Feb 26, 2009
Executives
Joe Holsten – President and Chief Executive Officer Mark Spears – EVP and Chief Financial Officer Sarah Lewensohn – Director of Investor Relations
Analysts
Tony Cristello – BB&T Capital Markets Craig Kennison – Robert W. Baird Michael Cox – Piper Jaffray Unidentified Analyst Scott Ciccarelli with RBC Capital Markets Craig Kennison – Robert W.
Baird & Co., Inc
Operator
Greetings, and welcome to the LKQ fourth quarter 2008 earnings call. At this time, all participants are in listen-only mode.
A brief question-and-answer session will follow the formal presentation. (Operator instructions) It is now my pleasure to introduce your host, Ms.
Sarah Lewensohn, Director of Investor Relations.
Sarah Lewensohn
Good morning everyone, and welcome to the LKQ Corporation fourth quarter and full year 2008 earnings conference call. With me today from LKQ Corporation is Joe Holsten, President and Chief Executive Officer, and Mark Spears, Executive Vice President and Chief Financial Officer.
Both Joe and Mark will share their thoughts on our results and then open the call up for questions. In addition to those who are listening by telephone, we’re providing an audio cast via the LKQ web site, and both forms will have replays available shortly after the conclusion of the call.
Before we begin with our discussion, I’d like to read the following. The statements 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, and strategies. Forward-looking statements involve risks and uncertainties, some of which are not currently known to us.
Actual events or results may differ materially from those expressed or implied in the forward-looking statements as a result of various factors. We assume no obligation to update any forward-looking statement to reflect events or circumstances arising after the date from which it was made except as required by law, and we ask that you please refer to our 2008 Form 10-K and the press release we issued this morning for information on potential risks.
With that, I will turn this over to Mr. Holsten.
Joe Holsten
Good morning and thanks for joining us today. I will begin by providing some high level comments about our performance as well as some perspective on the business, our industry, and the markets that we serve.
2008 was the year where we realized significant achievements, yet faced sizeable challenges. We reached our 10-year anniversary having founded the company in 1998 by combining 5 recycled automobile parts businesses with combined annual revenue of only $33 million.
As you can see from the results we issued this morning, we have come a long way from where we started. Revenue for the year was $1.9 billion, a 72% increase over revenue for 2007, and we generated diluted earnings per share after restructuring costs of $0.71 for 2008, a 29% increase over earnings per share of $0.55 in 2007.
Most of the revenue growth is the result of our acquisition of Keystone completed in October 2007. We did deliver organic revenue growth of 2008 of roughly 9%, which was calculated as if we owned Keystone for all of 2007.
On a pro forma basis, total revenue for the year grew approximately 13% as compared to 2007, driven by increases in the sale of recycled parts and services and by the growth of other revenue. Aftermarket new and refurbished revenue for 2008 was up slightly or by 1%, reflecting a slowing of the growth we realized in the first half of the year to a modest decline in the second half of 2008.
While gasoline prices dropped during the fourth quarter, high fuel costs throughout much of the year led consumers to drive less and stay closer to home. Miles driven for the fourth quarter were down 3.5% as compared to the fourth quarter of 2007, and for the year down 3.6%.
Claims volume continued to decline in the fourth quarter. Recent data from carriers that we’ve polled indicate they are down 5% to 10% over the prior year.
AllState indicated their claims were down 7% in the fourth quarter over prior year and down 6.5% for the entire year. With revenue growth of 23% for the recycled parts and services category and relatively flat revenue for the aftermarket other new and refurbished product category for all of 2008, we believe that we are winning a greater share of the collision repair parts business in both recycled and aftermarket parts.
In the fourth quarter, we saw a decline in aftermarket other new and refurbished parts sales of 2% on a year over year basis, yet with supplier reports of aftermarket part imports down 7% according to one vendor and down 20% from another vendor, we believe our share of the aftermarket collision parts industry is growing. The continuation of high fuel prices, lower miles driven, and a reduction in insured claims limited the growth of our collision repair parts during the year.
Demand for mechanical parts appears to be impacted to a lesser extent. Purchase of cars for wholesale recycled parts totaled 38000 units during the fourth quarter, a 17% increase from the nearly 33,000 we acquired in the fourth quarter of last year.
Wholesales vehicles that we acquired from the salvage auctions accounted for approximately 97% of the total incoming wholesale product flow. During the quarter, we purchased more than 77,000 lower cost self-serve and crush-only cars as compared to 52,000 in the prior year.
The fourth quarter 2008 total includes approximately 28,000 purchased cars from the Pick-Your-Part acquisition that we completed in late August. For the full year of 2008, we purchased 144,500 cars for our wholesale recycled parts business as compared to 126,000 cars in 2007.
During the same period, we acquired 297,000 lower cost self-serve and crush-only units, an increase of 50% over 2007. If we exclude the vehicles acquired at our Pick-Your-Part locations, we purchased 257,000 units, a 30% increase as compared to 2007.
The value of crushed car bodies, like most steel-related commodities, reached record high by mid summer and near record lows in the late fall. For the most part, scrap metal from crushed car bodies is a byproduct of our recycling operations.
The dramatic price movement, however, was in a relatively short period of time negatively impacted our financial results in the fourth quarter. The operating results for the fourth quarter reflect the challenges we faced with this rapid collapse of the scrap market at the start of Q4.
Gross margin for the quarter declined 260 basis points as compared to the same period last year as a result of the increases we realized on our cost of goods when we sold the scrap from the cars we had in inventory at the beginning of the fourth quarter. Operating income was further impacted due to lower volumes at our self-service facility.
Despite these challenges, net income for 2008 grew 52% to $100 million from $66 million for the prior year. Mark will talk more about the financial results in a few minutes.
Now let me turn to the summary and update of the integration of Keystone with the LKQ operations and this is probably the last quarter we’ll discuss this. When we first announced the Keystone acquisition, we indicated that we anticipated annual savings of $35 million by 2010.
Having realized at least $20 million in 2008, we now believe we will reach our target of $35 million run rate in savings by the end of 2009. Over the past 15 months, we’ve accomplished much, as we’ve completed all except two of the planned conversions to the Prelude point of sale and inventory management system in the US.
We’ve reduced 37 operating site by consolidating warehouses and closing store fronts. We’ve conformed customer discounts and company price lists, and we’ve trained hundreds of LKQ sales and operating people in the Prelude sales and inventory system.
The review of sales volumes and production capacity of the remaining 55 bumper, wheel, and light refurbishing locations is continuing, so we can determine future plant consolidation opportunity. We are committed to continue to improve operating margins by integrating the two companies into one by the end of the year.
Our regional management structure was completely combined. By consolidating the management oversight of both the aftermarket and the recycling businesses in a given geography, we intend to enhance revenue growth opportunities and achieve improved cost control.
The remapping of the organization is allowing us to consolidate and share shuttles, integrate delivery routes in a number of markets, and consolidate sales representatives from the recycled and aftermarket businesses. Today, members of our product and business development teams call on repair shops with a broader set of alternative collision parts and product solutions.
Last quarter, I mentioned that we were testing a new customer service called Key List which automates the estimate review program and creates streamlined parts ordering. This program electronically synchronizes an estimate written by an insurance estimator or a repair shop to our inventory systems and notifies the user of available recycled or aftermarket parts.
If the customer desires to do so, the aftermarket portion of the estimate can be converted into an online order increasing accuracy and moving more of our sales into a B2B arena. Key List also provides LKQ with a list of parts that could not be located within our inventory to allow us for a last look for additional sales.
We have installed Key List in several markets for one of the top 7 insurance carriers, and to date the results and feedbacks have been quite positive. We anticipate they will look to expand its reach to other markets in which they operate.
The product is also being rolled out to fleet management companies that increasingly own rather than lease their fleet, and as much as most self-insure for damage, they have a direct incentive to control collision repair expenses. During the year, we completed a number of acquisitions, the largest the purchase of Pick Your Part auto wrecking, a self-service operation with 9 sites in California that annual 2007 revenues of $114 million.
During the quarter, we purchased two recycle operations in Western Ontario in order to expand our market presence in that Canadian province. We acquired three heavy-duty recycled truck parts operations in Chicago, Toledo, and Houston and liked them with our Quebec operation to formally network the recycled truck parts businesses.
More recently in 2009, we acquired another heavy-duty recycled truck parts business based in Tampa and a wholesale salvage recycling business in Durham, North Carolina. These two new locations generated $13 million of combined historical annual revenues.
The heavy-duty recycled truck parts market is similar to market attributes we saw when we first began to acquire auto recycled businesses. It is an industry that is highly fragmented, and there are numerous small mom and pop companies operating with little benefit of scale and who lack the capital necessary to finance inventory and growth.
The trucking industry is facing significant cost pressures, while revenues are contracting along with the economic downturn. Many trucking companies have moved to an asset light economic model that has shifted more of the financial burden onto owner operators.
The use of recycled truck parts offers a strong value proposition to these very cost conscious customers. We are building traction with Secure Disposal and have signed two large national accounts, one a global parcel delivery company and the other a large cement business to handle their outgoing fleet.
Secure Disposal is a service where we believe we have a significant competitive advantage over local and regional truck salvage operators. We believe we can leverage some of our existing systems and capabilities such as our yard management system and our procurement disciplines to further enhance the financial performance of these acquired businesses.
I’d like to ask Mark to walk you through some of the financial information at this point.
Mark Spears
Good morning everyone! As we did last quarter, we included a few additional tables that we believe are helpful as you evaluate our results.
One of the schedules is a comparison of our major revenue categories on a pro forma basis as if Keystone for all of 2007. You may recall that the acquisition occurred in mid October of 2007, so the 2008 financials reflect Keystone as part of LKQ for the full year, but they’re only in 2007 for 2-1/2 months.
Looking at our income statement and the related tables, our fourth quarter revenue was up 13.4% to $470.3 million from $414.7 million in Q4 2007. Revenue for 2008 grew 71.9% to $1.937 billion compared with $1.127 billion for 2007.
As Joe mentioned earlier, our organic revenue growth calculated on a pro forma basis that assumes we owned Keystone for all of 2007 was just under 1% for the fourth quarter and 8.8% for the full year of 2008. Gross margin for the fourth quarter of 2008 was 42% versus 44.6% in the prior year.
The decline was largely due to scrap and commodity pricing in our recycled product line, in particular the self-service facilities. On a year-to-date basis, the 2008 gross margin was 44.2% versus 44.9% in 2007.
Facility and warehouse expense as a percentage of revenue for Q4 2008 was 10.8% versus 9.7% in 2007. The percentage decline in the quarter was related to our self-service operations as they run at a higher percentage of these types of cost to revenue.
On a full year basis facility and warehouse expenses grew $71.1 million or 61% over 2007, and a percentage of revenue was 9.7%, a decrease of 60 basis points from the prior year. Sequentially from Q3 to Q4 2008, facility and warehouse expenses grew $2.4 million.
This increase was primarily due to our acquisition of Pick Your Part on August 25, 2008. Distribution expenses for Q4 2008 were $3.3 million or 8.3% over Q4 2007.
As a percentage of revenue, distribution costs decreased to 9.2% in Q4 2008 from the 9.6% in 2007. For the full year of 2008, distribution expenses grew $71.9 million or 66.4% over 2007, and as a percentage of revenue improved to 9.3% from 9.6% for the same period in 2007.
Selling general and administrative expenses grew $10.3 million or 18.8% over Q4 2007. SG&A as a percentage of revenue increased to 13.9% in Q4 2008 from 13.2% in Q4 2007.
This growth as a percentage of revenue for the quarter is related to our self-service yards, like it was for in facility and warehouse expense. For the full year of 2008, SG&A expenses grew $111.1 million or 78.9% over 2007.
For the same period, these expenses as a percentage of revenue increased to 13% in 2008 from 12.5% in 2007. Selling and administrative costs tend to be higher for the aftermarket products than for the recycled.
During the third quarter, we had restructuring expenses of $1.9 million as part of our operating expenses, and for the full year had $8.6 million, all of which are related to the Keystone acquisition. You should note that certain costs of the Keystone acquisition related to severance and certain facility closure costs are considered purchase price allocations and are not charged to the income statement.
Our operating income decreased 35.6% to $27.8 million in Q4 2008 from $43.2 million in Q4 2007. Our margin was 5.2% in Q4 2008 compared to 10.4% in Q4 2007.
Excluding restructuring expenses, operating margin in Q4 2008 would have been 6.3%. Looking at the full year 2008, operating income grew 61.2% to $197.7 million from $122.7 million in 2007.
The 2008 operating margin was 10.2% compared to 10.9% in 2007. Excluding restructuring expenses, 2008 full year operating margin would have been 10.6%.
The erosion of Q4 2008 and full year operating margin excluding restructuring expense is attributable to our self-service facilities. The results of our self-service operations for the fourth quarter were extremely disappointing and considerably below the expectations we had when we updated guidance as part of our third quarter earnings release.
We did not fully anticipate three things. First, the values of both ferrous and nonferrous metals plunged far below nearly everyone’s worst case scenario and at a faster speed.
Second, the competitive market to buy self-service vehicles remained extremely strong resulting in prices for cars that were not supported by scrap values, and third, car volumes available was much lower than our expectations. In order to understand the situation better, let me start by providing a sense of scale of the business.
In 2008, total revenue for our self-service operations was $184 million or 9.5% of LKQ’s total revenue. Approximately 33% of the self-service revenue was included in recycled and related products and services reflecting part-related sales, and 67% was included in other revenue comprising of core and scrap sales.
Revenue for the fourth quarter of 2008 in the self-service businesses was $38 million or 8.2% of total revenue. Approximately 50% was for recycled products and 50% was in the other revenue category in the fourth quarter.
We generated the following statistics when comparing Q4 2008 to Q3 2008 for our sales services businesses, excluding the Pick Your Part or PYP business we acquired late in August 2008. Self-service cars procured in Q4 cost 34% less than those procured in the third quarter.
Average scrap prices received for car dropped 60% from that received in Q3. We procured 38% less self-service cars in Q4 compared to Q3.
The effect of having more expensive cars in inventory in Q3 that were then sold at the lower Q4 scrap prices generated approximately $8 million of lower gross profits in Q4. While our gross margin per car is not yet where it needs to be, we are moving in the right direction.
Our guidance for 2009 reflects these trends. We very much like the self-service business.
Historically, it has performed well, and we expect it to return to more normal trends as we enter the second quarter. Looking further down the income statement, we had net interest expense in Q4 2008 of $8.6 million as compared to $9.9 million in Q4 2007.
This decrease is primarily a result of lower interest rates. The Q4 2008 pre-tax income decreased 41% to $19.9 million from $33.7 million in Q4 2007.
For the full year 2008, pre-tax income increased 51.1% to $163.6 million from a $108.3 million in 2007. For the full year 2008, our effective tax rate was 38.9% compared to 39.1% in 2007.
If you exclude the effect of certain adjustments for a new federal tax deduction and certain new state tax credit, our effective tax rate for 2008 would have been 39.7%. If you exclude certain non-taxable income offset by write-offs of certain deferred tax assets in 2007, our effective tax rate would have been 40% for 2007.
Net income for the quarter decreased 39.8% to $13 million from $21.5 million in Q4 2007. For the full year 2008, net income increased 51.6% to $99.9 million from $65.9 million for the same period of 2007.
Our diluted earnings per share decreased 43.8% to $0.09 for Q4 2008 from $0.16 in Q4 2007. For the full the year 2008, diluted earnings per share increased 29.1% to $0.71 from $0.55 in 2007.
Without restructuring expenses, earnings per share for Q4 2008 would have been $0.10, and for the full year 2008, would have been $0.75. Our diluted weighted common shares outstanding used for calculating EPS were as follows.
Q4 2008 at 142.4 million shares versus Q4 2007 at 138.8 million shares. Full year 2008 at 141 million shares versus full year 2007 at 119.9 million shares.
Shifting our focus to the cash flow table, we generated $133 million in cash from operations for the full year. Capital expenditures for 2008 excluding business acquisitions were $66.9 million.
Cash used to acquire businesses for 2008 were $74.2 million. During the full year 2008, we issued 2.7 million shares of stock related to the exercise of stock options that resulted in $22.9 million in cash which includes related tax benefits.
Taking a look at the balance sheet as of December 31, 2008, you will see we had debt of $642.9 million that included $638.3 million under our secured credit facility. Cash and equivalents were $79.1 million at the end of 2008.
As of February 25th, we had approximately $53 million in cash and equivalents. As many of you know, we have a revolving credit facility of $115 million provided under our secured credit facility.
Currently, we have $5.3 million of borrowings under this line, and there are approximately $23 million of letters of credit that are backstopped by this facility reducing the availability for future borrowings to approximately $87 million. As we’ve previously reported in an 8-K filing with the SEC, Lehman Commercial Paper Inc.
which accounts for $15 million of revolver funding commitment filed for chapter 11 bankruptcy protection in 2008. Accordingly, we no longer believe this $15 million commitment is available, so in effect, our availability has been reduced to $72 million; however, we do not feel this $15 million number is significant to our liquidity needs.
Let’s move to our 2009 financial guidance. As Joe indicated earlier in light of current economic environment and its impact on collision repair trends, we anticipate our organic revenue growth for 2009 excluding the other revenue category that we show in our financial tables to grow at a rate of 6 to 8%.
LKQ anticipates full year 2009 net income will be in the range of $114 million to $123 million, and earnings per share will be in the range of $0.80 to $0.86 excluding any future restructuring expenses. Net cash provided by operating activities for 2009 is projected to be over $145 million.
While this $145 million cash from operations does not increase a lot compared to 2008 number, it is important to note that in 2008 we had some specific cash flow benefits. Looking at our cash flow statement, you’ll note we generated approximately $4 million in cash flows as we lowered our total inventory levels.
This was primarily related to the benefits of combining the Keystone and LKQ aftermarket-related inventories as we merged facilities on the aftermarket side, reducing aftermarket inventory by around $17 million, partially offset by an increase in our salvage inventory. In 2009, we anticipate inventories to grow at the same pace of revenue, that’s 6 to 8% level.
Offsetting this working capital growth, we expect to have $15 million less in payments in 2009 related to Keystone accrued acquisition expenses and restructuring expenses. The company estimates 2009 capital expenditures related to property and equipment excluding expenditures of acquiring businesses will be between $75 million to $80 million.
Maintenance or replacement capital expenditures are expected to be slightly less than 20% of this range. We’re also providing quarterly guidance for the first quarter 2009 excluding any restructuring expenses.
Net income is projected to be between $30 to $32 million, and diluted EPS is anticipated to be approximately $0.21 to $0.22. Weighted average diluted shares outstanding are anticipated to be approximately 143 million shares for 2009.
Share numbers are estimates and will be affected by factors such as future stock issuances, the number of options exercised in subsequent periods, and changes in our stock price. I’ll like to turn back to Joe for some closing comments.
Joe Holsten
Before you go to questions, I'd like to make a few more comments and share our outlook for the businesses and the industries in which we operate. While we are operating in a period of economic uncertainty, we at LKQ continue to believe that the current financial woes will translate into benefits that will accrue to the shareholders of our company.
Over the past five years, we have realized compounded annual revenue growth of 43%, and our shareholders have realized a compounded annual earnings growth of 29%. What made LKQ a good investment a good investment over that time period we believe still holds true today.
The demand for alternative collision and mechanical parts will continue to grow. Recycled and aftermarket collision parts provide significant cost savings over the use of new OEM parts to repair vehicle damage.
Insurance companies, the payment source for nearly 85% of all collision repairs, operate in an extremely competitive market and are constantly searching for ways to improve their operating ratios without raising premiums. LKQ alternative parts offer a way for them to reduce claims cost without sacrificing quality.
For those instances where consumers are the ultimate payer, they too will look to find ways to mitigate their repair costs by doing only what is necessary and by looking for less costly ways to complete their repairs. Next, I’d say our company has the right inventory in stock.
The flux in the automobile industry is leading the service erosion by selected auto dealers unable to consistently deliver new OEM replacement parts. OEM inventories are lean as a result of factory closures, both temporary and permanent, and the closure of auto dealerships is threatening the availability of new OEM replacement parts.
We are seeing instances especially in rural markets where the closure of a dealership results in an underserved market area and an opportunity for LKQ to provide alternative parts in a timely manner. A recent study by Mitchell seems to validate this trend as they reported that the usage rate of new OEM parts and collision repairs declined by 2 full points over the last six months.
Used car prices are down, leading to more claims being declared total losses and helping generate a healthy supply of vehicles for purchases as salvage pools. Our fulfillment rates continue to be well above the industry average.
We see the benefit of this in the prices that we are paying for cars as well, as our average cost for a wholesale car was down 9% in the fourth quarter as compared to the prior year fourth quarter. Next, some of our vendors in Taiwan have lost OE supply contracts, which is enabling them to focus additional resources on the production of aftermarket parts.
On the procurement side for aftermarket parts, the drop in steel prices and shipping costs will help us protect our margins. It is generally believed that the economic downturn will lead to consumer owning their cars longer and deferring new car purchases.
This may enhance demand for alternative parts both collision and mechanical as a result of the nation driving an older fleet of cars and as consumers look to minimize repair costs. I’d also focus on our balance sheet and its strength as it provides us with the flexibility to grow our operations, as our leverage is less than three times EBITDA.
We have liquidity in excess of $120 million. Our maintenance capital spending is roughly only $15 million per year, and we obviously have sufficient cash flow to fund our growth.
The combination of LKQ and Keystone cemented our significant market leadership position as a provider of recycled and aftermarket parts and provides operating leverage to grow revenue by selling ancillary product lines to repair shops and to expand margins by reducing redundancies. While the current economic environment is posing challenging for many, we are well capitalized to take advantage of the many opportunities that we believe are likely to come on the horizon over the next several years.
At this point, we’d like to open the lines for questions.
Operator
(Operator Instructions) Your first question comes from Tony Cristello from BB&T Capital Markets.
Tony Cristello – BB&T Capital Markets
The first question I want to ask is when you look at the 6-8% organic growth, which I guess is a function of both the aftermarket and the recycled, what are the underlying assumptions there from an organic standpoint? Is it fair to say that recycled might be positive low double and aftermarket might be low single?
Joe Holsten
Maybe not quite to that extreme, Tony, but you’re right. The budgets we put together would show slightly stronger organic growth for the recycled parts as compared to the aftermarket products.
Tony Cristello – BB&T Capital Markets
If you look at the mix of business, the aftermarket obviously is going to be a bigger contributor of the organic on a mix proportion, so you’re saying that what we saw here the last few quarters on organic for recycled is that level or better, whereas aftermarket you’re down 2, so am I still thinking flat to down? Is that sort of where we need to be on aftermarket?
Joe Holsten
No, absolutely not. I think the recycled parts business is getting a little more strength on organic growth due to the fact that there is a mechanical component that is not present in the aftermarket product line.
The assumption on our aftermarket products quite frankly is that we think we’ve slugged through a year of integration work. Certainly our comps are going to become easier as the year progresses, but I think most importantly as I indicated I think the integration work is largely behind us.
There was significant amount of training of LKQ sales reps on new systems that’s very disruptive as well as the price list integration work we did as well as the synchronization of customer discounts. We know that we lost jobbers throughout 2008 as a result of some of that work, but that is all behind us at this point, so it’s our anticipation that with the integration frustrations buried at this point, we should see the company growth start to accelerate a little bit.
Tony Cristello – BB&T Capital Markets
So, two months into the first quarter, are you seeing better aftermarket trends than what resulted in the fourth quarter?
Joe Holsten
Yes, we are. We’re six weeks into the year, and the performance in both our aftermarket parts business as well as the recycled parts business we’re very pleased with the results we see.
They’re running the through six weeks at or over our plan in both segments.
Tony Cristello – BB&T Capital Markets
Mark, when you look at the detail you gave in the scrap category, and some of the numbers I didn’t get them all down, but I think you said the Q4 number was $38 million for scrap, it was about 8.2% of total revenue, and it was 50% recycled and 50% other?
Mark Spears
The $38 million was the total revenue of our self-service operations, and 50% of that revenue was the scrap related to the self-serve and 50% was parts related to the self-serve.
Tony Cristello – BB&T Capital Markets
Did give a gross margin number on that scrap business?
Mark Spears
I don’t want to call it scrap business because 50% of it is parts business. No, we just said that our gross profit for the quarter was $9 million positive, and we had an operating loss of $11.8.
Tony Cristello – BB&T Capital Markets
That was related to the values of scrap than it is to market place and volumes.
Mark Spears
Yes.
Tony Cristello – BB&T Capital Markets
Has the cost of those cars sort of stabilized now? Have you sort of anniversaries some of those three issues?
Joe Holsten
Yes. There’s some good progress.
The decline from the third quarter to the fourth quarter was probably $140 a car. January flattened a little bit.
Here in the second half of February, I think we’re seeing another leg down in what we paying for cars. I’d say it’s a gradual recovery that’s coming along according to plan.
I’ll leave it at that.
Tony Cristello – BB&T Capital Markets
You gave good color on Q4. What does the headwind for first three quarters that you faced from a scrap or other category standpoint look like, or is there anyway you can quantify that a little bit for us?
I’ll leave it at that.
Joe Holsten
I’m not quite sure what you are asking.
Tony Cristello – BB&T Capital Markets
How much benefit did you have the first three quarters of 2008 versus the hit that you had in the fourth quarter of 2008?
Joe Holsten
Between volume issues and prices, I think that’s pretty tough for us to really discuss that meaningfully in this call. It probably warrants some followup discussion.
I don’t think we are prepared to address that at this moment.
Operator
Your next question comes from the line of Scott Ciccarelli with RBC Capital Markets.
Scott Ciccarelli – RBC Capital Markets
Can we assume a pretty tax rate to what you experienced in ’08 for ’09?
Mark Spears
Yes. I think I said the normal rate was 39.7 or right around that.
We use 40% for our guidelines because you never know how it fluctuates between different states you are in.
Scott Ciccarelli – RBC Capital Markets
Ss auction prices have come down, does that provide you guys with incremental margin opportunities or is that pretty much a full flow through?
Mark Spears
Repeat that.
Scott Ciccarelli – RBC Capital Markets
Auction prices have come down, right? You can buy the recycled vehicles or the scrap vehicles for cheaper.
Does that give you incremental margin opportunities that you can kind of hang on to at all?
Mark Spears
Are you talking about the wholesale yards?
Scott Ciccarelli – RBC Capital Markets
Yes, the wholesale yards.
Mark Spears
On the wholesale yards, they don’t fluctuate as much, because there’s not near as much scrap that comes off those cars for the we do the cores and everything, so they have come down a little bit, which helps us because the little bit of scrap you get off of them has come down as well.
Joe Holsten
Scott, maybe another way to look at that is that we typically price our parts based on new OE parts, and whether we pay $1600 for a car or $1700 for a car, how we price the parts that we sell is irrelevant to what we pay for a vehicle.
Scott Ciccarelli – RBC Capital Markets
But the 9% you referenced was your cost for a wholesale vehicle, correct?
Joe Holsten
Yes. That is correct.
Scott Ciccarelli – RBC Capital Markets
If I remember correctly, after the third quarter, you guys talked about a pretty nice pickup in the aftermarket business. It looks like it must have softened quite a bit in November and December.
Now you’re suggesting it’s bounced back up first part of the first quarter. Can you help us understand why the growth rate might be so volatile there or why you are comfortable with, let’s call it, a mid single digit growth rate from that business when we are flat to negative for most of ’08?
Joe Holsten
I think I’d just go back to our view that the business line integration issues are behind us at this point. I think that’s probably the most important thing.
I’m not going to repeat those comments, but I would probably add to them that we’ve also had an entire year now to rework our inventory. We have rebalanced probably over $20 million of inventory in Keystone that was good sellable inventory.
It was just in the wrong market and in the wrong warehouse. It has taken us about a year to move that product out to a better diversity in the warehouse locations, and we’ve also introduced an additional product line and there are aftermarket parts arsenal that we would refer to as a value line of parts that is creating growth opportunity for the company as well.
Just to be clear, those are parts that are probably typically going to be sold to re-builder, not sold to the collision repair shops who are typically seeking platinum plus products. It’s creating a nice growth opportunity for us.
Scott Ciccarelli – RBC Capital Markets
Can you specifically address the fourth quarter? Maybe I had misinterpreted the third quarter comments, but I thought you said aftermarket was doing well, and then we finished slightly down on a quarter over quarter basis.
Was there a big slackening in November and December or was that just economic driven, Joe?
Joe Holsten
I would have to probably say it was economic driven. The mileage driven and accident rates probably continued to deteriorate or stayed soft longer than we probably would have expected.
The AllState numbers for Q4 for their collision and claims experience, I think, continued to improve from their standpoint, or get worse from our standpoint.
Mark Spears
I think actually November had the biggest drop in mileage driven within the whole year. It’s a little surprising because the gas prices were down, but miles driven dropped 5.3% in the month of November, so some of the mileage in October and November were pretty weak.
It got a little better in December, but that’s somehow tied to demand. When people really don’t drive as much, it’s going to hurt you a little bit on collision.
Joseph Holsten
Just wanted to comment on that that we are not trying to be evasive in answering your question, but in the aftermarket product lines, it’s amazing how quickly sales respond to weather events as well. Weather is a pretty big factor in the revenue trends and our aftermarket product lines, and quite frankly we’ll see revenues start to move on a daily basis within 2 or 3 days of any kind of storm activity.
I would assume modest weather conditions probably impacted the November-December results as well, and obviously we’ve seen some benefits from good weather conditions the first six weeks of the year.
Operator
Your next question comes from the line of Craig Kennison with Robert W. Baird.
Please proceed with your question.
Craig Kennison – Robert W. Baird
Joe, you said you expect to get an incremental $15 million in cost synergy from the Keystone on top of $20 million enjoyed in 2008. How much of that $15 million is already in the bag and how much will result from actions you have yet to take?
Joseph Holsten
I’d say the majority is already in the bag. The final flow-through items we’re talking about are really down in the guts and bowels of the company.
This is a truck coming off the street here and continuing to work out of a few modest warehouses. As I indicated on former calls, there’s another wave of integration savings that comes out over a 3- to 4-year period.
These are markets where we will continue to look for opportunities to merge the LKQ and Keystone aftermarket operations into a single facility. We are working one of those in Houstin right now that we would expect to be operational by the end of 2009, and there is a situation where between the LKQ and Keystone operations, we’re leasing r or 4 different facilities that have managers and administrative people at all those locations.
By the end of ’09, all those operations will be in a single piece of real estate operating from common warehouses and the ability to integrate routing, administrative functions, management functions and our sales organization have just exponentially improved, and there are probably 10 to 12 markets like that in the US that will probably take a good 3 to 4 years to get all of them.
Craig Kennison – Robert W. Baird
On the scrap steel issue, obviously there was a bubble in price, and we’re trying to quantify the impact there, but is there also bubble in volume? In other words, a lot of cars may have come out of the woodwork, and so as we model forward 2009, not only should we assume lower prices, but also fewer also fewer cars going through the self-service business?
Joe Holsten
I think that’s a fair assessment. When scrap prices briefly moved over $400 a ton or very close to $400 a ton, you’re correct, the volume of product in the market was very robust, and we’re not expecting obviously those levels of scrap prices any time soon, so yes, I would assume if the volume is available, then the market will be constrained a little bit.
Craig Kennison – Robert W. Baird
Any chance you can quantify that? Should we expect a 10 or 20% decline in volumes?
Is that a fair assumption?
Joe Holsten
Not really. It kind of comes back to what do you want to pay for the car, and that’s what we’ve been working with.
You can get all the volumes if you want if you want to pay too much for the car, so the question is what’s the volume at the price we need based on scrap, so it’s kind of hard to sit here and tell you what would the volume of the client going to be. It depends on what price we end up at.
Craig Kennison – Robert W. Baird
In terms of your guidance, what kind of potential acquisitions are imbedded in that, or would acquisitions be incremental?
Mark Spears
No. That would be incremental.
We haven’t put in any unknown acquisitions here or any that we would be working on. The only thing in these numbers is any deals that we’ve closed and we’ve talked about.
Craig Kennison – Robert W. Baird
Joe, what’s the margin profile Key List program—you’re selling parts through a different B2B channel in some cases? Is the margin profile different there?
Joe Holsten
No, it would not be different.
Craig Kennison – Robert W. Baird
Your program with Advanced Auto Parts. Any update there?
Joe Holsten
Actually it’s mildly encouraging. The results we’ve been seeing going through that program the last few weeks are annualizing around $10 million, some weeks maybe even a hair over that.
The Advanced people have put a lot more pressure on their store managers to support the program. Catalogues of recycled parts have been created and are available in the Advanced stores.
At least year over year the percentage gain is pretty meaningful, although the dollar impact of the program in the scheme of a couple of billion dollar company is still pretty nominal.
Operator
Your next question comes from the line of Michael Cox with Piper Jaffray.
Michael Cox – Piper Jaffray
My first question is on the self-serve segment of your business and the acquisition you completed. It seems to have increased your exposure to scrap and the general volatility in the market.
Are you continuing to look for acquisitions in this field?
Joe Holsten
We are not actively pursuing acquisitions of self-service businesses at this point. It seems like everybody has had a question on that.
Maybe it’s worth just taking a few minutes to retrace our background in the self-service business. We’ve been in the business for 5 years.
Our first transaction was exactly five years ago I think this week, and 19 out of 20 quarters that we’ve reported, the results of the business has really been quite attractive. Obviously, the fourth quarter suffered because of what we perceive to be an unprecedented and immediate runs in scrap prices after an unprecedented run-up in the second and third quarters, and as we discussed with Craig, obviously the volumes accelerated quite a bit in 2008 because of the strong prices.
What we wanted to profile today is as Mark indicated the self-service business is less than 10% of the total company, and again just to be clear, of the revenue generated from being in self-service, somewhere between 40% to 50% of that is really coming out of the actual sales of parts and services and admission fees that we charge. We have been busy the last 60 days addressing the overall business segment.
We’ve successfully lowered our car costs significantly, and with that the volumes have come down slightly. In Q1, we’re seeing fairly stable cost per car, and again I think we’re seeing the cost per car that we pay drop again in the end of February.
We’ve cut a lot of headcount out of the business, and if we look at our operations and overhead cost in January compared to where we were in October of last year, they’ve come down about 12% to 13%. We’ve increased prices on the parts and services at the majority of our locations.
We’re raised them anywhere from 5 to 8%. That activity took place in January of this year, and we’re developing a new point of sale system that we think is going to allow for some further enhancements in our core charges and in the fees we charge.
So we continue to like the business. We think it generates certainly gross margins and operating income margins that are consistent with our recycled parts business.
We do believe we’re living through a couple of quarter issue as the market adjusts to the wild swings of the scrap businesses.
Michael Cox – Piper Jaffray
Taking it to the next step and looking at gross margins stabilizing, it sounds like in Q1 you’re expecting that to be soft again, but is Q2 really when we should start to see a more normalized margin?
Joe Holsten
In self-service in January, we operated at a small loss. Certainly significantly less than what we saw in any of the months in the fourth quarter.
I would note that part of that loss was attributed to the fact that the majority of our self-service managers held their non-ferrous scrap in January which is being shipped in February and March, so we’re expecting February probably to be around breakeven in the business and we’re successful in moving the car cost down another $40, which we think we will be, then we should see the margins start trending back toward more normal levels in March and certainly in Q2.
Michael Cox – Piper Jaffray
My last question is if you could just provide an update on the appeals court process with the ITC?
Joe Holsten
There are probably two issues to talk about. The first is the F150 case.
All the parties involved in that, Ford, a representative of the ITC, and LKQ Keystone, all presented their arguments to the Court of Appeals. That was on February 5th, and the timing of getting a decision from the Court of Appeals appears to be pretty broad range of guesses as the feedback we’ve gotten is that we should expect nothing shorter than 4 months and nothing longer than 14 months, so we’ve got a little time to wait on that.
On the Mustang case, the parties have substantially completed their discovery. The trial will take place in front of an ITC appointed administrative law judge who is scheduled to begin the last week of March, and the ITC has set November of this year as their target date to complete its investigations.
Again, on that one, we continue to think that the issue of prior art is still at the heart of the case than legal arguments, and we continue to believe that those arguments are on our side. Operator Your next question comes from the line of Rod Lache from Deutsche Bank Securities.
Unidentified Analyst
This is actually Dan in for Rod. First of all, did you say that aftermarket was down 2% in the quarter organically?
Joe Holsten
Yes. The way to see that is look at those pro forma tables.
You can see that there.
Unidentified Analyst
Can you provide an organic number for the other two segments, a growth number for this quarter?
Joe Holsten
Yes. We don’t usually break those out, but I will say you can get close to that.
Note we haven’t done a lot of acquisitions on the recycled, and obviously we’ve given the annual revenues of those we did and when we did it, so rather than quoting me that, I’ll let you figure that out.
Unidentified Analyst
In terms of the wholesale recycling business, as cores and scrap per unit are less even though they’re not a big portion of the entire vehicle, my understanding is that in terms of allocating cost to particular part sale, you guys use kind of a historical average cost of goods sold percentage. Will the core decline and scrap decline per unit affect that historical cost of goods sold percentage materially?
Joe Holsten
We also look at projected costs. We don’t just blindly look at historical costs on that, and I think the biggest thing on that is and we have seen the car costs come down a little bit and quite frankly the scrap revenue on the wholesale car is nowhere near the percentage of the self-serve, so that’s not a big issue for us.
Unidentified Analyst
So, net-net, gross margins shouldn’t change too much in that business.
Joe Holsten
Correct.
Unidentified Analyst
On the operating expenses, in terms of the two pieces, the facility and warehouse and SG&A that went up, were you saying that the self-service business has higher percentages of those costs and that’s why they went up?
Joe Holsten
Yes. Now, that doesn’t mean all their operating expenses are higher.
The one thing they don’t have really is distribution expense. They don’t deliver parts in trucks, so you’ve got kind of a different animal there.
You’ve got quite a bit of facility and warehouse people there and the sales people who are really cashiers and things like that, and those line items, they do operate at a higher percentage, but then they have zero distribution, and you saw distribution actually improve quite well.
Unidentified Analyst
The self-serve business seemed like the other revenue business was less of a mix of total revenue this quarter, so why would the operating expenses be higher?
Joe Holsten
Because of facility expenses of the self-serve and the selling expenses really are more fixed in nature. You’ve got a yard.
You can’t cut back on your people in the yard very much because your scrap volume is down. They’re handling the parts side of the business.
Unidentified Analyst
Is there still a bid for all the commodities that you guys do take out of these vehicles? Is there still an active market in copper and platinum and steel for you to get rid of these parts?
Joe Holsten
Yes. The markets are active right now.
I am actually glad you brought that up because we did see a period of time in late November and December where in some of our ferrous markets there were no buyers, and that certainly went away at the end of the year. We have demand for both ferrous and nonferrous commodities today.
Sarah Lewensohn
This concludes our call. We appreciate you listening to us and joining us for our fourth quarter and full year 2008 results, and we’ll back with you at some point in late April or early May to talk about the first quarter.