LKQ Corp (LKQ) 2013 Q3 法說會逐字稿

Greetings, and welcome to the LKQ Corporation third-quarter 2013 earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Joe Boutross, Director of Investor Relations. Thank you, Mr. Boutross. You may begin.

Thanks, Manny. Good morning, everyone, and thank you for joining us today. This morning, we released our third-quarter 2013 financial results. 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 this 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 statements 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 risk.

Hopefully everyone has had a chance to look at our 8-K which we filed with the SEC earlier. As normal, we are planning to file our 10-Q in the next few days. And with that, I'm now happy to turn the call over to Rob Wagman.

Thank you, Joe. 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 of $0.24 for the third quarter ended September 30, 2013, increased 33% from $0.18 for the third quarter of 2012. As noted in the press release, the third quarter of 2013 and 2012 diluted earnings per share figures both included losses totaling $0.01 per share resulting from restructuring and acquisition-related expenses and a change in the fair value of contingent consideration liabilities. Adjusting for these items in the quarter, diluted earnings per share would have been $0.25, which represents growth of 32% over the prior-year quarter. Revenue for the quarter was a record $1.3 billion, an increase of 27.7% as compared to $1.02 billion in the third quarter of 2012. Net income for the third quarter of 2013 was $73 million, an increase of 36% as compared to $54 million for the same period of 2012. During the third quarter of 2013, the Company delivered organic revenue growth for parts and services of 11.7%. I am particularly pleased with our North American organic revenue growth for parts and services, which increased 6.2% despite facing unseasonably mild summer temperatures and lower than average storm activity in the quarter.

Now for more detail on our North American operations. During the third quarter, we purchased approximately 69,000 vehicles for dismantling by our wholesale operations, which is a 15% increase over Q3 2012. The volume at the auctions is robust, and the outlook for supply remain steady. We continue to be pleased with the pricing dynamics we are witnessing at auction despite the recent movement in the Manheim index. During Q3, vehicle cost was down of 4% year over year. With inventory already on hand and a continuation of the current run rate for acquiring cars, we should be well positioned as we approach year and at the start 2014. In our heavy duty truck operations, during the third quarter repurchased approximately 1800 units for parts as opposed to as compared to nearly 1700 and Q3 2012, or a 6% increase. In our self-service retail business during the third quarter, we acquired over 128,000 lower cost self-service and crush-only cars as compared to nearly 106,000 in Q3 of 2012, or a 21% increase. Lastly, on North America, during the quarter we continued to make significant progress with the Intelligent Parts Solution initiative with CCC information services. CCC ONE's Total Repair Platform is now available to approximately 2000 users of the CCC ONE Control, Optimize, and Innovate product packages, up from 600 users in Q2. Though off of a small base, the revenue and number of purchase orders processed through the CCC platform both grew over 200% during the quarter.

Now turning to our European operations. We continue to be extremely pleased with the performance of Euro Car Parts and its ability to capture market share. In Q3, ECP achieve organic revenue growth of 32.9%, and for branches open more than 12 months, the organic growth rate was 24%. As mentioned on prior calls, we approved 15 additional ECP branches to be opened in the third and fourth quarter of 2013, and today we are on track to hit that target. Through October we have opened six new branches with the remaining nine branches scheduled to be open by year end.

Now for the update on ECP's collisions program. During the quarter, we again witnessed strong double-digit year-over-year growth of over 80% with our collision part sales at ECP. I am also pleased with the growth in our collision parts offerings, which today now stands at over 14,000 SKUs which represents an increase of 22% year-over-year. Also, we are proud to report we have finalized an agreement to supply collision parts to a second UK carrier in our pilot program. This particular agreement is with a top 10 carrier. Under the terms of the agreement, we are the sole supplier of alternative collision parts to the 16 of their carrier-owned shops located throughout the UK. Given that we were bound by an NDA, we cannot disclose the carrier's name or any specific details of the agreement at this time.

To further our commitment to expanding Euro Car Parts's collision parts business, the Company announced on August 6, 2013 that it acquired five paint distributors with a total of 26 locations throughout the United Kingdom. The acquired distributors include Bee Bee Refinishing Supplies Halstead, JCA Coatings, Milton Keynes Paint & Equipment, Premier Paints, and finally Sinemaster Motor Factors. We believe that with the addition of paint and an extended range of consumables for the Euro Car Parts product portfolio, we have taken another important step toward becoming the leading one-stop shop supplier for the collision repair industry in the UK market. These five companies provide us with coverage to most of the UK market. We believe were the only non-manufacturer with a national distribution capability in the UK. These acquisitions should help further our growing relationships with both insurers and body shop repairs in the UK.

Lastly, on our European operations, I am pleased with the initial round of purchasing synergies we are witnessing at Sator. Though still in the early stages, I am confident that we are on target to reach the metrics we indicated when we announced acquisition.

Now, moving on to development projects and other acquisitions. On August 20, 2013, the Company announced that it has formed a joint venture with Suncorp Group to develop an alternative auto-parts business in Australia. Measured by premiums, Suncorp Group is Australia's largest insurer. With this joint venture, we plan to develop at least one wholesale salvage yard, one aftermarket parts distribution business, and one self-service salvage yard in or near each of the Melbourne, Brisbane, and Sydney markets over the next four years. As part of that agreement, LKQ will supply aftermarket parts to the joint venture, in addition to contributing our experience and expertise to help establish all the models automotive parts recycling operations. Suncorp will supply salvage vehicles to the joint venture and help establish relationships with repair shops as customers. Suncorp acquires approximately 60,000 salvage vehicles from its policyholders annually, and approximately 37,000 of those salvage vehicles are acquired within 100 miles of the locations we intend to open. Within these markets, Suncorp currently has 25 of their own repair shops and an extensive list of preferred regional repairers. These dynamics combined to provide the joint venture with an immediate and cost-effective source of salvage supply and instant bodyshop demand on day one of operations. With over 12 million passenger vehicles on the road in Australia and a low usage of alternative parts of the market, we believe this joint venture model presents potential long-term opportunities for our shareholders not only in Australia but other markets well.

In addition to our UK distributors acquisition and the Australian joint venture, during Q3 we acquired two additional companies, a specialty automotive parts distributor in the Benelux and a salvage operation in Arizona. I am pleased with the strength of our acquisition pipeline and the opportunities it continues to present across all lines of business and within our geographic segments. At this time, I'd like to add asked John Quinn to provide some more detail on the financial results of the quarter.

Thanks, Rob. Good morning, and thank you for joining us today. Hopefully everyone's had a chance to review our press release this morning. As Joe mentioned, we expect to file our Form 10-Q with the SEC in the next few days, so please watch for that as well. Rob just spoke to the Australian joint venture. I just want to make it clear that we have 49% interest in that venture so from an accounting point of view that means that we will not be consolidating the joint venture. There is essentially no income statement impact from that transaction in Q3 2013. What we expect is in the future, we will show our share of net income or loss in the venture being reported on an after-tax basis as a single line on the income statement below the income tax provision line. If our investment gets large enough, it will be shown as a separate line in the balance sheet as a single line.

Beginning with revenue, our Q3 2013 revenue of $1.298 billion was an increase of $281 million as compared to Q3 last year or an increase of 28%. This is our second consecutive quarterly revenue which is annualized to more than $5 billion. Our total organic growth of 10.8% was supplemented by 17.4% acquisition growth, and we had about 0.5% of negative impact from foreign currency. Parts and services revenue grew organically 11.7%, and within that category, as Rob mentioned, our European operations continue to perform strongly with a 32.9% organic growth. The North American parts and services organic growth was also a healthy 6.2%. We did benefit from an extra selling day in Q3 2013 as compared to Q3 2012. We saw other revenue increase by $19 million, a 14% increase. We record scrap and core revenue in other revenue. Acquisitions increased other revenue by $12 million. Our organic growth in this line was $7 million positive as volume increases slightly more than offset lower commodity prices and the discontinuance of operations at one of our aluminum furnaces.

The trend I mentioned last quarter regarding other revenue continue this quarter. It remains important to the Company because of its absolute size and contribution to the profitability of a recycling and self-services businesses. But as a percent of revenue, we saw other revenue fall again in Q3 this year to 11.9% of total revenue as compared to 13.4% in Q3 last year. We will continue to experience short-term impacts from fluctuating commodity prices, but if the revenue trends continue, we expect for those fluctuations to become a significant to the overall business over time. In Q3 2013, revenue for self-service business was hundred $110 million or 8.5% of LKQ's total revenue. Approximately 32% of this revenue was parts sales included in North American's parts and services and 68% scrap and core sales included in other revenue.

Our gross margin for Q3 2013 was $518 million, or 39.9% of revenue, a decline of 40 basis points from our gross margin percentage of 40.3% in Q3 2012. The impact from the European segment was primarily an acquisition-driven decline, whereas the North American impact was an operationally driven improvement. I mentioned on last quarter's call that we expected Sator's impact margins negatively both year over year and sequentially. We treated 70 basis points of the year-over-year decline to Sator and a further 20 basis points to the UK paint business we bought part way through the quarter. As we have discussed in the past, paint has a lower gross margin. In Q4, we will see a smaller additional negative impact from having those businesses the entire quarter.

In the North American segment, we saw an 80 basis point improvement in the recycled margins as we saw some benefits of our pricing programs and a reduction and warranty costs. You may recall that we had the negative impact in Q3 2012. In North America, we also saw our self-service margins lower and thereby contributing 30 basis points to lower Company margin as the falling car costs has not kept pace with the drop in scrap.

Facility and warehouse costs were 8.3% of revenue in Q3 2013, at 20 basis point improvement over 8.5% in Q3 last year. Our increased European operations are driving that figure lower and in the UK in particular where infrastructure is being spread over more branch locations and a larger revenue base. Distribution costs were 8.4% in this quarter as compared to 9.2% in the same quarter last year, an improvement of 80 basis points. Sator has lowered distribution costs and that acquisition drove 30 basis points of the improvement. In North America and the UK, we saw the benefits of high revenue leveraging these costs. We also saw lower fuel costs contributing about 10 basis points.

Selling and G&A expenses increased decreased from 11.9% of revenue in Q3 last year compared to 11.8% in Q3 this year, again related to Sator, as higher sales per customer and therefore lower SG&A costs. In total, facility and warehouse, distribution, and SG&A costs were 29.6% of revenue in Q3 2012 as compared to 28.6% of revenue in Q3 2013, an improvement of 100 basis points. I mentioned that Sator accounts for approximately 40 to 50 basis points of that change. I mentioned on our last quarterly call excluding acquisitions we appear to be getting operating leverage in these costs, at least for the last two quarters. Other revenue which tends to require a limited amount of these costs has been decreasing as a portion of the total revenue and actually fell faster this quarter compared to last, making this leverage all the more meaningful.

During Q3 of this year, we recorded $2.2 million of restructuring and acquisition related expenses, primarily related to the UK paint acquisitions. Depreciation and amortization was 1.6% of revenue during Q3 of this year and last. Other expenses net increased to $14.4 million in the three months ended September 30, 2013, compared to $8.2 million in the same period last year, an increase of $6.2 million.

Interest expense was $7.2 million higher due to higher debt levels combined with the higher interest rates our senior notes. Expenses in Q3 2013 related to adjustments of contingent consideration were $700,000 as compared to the $1.9 million in period last year. Our effective boring rate for the quarter was 4.5%. Our effective tax rate for the quarter was 32.6% compared to 35.1% in Q3 last year. We continue to see some benefit from lower foreign tax rates as our international business becomes a larger percentage of the Company total.

In Q3 2012, we had $1.3 million of favorable discrete adjustments to the taxes and in Q3 this year we had $2.9 million. On a reported basis, diluted earnings per share was $0.24 per share in Q3 2013 as compared to $0.18 in Q3 2012. The combination of acquisition related expenses and contingent purchase price adjustments impacted EPS by $0.01 for both Q3 in 2012 and 2013. On an adjusted basis, the diluted earnings per share was $0.25 this year as compared to $0.19 last year, or an improvement of 32%.

Switching to our year-to-date cash flow, net cash provided by operating activities totaled $341 million for the nine months ended September 30, 2013. Compared to $182 million for the first nine months of 2012. During the first nine months of 2013, our EBITDA increased by $71 million compared to the prior-year period. While we generated greater pretax income in 2013 compared to 2012, we had lower cash payments for income taxes of $28 million due to the fee payments made in 2012. Cash payments for incentive comp were $14 million lower in the nine months ended September 2013. Other operating cash flows exceeded the prior-year period primarily due to the timing of payments of various accrued liabilities such as value-added tax and interest. Capital spending was $61 million year to date consistent with the same period last year. We have spent $396 million on acquisitions, the largest being Sator, which accounted for $273 million of the total. On that cash flow statement, you will also note that we have a $9 million investment in the unconsolidated subsidiary related to our Australian joint venture.

Year to date, we increased our net debt by $146 million. We ended Q3 with $1.3 billion of debt and cash and cash equivalents of $107 million. As of September 30, 2013, availability in our credit facility and accounts receivable securitization facility was $1.2 billion, which together with our cash balances provides us with total liquidity at $1.3 billion.

Turning to guidance, as we have stated in the past, our guidance excludes any restructuring costs and transactions cost, gains, losses, contingent purchase price adjustments, capital expenditures, or cash flow associated with acquisitions. At the moment, we are also assuming no material impact of the P&L from the Australian joint venture. Our revised guidance for the full year organic growth for parts and services is 10% to 11.5%; we increases range from a 8.5% to 10.5% to reflect the stronger Q3 reported this morning. We left unchanged our net income and an earnings-per-share guidance. We increased our cash flow guidance from approximately $300 million to approximately $340 million. Our year-to-date cash flow from operations was $341 million. Our inventory levels in North America are actually about $25 million lower than they were at the beginning of the year, so we may have some inventory build from between now and year end. That combined with the other potential movements in working capital may affect the quarter depending on the timing of various payments, but we still anticipate being significantly ahead of our original guidance for this metric.

We also reduced our expectations for capital spending from between $100 million and $115 million to revised estimate of $85 million to $100 million. We've managed to control the replacement capital spending, and at this point, we think a few of our bigger development projects we budgeted will be pushed to next year. The higher cash flow from operations and the lower capital spending combined to provide a nice bump to our free cash flow for the year.

A couple of comments on how our guidance has evolved and how we're thinking about it. On the Q2 earnings call, we said that scrap prices had increased in July, and we were expecting that to continue its August. Average scrap prices in Q3 were lower than in Q2, and that was a negative compared our thinking on the last call. The prices we achieved for scrap in Q3 2013 were the lowest we have seen since Q3 2010. The drop in prices sequentially -- it wasn't large enough call out as having a material impact on our EPS, but suffering a drop when we expected an increase was obviously still a negative to the quarter and potentially to the remainder of the full year.

The movement in Manheim Index also went contrary to what we have been expecting. On the Q2 call, we said that the index had been falling and that it had reached 119.7 at the end of June. Unfortunately as opposed to continuing to fall, the index has risen every month since then and it was standing at 122.8 in September. So while we've seen some relief in car-buying costs year-over-year, the improvement hasn't been as great as we had expected.

Having both scrap prices and the Manheim Index move against us as compared to where they were headed 90 days ago is obviously a short-term negative. But it also points to the volatility of these items. If we see these materially improve, that could help us get closer to the top of our guidance, and if they deteriorate further, our margins could see the little pressure in Q4.

The other items we discussed internally is the timing of Christmas this year and how the increase of our European business might impact us. Christmas falls on a Wednesday. If our customers take that whole week as a vacation, we could see a drop in the revenue and cash flow from operations in December. Last year, we saw our UK business decline in December, and we had expect to see something similar this year also in the Benelux business.

I don't want to dwell on these items because I believe they will correct themselves over time. Meanwhile, the fundamentals that impact us look like they are continuing to improve. New car production continues to be strong, and that will eventually lead to more late-model vehicle repairs and lower used car prices. Miles driven continues to be a positive this year. The acceptance of alternative parts continues to grow among our customers and international expansion continues on pace. With the increases in our guidance for cash flow and the reduction of capital expenditures, the Company continues to be a strong generator of free cash flow, which we expect to continue to deploy on accreted acquisitions. Obviously, we view raising our organic growth guidance as a strong positive. With that, I'll turn call back over to Rob before we open the call to questions.

Thanks, John. To summarize, we are pleased with our third-quarter performance. As we approach the end of 2013, I am proud of the achievements we've made thus far. The North American market continues to grow in geography and product offerings, and we are far from being fully built out. APU trends are favorable; certified parts continue to grow; vehicle procurement dynamics are improving; and macro trends, such as miles driven, unemployment, and gas prices, are trending in our favor. These dynamics coupled with our first mover advantage on technological initiatives such as the CCC ONE integration have positioned our North American operations well for 2014 and beyond.

Also, the unique value proposition we offer to insurance carriers and the professional automotive repair industry transfers well outside of North America, and we are pleased with the initial results of expanding that message into new geographic markets beyond the US and Canada. We believe that great things are not done by impulse but by a series of small things brought together. Everyday our 23,000 plus employees work together to build a better company for our customers and shareholders and for that, I say thank you. Manny, 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) Nate Brochmann, William Blair.

I wanted to talk a little bit on the organic growth, both for North America and Europe. Obviously, throughout the year it has been steadily kind of improving. On the North American side, do you think that that is more of your injection of broadening the different parts throughout the entire network and maybe taking some share? Or is it still a little bit more just because of the APU going up and the insurance carriers adoption rates improving? And then a kind of similar question over to ECP -- I mean I think that continues to exceed everyone's expectations. Is that because of injecting more inventory there as well or just blocking and tackling in terms of marketing and sales efforts by the team over there in terms of winning business?

Certainly in North America, Nate, it's everything you said. It's better acceptance by the insurance company. You left one important part out -- certified parts. Certified parts are up 24.7% year over year. And as you know many carriers specifically will only use certified parts, so I think it's a combination of better acceptance, certainly taking market share from industry as well, but certified parts are playing a role as well. We are -- each and every month we see better cross-selling by our reps selling both salvage an aftermarket so we get our reps trained very quickly on the dual systems. We have made great strides over the years with having the systems communicate to each other. I think it's a combination of all those factors. As far as the UK goes, yes, it's new product offerings. Certainly the collision parts program has helped add to that, the new store openings. It's amazing how quickly they come up to speed; basically within six to nine months they are breakeven. So great product training over there, new product offerings, and really taking market share from the competition in that market as well. So we're very pleased on both sides of the pond.

And with that, how are you feeling about the rollout potentially of some other product categories over there in the UK such maybe recycled or getting some of the remanufactured business over there? I know that that probably won't be as big of a percentage as we are in the US just because the land space, but it does sound like there is an opportunity for that. Just wondering what you think maybe in terms of the timeline for that.

We're still looking at those opportunities, of course. As you know, on previous calls we mentioned that we challenged the insurance industry to adopt the aftermarket parts. As we mentioned on the call today, we've got another insurer that came over the wall. So, we're down to six in the pilot and two in the full program. So, we're feeling optimistic that were obviously gaining acceptance of alternative parts. So, we will continue to look at those alternatives being salvaged, remanned. August, we entered the paint market in August. So we've covered that leg of the stool. We continue to look at opportunities, Nate. As far as the timeline goes, nothing written in stone yet, but, certainly, as the acceptance of aftermarket gets better and better, we will continue to look at that more and more closely.

Okay. Fair enough. Thanks for the time. I'll turn it over.

Thanks, Nate.

John Lawrence, Stephens.

Rob, would you comment a little bit about -- you mentioned obviously the progress with the triple C ONE integration. Can you talk a little bit about -- have you been able to dig through some of those orders? And what do those orders look like as far as -- not only from line items and ticket size but just some kind of character of what they look like?

John, we are looking at, obviously, at the estimates and orders that we're getting. One of the things that were very pleased with, one of the ancillary benefits that we didn't anticipate, was a lower return percentage. It seems when the shops order their own parts -- we just have a better accuracy on the part ordered. It's substantially lower. So that certainly has been exciting. As far as looking at line by line, we believe most of these parts orders are basically supplemental to the phone call. However, what we haven't been able to determine yet -- we're going to do a little bit more research on this. What we suspect is likely happening is that if a shop called in looking for a vendor, for example, the rep would take the order and be done. If the shop needs an inner fender for example -- it's a piece of plastic behind fender -- and didn't ask for it, we probably wouldn't have sold it. So, we think now that that part is automatically showing, there's a likelihood that we are getting some additional sales. Really hard to quantify because we don't know if that person would have asked for it on the call. But we're going to do more research on that. But our initial view of this program has been very good. You can see the growth, the return rates. We do expect the rollout of all 4000 CCC shops that have this product. They have many more customers but 4000 have access to this product. We will be done by year end and we're really encouraged by the growth, so we think there's opportunities there for sure.

Too early to know what that order cost you compared to a physical order at this point?

It is a bit comparable at the moment.

It seems to be comparable at the moment.

Just another question. If you look at the Australian joint venture, is there any timeline in that contract joint venture as far as at the end of three years what happens or a first exclusive right to buy more of that, or how is that language at this point?

It is open-ended. I don't expect suspect that at three years we will be having that kind of a meeting. This will be a long-term partnership. It's a great partnership, and quite frankly, I can't think of a better way to enter a market than partnering with the number one insurance company in the country. This is going to be a long-term deal for us.

Great. Thanks. Last question, John, how much -- of all the acquisitions mentioned, what kind of run rate and revenue is that?

Sure. In Q3, the acquisitions analyzed revenue was $170 million. So call it $42 million, roughly a quarter. We reported about $30 million of that in Q3. So, in Q4 you should see an incremental, roughly about a $12 million impact from the acquisitions.

Great. Congratulations. Thanks, guys.

Craig Kennison, Robert W. Baird

Good morning. Thanks for taking my question as well. John, maybe I'll just piggyback the previous question. What is the amount of acquired revenue that is assumed in guidance?

It's the incremental for Q4. It is just the acquisitions we've announced, which is about $12 million in Q4 in incremental revenue.

Is there a total annual figure that you're able to share?

We can dig that up. I don't have it right in front of the. The annualized acquired revenue in Q3 was one $170 million. Is that what you're asking?

Yes, so the Q3 revenue contribution from acquired businesses is $170 million?

On an annualized basis, of which $30 million was reported in Q3.

Okay. That is helpful. Thank you. Rob, maybe shifting to the Benelux region, you've had Sator for a few months now. I'm curious about what you've learned, what has surprised you, and how you see that European model evolving given that you've got different distribution models in the UK and continental Europe.

Craig, as I mentioned on my remarks, we're very pleased with the synergies were going to achieve, and we're on target to do that. As we noted, there are very little distribution synergies because obviously the UK isn't literally an island from the Benelux market. But very pleased, really starting to learn the territory with our customer base and looking at opportunities to add new products which we are doing. There were some products that were available in the UK that have now been introduced into the Benelux market. As far as the future of the rollout and different distribution models, we continue to do our due diligence on other markets. As I mentioned on our previous calls there is a Sator and an ECP in every country -- every country European country that we are looking at. So, there's small regional players, no pan-European distributor. So we will continue to look at those markets, do our due diligence, but I think in time we will look to expand that model. We do believe different countries have different models of course, UK being two-step and the Benelux being three-step. We certainly see that across different European countries, the two- and three-step models mixed in different countries. And we will certainly look at different opportunities as those markets present themselves. But really still our due diligence phase of which market presents the best opportunities today.

And then, finally I know you're about to embark on a series of meetings with your regions around country. If you have proceeded with any of those, do you have an early impression on trends and what the outlook for 2014 might look like?

We actually haven't started those. We kick out off with our UK trip next month. So too early to give any feedback.

Too early to say. Okay. Thanks guys.

Bret Jordan, BB&T Capital Markets

For good morning, this is actually [David Kelley] in for Bret this morning. Couple of questions and really just first piggybacking off of the previous question on the expectations for Sator Beheer going forward. I think you mentioned that business was roughly 70 basis points of headwind gross margins in the quarter. Just wondering if you can provide any a little bit of color on your expectations for gross margin impact and when it potentially could be accreted to aggregate gross margins and maybe sequential expectations heading into the fourth quarter as well.

It's John speaking, David. What we said was that the EBITDA -- I'll talk to EBITDA or gross margin, similar impact. Those margins are below what ECP does. Part of that is because of the two-step versus the three-step model. What we said at the time of the acquisition is that we think that within in two years, two to three years, we should be able to achieve procurement synergies that you close that gap and have the margins come up to be similar to the ECP margin. I don't know that it would be accretive but at least it won't be diluted within two years. Those acquisition synergies seem to be on track, so I don't think we've changed our thinking on that regard.

Okay. Great. Thank you. So, no change in the timeline there. And then a quick question as well on the tax rate -- 32.6% or so for the quarter. I think on the second quarter conference call you mentioned for the full year looking at a plus or minus 35% to give it a few basis points either way. Any expectations or change in expectations in the annualized tax rate given the significant growth that continues in Europe?

No, Q2 -- excuse me, Q3 was benefitted both this year and last year for some discrete items, which you record those in the period as opposed to in the blended full-year rate. We don't anticipate for this year being materially different from that 35%. It could be a little bit higher or lower depending on the mix of the income and the timing of any perms that we happen to have. But I don't anticipate that. The UK rate is coming down. That's what drove the discrete item quarter primarily. So the UK tax rates are going down, which obviously makes the European business more attractive on an after-tax basis. As that business grows and becomes a little bit bigger of a portion, you will see our tax rate drift down over the next couple of years, but it's not material at this point.

Okay. Great. Thank you.

John Lavallo, Bank of America Merrill Lynch.

Hey guys, thanks for taking the call. First question is on operating margin expansion. Over the past couple of quarters you guys have done a nice job generating -- call it 60 to 70 basis points of year-over-year expansion. I think historically that was kind of the target range that you guys had talked about. This follows the couple of quarters prior to the past two that we've seen some contraction in the margin. I guess the question is, are you feeling more comfortable -- call it the acquisitions in Europe or just better execution in North America? Are you feeling more confident that you could return to -- call it that 60 to 70 basis points of year-over-year expansion on an ongoing basis?

We've often talk about the business model that if we can grow organically, call it 5% to 8%, then supplement that with some acquisitions, we've always said it's going to be a bit lumpy, but we believe that over time we ought to be able to get operating income expansion. I think that model has worked out precisely the way we've described it in the last couple of quarters because we have had the benefit of the acquisitions we did last year. We did 30 acquisitions last year and some fairly significant acquisitions this year. We've been blessed with some strong organic growth. I think that model is continuing. We believe that were going to continue to have organic growth and acquisition activity in the coming year so it is -- somebody asked about our focus on the budgets. That is one of the discussion points that we have with our field every budget season, and we hammer at home throughout the year, is what we refer to as operating leverage which means getting an extra dollar of revenue and having more than that portion falling through to the bottom of the line in terms of the percentage that we normally see. We still believe in that. It will be lumpy, and some of it does get driven by the impact of commodity prices. The nice thing that were seeing right now is that commodity prices, although they're falling, we are still seeing that operating leverage come through because sometimes when that other income shrinks it puts a little bit of pressure on the operating margin. We have managed to overcome that the last couple of quarters as you've noticed.

That's helpful. Thank you. And if we think about some Suncorp and just kind of the Australian market, would you say that kind of the same barriers to entry exist there, meaning the need for permits and things of that nature?

Actually, John, it's much better. Certainly, there are some permits to getting salvage out of operations, but certainly going in the insurer as a partner makes the sale part of it easier. I was actually in Australia last week looking at the potential operations, and I don't think is going to be a major barrier to get the zoning permits we need. We are also looking at possibly acquisition opportunities as well, in the event that does become a barrier. We are optimistic that we can get up and running relatively quickly. It will take some time but, certainly, within a couple of quarters we expect to be start selling our first parts. Likely to be aftermarket initially, but the salvage operations will open relatively quickly, I think, considering what we have to get done in the meantime.

Great. I'll leave it there. I'm sorry. Go ahead, John.

I was just going to say -- those cars are all been handled today. There is an end-of-life program for vehicles in Australia right now, so I would think that with us bringing our professional standards we should not be have a major issue. And we are really only talking about three major markets that we're going to hit initially.

That's helpful. Thanks very much, guys.

Bill Armstrong, C.L. King & Associates.

Good morning, Rob and John. You mentioned miles driven earlier. We saw it was up in July and August. Did that help Q3 at all or should we see more of an impact in Q4?

Miles driven for the year are up 0.8% -- I'm sorry, for year over year, Q3. We do expect some of the trends we're seeing -- gas prices certainly stabilized if not down in many markets. I anticipate miles driven to continue to be at least steady if not slightly up. That certainly won't hurt us with miles driven increasing.

John Quinn At this time of year, most of the accidents will get repaired within probably 4 to 6 weeks. In the wintertime, sometimes be drivable gets extended a little bit, and we saw a little bit of that probably in Q2 where we got some benefit from the winter in Q3. I think most of the increase that we saw last quarter has probably flushed through the system by now. But obviously, the point I guess I was trying to make was that the trend at least has started to turn a little bit it appears from suffering from negative miles driven to a positive.

One other thing I would add to that, Bill, going back to Nate's question from the beginning about organic growth, one of the trends we really like seeing is that saw rate improving. These are going to be late-model cars, fully insured. With the saw rate over 16 million -- and I've seen estimates next year and the 17 million range, that bodes well for both the collision repair industry and our business in that later model cars tend to be more insured -- or insured in the first place. If we think long term, the trends looking better, for sure.

Great. And in the UK this paint distributor that you bought in the third quarter is that going folded into the ECP? And will those products be included in these exclusive deals that you've announced with these insurance companies?

They will be -- actually there are five paint deals by the way rolled into one. But there were five separate companies we did. They will be merged with ECP delivery in many cases. We anticipate foreclosures by the end of this year, and as I said in my prepared remarks, Bill, this gives us virtual UK coverage. We may have to open one or two or three branches just to fill out some geographicals, but there will be some integration with the ECP branches and delivery wherever we can. As far as offerings to the insurance companies as part of those deals, those tend to be separate. The UK has always had paint deals separately with insurance companies. However, we do plan on leveraging those relationships where we have parts relationships and we don't have paint, we will leverage that and vice versa. So, insurers are very much involved in the repair process in the UK as compared to the United States. So that will definitely benefit us long term, those relationships on both sides.

Okay. And just one last question for John on the guidance. I think you might have addressed this, and I might have just missed it. But your cash flow from operations guidance is up about $40 million; your earnings guidance is unchanged. Is the difference just a change of working capital or is there something else?

It's mainly just the timing of working capital. I mentioned that our inventories in North America is actually down year over year. We probably will have a little bit of a build later this year. I wouldn't read too much into it though.

Okay. Great. Thanks.

Sam Darkatsh, Raymond James.

Good morning, Rob, John. How are you?

Good morning, Sam.

A couple of questions. At least it appears as though for the acquisitions you made this quarter, you paid less on a per sales basis than you did for the beachhead deals. Is that accurate from an EBITDA standpoint also? And should we continue to expect that your European deals would be at lower multiples?

I think the big deal -- the paint transactions, they are a lower gross margin business, frankly. So you tend to do -- when you look at the economic law, the cash flows, we're paying on the cash flow as opposed to a revenue multiple. I think it's safe to say it's within our normal parameters in terms of the acquisitions deals but probably right there probably is a little bit more revenue per dollar of acquisition cost because the EBITDA is less, the percentage of EBITDA.

Shouldn't we see multiples of subsequent acquisitions come down though as the need for a beachhead is diminished and they become more plug-and-play?

Obviously, we always pay as little as we can, but it is going to depend on the asset. If we were to enter the salvage market, that would be a new market for us we tend to try to buy the best companies that we can whenever we enter a market. So whether it's into a new geographic on the continent or whether it's the product line within the UK or the Benelux area, we're going to look for the best companies; we're going to pay based on the cash flows; and it's going to be based on the competitive situation as well.

But I think is a fair statement, Sam, that the first guy in the box does tend to get a little bit higher multiple, generally speaking. I can assure you that the second deal we announced in the Benelux did not transpire at the same multiple of the first one. So I think that's a fair statement.

Two more quick questions if I could. First off, are you seen the tipping point either occur or is imminent to occur where the UK insurance premiums are getting cut by those carriers that are participating in your programs?

We have not seen that yet; however, there is still an ongoing investigation I the office of fair trade over in the UK looking into premiums. So, I think everything is on hold until they get done with their investigation, but we certainly expect that to be the ultimate result at some point.

Last question, it was interesting said that your vehicle costs at auction have not reflected what Manheim is suggesting. What's typically, Rob, in your experience, the lag? And might this be a potential upside if you're not seeing it and to Q4 where you might not see the uptick in auction vehicle prices?

It's interesting, Sam, we've actually seen Manheim tick up and our costs have ticked down a little bit. So we actually are seeing opposite in a good way so we do expect that Manheim to tip at some point. And just my talk with various industry players, in particular CCC, who we talk to constantly who watches the Manheim Index very closely, they were actually surprised it hasn't started to come down. But they are expecting that to start ticking down as used car start to hit the marketplace. We do expect some relief. As we said on the previous call, Sam, we saw that correlation on the way out where Manheim got higher, we were paying more. We are actually pretty pleased with Manheim ticking slightly up last quarter, yet our prices did drop nicely. So, we do expect good things coming when that drops.

As I understood it, John, your guidance for Q4 at least assumes that Manheim will provide pressure on vehicle prices, though.

We're assuming the status quo. I guess the point of trying to make, Sam, was that in Q2 we saw the Manheim coming down. It turned around and started going back up. We didn't see is much benefit as we anticipated. As Rob said, we did get a little bit of benefit, and I think that's reflected in the North American gross margins a little bit. Right now, we're not forecasting Manheim to go up or down, particularly.

To further complicate the matter, Sam, we saw a reduction in scrap prices so we know some of that decreasing cost was related scrap not necessarily Manheim going one way or the other. We're not sure where scrap is going. I can tell you scrap in October was actually slightly down compared to Q3. I'm not sure where is going November, December, but we've seen a little bit more pressure on the scrap market. So that's still up in the air too. But that's certainly causing some relief at the auctions in spite of where Manheim's going.

Thank you. Very helpful.

Thanks, Sam.

Scott Stember, Sidoti & Company.

Can you talk about in the US any appreciable difference between what you're seeing on the recycling side versus the aftermarket?

No, actually when we look at the APU usages, they're both getting small gains or minor variations on both sides but the salvage markets remain strong. We track the number of cars at auctions. They've been very steady. Aftermarket continues to put certified parts in as I said and continue to open up new products to us in terms of when new models come out. I think they're both really steadily just moving along.

Okay. And back to the comment you made about certified parts being up in the high 20% range I guess through the first three quarters of the year. Are you referring to NSF program and other capital programs as well?

Yes, I'm referring all three. We have our own quality assurance program. That is up; CAPA is up; and NSF is up. Combined, they're up 24.7%, Scott.

Okay. Got you. And just the last question I know you have a lot to bite on with in the UK on the collision side, but can you just remind us again the eventual opportunity over in Western Europe to grow that piece of the business and a timeline for your expectations.

Yes, the total car park is roughly 250 million cars as compared to the US of 245 million. We had the vice president of insurance relations head over to the Benelux market to start initial discussions on the continent with insurers. We're very pleased with the -- at least the initial discussions. Again one thing we've always liked, Scott, is that the insurers in the UK are also the insurers on the continent in many cases. So there's some overlap. So, we're convinced that if we can pull this off in the UK, and, again, 80% growth year over year. We're very pleased. Getting that second insurance company into a program has been very good. Certainly, we expect to bring this on to the continent in time. As far as a timeline goes, I've instructed our teams over there that let's continue to work on the synergies that we have. But I expect to have our interesting back over there probably spring or summer at the latest to start looking at more substantive programs on the continent.

Great. That's all I have. Thanks.

And we probably only have time for one more quick call. I want to be respectful of everybody's time.

Gary Prestopino, Barrington Research.

Good morning guys. I'll be brief because most of my questions have been answered. Rob, you called out 4000 shops might rollout with this intelligent system from CCC. Is that a maximum because these are the better shops that CCC deals with or is that just a goal by the end of say 2014?

Gary, those are the shops that have access to this particular product of CCC. They have many, many, many more customers that probably just haven't stepped up for this package. They certainly could grow if CCC is successful in selling that product. They have -- I would imagine 20,000 plus customers, 25,000 plus bodyshop customers across the US. So, they can continue to sell this product and get more into it. The 4000 are the ones that have access to it today and they will have access by the end of this year.

Lastly, you called out about a year or so ago or two years ago, you had done some kind of integration with Mitchell. Is that kind of the same thing that you've done with CCC? You don't really call that out on the conference calls. Or is that something entirely different?

Very similar but the difference is that CCC is interactive within the estimate. I think honestly that's why it's been so much more successful than the Mitchell. Mitchell's plan is to integrate that in time. They just haven't got that done yet. One last thing on the CCC product that is going to launch in Q4 is a salvage interaction. Right now, our current program with CCC is basically just the aftermarket. We do plan on getting the salvage part launched by the end of Q4.

Okay. Thanks, guys.

Thanks, Gary.

That is all the time we have for questions. I would like to turn the floor back over to Mr. Wagman for any additional remarks.

Thank you. And thank you, everyone, for the time this morning, and we look forward to speaking to you in the new year when we report our fourth-quarter and full-year 2013 results. Have a great holiday season, everyone. Thank you.

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