LKQ Corp (LKQ) 2012 Q2 法說會逐字稿

Greetings, and welcome to the LKQ Corporation second quarter earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded. It is my pleasure to introduce your host, Joe Boutross, Director of Investor Relations. Thank you, sir; you may begin.

Thanks, Kristine. Good morning, everyone, and thank you for joining us today. This morning, we released our second quarter 2012 financial results and updated our full year 2012 guidance.

In the room with me today are Rob Wagman, President and Chief Executive Officer, and John Quinn, Executive Vice President and Chief Financial Officer. Rob and John have some prepared remarks and then we will open the call up for questions. In addition to the telephone access for today's call, we are 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. These 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 to 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 more information on potential risks. 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 10-Q in the next few days. With that, I'm happy to turn the call over to Mr. Rob Wagman.

Thank you, Joe. Good morning and thank you for joining us on the call today. We are very pleased with the results we reported this morning.

Diluted earnings per share from continuing operations in Q2 was a record $0.43, an increase of 34%, as compared to $0.32 for the second quarter of 2011. As noted in our press release, the second quarter 2012 diluted earnings per share included a gain equal to $0.04 per share that resulted from that favorable legal settlement partially offset by restructuring and acquisition-related expenses and change in fair value of contingent consideration liabilities totaling $0.02.

Revenue for the quarter was is $1.01 billion, the second highest quarterly revenue achieved by LKQ, second only to Q1 2012, despite the fact that insurance carriers reported fewer claims in Q2. Industry sources have reported overall claims volumes are down circa 2% year-over-year, mainly as a result of fewer catastrophe claims. Despite the continued challenges of a mild winter we witnessed in the first quarter, the effect of which carried into Q2 and the volatility in the scrap metal, aluminum, and precious metal markets, we still achieved 6.3% organic growth for parts and services and 3.7% total organic growth. The softness in the scrap market negatively affected our results by $0.02 of EPS and caused our gross margin to decline by 50 basis points.

Revenue growth from acquisitions was 29% in the quarter. The continued growth in organic parts and service revenue in 2012 is a combination of the increased use of alternative parts by insurers and a direct repair program networks to reduce claim costs and our continued success at gaining market share from the competition. As mentioned on the last quarter call, we still believe alternative part usage in 2012 will realize a 100 basis point improvement over 2011 alternative part usage levels.

Next, I'd like to share some operational statistics. During the second quarter, we purchased nearly 67,000 vehicles for dismantling by our wholesale operations, which is an 18% increase over Q2 2011. As for volumes at the auctions, supply remains strong throughout Q2 and continues to meet our needs early in Q3. With inventory already on hand and a continuation of our current run rate for acquiring cars, we should have sufficient inventory to grow our recycled parts operations.

I would also like to mention we are starting to see some pricing relief at auction. According to industry sources, wholesale used vehicle prices were down 3.7% in June compared to May and down 3.6% relative to June 2011. We are starting to realize corresponding price reductions in our vehicle procurement including our self-service operations, which we hope will positively impact our gross margin. But please note that our gross margin may be negatively affected by scrap price reductions going forward.

Turning to our self-service retail business, during the second quarter, we acquired over 107,000 lower cost self-service and crush only cars, as compared to 91,000 in Q2 of 2011, which is an 18% increase. In our heavy duty truck operations, during the second quarter, we purchased roughly 1,700 units for resale or parts, as compared to 1,600 in Q2 2011. We continue to be excited about the growth prospects and customer demand for this business which posted solid double digit organic growth in the quarter.

Turning to Euro Car Parts, we continue to be extremely pleased with the performance of Euro Car Parts with its ability to capture market share and open new store branches. In Q2, ECP achieved organic growth revenue of 22% versus preacquisition periods and we opened 11 new branches with an additional two branches open this month to bring our total branch count to 112. As of July 12, we have opened 23 locations since we acquired ECP in early October 2011, and we are on target to open a total of 30 branches in 2012, which I mentioned on our first quarter call.

I would also like to update everyone on our collision parts program in the UK that we initiated back in late March. While still early, we are encouraged by our progress thus far, with our primary focus on meetings with insurers and repairers in an attempt to educate the industry on the value of alternative parts. Daily sales are advancing to plan as we continue to market this product line.

Moving on to acquisitions, during the quarter, we acquired seven companies. We purchased a chrome accessories distribution business headquartered in Nebraska, a self-service operation in New Hampshire, a self-service operation with two locations in Florida, a wholesale salvage operation in West Texas, a paint distribution business with four locations in California, we added a precious metal extraction business based in Rhode Island, and, finally, we purchased a self-service operation with five locations in Maryland.

I would like to briefly highlight two of these acquisitions. In June, we acquired five self-service operations in Maryland that operate under the trade name Crazy Ray's. This acquisition reflects our strategic goal of building out our national footprint in all lines of business. Prior to this acquisition, the Company serviced the Maryland market with our aftermarket, heavy-duty, and salvage lines of business but not self-service. Also in June, we acquired Material Sampling Technologies, a precious metal extracting business based in Rhode Island. This acquisition will increase the efficiency of our scrap recovery process by improving the yield of precious metals from our salvaged vehicle parts, such as catalytic converters, the vehicle onboard computers, and vehicle sensors.

As you can see, we have been very busy with acquisitions and our pipeline should continue to present opportunities for additional growth for the Company. Acquisition candidates exist across all of our business lines in terms of product types, as well as geographic opportunities, as we continue our plan to put additional facilities in key under-served markets.

At this time I would like to ask John Quinn to provide some more detail on the financial results for the quarter.

Thanks, Rob. Good morning, and thank you for joining us today. I am going to speak to a few highlights of the financial statements and then provide some color on our guidance/ thoughts for the balance of the year.

Starting with revenue, this is our second quarter reporting revenue in excess of $1 billion. Revenue in Q2 was $1.007 billion, representing a 32.5% growth over the second quarter of last year. Acquisitions grew -- drove 29% of the growth, representing $220 million. Our organic growth was 3.7% in total and parts and services organic growth was 6.3%. Please note that the parts and services growth number includes revenue associated with the new branches opened by ECP since our acquisition. This contributed about 120 basis points to the growth.

Revenue for ECP was $165 million in the quarter, and while we he didn't own ECP in Q2 last year, we believe it grew you 22% over the same quarter last year when it billed $135 million. I would also point out that we saw negative organic revenue change of 8.2% in other revenue. Other revenue is where we record scrap and core sales. This negative organic growth is almost entirely driven by fallen scrap prices, particularly aluminum from our furnace operations. We also saw a drop in scrap steel; we estimated we saw an 8.3% drop in scrap for our crushed cars on a year-over-year basis.

Total growth for other revenue was positive 90 basis points, primarily due to acquisitions slightly more than offsetting the falling pricing. Rounding out the revenue conversation, we did see about a negative 30 basis point impact from foreign exchange on our revenue. This primarily relates to the Canadian dollar as we have yet to anniversary the acquisition in Q4 2011 of ECP. After Q3 2012, this number may be a little more volatile with a larger base of foreign revenue coming into play. In Q2 2012, revenue for our self-service business was $84 million, or 8.3%, of LKQ total revenue. Approximately 33% of this revenue was part sales included in recycled and related products and 67% scrap and core sales included in other revenue.

Our reported gross margin was $422 million, or 41.9% of revenue. Last year, we reported a gross margin of 42.4%, so our gross margin fell 50 basis points year-over-year. Included in this change the legal settlement that Rob mentioned was $8.4 million or a favorable 80 basis point impact. This is partially offset by ECP which caused a 40 basis point unfavorable impact year-over-year. And Rob mentioned that we saw scrap prices fall during the quarter. We estimate the impact of the falling scrap prices was $0.02, or are about 50 basis points. And we also paid more for are some of our self-serve cars which caused an additional 50 basis point compression to our margins. The balance in the margin changes were primarily mix.

Our facility warehouse distribution and SG&A expenses were 29.4% of revenue in Q2 2012, compared to 30.2% in 2011 Q2. Rob and I are pleased to see that we appear to be getting a bit of leverage out of these (inaudible) as our revenue is growing. Facility and warehouse costs were 8.2% of revenue compared to 9.1% in Q2 last year. This decrease was primarily due to adding ECP, which has a lesser amount of facility and warehouse expenses than our North American operations. However, having said that, we did see about a 20 basis point labor savings in the North American operations.

Distribution costs were flat at 9.1% both this quarter and the same quarter last year. ECP drove a 20 basis point increase, which was offset by lower fuel costs in North America. Selling and G&A expenses were 12.1% of revenue in Q2 this year compared to 12% last year. ECP actually drove this percentage 50 basis points higher, but we saw improvements in North America contributing 40 basis points of improvement as we saw some leverage in both the sales and administrative costs.

During the quarter we recorded $2.2 million of restructuring and acquisition related expenses. Depreciation and amortization for the quarter increased $3.6 million to $15.4 million, primarily as a result of acquisitions. The amortization of intangibles and depreciation associated with ECP was the primary driver of the increase.

Net interest expense of $7.4 million was $2.7 million higher than the same quarter last year. This increase was mainly due to our higher debt levels, but we did see an improvement in our average borrowing cost. Our effective borrowing rate on our bank borrowings was 3.2% in Q2 2012, compared to 3.4% in Q2 2011. We are showing an expense related to the change in contingent consideration liabilities of $1.2 million, and that's primarily related to accretion on the liabilities we have recorded.

Our tax rate for the quarter was 36.8% compared to 38.4% in Q2 last year. We continue to see some benefit from the lower foreign tax rates as we earn more income offshore. On a reported basis, diluted earnings per share was $0.43 in Q2 2012 compared to $0.32 in Q2 2011, an increase of $0.11 or 34%. Last year included $0.01 restructuring cost offset by $0.01 of favorable adjustments to contingent purchase price. We view last year as being $0.32 on an adjusted basis.

In Q2 this year, the $0.43 includes $0.04 income related to the legal settlement and $0.02 expense related to the restructuring costs and contingent purchase price, so on an adjusted basis, Q2 2012 EPS would have been $0.41, again, compared to an adjusted 32% last year.

A few comments on the six month year-to-date cash flows and uses of cash. Cash flow from operations from the first six months of 2012 was $121 million compared to $101 million in 2011, an improvement of $20 million. Year-to-date EBITDA improved $65 million, but we had higher interest expense of $4 million and $19 million higher cash taxes in 2012.

In 2012, we made additional investments in inventory. The investments were $11 million higher in 2012 compared to 2011. We did this particularly to support the growth in the UK, which accounts for $27 million of the $31 million total increase in our year-to-date inventory growth. Compared to 2011, we also saw higher payroll expenses being an $11 million greater use of cash. Year-to-date, we spent $42 million on capital expenditures. We also spent $120 million on acquisitions, which $95 million was in the second quarter.

As of June 30, 2011, we had $1 billion of debt and cash and cash equivalents of $59 million. These figures compare to the $956 million of debt and the $48 million of cash and cash equivalents at December 31, 2011. Availability under our credit facility at quarter end was $395 million after taking into account letters of credit drawn against it. With the cash of $59 million on balance sheet, our total availability is $454 million. At quarter end our debt under the credit facility was 66% fixed and 34% floating. Now, turn to guidance.

As we stated in the past, our guidance excludes any restructuring costs and transactions costs gains and losses and contingent purchase price adjustments and capital expenditures or cash flow related to acquisitions. We increased our guidance for organic revenue growth from parts and services to 5.5% to 7%. You will note that after a soft Q1, we improved to a 6.3% rate in Q2.

Year-to-date, we have achieved a 4.9% growth but we expect the second half of the year to be stronger as we don't expect to have the weather impacts we had in Q1, and in Q4, we will start reporting all of ECP's growth as organic. Our revised guidance for net income is $265 million to $282 million, which equates to $1.77 to $1.88 diluted earnings per share. This change incorporates into our guidance the legal settlement gain recognized in Q2. We left unchanged our guidance for cash flow from operations of $250 million to $280 million and we continue to expect our capital spending to be in the $100 million to $115 million range.

As normal, I will give you an update on some of the larger things Rob and I have considered that could impact the guidance. Rob mentioned that we're on pace to open 30 new branches with ECP. I mentioned on the last few calls that new branches are generally unprofitable for a few months, so that development activity will be a bit of a drag on 2012 earnings, particularly since the remaining branches will be opening later in the year.

I still believe it is the right strategic thing to do because, in the long run, we will see these locations contributing both to dollars and operating income. The original cash flow guidance didn't contemplate as much inventory build as these branches required, so although we brought up the bottom end of the income guidance, we haven't changed the cash flow guidance until we get a better understanding of the impact of the accelerated growth in the UK and how it could impact our cash flow.

On the North American side of the business, we started a fairly low, at least for us, organic growth, which we attributed to the severe winter in 2011 and the mild winter in 2012. Rob mentioned it appears we are getting into more normalized weather patterns and people seem to be responding to lower gas prices by driving a bit more. But if the economy slows or Q4 is mild, that could be a risk to our assumptions.

Moving on to scrap prices. Let me explain what happened in Q2 and what we have seen so far this quarter. Prices in April and May for scrap steel were fairly stable but we saw a drop in June and have seen another drop in July. We have adjusted our car buying fairly well, so we think that we will have a return to more normal gross margin dollar per car going forward, but we have a couple of months of backlog to work through you.

I have mentioned that we believe that scrap impacted our EPS by $0.02 in Q2. Based on July prices and our inventory turns, we think we probably have another $0.02 to $0.04 impact that will hit us in Q3. Obviously, we haven't completed July so this is our current best estimate. The full year guidance assumes pricing roughly in line with today's scrap prices. Scrap steel is approximately 25% lower at the moment than we saw in Q3 last year and is approximately 18% than we've averaged in Q2 2012.

LKQ doesn't give line item or quarterly guidance but I did want to make you aware of the potential impact of this drop on other revenue where we record scrap and core sales. Total other revenue is 13% of our total revenue in Q2 this year, compared to 17% or 18% in Q2 last year. So our exposure as a percentage of our revenue to commodity prices continues to lessen, but as we repeatedly pointed out, it can cause short term fluctuations in our EPS.

The decline in scrap pricing is going to impact gross margins for at least the first two months of Q3. Again, we don't give quarterly guidance but I do expect to see some pressure we had on Q2 gross margins carry into Q3, and then assuming that scrap remains stable, we'd see some recovery in Q4 relative to Q3.

Rob mentioned our car buying. The average price we paid at auction for recycled cars has been fairly stable for several quarters. We have seen a slight tick down in the back half of June, but that may simply be the falling commodity value built into the cars. Having said that, the Manheim Used Car Index has started to move up its peak. If used car prices start to fall and that impacts our costs beyond the impact of scrap, then we may start to see margins in late model recycled business improve later this year.

Finally, the precious metals processing acquisition this quarter is similar to our furnace operations in that they process a high volume of lower margin revenue. We expect this acquisition to negatively impact our Q3 gross margins by approximately 30 to 50 basis points. We valued this company on its own merits and cash flows, but believe it will allow us to achieve better yields from the nonferrous metal as we get out of cars, such as the platinum in the catalytic converter. When Rob and I looked at that, we believe that if we can achieve an extra $2 or $3 per vehicle with an annual car purchase of around 700,000 units, the acquisition would provide a very attractive return to our shareholders.

I would like to turn the microphone back to Rob to summarize before we open the call for questions.

Thanks, John. As we enter the back half of 2012, our outlook continues to be positive for the balance of the year. I am encouraged by the tailwinds of lower fuel prices, the increase in miles driven, anticipated alternative part usage growth, and recent reduction in vehicle pricing we are witnessing. I'm equally proud of how our group of over 19,000 valuable employees have attacked the headwinds we faced in the first half of the year.

We believe our unique competitive advantage and the actions we taken in response to the challenging operating environments have translated into consistent earnings growth since our founding. We continue to focus on other ways to improve our gross margin, built partnerships the increase the acceptance of alternative parts, and identify strategic opportunities that provide results for our stockholders.

Kristine, we are now prepared to open the call for Q&A.

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Our first question is from Sam Darkatsh with Raymond James. Please proceed with your question.

Good morning, Rob, John. How are you?

Good morning, Sam.

Very well, thank you.

A couple of quick questions here. First off, what -- the seven companies that you acquired, what are the annualized sales and how would that break out among aftermarket collision -- I'm sorry, after-market, recycled, and other?

The acquisitions in Q2, there was about $6 million of revenue included from those, but the trailing 12 month revenue is about $130 million.

And how would that break out mix-wise?

I will have to follow up with that. Why don't we go to another question and see if I can grab that.

Sure; that's fine. Obviously, there is a lot of moving parts in gross margin with the scrap. You've got the precious metals impact and you've got the lower wholesale costs. By my math, and I'm probably forgetting something, but it looks like gross margins in Q3 might be 10, 20, 30 basis points lower than Q2. Is that about right or am I forgetting something?

I'm sorry could you -- what were you --?

Gross margins in Q3 versus Q2, based on all of the moving parts you gave, it looks like it will be down slightly. Is that correct or am I missing something?

Sure, good question. You know, let me just hit on what we think is going to happen with the margins. Again, we don't give quarterly guidance to you on the gross margin line. But I will just reiterate a few of the things we said. Other than seasonality, in the winter time, we tend to see a little bit better margins when the shops are very busy. Our gross margin discussions tend to make more sense on a sequential basis rather than year-over-year, but let me just walk you through you that. In Q2, we saw gross margin was 41.9%, and that included the legal settlement. Without that legal settlement, our margin would have been a 41.1%. So let's just start with that as the base.

If we assume that scrap stays where it is today, Q2 had a 50 basis point impact from scrap and I mentioned we believe that based on today's prices, we'll probably see an impact of $0.02 to $0.04 in Q3. If it is only $0.02, then scrap isn't really going impact the margin in Q3 but it will cause Q4 to snap back by that 50 basis points because you won't see -- we won't have that impact in Q4, if that makes sense. If it turns out the scrap is higher impact in Q3, say it was is $0.04, that will cause an additional drag of probably another 50 basis points, but then the snap back in Q4 is going to be 100 basis points, the cumulative impact as we work through that inventory.

The other thing I mentioned was that we expect to see the precious metal business negatively impact margins by Q3. We think that is going to be some where in the 30 to 50 basis points drag and that change will initially be a new run level for us. Over time, we will be able to mitigate some of that as we are able to move more of our nonferrous metals through that facility and gain better yields from each car, but that's going to take some time.

The other two things we normally talk about are car acquisition costs and pricing. The Manheim Index has come down some. We have seen a reduction in the car prices that we're paying at auction. At the moment, I think that reduction is probably just offsetting some of the scrap reduction in the value of those cars as opposed to improving our margins. But if we continue to see those drop, we may see some benefit on the gross margin line in later quarters.

And then on the pricing front, just give you a little update while I've got you on the gross margin comments, we continue to work on our modeling. We have been running some tests. I think there is a little reticence on our part to pull the trigger on some of this with the low volumes in Q1, so we'll probably put that on hold for three to six months. And we have run some tests, we've had some encouraging things. We're running additional testing, so I think that has probably been pushed out a few months versus what we had originally planned for Q4.

Okay. Last question and then I will defer to others. ECP specifically, if you take a look at their same store or same location sales growth, what was that? And then I also noticed that the EBITDA margin sequentially declined in ECP from Q1 to Q2. Is that typical seasonal or does that have to do with a bunch of opening costs and such?

On the ECP EBITDA margins, you have to be careful because some of those contingent purchase price adjustments are in there. So in Q1, we had a favorable contingent purchase price of $1.3 million and $1.1 million unfavorable in Q2. If you adjust those out, you are right; there is a little bit of a step-down of about 90 basis points. And that -- we are attributing that mainly to the drag of the new locations being open.

And the same location sales growth?

I'm sorry?

The ECP comps, the same store sales growth in the quarter?

Year-over-year -- we didn't own them obviously in Q2 last year, they grew about 22% year-over-year, which was essentially all organic, not necessarily same store. I don't really have the same store sale number for them, Sam.

Okay. Thank you.

Thanks.

Our next question comes from the line of Bret Jordan with BB&T. Please proceed with your question.

Good morning. On the -- following up on the ECP line of questioning, could you give us a feeling for what we are seeing on collision sales in the UK?

Sure, Bret. We are very pleased with our progress there. We knew this was going be a long curve to get done with their alternative part usage in the 5% to 8% range. It was more of an educational process and we are continuing that process. We are meeting with insurers and repairers, and it's -- our daily sales are progressing to what we expected. We know it is going to be a long haul and we are on it as we speak. The -- all of the estimating data has been uploaded to AutoTech Solara. We are also working with a company called GlassMatix, that's the other estimating company in the marketplace. So we're working directly with them and the sales are growing daily.

Okay. So within that 22% growth of ECP, there was some collision contribution but not meaningful collision contribution?

That would be fair to say.

Okay. And I guess on the UK side of the business, there was one primary competitor over there to ECP. Do you have any sort of color as to how they are doing? Were they restructuring or under new ownership and what the competitive environment in the UK looks like?

They are still in their restructuring process. I think they just named a new CEO over there, so they are working through that as we speak, but we continue to obviously take market share, we believe, from them as well as others with our growth that we are having. So we continue to eat away at the marketplace and grow the market share and with the store openings been very well received. As we mentioned, we have done 23 stores already. We will have the other seven done by hopefully the end of Q3 and we plan on continuing to grow that business aggressively.

Okay, great, and one last question. On the core side of the scrap and core, do you see anything shifting on core pricing or core demand? It seems like we are seeing some signs of some softening demand than the aftermarket parts. Are you seeing any read through as you are distributing the cores?

No, core business is healthy other than the fact that pricing is down a little bit on some of the precious metals. And, again, we hope that our precious metal acquisition will help us recover some of that. But no really bad signs on that respect.

Great. Thank you very much.

Thanks, Bret.

Our next question comes from the line of Nate Brochmann with William Blair. Please proceed with your question.

Good morning, everyone.

Good morning, Nate.

Just wanted to kind of follow up on that a little bit. I think that, obviously, the strength of the overall business remains pretty strong and maybe even a little bit surprising given some of the economic malaise that we've read about here a lot recently, particularly with the unemployment trends getting a little worse but you guys continue to go better. Obviously, part of that is driven by just APU, but could you talk a little bit maybe a little bit further in terms of any additional efforts on the sales front or just execution or is it just simply winning share from the smaller guys that don't have the same inventory levels?

I think there is a quite a few organic growth drivers that we've witnessed lately that are really encouraging. First, fuel is coming down, Nate. It is really good to see that the fuel is coming down. Through May, we have miles driven in the country up 1.2%, so we are seeing a positive trend there as well. We are encouraged by the SAR rate, as well. Now, the latest figure we saw was about 14 million cars. That's obviously going to impact the number of fully insured drivers. We did see the average model year car now in the United States has reached now 11 years old, which is good for our mechanical side of the business, perhaps not as good for our collision side of the business, but with the SAR rate coming up, we'll start to see that shift towards a better trend.

Our backlog in the salvage business is really -- I don't think has ever been stronger than what it is today in the summer. We have just seen great volumes at the auctions and we've have been able to pad that. As you saw, we announced the 18% growth in the salvage acquisition vehicles, so we're being able to buy our inventory quite easily today. One other thing we are excited about on the aftermarket side is the certification programs continue to gain strength. Just some year-over-year stats, capital year-over-year from Q2 to Q2 is up 25% in the number of certified parts, NSF has doubled their year-over-year count, and our AQRP program's still strong and strong interest by the insurance carriers to help increase their alternative part usage.

And finally, we did predict that, and we are still predicting, that we are going to see a 100 basis point improvement in alternative parts. I guess I would add that we are obviously taking market share. I did in my prepared remarks mention that insurance companies are seeing softer claims and yet we are still growing the business. So we are certainly taking market share as well, but the alternative part usage and those other tailwinds are really helping the business.

That is great color, thanks. Just in terms of -- one of the things that you did heading into this year, you made some efficiency improvements in some of our routes within your intraregional trade networks. Anything more to update there in terms of any newer initiatives to continue to drive some of those efficiencies?

The biggest thing is just filling in some of those holes in our maps. We have done now 11 deals this year and each one of those will get plugged into those distribution networks and help offset some of the costs. So that's a main driver there, just putting more -- filling in more of the holes and getting more facilities into those distribution networks.

Okay, great. And then, John, just one bookkeeping question. On that gain from the legal settlement, it sounds like that ended up falling into the cost of goods sold line. Is that true? And what is the exact dollar amount of that?

Sure. That's correct, Nate, and it's $8.4 million.

Great. Thank you very much, guys.

Thanks, Nate.

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

Good morning, everyone. Just a couple of clarifications. John, in what you are looking for in your projections, you're basing your projections off scrap prices that are today what the spot prices are, you're not extrapolating that they could go lower.

Correct.

And then as far as the guidance goes, again, I just want to be clear. There's -- it excludes all nonrecurring gains/losses, so you had about $0.05 of positive gains over the first two quarter net, is that correct?

I'm sorry, we had $0.05 gain with respect to which?

First two quarters of this year.

The guidance is including the legal settlement, it's excluding anything associated with restructuring or anything to do with contingent purchase price adjustments.

But includes the legal settlement but excludes the restructuring.

Correct, and it excludes the contingent purchase price adjustments.

Okay. Thank you.

If I could just add one thing to that. On the scrap, one thing we have seen, we saw the rapid deterioration, as John mentioned, in June into July, but there are signs that it looks like the market is stabilizing. There isn't a sign of rebound but it appears that the market does appear to be stabilizing. So we are not expecting a further drop at least in August.

Okay, that's good news. Thank you.

Thank you.

Thanks, Gary.

Our next question comes from the line of John Lawrence with Stephens. Please proceed with your question.

Good morning, guys.

Good morning, John.

Rob, would you just clarify just a little bit, some of those -- some of the tests that you are talking about as far as being more aggressive for the fourth that you are going to push out a little bit, remind us a little bit about what those are, how aggressive they are, how they could help, and what they could mean, say, for 2013?

Pushing out the price increases?

Well, just -- you are talking about some tests that you were are playing with. John mentioned some tests as far as either on pricing programs or the way you were going to market.

Sure. John, it is John Quinn speaking. We have been modeling, trying to understand the elasticity of the product lines and of customers and we have been using testing in one region on a segment of the customers and I don't think we are prepared to say yet how much that could drive gross margins. The early returns were that there were some positive things and we think it is meaningful. But we are redoing the second test with another larger sample. So we had originally planned to do a lot of that in Q1 when the volumes were very soft in Q1. We decided to hold off because we didn't think that was a sort of a normal market and we wanted to make sure we got some good data. So we've done some testing earlier this year; we're redoing it this quarter. And so I'll probably give you a better update on that in the next call, but it is still progressing.

So it's basically just an overall price optimization type of program.

Exactly.

And we do continue, John, our work with the inside sales reps on deviation controls and those are still in place, as well.

Great. Thanks, guys, good luck.

Thanks, John.

The next question comes from the line of Craig Kennison with Robert W. Baird. Please proceed with your question.

Good morning and thanks for taking my question, as well. Just to finalize on the guidance, in the second quarter, you had a $0.04 legal benefit which is being included in your guidance. Did you expect that when you initially gave guidance after last quarter?

It was not included in the guidance last quarter.

Is it -- so if we look at that, just operationally without the legal benefit, are you signaling any deterioration? Obviously not, but just need to ask the question.

We're not trying to signal anything in particular. If you peel back the onion a little bit what you will see is there is a couple of pennies of improvement coming out of that legal settlement that was not in the guidance and that's probably offset by some scrap that wasn't in the guidance either.

That's fair. And then in terms of our acquisition pipeline, we've got a change in tax policy that is looming. Is that providing an incentive at all for some of your potential targets to go ahead and join LKQ now?

We sort of think that is correct that it will -- as I said, we have done 11 deals in the first half of the year, last year we did 21, so we are certainly on pace to have a record year. And we do anticipate that there might be a little bit of aggressiveness on the back half a of the year as that looming tax increase comes. Our pipeline has been as active as it has ever been. And just let me touch on just our business lines and what we are seeing across the business.

We going to continue our aftermarket strategic tuck-ins similar to the two we mentioned that we announced today, the chrome accessories and the paint distribution. We have plenty of opportunities on that side of the business. Self-service, we announced three acquisitions this quarter and we are doing a lot of greenfields, as well, but great opportunity there as we continue to build up that marketplace. (Inaudible) we believe on the engine side. We certainly continue our zest to find a transmission rebuilding company because we think that is a great opportunity for us and we will continue to work in that respect.

Full serve, we are actively looking for opportunities as well. That facility in West Texas was more of a strategic place because it is a new geographic market for us. And we are announcing just did the deal up in western Canada to start a greenfield. So there's plenty of opportunities there and I expect because of that tax consequence coming that it will stay active throughout the rest of the year.

And then one follow-up related to ECP and the acquisitions. Now that you've made very good progress on the ECP and the aftermarket side, at what point would you be willing to look at the recycled side or moving on to continental Europe?

We are actively looking at opportunities there. We are going to focus more on the northern half of Europe at this time. I think that the Scandinavian countries and northern Europe to be a little bit more stable than perhaps the economies in Spain or Italy or Greece. So we are actively looking at that opportunity, nothing imminent I can say, but certainly attractive as we are pretty pleased with the success we've had at ECP and the opportunities that the salvage market provides in continental Europe, as well as the UK as well.

Great. Thanks and congratulations.

Thanks, Craig.

Our next question comes from the line of Richard Hilgert with Morningstar. Please proceed with your question.

Thanks. Good morning, everybody,.

Good morning., Richard.

I also had a question on the European outlook there. I was thinking that with currency being what it is at this point, the economy being what it is over in Europe, you might have some businesses over there that are more willing to sell now than what they have been in the past. Are you seeing that in terms of your pipeline, some of the M&A stuff going on over there?

I think it is fair to say that we have active sellers in the marketplace. However, some of them are in those economies that we are not particularly excited about at this time. And it seems to be -- inevitably what happens, Richard, is that when we enter a new marketplace, we do get inquiries. They tend to be more from companies that may be struggling and looking for an exit strategy right away. So we're actively looking, as I said, and we want to -- our strategy has been and will continue to be to buy the best performers in the marketplace. So we just want to make sure we do our due diligence correctly and have time to really assess the marketplace. But I would say that the opportunities in Europe are as good as they are here in the States.

Some of the softness in the aftermarket, we've got the retailers talking about some of that softness, too, I was wondering are you seeing some of the other aftermarket parts providers working with their pricing right now?

I think we differ a little bit than the standard big box retailer here in the United States. Ours is more driven from an insurance company, 85% of all insurance claims are -- excuse me, automobile accidents are paid for by insurance companies, so we have a little bit of a different driver I think in terms of our sales whereas I think they are more retail oriented. Even when they are selling in the commercial markets, it's a retail person making that decision. So I think their pricing is a little bit separate from ours in terms of I think they are much more competitive in terms of each other whereas we are really focusing on taking market share from the OEs which are really outside of our competition per se. So I think their pricing strategy may be different than hour ours.

And given the current fundamentals going on in our market here in the States, the softness that we are talking about, the economic conditions not being the greatest, has that driven some of this penetration, additional penetration into your side of the business versus the OEs where you have got, obviously, a huge price differential between the two?

There is no doubt there is a direct correlation to a weaker economy and the strength of our business; people want to save money. But with that being said, even in the stronger economy, with the insurance companies again paying 85% of collision repairs, they have a financial incentive good economy or bad economy. But we do see, certainly, in tougher economies that we become a much more viable option from this perspective, two perspectives actually.

People are keeping their cars longer, so the average model year car now is 11 years in the United States, so more things will break and when things break, they'll certainly tend to pay more out of their pocket. We think one of the -- John and I have talked this that one of the greatest tailwinds we can see is a lower unemployment rate with more people commuting to work and having money, obviously, to do those repairs. So we certainly believe, though, a weaker economy does not hurt us at all.

Okay.

One thing just to add to that is the insurance companies in the weaker economy, they are very price competitive and they are still struggling to get any kind of return on their investments and so difficulty raising the top line and difficulty gaining any kind of investment income really the only place they can squeeze is where we are there to help.

Great. All right, guys, thanks. Good quarter.

Thanks, Richard.

Operator, are there any more questions in the queue?

We have no further questions is at this time.

Well, that -- thank you, Kristine. Thank you everybody for joining the call. We'll look forward to joining you in about 90 days to give you the results of our Q3 call. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.