LKQ Corporation (LKQ) Q1 2013 Earnings Report, Transcript and Summary

Greetings, and welcome to the LKQ Corporation First Quarter 2013 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Joe Boutross, Director of Investor Relations. Thank you. Sir, you may begin.

Thanks, Brenda. Good morning, everyone, and thank you for joining us today. This morning, we released our first 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 for questions. In addition to the telephone access for today's call, we are providing an audio cast via the LKQ website. A replay of the audio cast 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 risk and uncertainties, some of which are currently not known to us. Actual events or results may differ materially from those expressed or implied in the forward-looking statements as a result of various factors. We assume no obligation to update any forward-looking statement to reflect events or circumstances arising after the date on which it was made, except as required by law. Please refer to our Form 10-K and other subsequent documents filed with the SEC and the press release we issued this morning for more information on potential risk. Hopefully, everyone has had a chance to look at our 8-K, which we filed with the SEC earlier today. As normal, we are planning to file our 10-Q in the next few days. And 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 pleased with the results we reported this morning. Diluted earnings per share of $0.28 for the first quarter ended March 31, 2013, increased 3.7% to $0.27 for the first quarter of 2012. As noted in the press release, the first quarter 2013 diluted earnings per share included a loss equal to $0.01 per share, resulting from restructuring and acquisition-related expenses and the change in fair value of contingent consideration liabilities. Earnings per share in the first quarter of 2012 included a gain equal to $0.02 per share that resulted from a favorable legal settlement. Adjusting for these items, diluted earnings per share grew by 16% over the prior year quarter. I am proud of our bottom line growth with the first quarter of 2013 producing record earnings. Revenue for the quarter was $1.2 billion, an increase of 15.9% as compared to $1.03 billion in the first quarter of 2012. This revenue is the highest quarterly revenue achieved by LKQ since our founding. During the first quarter of 2013, the company delivered strong organic revenue growth for parts and services of 9.6% despite fewer selling days in both North America and United Kingdom. I am particularly pleased with our North American organic revenue growth for parts and services, which grew at 4.7%. Adding back that extra business day, we estimate that our North American organic revenue growth for parts and services would have been 5.9% in the quarter, a quarter that also witnessed high fuel prices and a 1.4% decrease of miles driven for February year-over-year. The solid growth in North American organic parts and service revenue for the quarter is primarily a result of a combination of the increased use of alternative parts…

Thanks, Rob. Good morning, and thank you for joining us today. Hopefully, everyone has had a chance to review our press release this morning. We expect to file our Form 10-Q with the SEC in the next few days, so please watch for that as well. Before I begin, I'd like to point out that we've slightly changed the segment disclosures dealing with revenue. In the past, our revenue growth components were focused around the type of revenue, including aftermarket, recycled parts and services and other revenue. Since our European operations have become a much larger portion of our revenue and because with Sator they will become proportionately larger still, we've begun to show revenue growth by geographic segment. In the North American segment, we are combining the growth statistics for aftermarket and recycled parts and services. We'll continue to break out other revenue where we record scrap and core. We've long maintained that we'd like our customers to be indifferent to an aftermarket, recycled, refurbished or an OEM part. We manage our business with that mindset. Given that these products are frequently being sold to the same customers and carry economic similarities, we believe that investors should be indifferent whether we generate revenue through the sale of recycled, refurbished or aftermarket parts. Having said that, for the time being, we'll continue to provide car purchase volumes. It's only the components of revenue growth that we are combining. Starting with the revenue. Our Q1 2013 revenue was $1.2 billion, an increase of $164 million compared to Q1 last year or an increase of 15.9%. Organic growth of 8.2% outstripped our acquisition growth 8%. We also had a negative 0.3% impact from exchange rates. Parts and services revenue grew organically 9.6%. Within that category, as Rob mentioned, ECP continued to perform…

Thank you, John. To summarize, we are pleased with our first quarter performance. In 2012, we were faced with unforeseen challenges in our core North American business. As we enter 2013, these challenges appear to be subsiding, which is evident with our first quarter organic revenue growth. Though headwinds continue, I am encouraged by the tailwinds we've benefited from in the quarter. In addition, given our success with ECP, we are very excited about the pending acquisition of Sator. Sator has unparalleled market knowledge with a strong reputation and a high degree of credibility with customers, and we believe this transaction presents a great long-term opportunity for the company as we continue our European expansion. ECP continues to provide exciting growth opportunities for the company and we are quite pleased with its performance and the value it has created for our shareholders. We plan to continue to expand our ECP branch count in the U.K. by adding 15 additional branches in the third and fourth quarter of 2013. Our position in North America is extremely strong relative to alternative parts competitors. LKQ is the only company with a national footprint and the only company of any size that offers a full range of alternative parts to our customers. Still, we are not fully built out and we believe there are opportunities to continue our North American growth both organically and through acquisition. All of these business units, supported by our 21,000 plus dedicated employees, allowed us to post a solid first quarter, which has positioned the company well for the balance of 2013. Brenda, we are now prepared to open the call for Q&A.

[Operator Instructions] Our first question comes from the line of Nate Brochmann with William Blair & Company. Nathan Brochmann - William Blair & Company L.L.C., Research Division: Wanted to talk to your -- 2 quick questions. One, John, you gave some nice detail on kind of the dip in the gross margins when you exclude kind of the gain or whatever, still a lot of that due to the precious metal business. Could you talk about the overall profitability? I mean, obviously, you guys did a lot of acquisitions in the fourth quarter. Whether there is any additional mix issues coming from those or a little bit lower profitability near term and what's the opportunity to kind of maybe get those margins up over the next maybe 12 months or so?

Thanks, Nate. I'll start and maybe Rob can supplement. You're right, we did a fair number of acquisitions last year, 30 of which -- I think 1/2 were in Q4. I would say the metals business is not yet fully integrated. We've started to decant some of our own catalytic converters and starting to process, but the majority of the cats are not going through there yet. When you look at some of the bigger acquisitions we did, which were up in Canada, I'd say those are still -- we're still in the implementation phase with respect to those. The facility and warehouses I talked a little bit about the drag that, that created on as a percentage of revenue facility and warehouse costs. If you look at the map that we typically publish, you see we still have duplicate facilities in multiple locations in Canada. So it's going to take a while to get through those. Still in the implementation phase with respect to a number of the acquisitions where we have overlap facilities.

And I would just add, Nate, one other acquisition I want to highlight is the shredder business that we bought in Q4. We are in the process of bringing all those -- our own cars to that shredder and still plenty of capacity to grow there. So early days there, but we're very excited about the opportunity that provides. Nathan Brochmann - William Blair & Company L.L.C., Research Division: So it kind of sounds like all else equal assuming no extra benefit on the gross margin side from maybe lower used car prices or purchase prices, but it sounds like over the next 12 months we definitely can see some upside just on the overall margin line as everything kind of gets integrated assuming no new deals?

Yes, I don't know whether it'll come so much through the gross margin line. I think it's more leveraging the distribution and the warehousing costs. Nathan Brochmann - William Blair & Company L.L.C., Research Division: Okay, that's fair. And then regarding the acquisition in Europe. Obviously, again, it sounds like a great foothold in the continent there. Could you talk, and I know it's too early to talk exactly about maybe what the accretion is, but I mean can you talk about the general accretion profile whether we'd get anything in '13 without giving exact numbers and what it might be in '14? And could you talk about the base premise of that model whether it is similar to like ECP in terms of more of a branch-based distribution model? And what the percentage currently comes from mechanical versus collision parts there?

Sure. Nathan, unfortunately due to the confidentiality provisions in our agreement with the sellers, we can't disclose too many details until we actually close, which we are scheduled to close on May 1. We are doing -- we plan on doing a follow-up after that with more updates on some of the questions you asked. However, I can talk about the market dynamics that we're getting into. The main competitors in the marketplace are generally smaller regional players. However, in other countries surrounding there, there are similar type of companies to the Sator operation. Very little of their sales today are in collision sales. The vast majority of their parts are going to be very similar to ECP in terms of aftermarket mechanical components. As I mentioned, they have approximately a 20% market share in the Benelux region. There is a high acceptance of alternative mechanical parts in the marketplace, very similar to the U.K. Some really good trends that we like: mandatory insurance, very low alternative part usage. So over time, our plan would be to bring our collision parts program from the U.K. over to the continent. 85% of Sator's revenue is in Belgium and the Netherlands. And just the overall Western Europe marketplace, about 250 million vehicles larger than the United States. And the part spend in the aftermarket, parts market, is a $115 billion. So really a great opportunity. We plan on using that obviously as our beachhead onto the continent and we will look to expand and we'll continue to look at opportunities throughout the continent.

Our next question comes from the line of Craig Kennison with Robert W. Baird. Craig R. Kennison - Robert W. Baird & Co. Incorporated, Research Division: Just to follow-up on the Sator commentary. Is the model any different than in the U.K. where in the U.K., you acquired 89 stores and then expanded to 130 plus. It looks like this model is more based on DCs, you're acquiring 11. Maybe you could help us understand the difference in the model a little bit.

Yes, I think that's fair, Craig. It's a DC-type distribution business where they're selling into the marketplace. Great -- certainly, great penetration in the marketplace today with a 20% market share. So great upside for us there to keep growing the business. We'll be looking at that model. Our primary concentration from the beginning will be to focus on the synergies that John and I both spoke about in our prepared remarks. We think that's the greatest opportunity right out of the gate, is to focus on the purchasing synergies and look at logistic opportunities as well. So we're going to look to be able to share parts between the U.K. and our Netherlands operations. So that's where the focus is going to be out of the first year or so. Craig R. Kennison - Robert W. Baird & Co. Incorporated, Research Division: Regarding the synergies that you mentioned, you mentioned they are purchasing synergies, so I assume that all of that savings is on the cost side and not really on the revenue side yet?

That's correct. Craig R. Kennison - Robert W. Baird & Co. Incorporated, Research Division: And then lastly, just with respect to your phase 2 test with CCC. I realize it's only 5 customers, but the click-through functionality seems like a meaningful upgrade. What kind of sales lift do you think that could provide and does that drive any of your assumptions regarding organic growth?

Yes, let me talk about the difference between this program and the Mitchell program that we mentioned 2 quarters ago. The Mitchell program is not fully integrated with the estimating system, but this one is. So what we like about this system -- phase 2 of the Mitchell system was that we fully integrated with the estimating system. CCC's is already integrated, meaning the shop doesn't have to leave the estimate platform to see our products. So by staying in that system, we think it's going to be a lot more powerful. The second thing we like about the program is that CCC has the majority of the body shop business in the United States with Mitchell being a second and Solera being first. So we have a bigger data -- bigger customer base to focus on with this program. You're right, it is very early days, Craig. We only have 5 shops and initial tests now are up to 20. We're encouraged by the results. The beta shops have really enjoyed the B2B functionality of it, but it really is too early for us to be projecting how well this is going to be received in the marketplace. I think we'll have a better idea after Q2 or Q3.

Our next question comes from the line of Bret Johnson (sic) [Jordan] with BB&T Capital Markets. Bret David Jordan - BB&T Capital Markets, Research Division: A couple of quick questions. And one, I might have missed this. Did you give any margin impact from the precious metals business in the first quarter?

It's 50 basis points. Bret David Jordan - BB&T Capital Markets, Research Division: Okay. So it's very consistent with last year's run rate. And I guess if you look at that and sort of get a feeling for utilization, it doesn't sound like it's fully loaded. Is there sort of an expectation as we get into the anniversary of that acquisition the middle of this year, sort of a ramp rate at which point it begins to become less impactful?

The reason that they had their own metals business and that has not gone away and will discontinue. What we're really trying to do there is where we've got revenue -- precious metal revenue out of the cars we're selling. We're really just trying to capture some of the value that's the downstream impacts with the refiners. So I don't think you're going to see a dramatic change from that frankly because they'll continue to do their own processing of third-party metals. Bret David Jordan - BB&T Capital Markets, Research Division: Okay, all right. And then a question on Sator. Do you -- at least color for us as far the growth rate and their revenues that EUR 288 million was up from x in the prior year, sort of get a feeling for how that business has been growing prior to the acquisition?

We will update. After we close, Bret, we'll be updating everybody on those figures.

Our next question comes from the line of Sam Darkatsh with Raymond James.

This is Josh filling in for Sam. Could you talk a little bit about the ECP multiple you ended up paying after the earn-outs and sort of compare and contrast the purchase price for ECP and Sator and the justification for each?

I don't have that off the top of my head. The total consideration was EUR 280 million. If the earn-out -- excuse me, GBP 280 million for ECP, assuming that the earn-outs are fully paid. And the EBITDA, you can actually get the EBITDA because we disclosed that in the Qs. Just be careful to add back the changes and consideration.

I think x the earn-out, you were somewhere 8x when the deal was first announced. So I just was wanting to understand the thoughts on the 2 different.

I don't want to quote a number, but it's going to be dramatically less than that.

And the reason for that?

I'm saying -- I'm sorry, Josh?

What was the reason for the difference?

Oh, at the time of the acquisition, you were saying it was around 8x. I don't recall that. I'm just saying that if you look at whether the EBITDA or ECP is throwing off now and assume that we fully paid the consideration, we can work up the number. But it's well under 8x.

Okay. I'll come back on that later then. And does this reduce your bandwidth any for U.S. acquisitions?

No, it doesn't, Josh. We have teams on both sides of the pond working deals, and the acquisition pipeline actually is still relatively strong. We did push a little bit lighter in North America with us announcing only 2 deals this quarter. I think that was because of the rush in Q4 to beat the tax deadline. We mentioned that we did 15 deals in Q4. So a little bit slower in North America, I think, just catching up. But the pipeline remains very active on both sides.

Our next question comes from the line of Gary Prestopino with Barrington.

Rob, did you say that the Mitchell system that you're working with now is not fully integrated into the estimating system yet, but it will be?

That's correct, yes. It was 2 phases. The first phase was a B2B buying. So they actually leave the estimating platform to see our inventory. With CCC, they don't have to leave the estimating platform. We mentioned on the last call that Mitchell had a phase 2 that's supposed to be released in Q3. That will be very similar to CCC's. It's fully integrated where the shop or the insurance company never has to leave the estimate.

And with both of these and I guess the third estimating system in the country as well, you will be the only recycler that has this capability?

Today, yes. There are plans maybe to open up in the future, but we are the only ones right now with both companies.

And just a couple of quick questions. How many ECP branches did you end the quarter with?

We were at 132 and then we have 1 with Autoclimate, so that's 133.

And then in terms of the alternative part usages -- usage on the continent, you said it's low. Trying to figure there, is it similar to the U.K.?

Very similar to the U.K., Gary. We estimated it's between 5% and 8%. And what we've always said is that it's many of the same insurance companies writing in the U.K. also writing the continent. So our hope is that we can piggyback on our relationships in the U.K. that we've already developed through the launch eventually on the continent as well.

That was my next question. I mean, in terms of crossover, I mean, all the major players are writing in the U.K. as well as the continent on insurance basis, what about those that are smaller ones that are domiciled in the U.K. that you may be working with? Do they write on the continent as well?

All the big players do, of course, write both on the U.K. and the continent. I think it's fair to say that there's regional players in the U.K., there'll be regional payers on the continent as well. So there'll be a little bit of difference there, but it's the 80-20 rule here with the big carriers owning the majority of the market share.

And I assume you're working with all the big carriers that are in the U.K. right now, right?

Absolutely.

Our next question comes from the line of Scott Stember with Sidoti & Co. Scott L. Stember - Sidoti & Company, LLC: Could you talk about how the weather impacted the quarter? Obviously, we had some extraneous amounts of snow that hit the Northeast. Could you just talk about on the net basis how it helped you and if there's any lingering impact into the second quarter?

Yes, it was a winter that finally arrived. It was pretty interesting when you look at the stats that, really before February, we were actually behind our normal expectation. And then late February and March, the Northeast really got pounded pretty good. Certainly, we believe that it certainly didn't hurt the Q1. We certainly believe that it brought enough of volume into the marketplace in the collision repair industry. And April is very much the plan right now. So we think that it's pushed some of that weather in March into April. So it really had some nice late winter weather to help us in late Q1 and early Q2. Scott L. Stember - Sidoti & Company, LLC: Okay. And North America, looking at the parts and service, I know you're not breaking it out anymore but could you just give some high-level commentary of how the recycled parts side did, namely, the mechanical parts just with some reports of some weakness there over the last -- particularly in March?

I don't know if we've seen any appreciable change in our mechanical. Keep in mind, our mechanical sales are primarily large-ticket items like engines and transmissions that really are not discretionary in terms of people's ability to time those. When somebody's engine blows, they generally have to go and get it fixed. And it's primarily just driven off our car buying in Q4. So I don't think we've been impacted particularly.

And quite frankly, Scott, with the aging car part, our engine transmission businesses is very strong right now. So we didn't see any impact at all to our mechanical components. Scott L. Stember - Sidoti & Company, LLC: Okay, got you. And just last question, just following up on the U.K. and the collision parts initiative, how many insurers do you have programs with now?

We have relationships with 8 insurers today, all in pilot stage, but continuing and growing by the quarter.

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

With the Sator acquisition, you had mentioned that this is also in Northern France, and I was under the impression that France has legislation in place that requires new parts -- aftermarket parts to be used. So -- and that was one of the reasons why Europe was going to be a difficulty for you in terms of your strategy going forward. But now it seems like you're more comfortable with the aftermarket business over there?

Yes, Richard, let me clarify the law there. The law is for collision parts only that have to be OEM parts only. So on the mechanical, the aftermarket mechanical, there is not that same restriction. So that only applies to collision parts, and our collision parts sales in the continent are very low today. So that didn't hinder us at all. Now, with that being said, France is an interesting country. So I'm not sure what our plans will be to expand in France at this point. It's still early days, but we certainly won't be pushing our collision parts into that marketplace. But as far as mechanical parts, they are readily accepted in France.

Now this business, it sounds more something that's like a Napa. Is that characterization fair to say about Sator?

Yes, they distribute mechanical parts, very similar mechanical parts as ECP did.

Okay. And is this the type of operation -- would you be considering this type of operation to acquire here in the United States?

We certainly are looking at the hard part industry in all markets. It's an intriguing part of our business. It's a little bit different model that what we operate here today in terms of the way we deliver our products. Those tend to be more hotshot and we tend to be a little bit more once-a-day delivery for our collision and heavy mechanical parts. But it's certainly something we will continue to look at in the States as well.

And when you say hotshot, you mean you deliver on demand?

Yes, and they tend to deliver in the U.K. and at Sator within 30 minutes to 45 minutes. So they'll have a truck waiting just to dispatch immediately once the call comes in.

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

Sorry, I'm late to the call. But could you give me just a couple of, I know you've probably been through this on the acquisition, a little bit of the size of the market that Sator is addressing?

Sure. Let me talk about the Western European market first, John. Western Europe is about USD 115 billion parts, aftermarket parts market. There are over 250 million vehicles on the road there in the Western European. 85% of Sator's revenue is in the Belgium and the Netherlands. Very similar market dynamics as what we've seen in the U.K. Mandatory insurance with very, very low levels of alternative part usage on the collision side. There is a high acceptance of alternative mechanical parts. So that obviously bodes well for us. They have about a 20% market share in the Benelux region. And basically, the main competitors are small regional players. If you get outside of their main markets they operate, there are similar companies to Sator in Germany, France, et cetera. But really great growth opportunity and plenty of runway left.

And the situation with the ownership, was it -- what was the situation for the seller?

Private equity.

It was private equity. And they've had it how long?

3 years, 3 or 4 years.

Great. And once again you probably covered it, was there anything unusual in the cost structure in the quarter?

Anything unusual -- I'm sorry, John, anything unusual what?

In the cost structure other than just some of the comparisons to onetime items, et cetera. Was there anything else unusual in the cost structure?

No, just COGS that there was in Q1 last year with the...

Yes, right. But other than that comparison, nothing else unusual?

No.

Great. And what did you say, what are the cost of the car do in the quarter?

In the quarter, our average cost in Q1 2012, we were at about $19.31 per car, John. In this quarter, year-over-year, we're $18.70. So seeing a little bit of improvement there.

In this case, since there are no further questions, I'd like to turn the floor back over for closing comments.

Thank you, Brenda. I want to thank everyone for joining the call today, and we look forward to speaking with you again in a few months to report our Q2 results. Thanks, everybody. Have a great day.

This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.