we're really in no rush to bring salvage there. We'll keep our eyes open and look for opportunities if they come along, but we really want to digest what we have. We do have one Greenfield in the works in Southern California, so hopefully can add some capacity in that marketplace.

The aftermarket -- we did talk a little bit about looking at niche players -- the paint and the cooling, and those will continue. And we'll certainly continue our warehouse expansion and upgrades in that particular field.

Self-service -- really, geographical expansion of new markets will be our targets. Acquisition is our first preference, but in the event we can't, we will certainly do Greenfields. In fact, we have four Greenfields already in process.

Finally, we'll be doing a little bit with the self-service (inaudible) these hybrid yards. In our purchase of Greenleaf a couple years ago, up in Leominster, Mass, we decided to split the yard in half because of the capacity we have there, to a half full service, half self-service, to really get a hybrid model.

Then, finally -- Joe already did talk about the HD, so I'll skip that, but in reman, we added one additional reman facility this quarter. Really has us where we need, in terms of capacity, so probably not looking to do anymore reman engines. However we have mentioned, in the past calls, that reman transmissions are an interest to us, and other reman capabilities. So, we'll continue to look for opportunities in the reman.

As far -- In terms of paying for them, John, what would -- our strategy will be?

Sorry, Craig, I was -- your question was how do we pay for the acquisitions?

My question was, what were the valuations looking like? And how would you intend to finance those acquisitions?

Okay. I don't think -- in terms of the valuations, nothing's really changed with respect to the -- how we view the deals. We're still looking using an EBITDA metric, which is not the only thing we look at. We're still four to five, four to six times. Maybe on the higher end, if we didn't want to stretch because it's a new market for us or something, but we really haven't changed our valuation metrics.

I spoke to the fact that we will have about $450 million of capacity between the cash and the balance sheet and the dry powder on the revolver without any additional cash flow coming in. So, part of the reason we expanded the credit facility was to allow us to do the ECP transaction. But, after we came out of that transaction, we actually ended up with additional capacity because we expanded it by $400 million. And I mentioned we drew down $326 million in conjunction with that transaction.

We think we're in reasonably good shape, here, between the cash flows out of the business next year and the revolver. We should have adequate capacity continue to -- our acquisition program, if you will.

Thanks. And if I could ask a follow-on to Tony's question on secure disposal, as you add locations, does that since your revenue opportunity with existing contracts? Or is it more about winning new contracts that you would not have otherwise been able to serve because you don't have a national footprint?

I think it's -- adding to the footprint allows us to manage more product ourselves as opposed to having to find, essentially, competitors to take a piece of the action. Yes, I'd say that's -- allows us to kind of grow from the existing business base we have.

Then, to follow on that, the Navistar contract -- it would seem to be an additional nuance and that you were managing part inventory more than just securely disposing their assets? Is that fair? Is that a new opportunity?

That's fair, and let's hope it's a new opportunity.

A couple housekeeping. What was the in-stock rate in the quarter? You mentioned it was better. Maybe compare that to the prior quarter.

It was increased, actually, over prior quarters on all three lines -- salvage, aftermarket and refurb. It is in the mid-90 range now, Craig, and improvement of about 100 basis points actually.

You including recycled? It's in mid 90 range?

Oh, I'm sorry. Without recycle. I'm sorry. That's aftermarket. Recycled -- they're in the 70% range.

Okay. Thank you. Just lastly, to clarify, the NSF international certification that you had mentioned, does that help you with your ECP acquisition as you try to penetrate that market with certified parts?

Not necessarily. There is a certification body over in the UK, Craig, called [Fetcham]. NSF is not in that marketplace. However, they have shown interest in following us over there. The biggest bang here is in the United States with the NSF certification program. It is putting pressure on the other certifier to put more parts into the program, which is actually happening.

The other nice benefit is how quickly they're getting parts into the program. As I said, they've been around for little less than two years, and they're -- already have, what's in the pipeline, 50% of what their competitor has, certified and for 25 years.

Our -- their strategy, as we've talked to them, is to get more insurers to recognize them as a reputable certifier, and they already have pulled off one of the top five carriers to recognize their certification program. Right now, the -- all the tailwinds here are in the States, but there is an opportunity in the UK for sure.

Just to be clear, NSF has been around for many, many years. They certify most food processing equipment in the country. Internationally, water and food processing is really what their origins are. So, they do operate in the UK and in -- throughout Europe.

Correct.

They do have a national -- international standing. It's just that, in the aftermarket, auto parts is really their new niche that they're getting into.

That's correct.

Thank you.

Thanks.

Thanks, Craig.

Thanks, Craig.

John Lawrence with Morgan Keegan.

Rob, would you take a look -- I don't know if this is a fair question, but as you look across the different lines of businesses over the last couple years, what's the best measurement or way we could look at the customer base itself? I mean, you had -- at one time, more buying aftermarket and now buying -- how many of these customers are buying from different pieces of your business? Are you tracking it that way in terms of the share?

Predominantly, when you look at our history, in 2003 we were just a salvage recycler selling predominantly to the body shop industry. As the Internet got some legs, we started seeing some retail sales come on that side of the business. Of course, then, we've gone into the aftermarket parts business, which brought in more, obviously, collision repair parts, so focusing on that side of the business.

However, the cooling products that they have allow us to get into the mechanical side of the business as well. Currently, we're operating on two systems. Our aftermarket is on one system, and the salvage system is another. Eventually, the long-term plan would -- to bring everybody on the same system so that we can absolutely sell more products to the existing customers on both sides.

It's interesting. The cooling acquisition we did a couple years ago brought in a whole new line of potential repairers to us. That's the general repairer. That particular repairer probably wasn't doing too many engine or transmission jobs, which is what we had with -- obviously with the salvage. Now, the cooling [fixer]/radiator, fixer/condenser -- it's brought in a whole 'nother line of business and potential customers.

And then, of course, ECP has brought in not only that -- expanded that customer base dramatically, but also opened up a new continent to us as well. In terms of the market share, I think that we don't track that necessarily by market segments, but certainly the base of who we sell to has expanded greatly in the last couple years.

Secondly, to that, what are we seeing in the foreign name plates as far as the mix of product at this point, as you continue to expand the SKUs?

We report that over 90% of our products in the aftermarket are sourced internationally. The vast majority are coming from foreign markets. I believe that was your question, John?

Yes more or less. As you look at the mix of products getting older, more or less on the salvage side of -- how much are you looking at foreign name plates these days?

Oh, I'm sorry.

On the mix?

It's something we don't know that we track, John.

Yes.

I would assume it's a growing, though, as you look at those aftermarket trends? I would assume that's just another opportunity?

I would agree. I would agree it's probably growing, but it's something we don't track. Not up to that level.

Okay. Thanks, guys. Good luck.

Thank you.

Thanks, John.

Thank you. I think maybe one final question, Manny.

Certainly. Mark Mandel with ThinkEquity.

Good morning, and congratulations.

Thanks, Mark.

Thanks, Mark.

Just a couple cleanup questions at this point. You had mentioned potential impact from commodity price deflation. I just wanted to understand clearly that this would have a depressing effect on gross profit dollars, but it should have a favorable effect on gross profit rate. Is that correct?

In the long run, yes, because what happens is, particularly on the self-serve side of the business. When we buy a vehicle, we build in a certain amount of gross margin dollars. As commodity prices rise, we don't -- we're not able to maintain that margin.

If commodity prices increase, as they have -- and we talked about the fact that that's caused some gross margin compression, particularly on the self-service side of the business. There -- but, if, in Q4, we're to see a drop in commodity prices, it does cause a one-time drop, as -- because we buy a car today, for argument's sake, for $500 in the self-serve, and we build into that the value of the scrap today. If we sell that car 90 days from now, and scrap has dropped, we take a little bit of a decrease in our gross margin until we can go back and start buying those cars cheaper.

That's what we were --.

Okay.

Trying to point out is, just like in Q1 we mentioned that there was a $0.02 benefit because commodity prices increased between Q4 and Q1 last year, if that phenomena reverses, we're going to see a little bit of a impact on our gross margin this quarter. It's -- it comes and it goes, but, ultimately, you're right. If lower commodity prices tend to -- if we can maintain the same gross margin dollars, you see the percentage go up.

Okay, great. Second question. I didn't quite hear what you said about the average price paid per vehicle compared with $1,870 a year ago, but I didn't catch the number for this year.

I'm sorry?

It was about $1,960.

Okay, great. Then, finally, in terms of your pricing initiatives, where I think you were taking some of the flexibility, some of the initiative, away from the regional managers, where do you stand with that program? And how far along are you?

We have a -- as we've mentioned in our previous calls, Mark, we have a Vice President of Pricing Optimization. So, we've taken that away from the regions, to a certain extent, and we're controlling it more corporately.

We do allow the regions to put their input in on regional differences, because there are, absolutely -- some products do better in some markets than other. California tends to be a high foreign populated car population, as opposed to Detroit, which is really the big three.

We do allow the regions to have some input on that, but in terms of the aftermarket, it's completely controlled at the corporation. So, we're getting a little bit more of a pull-through with less regional differences there.

Mark might have been asking [about] the lockdown on the sales rep deviation. The system changes?

In terms of the system changes, we are, in fact, going forward with the reps being locked down. There's a new release coming out next week on that, actually, that controls the reps from being able to deviate from the pricing as well.

And you expect that to be rolled out over the next 12 months?

Yes. Over time, that will roll out. We tend to walk before we run, see the impact, making sure it's not causing any negative impact. And then, we'll roll it out over the substantial quarters.

Great. Good luck, and have a great holiday season.

Thanks. You, too.

With that, respectful of your time, we'll let you get to your other calls. Thanks for joining us on this call, and we'll look forward to talking to you in a few months as we report our Q4 earnings. Thanks, everyone.

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.