Oct 30, 2010
Executives
Sarah Lewensohn – Director, Investor Relations Joe Holsten – President and CEO John Quinn – Chief Financial Officer Rob Wagman – SVP, Operations, Wholesale Parts Division
Analysts
Scot Ciccarelli – RBC Capital Markets John Lovallo – Merrill Lynch Nat Brochmann – William Blair Bill Armstrong – C.L. King & Associates Craig Kennison – Robert W.
Baird Sam Darkatsh – Raymond James John Lawrence – Morgan, Keegan
Operator
Greetings. And welcome to LKQ’s third quarter 2010 earnings conference call.
At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.
(Operator instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Sarah Lewensohn.
Thank you, Ms. Lewensohn.
You may begin.
Sarah Lewensohn
Thank you. Good morning and thank you for joining us today.
I -- today we announced our third quarter 2010 financial results. And with me today from LKQ Corporation are Joe Holsten, President and Chief Executive Officer; John Quinn, Chief Financial Officer; and Rob Wagman, Senior VP of Operations, Wholesale Parts Division.
Both Joe and John will provide some prepared remarks on our results and then we will open the call up for questions. In addition to those who are listening by telephone, we’re providing an audiocast via the LKQ website and of course, both have replays available that will be accessible after the call.
Before we begin our discussion, I would like to read the following. 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 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 on which it was made, except as required by law.
So please refer to our 2009 Form 10-K and other subsequent documents filed with the SEC and the press release we issued this morning for more information on the potential risks. And with that, I’m happy to turn the call over to Mr.
Joe Holsten.
Joe Holsten
Thanks, Sarah. Good morning.
Thanks for joining us today. I’m very pleased with the results we reported this morning.
We delivered a very strong third quarter. Diluted earnings per share from continuing operations were $0.25, an increase of 19% as compared to $0.21 for the third quarter of 2009.
Revenue reached an all time record of $608 million, an increase of 22.8% as compared to last year. And slightly more than half of the growth in fact 11.6% was organic growth and a result of increased recycled and aftermarket parts sales and higher commodity prices.
I believe the results showed the strength of our business model in this environment, an environment when insurers are working to hold down claims costs and car owners and professional repairers want quality repair parts at lower than OE prices. The latest data indicates that collision shops continue to increase their use of alternative parts when repairing vehicles and that the alternative part usage rate, up 300 basis points during 2009, continues its climb to higher levels.
There are other positive signs for our business. NSF, the administrator of our AQRP program and a nationally recognized standards and certification firm, announced a new automotive aftermarket collision parts certification program.
In addition to the bumper components that they certified for diamond standard and reflection, they have added bumper absorbers produced by two other manufacturers to their list of certified parts. NSF’s efforts should expand the universe of certified aftermarket parts and part sites, and reinforce the use of aftermarket parts in the collision industry.
On another front, the August miles driven figure was up 1.6%, the highest increase we have seen in the last five months. While reports on economic activity seem to foreshadow flat to minimal growth, a continuation of positive driving trends should support further demand for collision repairs and parts.
Demand for LKQ’s wholesale parts was quite strong in the quarter. Our third quarter organic revenue from the sale of all parts and services increased 8.3%.
Both aftermarket and recycled parts realized good growth. Aftermarket and refurbished revenue increased 13.2% with an organic growth rate of 8.5%.
This was the fifth quarter in a row where organic revenue growth of aftermarket and refurbished parts has run 8% or better. Organic revenue growth of recycled parts and services was up 8%, in line with growth rates that we realized in 2009.
We believe that the impact of the Cash for Clunkers program is behind us, and the aggressive car buying that we began earlier this year paid off and we were able to book more recycled inventory on our shelf to sell. During the third quarter, we purchased 49,000 vehicles for dismantling by our wholesale operations, which is a 6% increase over Q3 2009.
But you should keep in mind, last year included about 15,000 Cash for Clunker cars. So the increase in higher value salvage product is much greater than 6%.
The supply of vehicles was good during the quarter but the prices we had to pay continued to be at the high end of our historical averages. At the current volume at the auctions, the outlook for supply remains good for the balance of the year.
And with a healthy backlog of vehicles waiting to be dismantled and a continuation of our current run rate for acquiring cars, we should have sufficient inventory for our recycled business. At the same time, we are focused on the improvement of pricing to help offset the downward pressure from high auction prices on gross margins.
Turning to our Self Service Retail operations, during the quarter we purchased roughly 75,000 lower cost, self service and crush only cars. After nearly two years of fluctuation for what we pay for self service cars, prices are in line with what we are realizing on the crushed car bodies and margins have stabilized.
I anticipate the global demand for scrap will remain relatively steady and the performance of our self service business should continue at its current level. Shifting to our Heavy-Duty Truck operations, we purchased approximately 1100 units for resale or parts during the quarter.
While there were no acquisitions in heavy-duty trucks during the quarter, we remain focused on expanding the network. We are continuing to build out our marketing capabilities in this area and in addition to our focus to bring all heavy truck operations under the single IT platform.
We are working on the development of another change to facilitate part identification between operations and we are introducing some of the basic sales training and tools under the heavy-duty operations that have served us well in the auto-sided business. This was a particularly productive quarter for acquisitions.
Our acquisitions included an Alabama wholesale recycling operation near the Tennessee border that will serve the Huntsville and Birmingham, Alabama and Nashville, Tennessee markets, as well as a wholesale recycling operation in Philadelphia, Pennsylvania. These additional markets helped to expand our geographic footprint.
We also purchased an aftermarket business that had operations in five markets, four of which will be merged into LKQ facilities and one we will merge into the sellers warehouse. We added two other businesses that support our efforts to broaden our product line beyond collision parts.
They include an automotive paint distribution business in the Boston mass area and a wheel refinishing operation in Indiana. The latter, when combined with our existing wheel reconditioning business, makes LKQ the largest provider of refinished wheels in the United States.
For the quarter, we acquired approximately $115 million of annualized revenue. Once integrated, we expect about 60% of that revenue to produce in line with the company’s historical margins.
Similar to our existing Transwheel refinishing operation, the acquired wheel plant included a smelter business that operates lower margins and that revenue accounted for 40% of the acquired revenue and adversely impacts our gross margin. Through our own ground-up development efforts, we opened a new wholesale recycling facility in Denver in the third -- in the current quarter.
We had been servicing this market by shipping recycled products from our Topeka, Kansas facility. Having dismantling capabilities and local inventory in Denver along with a strong aftermarket presence should create good product selling opportunities and improve our service level.
We inevitably get a question or two on the status of our AQRP programs. We explained some quarters ago that we cannot speak to the status of specific customers who are in or not in the program, because we are bound by confidentiality agreements.
However, we are comfortable representing that we have added new carriers to these service programs during 2010, and expect to continue to do so throughout 2011. Now, I’ll turn this over to John so he can provide more detail on the financial performance of the company.
John Quinn
Thank you, Joe, and good morning. Hopefully, everyone has had a chance to look at our 8-K which we filed with the SEC early today, and as normal, we’re planning to file our 10-Q in the next few days.
As Joe mentioned, we believe the business performed very much like expected in Q3. Our revenue for the third quarter increased approximately $113 million to $608 million, compared to $495 million for the same period last year, an increase of 23%.
For Q3, our organic revenue growth was 11.6% and we had an additional growth of 11% from acquisitions. We had a small favorable foreign exchange impact of 0.2%.
Organic growth of our parts and services revenue was 8.3% and organic growth of other revenue, which is where we record our scrap commodity sales was up 37.2% as commodity prices were higher on a year-over-year basis. For Q3 2010, our same-store sales growth for aftermarket and refurbished parts was 8.5%, while our growth rate for recycled parts was 8% and our year-to-date growth rates for same-store sales for aftermarket and refurbished parts was 8.4%, recycled parts was 3.6%.
So the total same-store sales growth rate for parts sales overall was 6.5% year-to-date. You’ll notice our growth rate is now within our annual guidance range of 6% to 8%.
We attribute the reasons for growth rate picking up this quarter to the things we’ve been discussing during the last two quarters. Our inventories at the end of Q2 were in much better shape than in Q1 and we got through the Cash for Clunkers issues that were pulling down parts availability on the recycled side.
In Q3 2010, revenue for our self service business was $54 million or 8.8% of LKQ’s total revenue. Approximately 35% of this revenue was parts sales included in recycled and related products, and 65% was scrap in core sales included in other revenue.
Our acquisition revenue growth was driven primarily by the acquisition of Greenleaf. This transaction accounted for approximately half of the acquisition related revenue growth.
But I’d remind everyone that because this acquisition is now over one year old, the revenue impact will not be shown as acquisition revenue in Q4. Gross margin for the third quarter of 2010 was 43%, which is down 250 basis points from 45.5% in the same period 2009.
Last year we may have had a little benefit from the rising scrap environment. This decline is primarily related to higher costs incurred for acquiring salvage cars at auction.
Margin percentage was also impacted by higher cost for self service cars and lower margin on the scrap aluminum sales. We’ve been talking for the past two quarters about the fact that we’re paying more for cars at auction and that would put some pressure on our gross margin percentage.
We also said that we’re going to try to maintain gross margin dollars and we think the operations team did a really good job on that front. While our gross margin percentage is down on a year-over-year basis, we did see some offsetting improvements from our facility and warehouse, distribution and SG&A expenses.
In total, these three items fell from 32.3% of revenue to 30.7%, offsetting much of the gross margin decline. Our facility and warehouse expense for the quarter increased $8.7 million or 17.9% as compared to the same quarter of 2009.
Approximately $4.8 million of the growth was related to business acquisition. Facility and warehouse expense as a percent of revenue for the quarter showed an improvement to 9.4% from 9.8% last year.
Distribution expenses for the quarter increased $6.2 million or 13.5% from Q3 2009, with $2.9 in the growth related to business acquisitions. The remaining growth is primarily fuel and labor of $1 million fees and $2.6 million of volume related items such as freight and truck rentals, all of which were partially offset by an improvement of $1.4 million in our insurance and claims costs.
As a percentage of revenue, distribution costs showed a 70-basis-point improvement, up to 8.5%. Selling, general and administration expenses grew $11.8 million or 17.9% over third quarter 2009, with $2.9 million of the growth related to business acquisitions.
We also had higher labor costs to support the increased business of about $6.8 million. As a percent of revenue, SG&A expenses were 12.8% in Q3 2010, compared to 13.3% in the same period last year.
Our operating income was $65 million in Q3 2010, compared to $56 million in Q3 last year, an improvement of $9 million or 16%. Net interest expense of $7.2 million was about $600,000 better than the third quarter last year due to lower average debt balances of $47 million.
Our effective borrowing rates were 4.9% in both quarters. Income from continuing operations in Q3 was $35.9 million, a 19% increase, compared to $30.1 million in the prior year.
As Joe mentioned, diluted earnings per share from continuing operations for the quarter were $0.25 in 2010 compared to $0.21 in 2009, an improvement of 19%. Year-to-date through nine months, we’ve experienced strong cash flow from operations of $145 million, compared to $135 million in the same period last year.
During the quarter, we used cash from operations to build inventories by a little over $19 million. I mentioned last quarter that we were rebuilding our recycled inventories after a low level in Q1, although some of the expenditures reflect a higher cost of salvage vehicles.
We pulled up some of our normal seasonal bills ahead for the aftermarket business because we were concerned about shipping lanes would be tighter in Q4. During Q3, recycled inventories grew $11 million and aftermarket inventories grew by a further $8 million.
These numbers exclude inventories acquired through acquisitions. Capital expenditures for the quarter were $16.1 million, bringing our year-to-date total to $37 million.
During the quarter, we spent $57 million on acquisitions for $70 million year-to-date. During the quarter, we issued approximately 700,000 shares of stock related to exercise of stock options and that resulted in $7 million cash inflow, including tax related benefits.
Debt at the end of the quarter was $597.5 million, including $589 million under our secured credit facility. Cash and equivalents were $168.7 million at the end of the quarter.
As I mentioned in the past, we prepaid the final 2010 mandatory term loan payment. So we have no further scheduled term loan payments for the balance of the year.
Today we have no draw on our $100 million revolving credit facility and approximately $20 million of letters of credit that are back stopped by the facility, leaving $80 million available for future borrowing. Combined with the cash balances and the fact that we prepaid the mandatory term loan payment for 2010, we believe we have adequate liquidity.
During the quarter, we announced that we put two new (inaudible) hedges in place. The first swaps $250 million of floating to fixed debt from October 14th, this year through October 14, 2015.
Including the margin of 225 basis points on our current facility, which could change in the future, the interest rate on this tranche is fixed at 3.81%. The second hedge is for a further $100 million and it doesn’t become effective until April 14, 2010 and has a term through the end of our current credit facility on October 12, 2013.
Including the margin, this tranche is fixed at 3.34%. Now I’ll turn to guidance, which as always, excludes restructuring charges or gains and losses related to acquisitions and divestitures.
As noted in our press release, we are again raising our guidance. We’re increasing our previous EPS from continuing operations estimate from $1.08 to $1.14 to revised estimate of $1.11 to $1.15.
Accordingly, income from continuing operations is expected to increase from our previous $158 to $167 million to revised estimate of $162 to $168 million. Cash flow from operations is now expected to exceed $165 million and we’re updating our guidance for capital expenditures down to a range of $65 to $75 million, which is lower than the $85 to $95 million we previously expected.
We still expect organic growth of 6% to 8% for the parts and services revenue for the year. The last two quarters, we laid out some potential headwinds and tailwinds that could impact us the rest of the year.
And I thought I’d give you an update on where we see those items today. On scrap prices, Q3 was fairly flat sequentially, which means we didn’t see much in the way of a gain or loss coming through the income statement being driven by scrap prices.
At the moment, we don’t expect scrap to be a material driver to Q4 either. We’ve also been talking the last few quarters about salvage auction markets and the high prices we’ve seen there.
We saw prices peak in May and then they’ve moved sideways or come down slowly a bit between then and now. So we don’t really see a lot of risk of another spike in these costs but at the same time, we are feeling the pressure on gross margins.
We’re continuing to look at our pricing practices but these are going to take some time to evaluate and make changes where we can. And finally, we talked about potential pressure on the aftermarket margins as a result of freight increases.
Those impacts have largely started to flow through the inventory. And again, we’re looking at our pricing to see where we can make improvements.
So we don’t really see much risk on that front for the balance of the year either. With that, I’d like to turn it back to Joe.
Joe Holsten
Okay, John. Thanks.
As I stated earlier, I’m very pleased with the third quarter and John has just shared with you the revised and increased guidance for the balance of 2010. Last quarter, I said I believed that recovery will be slow with weak to moderate economic growth for the near future.
Our results this quarter demonstrate that even without the benefit of external economic drivers, LKQ was able to realize strong revenue and earnings growth. We had good organic growth in all of our product areas by building strategic partnerships with the collision repair industry and offering quality alternative parts.
We also realized growth from the successful integration of previous acquisitions. There’s a strong pipeline of acquisition candidates that if closed will help support future growth by increasing our presence in underserved markets and by broadening the products that we sell.
After recalibrating our salvage auction strategy earlier in the year and rebuilding the recycled parts inventory, we were able to generate strong results this quarter despite higher procurement costs. I expect car costs will remain at higher levels until the auto industry works its way back to equilibrium and a healthier market for new and used cars emerges.
In the meantime, we will continue to focus on other ways to improve our gross margin, build partnerships that increase the acceptance of alternative parts and identify strategic opportunities that provide results for our shareholders. Kristine that concludes our initial remarks, so we’d like to open up for questions at this time.
Operator
Thank you. (Operator Instructions) Thank you.
Our first question is from Scot Ciccarelli with RBC Capital Markets. Please proceed with your question.
Scot Ciccarelli – RBC Capital Markets
Hey, guys. How are you?
Joe Holsten
Hey. Good, Scot.
How are you?
Scot Ciccarelli – RBC Capital Markets
Not too bad. Obviously, there’s a bunch of moving parts that impacted the gross margin but any way you can help us kind of quantify the different pieces in terms of what was kind of mix shift, what was the higher prices you were paying at auction, what was the shipping impact, et cetera?
John Quinn
Scot, its John Quinn speaking. The -- I think the number one driver is just the increased salvage prices at the auction going through that line of business.
We also saw a little bit of compression in the self service because with higher prices, you tend to try to maintain gross margin dollars per vehicle. And then we had a little impact from the aluminum sales, a little smelter.
In terms of the freight costs, we’ve been able to pretty well increase the pricing on that through the control of the discounts primarily.
Scot Ciccarelli – RBC Capital Markets
So should we think about, John, the salvage was at least half of the gross margin pressure?
John Quinn
Yeah.
Scot Ciccarelli – RBC Capital Markets
Okay. And then, Joe, you talked about trying to change some of the pricing on the aftermarket and the recycled parts and you said it would take a little while.
Can you kind of walk us through a little bit of that process and what an expectation would be, a reasonable expectation would be in terms of when you might be able to realize some pricing changes?
John Quinn
Sure. Let me just sort of break it down in a couple of pieces.
One is the aftermarket and we’re, there’re always benchmarks if you will for a lot of the pricing. So we’re constantly taking a look to see what the OEs are doing.
It looks like year-over-year on our mix the OE prices are up about 1%. We tend to follow that.
And then, we also look into other things that we can do around those areas. If you think about what we consider as our low hanging fruit, implementing mandatory core charges, we raised wheel prices about $5 during the quarter, we’re seeing some pretty good acceptance on that, and I mentioned discounts with respect to what the sales folk’s discount of the list.
So we’ve introduced some reports to track discounts for what down to the individual salespersons. In the longer term, particularly on the salvage side where it’s much more difficult.
We’ve established passwords just to examine the way we look at pricing and they’re just getting kicked off, if you will, and they’re going to be making recommendations of what we can do differently. So it’s going to take some time, probably several quarters, before we figure out exactly how to attack some of this.
But in the meantime, we’re just taking a look at easy things to do. For example, we have different price books around the country.
So where products are very similar, we’re taking a look in comparing the price books around the country and just seeing if we can take things to the best-in-class if you will, look at the highest common denominator and try to challenge people if they can bring everything up a little bit.
Scot Ciccarelli – RBC Capital Markets
Got it. Thanks a lot guys.
Joe Holsten
I’ll just add one thing to that. We’ve -- through the last 10 to 12 years, we’ve -- I have felt that we’ve had a pretty robust process to evaluate pricing on a regular basis.
And in the last quarter, I asked John to lead an effort to do an assessment of the effectiveness of our process. And as you might anticipate, we weren’t as pleased with how our process was working as probably we thought we should be, process we believe could be far more robust than it is today and certainly much more disciplined.
So John is leading that effort for the company and I imagine we’ll probably end up with a centralized desk where pricing is managed for the whole company kind of under one roof and one leader. So we’re working through that as quickly as we can and as thoughtfully as we can, as the last thing we want to do is chase any of our customers away because of ill-conceived pricing concepts.
But we still look forward to sharing good improvements to come out of that process over the next several quarters.
Scot Ciccarelli – RBC Capital Markets
All right. Thanks a lot guys.
Joe Holsten
Thanks, Scot.
John Quinn
Thanks, Scot.
Operator
Our next question comes from John Lovallo with Merrill Lynch. Please proceed with your question.
John Lovallo – Merrill Lynch
Hey, guys. Thanks for taking my call.
Joe Holsten
Hi, John.
John Lovallo – Merrill Lynch
A couple questions here. One, I mean, it was certainly a strong quarter for acquisitions.
How would you characterize kind of the multiples that are being paid now versus say a year ago?
Joe Holsten
Over this year I would say I’m highly encouraged by the acquisition market right now. I would characterize the market as the best deal market that we’ve seen in 12 years.
And I would also tell you that it’s great to have a solid finance team behind us because the company is well positioned in terms of our cash availability and the liquidity of the company and the strength of our balance sheet to work aggressively and freely in what I think is a very lucrative market. I would not suggest that the multiples in the market have really changed at all over the last year.
We continue to probably pay the smallest multiple for the self service operations because they don’t have quite as robust of growth characteristics as the late model yards. The aftermarket businesses receive kind of a medium multiplier, if you will, because they don’t really have the special permits and licenses and use permits that are necessary in the recycled parts business and we would continue to pay a slightly higher multiple on the late model recycled businesses.
John Lovallo – Merrill Lynch
That’s very helpful. And the last question here, the Cap -- your CapEx forecast has come down.
What are the drivers behind that?
John Quinn
It’s primarily just timing in terms of some of the bigger projects that we had. Permits seem to always take a little bit longer than what the deal forecasted budget time.
So I would say that some of this is going to be carryover into next year.
John Lovallo – Merrill Lynch
Okay. Great.
Thanks very much guys.
John Quinn
Thank you.
Joe Holsten
Thanks, John.
Operator
Our next question comes from Nat Brochmann with William Blair. Please proceed with your question.
Nat Brochmann – William Blair
Good morning, everyone. Great quarter.
Joe Holsten
Hi, Nat. Thank you.
Nat Brochmann – William Blair
Hey, I just wanted to talk a little about with the NSF now certifying more parts kind of maybe how many parts they’re up to and whether you think then ultimately that will help your discussions then with some of the insurance agencies in terms of ramping up their quality or their alternative parts usage figures?
Rob Wagman
Yeah, Nat. This is Rob.
They have really just started putting parts in the process. The first process that they certify has to do with substandards and then start building parts to those standards.
They are -- have added already 50 parts into the system, they just announced last week and there are many more in the pipeline. It’s an interesting comment about what it means to the insurance companies.
We think it’s a very positive thing. There are several carriers that have a certification policy only, if they only write certified parts.
So the addition of these part types into the marketplace, we think it’s going to provide an actual uptick in potential revenue, because with some of the issues that NSF started to address were parts that insurance companies never wrote. Only one of the top 10 carriers even wrote core supports and bumper rebar.
So with the addition of these parts into the certified market, we actually expect some carriers to increase their usage because of that.
Nat Brochmann – William Blair
Very helpful. And do you think that they’ll be then even more aggressive over time in terms of ramping up the number of parts that they do certify?
Rob Wagman
Absolutely. Yeah.
They’ve already told us in conjunction with our manufacturers that they want more parts into the program. And we think we’re going to see cap increase their reaction to this to stay competitive.
So we think both certification bodies will add more parts into the industry.
Nat Brochmann – William Blair
Great. And then a question too about with some of the movement in terms of the convergence of co-locating some of the Keystone and LKQ facilities together, maybe a question for John.
Are you seeing a little bit of cost in terms of just the transition there?
John Quinn
I don’t know that I could point to anything specifically with respect to costs associated with putting the facilities together. We talked overtime again this margin expansion through leveraging and that kind of thing.
What I would share with you is that in the quarter, we did have some costs associated with the Nashville Accounting Center consolidation that we talked about previously. We’re bringing all of the accounting functions from our regional centers into a single shared services organization.
We had some severance and other costs there for I think it was $0.5 million.
Nat Brochmann – William Blair
Great. Thank you very much.
John Quinn
Okay. Thanks.
Operator
Our next question comes from Bill Armstrong with C.L. King & Associates.
Please proceed with your question.
Bill Armstrong – C.L. King & Associates
Good morning. So with the auctions getting back to that a little bit, if prices are expected to remain high and I think you said supply is better now, are we still seeing more competition in terms of buyers out there?
Is that what’s supporting, what’s keeping prices high?
Joe Holsten
We believe the primary impact on higher pricing at the auctions is really kind of overflow from what’s happening in the used car market. And with the wholesale auctions availability of the used cars and the pricing of the used cars at all time highs, that’s forcing new buyers to look at the salvage options.
We also believe that with the collision repair shops volumes being kind of flat in a number of markets, some of the repair shops are turning to rebuilding cars and that means that they’re also competitors at the salvage auction pools. But as we’ve moved into the fourth quarter, the volumes have seasonally come down a little bit.
We normally expect that and compared to what we were seeing say 100 days ago, the volumes at the auctions are probably down about 5%. But at the same time, when we got into early October, I’m sorry, early September and it’s continued into October, the average price that we’re paying at the salvage auctions has also been moderating.
And in the last seven weeks, I think we’ve been down a good 5% or 6% from where we were back at the beginning of Q3. So it does feel to us as though there’s some moderation in pricing starting to take place.
The volumes at the auctions are certainly robust enough that there’s plenty of product. We are assessing ways for us to bid a lot more of the product at the auctions.
I think historically we’ve bid a little over 40% of volumes at the auctions. We think there are some alternatives available for us if we can get our bid rates up to in excess of 50% of the vehicles at the auction.
So we’re coming at this a number of different ways.
Bill Armstrong – C.L. King & Associates
So looking at your gross margin this quarter of 43%, I think that’s the lowest I can recall seeing. I mean, do you think that’s bottomed out or should we kind of be looking for, going forward a 43% type gross margin?
John Quinn
Yeah. I think we don’t specifically give margin guidance per se.
But if you think about the things that impact our margin, scrap prices, rising environment, we pick up a little bit and in a falling we give a little bit back maybe. We think those are pretty stable at the moment.
Joe just mentioned salvage costs. The costs that we were paying through the summer that inventory is probably flowing through Q3 and will continue to flow through Q4.
So that’s relatively stable. Some of the cars that Joe mentioned today that we’re buying, we’ll start to part those out probably the end of November and start to see a few of those in this quarter but mostly, the balance of the purchases of this quarter will start to flow in Q1.
And I think, I mentioned that the costs in terms of freight costs, they’re pretty well baked into our Q3 numbers. So pricing, barrowing any of those things change or getting something on pricing and we sometimes get a seasonal uptick in the winter because the shops are a little busier and we get a little bit better pricing on the mix and I think let’s say the state colder at the moment.
Bill Armstrong – C.L. King & Associates
Okay. Just moving quickly then onto revenues from recycled parts.
You had a nice rebound there. You mentioned that your inventories were higher and that helped.
Was there anything else going on that might have contributed to the strong revenues? Is there anything going on on the demand side that might be pushing stronger revenues?
Rob Wagman
We do track that different trends that are hitting the industry and of course, we did talk about miles driven being up. Certainly, it was a positive impact.
We did report in our Q4 announcement an increase of alternative part usage of 300 basis points from 2008 to 2009. We certainly think that the recycled part inventory, as we mentioned, it’s been a little bit more difficult to procure salvage.
So I think that gave some runway for the aftermarket part of our business. It’s a nice fall back for us.
Certainly, insurance companies have been and will continue to look to save the claims costs. They’re going to continue to push the envelope to get costs out of their claims experience.
One of the things that we did talk about as well was the cross-selling of our reps, that’s fully been integrated now. All of our reps can sell both sides of our lines, opening up more opportunities.
With our recent acquisitions this past quarter, every one of them has already converted to our operating system. So that process is well in place there.
But clearly, I think the biggest reason for the organic growth on both sides of our business has been the strong inventory, beefing up the aftermarket inventory and then, as John mentioned, clearing out some of that Cash for Clunkers inventory with higher margin product that is now on the shelf and selling through.
Bill Armstrong – C.L. King & Associates
Got it. Okay.
And then finally, on your paint distribution business, two questions. I guess, first, just housekeeping, where -- which of your three revenue categories includes paint sales?
And can you just kind of step back and tell us, what’s the value add that you provide or what’s your competitive advantage in paint distribution? It looks like you’re pursuing that business a little bit.
I was wondering if you could just maybe talk about that a little bit?
John Quinn
Sure. Bill, we report paint sales in aftermarket.
Bill Armstrong – C.L. King & Associates
Okay.
Rob Wagman
And as far as what the value add is, this is a product that we can put on our trucks. There’s no additional trucking capacity needed.
It’s providing that one-stop shop concept to our customers that we’ve promoted over the last couple of years since we really came with the Keystone acquisition. So we are actively promoting customers basically a bundle package of all their alternative needs plus paint.
So it’s really just been a nice add-on for the shops to be able to get delivery from one vendor across all lines.
Bill Armstrong – C.L. King & Associates
Okay. So you’re not really looking at it as a standalone business, but sort of more integrating it into everything else you’re offering?
Rob Wagman
Absolutely. Right.
As we, yeah, one of the acquisitions we made last quarter was up in Boston. That’s fully integrated into our operations already, with the ability to cross-sell as well as combine deliveries.
Bill Armstrong – C.L. King & Associates
Okay. Yeah.
That makes sense. All right.
Thanks very much.
Joe Holsten
Thank you.
John Quinn
Yeah.
Operator
Our next question comes from Craig Kennison with Robert W. Baird.
Please proceed with your question.
Craig Kennison – Robert W. Baird
Good morning. Thanks for taking my question.
Joe, you mentioned that OE prices generally are up about 1%. That might have been you, John.
When does the OEM or when do the OEMs generally reset price and give you an opportunity maybe to take a little price on that level?
Joe Holsten
It’s really all the time, Craig, kind of like us, they’re in constant price revision mode and the reason, I guess, for us to track their pricing is a fairly detailed process. They don’t do 1% across the board price increases.
There’ll be some parts that go up 35% and some go down 20%. So, unfortunately, we have to kind of monitor and track that part by part, but it’s throughout the year.
There’s no and like the paint industry, typically they all bump prices in December or January. So you kind of set your clock by it but the manufacturers just constant.
Craig Kennison – Robert W. Baird
Okay. Thank you.
And then, with respect to tax policy, clearly that has been a driver to the acquisition activity you’ve seen. Are you concerned at all, Joe, that an extension of the Bush tax cuts, as it were, would actually diminish some of those opportunities?
Joe Holsten
Not at all. I think the tax -- possible tax increases just a small part of why we see so much deal flow right now.
Certainly, a few of the transactions that we’re working on, the sellers are pressing hard for a December 31st or early close. But I’ll tell you two other factors I think that are creating just as much activity as anything else.
First is the number of smaller competitors who are finding a lack of access to the credit markets and even the ones who have credit facilities in place, they’re finding this time of year when they’re ready to stock up for the winter season and they’re contacting their bank to draw down their credit lines and the bank’s saying sure, we need to see you put it under $800,000 of your own equity in the business. And then, yeah, you bet you can pull down your credit line.
And that’s -- we can count certainly several acquisitions that are kind of coming to us because of tight credit conditions. The other I can tell you kook probably sound silly but there’s kind of a new category that I term just kind of tired management and no succession plan.
And, certainly, we have a few of those on the table where people are just -- it’s been a good life for them and they don’t have kids or if they do have kids, they’re not interested in being the “junk” business. And certainly, we’re seeing more than a few people at the table who are in that category.
So I would anticipate 2011 will be just as robust as an acquisition deal year of 2010.
Craig Kennison – Robert W. Baird
Thank you. And lastly, any changes to fulfillment rates in either the recycled business or aftermarket business, given some of the trends there?
Joe Holsten
Yeah. There’s a very slight uptick in the aftermarket fill rates from third quarter of a year ago.
I think it was a little -- it was less than 100 basis points but it was up. Then, as you probably recall on the recycled parts, we track kind of the inverse of the not in stocks.
And I would say those are pretty much flat year over year. We’ve taken into account kind of the Clunkers.
The Clunkers really hadn’t hit the inventory in Q3 of last year to a significant degree. So I would think those are relatively even year-to-year.
Craig Kennison – Robert W. Baird
If I may follow up, are you able to track some of the new SKUs certified by NSF to get an understanding as to whether the insurance industry is aware of these new SKUs and are training for it?
Rob Wagman
Absolutely. We can track by the part number, Craig, right down to who’s ordered it through our traceability program.
So we have full capacity and edit desk is doing press releases as these things come out as well.
Craig Kennison – Robert W. Baird
So can you quantify at all the impact on organic growth and maybe revenue you wouldn’t have had without those parts?
Rob Wagman
Not -- the introduction of these things is so fresh, so no, not at this point. But we can track by part type the impact of any part type within our system.
Craig Kennison – Robert W. Baird
Got it. Thanks and congratulations.
Joe Holsten
Thanks, Craig.
John Quinn
Thank you.
Operator
Our next question comes from Sam Darkatsh with Raymond James. Please proceed with your question.
Sam Darkatsh – Raymond James
Good morning, Joe. Good morning, John.
How are you?
Joe Holsten
Hello, Sam.
Sam Darkatsh – Raymond James
Most of my questions have been asked and answered. I wanted to see if I could dive down a little bit more into the pricing initiatives that you have both on the aftermarket and the recycled side.
Has the spread between aftermarket and OEM parts over the last year or two contracted at all? And if not, do you find maybe that your value proposition has gotten to the point where you might be able to contract a little bit of that spread and pick up some extra net pricing in this type of freight environment?
Rob Wagman
Yeah. The pressure -- the difference between the OE and the aftermarket is pretty consistent, the price range.
We do price, obviously, in comparison to the OEs and as Joe mentioned, these things fluctuate all over the year. So we’re constantly reacting to those changes.
But as far as the spread between the OE and the aftermarket, it’s been very healthy and continues to be very good for us to be able to price our parts and give an alternative to the collision repair industry.
Sam Darkatsh – Raymond James
But wouldn’t it be to a point now where you might be able to -- because of your market positioning and your clear value proposition be able to maybe even take a little bit more in price instead of just match their changes on the aftermarket side, particularly with what you’re seeing on the freight costs side?
Rob Wagman
Well, we certainly push the envelope as hard as we can on getting the prices as close as the industry will accept it. There is a certain breaking point here a carrier may in fact go with an OE part instead of an aftermarket part.
So we have to be cognizant of the fact that we can only go so close to OE before they become -- they don’t think it’s an advantage. So we continually push that envelope as hard as we can and monitor that by our sales and being able to react to pricing whether it be both increase or decrease as necessary.
Sam Darkatsh – Raymond James
(Inaudible) question then. Why would it take a fair amount of time to get some additional pricing on the recycled side?
Would it be contractual? Would it just be harder to ascertain what the competitive environment is?
Why does it take a little bit longer on the recycled side to establish a little bit higher price?
John Quinn
It’s John speaking. One point is, we certainly have a benchmark price in terms of, for example, doors and assembly, right?
There’s no OE equivalent of a door. And so, that’s a good thing and a bad thing.
And one thing, and it doesn’t -- there’s no benchmark. On the other hand, there’s a variety of qualities as well, does something have parking lot dings or not?
And so it’s not possible for us to just say every door is a door and there’s no unique SKU, if you will, that says all of these products are the same. So, and Joe mentioned that we’re going to be cautious not to do anything that’s going to scare customers away.
But we try to understand why it is that one door sells for $700 and one door sells for $800. And why is it different across the country?
And what is the elasticity associated with that? And to pull those little nuances apart takes time and then, if you try to do an experiment, if you will, and we’re going to raise prices 5% say, and what is the impact on it?
You’ve got to do a large enough sample of a large enough product and then try to understand what the impact is. So it just takes time.
Or when you’ve got an aftermarket product and you have a recycled headlight, an aftermarket headlight, a refurbished headlight or an OE headlight, they all have the same fit form function. They all perform exactly the same.
They all fit and have the same interchange numbers. We know it’s more of a homogeneous product, so it’s easier to compare those things.
It’s easier to do specific tracking, as Rob mentioned. It’s a little harder when you get into the aftermarket, excuse me, into the salvage side, because there’s each product could be a little bit unique, a little bit different.
Sam Darkatsh – Raymond James
That’s very illustrative. Thank you.
One last question, if I might, two years ago at the end of 2008, there began a stretch where there really became a dearth of leased vehicles. And I guess the average lease time is two, three years.
So now coming off lease, there’s a real lack of vehicles. Is that on a net basis helpful, harmful?
Does it have an affect on you guys? I would think it plays into used car values to a certain degree but how does that dynamic play into your business specifically?
Joe Holsten
Well, we do believe that that is one of the contributors to the lack of product at the used car wholesale auctions, which I indicated we believe that’s creating a spillover effect of people who would normally buy at those auctions also buying and competing at the salvage pool auctions. So, yeah, we think that has been a contributor to the shortage of used cars and the high used car pricing.
I did see some speculation in the market that the used car pricing has finally reached to level it is likely to start pushing more new car sales, just because there’s so little difference between on some models now, there’s so little difference between used car pricing and new car pricing that it’s likely to be a little bit of a stimulant for new car sales.
Rob Wagman
And if I could just add one thing to that, the obviously, the benefit for us on the higher used car prices is it’s more difficult for insurance companies to total a car and therefore giving us more parts sales opportunities as well. So, while it hurts us, perhaps prevents the salvage from availability, it does provide a lot of sales opportunities.
Sam Darkatsh – Raymond James
Very good. How helpful.
Thank you, gentlemen.
John Quinn
Thank you.
Joe Holsten
Thank you, Sam. I think we have time for one more here.
Operator
Our next question comes from John Lawrence with Morgan, Keegan. Please proceed with your question.
John Lawrence – Morgan, Keegan
Good morning.
Joe Holsten
Hi, John.
John Lawrence – Morgan, Keegan
Just very quickly, Joe, most of my questions have been answered. But would you, just in your opinion, having looked at the industry for a long time and these parts certifications, what is the major factor, in your opinion now, for more and more carriers to continue?
Is it more of these certifications? Is it fill rates?
What continues to be the driving force for most of these insurance carriers?
Joe Holsten
I think it’s generally trying to remain competitive. We’ve talked about the financial returns for the insurance carriers over the last few years not being particularly robust.
Last year, for the first time I think since World War II, there were actually fewer insured cars year-on-year. So there is a shrinking premium pool.
And you’re not seeing at least, to my knowledge, you’re not seeing any consolidation in the auto insurance industry. So you have the same number of customers chasing a shrinking premium dollar pool right now and they have to be able to compete on costs.
So personally I think it’s survival.
John Lawrence – Morgan, Keegan
And secondly, thanks for that, would you -- when you look at the acquisitions, John, there’s no change from what we’ve seen over the years. You still get the scale from combining the facilities.
Anything in the model that’s different than there’s been over the last 10 years or so that would change the dynamics of an acquisition? And when you look at something like the wheel business, now that you’re the largest, do you get any scale in margin opportunities from a scale from that type of business?
John Quinn
Yeah. I think we mentioned when we did a mid-quarter press release with respect to the margin, the smelter business is very low.
So in terms of what might be different, we were just cautioning people a little bit not to apply our normal margin to all of that revenue. In terms of the wheel, the reason we bought that business, it came with a big piece of revenue from the scrap aluminum sales.
But the real reason we bought it was to get control of the cores because you can’t rebuild them if you don’t have them. And when we buy a truckload of wheels, for every 100 we may only get three to 10 wheels that we can rebuild.
The rest we just scrap. So that was really the purpose of that transaction.
We think that we will get some additional scale because of the probability of being able to fill will be higher. Because with, again, this is a product that demand exceeds supply if you will, because of a limited number of cores.
And so, to the extent that one plus one just increases the probability that we’ll be able to make the sale. So I think there will be some savings on that, probably a little bit on the SG&A piece as we’re able to leverage our sales organization.
John Lawrence – Morgan, Keegan
Right. Congratulations, guys.
Thanks.
John Quinn
Thank you, John.
Joe Holsten
Thanks. Very good.
Thanks for joining us. Look forward to our next call, when we’ll cover the fourth quarter and provide guidance for our 2011 fiscal year as well.
Thanks again.
Operator
Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time.
Thank you for your participation.