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Executives

Joseph Holsten - President and Chief Executive Officer

Mark Spears - Executive Vice President and Chief Financial Officer

Analysts

Sam Darkatsh - Raymond James

Scott Stember - Sidoti & Company

Tony Cristello - BB&T Capital Market

Scott Ciccarelli - RBC Capital Markets

Bill Armstrong - CL King & Associates

LKQ Corporation (LKQX) Q4 2007 Earnings Call February 27, 2008 10:30 AM ET

Operator

Good day ladies and gentlemen, and welcome to the Fourth Quarter 2007 LKQ Corporation Earnings Conference Call. My name is Daniel and I will be your coordinator for today. At this time, all participants are in a listen-only mode, and we will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

And I would now like to turn the presentation over to Mr. Joseph Holsten, President and Chief Executive Officer. Please proceed.

Joseph Holsten - President and Chief Executive Officer

Before we get started, I need to talk about forward-looking statements. The statements in this press release and webcast include forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our expectations, beliefs, hopes, intentions or strategies.

Forward-looking statements involve risks and uncertainties, some of which are not currently known to us. Actual events or results may differ materially from those expressed or implied in the forward looking statements as a result of various factors. These factors include the risk factors and other risks that are described in our Form 10-K filed February 28, 2007 and in other reports filed by us from time-to-time with the Securities and Exchange Commission.

We assume no obligation to publicly update any forward-looking statements to reflect events or circumstances arising after date on which it was made, acceptance required by law. I also want to remind everyone that we declared a two-for-one stock split in December 2007. So all earnings per share amount and share count discussed today reflect the split.

Okay good morning and thank you for joining LKQ Corporation's fourth quarter 2007 earnings call. On the call today are two members of management, Mark Spears and me. My name is Joe Holsten and I am the CEO of LKQ.

I'll begin by providing some high-level overviews of our performance as well as some qualitative views on the business and our industry, and Mark will provide a more detailed assessment of our financial results. I will also update you on some of our integration work relative to the recent acquisition of Keystone.

Today we are reporting a very good fourth quarter with respect to several things. First, we delivered excellent financial results for the quarter. We recorded $414.7 million in revenue for the quarter, which represents close to 103% total revenue growth over the fourth quarter of 2006.

Our pre-Keystone businesses delivered a strong quarter as our organic revenue growth was just over 13%. This is the highest level of revenue we have ever achieved in a quarter and of course the acquisition of Keystone is the major contributor to the growth.

Second, we continue to make excellent progress to leverage our infrastructure as we expanded our EBITDA margin by a 150 basis points. Our EBITDA margin was 12.2% for the quarter compared to 10.7% in the fourth quarter of 2006.

And finally, our net income increased just over 111% to $21.5 million for the quarter and diluted earnings per share increased by close to 78% to $0.16 per share.

As we've previously reported, the Keystone acquisition closed on October 12th, and their financial results are included in our financial report for the last two and one-half month of 2007.

For the Keystone fiscal year ended March 30, 2007, as a reminder, Keystone reported sales of $714 million and net income of 30.3 million. So needless to say, with an acquisition of that size. Our primary focus in the fourth quarter was a consolidation of these two businesses. The first priority we completed in Q4 was the cross reference, literally thousands of part numbers and catalog prices, and developed a common catalog for the shop estimating systems showing the same part and prices.

As Keystone and LKQ shared some common customers with different customer discounts for certain part sites, we had average and modified these discounts to what would be fair to both our customers as well as ourselves. This process was time consuming, required significant efforts by our field management, and while it is now substantially complete, discount levels will receive constant review both up and down on an ongoing basis as a key business process.

We also prepared computer conversion programs that can put customer data out of LKQ's information systems and to prelude the Keystone ERP systems. Currently, we've converted 33 LKQ or Action locations, which now sell aftermarket parts to the prelude system. This includes the physical combination of nine warehouses and thirteen aftermarket selling locations, which have or will be closed. The remaining 11 converted locations will not be physically merged with Keystone locations.

By the end of 2008, it is our plan to convert 56 locations to prelude, which includes physical combination of 25 warehouses and 14 aftermarket selling locations. You can take the selling location as a storefront with very nominal warehousing capacity.

We're also reviewing currently volumes and capacities of roughly 70 bumper wheels and light refurbishing locations to determine the possibility of consolidating some locations in the future. As part of these consolidation efforts, we've also been standardizing our refurbishing processes to achieve consistent quality and increased volumes.

While we have reduced corporate overhead as a result of merging corporate functions, there were certain functional areas where we had combined resources at Keystone and LKQ to strengthen the overall organization. These include risk management, human resources, organizational development and training, and government affair.

We previously indicated that in 2008 the cost savings and efficiency excluding any restructuring cost to be between $15 and $20 million. Based on current estimates, we believe these cost savings will be much closer to the $20 million level in 2008. We also indicated the annual cost savings and efficiencies excluding any restructuring costs would be between $25 million and $35 million to be captured over the next several years. We now believe we will be much closer to the $35 million level and we believe our ongoing efforts may identify new synergies to add to this split.

Moving onto some other acquisitions that we completed, you may recall that in first three quarters of 2007, we acquired eight businesses. These eight acquisitions consisted of five recycled parts businesses, Potomac German acquired in February and recycling business serving the professional repair market facilities in Frederick, Maryland and St. Augustine, Florida. Al's Atomic, a retail oriented recycling business with two facilities in Dallas, Texas acquired in March. Thruway a small recycling business acquired in April on 30 acres in Parryville, Pennsylvania. This facility is a startup for us to better serve the professional repair market in the greater Philadelphia area. Dominion Auto Recycling acquired in June located near Toronto, Canada, also serving the professional repair market, and in July we acquired (Pintendre) Autos a large recycled part business near Quebec City. This business primarily serves the professional repaired markets for not only automobiles but also the heavy truck and several types of light duty vehicles and operates on a property totaling approximately 125 acres.

We also acquired two small aftermarket businesses, crash parts warehouse, a small aftermarket business in Birmingham, Alabama acquired in March. And in May we acquired some body parts and after market business located in Alexandria, Louisiana. And in January 2007, we entered the head and tail light refurbishing business through our acquisition of Northern Light. These eight businesses reported approximately $53 million in trailing annual revenue just prior our acquisition of them. We made three more small acquisitions in the fourth quarter, which included northwest recycling closed in November. Our retail oriented recycle parts business in Portland, Oregon. In December, we acquired a small recycle parts business near Birmingham, Alabama, an extremely small company. It is located in 35 acres of wholly permitted property. We plan to construct warehousing and make other improvements here in 2008 and ultimately relocate our large Birmingham recycle parts business under this property late in the year.

Finally in December, we acquired a business located in California and Indiana. It specializes in buying only repair parts that can provide our recycle businesses, additional sellable products. These three businesses reported approximately $15.1 million, a trailing annual revenue just prior to our acquisition event.

At LKQ, insurance relationships and programs have always been important to us and are even more so now with our investment in Keystone. We have three insurance carriers up one up one from the prior quarter in the Midwest that directly provide us low-end cars that will some supply parts to be sold into the professional repair market and the remainder of each car being placed into retail-oriented self served locations. These three programs are providing us about 250 cars per month, and there is another large carrier, it is expected entering the recycle program shortly.

Our Right Choice Program with Advanced auto parts as revenues are continued to be annualizing in the $7 million range, separately Keystone also sells with them that are in the much lower volume. We have identified all advanced stores in close proximity to Keystone location and integrated them into the Right Choice program.

At the end of Q4, LKQ operated approximately 265 daily transfer runs, and approximately 2400 local delivery routes. We acquired approximately 32,900 cars in our wholesale recycle business during the quarter which is 19% more than we acquired in Q4 of 2006.

For the full year 2007, we acquired 126,000 such cars which is 13.1% more than the full year 2006. The percentage of vehicle we acquired from the salvage auctions during the full year of 2007 accounted for about 96% of our total incoming wholesale product growth. We continue to increase our sales staff levels for our recycle part business and we have done so by an average of 90% or 19.6% more in Q4 2007 compared to 2006. As we continue to invest and what we see to be the key to our business models, our sales and distribution system.

In summary, we are pleased with our results for the quarter and look forward to 2008. The combination of LKQ and Keystones provides an attractive value proposition to a wider ray of customers and to the insurance industry that we serve with our network of nearly 300 facilities. We are in a unique position to leverage our inventory, the aftermarket collision replacement products, recycled OEM parts, and refurbished OEM products such as wheels, bumpers cover, and light, by having the ability to sell out of these combined inventories in response to customer request.

In addition to providing an enhanced level of service to our customer, we believe the combination of LKQ and Keystone will result in improved levels of profitability as we capture the revenue and cost synergies integrating our operations.

Furthermore, I would remind you that in particular given the current concerns about the US economy, I would point out that we believe our industry is generally not a cyclical business.

At this point, I would like to ask Mark to provide more detailed discussion on the company’s financial results.

Mark Spears – Executive Vice President and Chief Financial Officer

Thank you Joe and good morning everyone. Let's take a look at the tables in our press release. I know we’ve also included a table that reconciles net income to Earnings Before Interest, Tax, Depreciation, and Amortization otherwise known as EBIDTA. We also added supplementary data schedules related to our income statement that showed growth and margin percentages.

Looking at our income statement and related tables, our fourth quarter 2007 revenue was up 102.8% to $414.7 million from $204.5 million in Q4 of 2006. Our revenue for the year grew 42.7% to over $1.1 billion compared with 789.4 million for the full year of 2006. Our organic revenue growth was 13.3% for the quarter and 12.4% for the full year of 2007.

Our fourth quarter 2007 gross margin was 44.6% versus 44.8% in the fourth quarter of 2006. For the full year of 2007, our gross margin was 44.9% versus 45.3% in the same period in 2006.

Our facility and warehouse expenses for Q4 grew $16.9 million or 72.5% over Q4 2006. The majority of this growth was from our 2007 business acquisitions and the full year impact of our 2006 business acquisitions which accounted for $15.6 million of the growth or 67% expense growth.

Excluding the effects of business acquisitions costs increases in Q4 of 2007 over Q4 of 2006 were primarily related to labor and labor related costs. This related increased staffing needed to handle parts volume growth.

For the full year of 2007, facility and warehouse expense as a percentage of revenue decreased to 10.3% from 10.9% in 2006. For the full year, facility and warehouse expenses grew $30.3 million or 35.1% over 2006. Business acquisitions represented 24 million of the growth or 27.8% expense growth.

Our distribution expenses of Q4 grew $20 million or 100.3% over Q4 of 2006, of which $17 million or 85.3% expense growth was due to our business acquisition.

Excluding the effects of business acquisitions, the fourth quarter of 2007 had increased distribution costs over fourth quarter of '06, primarily related to labor and labor related cost growth of approximately $1.2 million, and also had additional fuel cost of $1.1 million.

For the full year of 2007, distribution expenses as a percentage of revenue improved to 9.6% from 10.1% in 2006. For the full year of 2007, distribution expenses grew $28.1 million or 35.1% over 2006.

Business acquisitions represented 20.3 million of the growth or 25.3% expense growth.

Selling general and administrative expenses grew $27.9 million or 103.8% over Q4 '06, of which $26.9 million or 100.2% expense growth was due to our business acquisition.

Excluding the affect of business acquisitions, the quarter's growth was primarily due to higher compensation and fringe cost.

For the full year of 2007, SG&A expenses as a percentage of revenue improved to 12.5% from 12.9% for the same period in '06. For the full year, selling general and administrative expenses grew $38.7 million or 37.8% over 2006, of which $32.7 million or 32% expense growth was due to our business acquisitions.

For the quarter, our EBIDTA grew 132.3% to $50.7 million. EBIDTA was 12.2% of revenue for the quarter compared to 10.7% in Q4 of 2006. For the full year of 2007 our EBIDTA was 12.6% of revenue versus 11.5% for the same period in 2006. Our operating income for Q4 of 2007 grew a 135.1% over Q4 of 2006 to $43.2 million.

Operating income as a percentage of revenue was 10.4% in the quarter compared to 9% in Q4 of 2006. We improved operating margins 140 basis points with Keystone in our results for 2.5 months in Q4 2007.

An important point to remember however is the best margin for us for Keystone and the after market business for that matter in general is Q4 and Q1 with lower margins in Q2 and Q3. Keystone seasonal strength in this quarter allows little effect on our overall operating margin in Q4 2007. For the full year 2007, operating income improved to 10.9% of revenue compared to 9.8% for the same period in 2006.

We had net interest expense in Q4 2007 for – of $9.9 million compared to net interest expense of $1.7 million in Q4 2006. This was related to higher debt levels from the acquisition debt incurred to acquire Keystone on October 12, 2007.

Our Q4 2007 pre-tax income grew 98.7% to $33.7 million from 17 million in Q4 2006. For the full year 2007 pre-tax income increase 48.7% to a $108.3 million from 72.8 million for the same period in 2006. For Q4 2007, our effective tax rate was 36.1% compared to 39.9% in the same period of 2006. If you exclude certain non-taxable items and adjustments for provision for income taxes, our Q4 2007 effective tax rate would have been 39.6% compared to 39.9% in the same period of 2006. For the full year 2007 our effective tax rate was 39.1% compared to 39% in the same period of 2006. If you exclude certain non-taxable items in adjustment through the provision for income taxes, our effective tax rate for both the full year of ‘07 in the full year 2006 would have been in 40%.

Net income for the quater increased 111.3% to $21.5 million from 10.2 million in Q4 2006. For the full year 2007 net income increased 48.4% to $65.9 million from 44.4 million in 2006. Our diluted earnings per share increased 77.8% to $0.16 in the quarter from $0.09 in Q4 ‘06. For the full year 2007 diluted earnings per share increased 37.5% to $0.55 from $0.40 of 2006.

Our diluted weighted average common shares outstanding use for EPS purposes for as follows; Q4 2007 at a 148.8 million shares versus Q4 2006 to 112.3 million shares. Full year 2007 at a 119.9 million shares, versus full year 2006 at 111.6 shares.

Let’s take a look at our cash flow table now. We generated 54.4 million in cash from operation during 2007, which included the effect of investing 35.1 million in additional inventory. CapEx in 2007 excluding business acquisitions was $38.4 million. Cash paid for business acquisitions in 2007 was $868 million which included 806.8 million for the Keystone acquisition.

On September 25, 2007, we completed very successful a public offerings of 27.6 million share of common stock at a price for share of the public of $15.50. The offering included 23.6 million shares sold by LKQ and 4 million shares sold by selling stockholders. The shares sold by LKQ included 3.6 million shares sold pursuant to the exercise of the underwriter’s over allotment option. We received approximately $349.5 million in net proceeds from the sale of the shares by us in the offering, after deducting discounts and commissions and the estimated expenses of the offering.

During 2007, we also issued stock related to the exercise the stock options the resulted in shares issued in dollar proceeds received that totaled 3.9 million shares for 31. .3 million in proceeds, which includes related tax effects. In addition we retired 200,000 shares of redeemable stock to $1.1 million related to a 2003 business acquisition.

And looking at our 2007 balance sheet, you will note we had 658.5 million in debt that included 650.3 million under our unsecured credit facility. We also had 74.2 million in cash and equivalents as a result of our public offering completed the last week of September.

Note that we obtained a senior secure debt financing facility on October 12 to fund a portion of the Keystone acquisition. As of February 26 2007, we had outstanding debt under our debt facility of approximately $650 million and cash and equivalents of around $45 million. On October 18, 2007 we filed a Form 8-K with the SEC that gives a summary of our new debt facility and includes a copy of that credit facility.

Let's look at our 2008 financial estimates. We expect that 2008 organic revenue will grow by approximately 10% with the balance of the growth being the full-year impact of 2007 business acquisitions. Excluding the effect of any 2008 restructuring expenses, we may have related to the Keystone acquisitions, we expect full year 2008 net income to be within the range of a $102 million to $108 million and diluted earnings per share to be between $0.73 and $0.77.

We anticipate the net cash provided by operating activities for 2008 will be over $85 million. We estimate our full year 2008 capital expenditures related to property and equipment excluding the expenditures of LKQ to acquire businesses will be between 65 million and $75 million. This includes about $10 million related to capital expenditures we’ve really planned for late 2007 on projects that were delayed into 2008, and approximately 4.8 million related to restructuring our after-market business as a result of the Keystone acquisition.

We estimated the weighted average diluted shares outstanding for the full year 2008 will be approximately $140 million. These share numbers are estimates and will be affected by factors such as any future stock issuance, the number of our options exercises in subsequent periods, and changes in our stock price.

I'd like to return back to Joe for any further comments and we'll open up for Q&A.

Joseph Holsten - President and Chief Executive Officer

Daniel, I think we'll just go right to the questions please if you could open the system up please.

Question-and-answer Session

Operator

Yes sir. (Operator Instructions). The first question comes from the line of Sam Darkatsh with Raymond James. Please proceed.

Sam Darkatsh

Good morning Joe, good morning Mark.

Joseph Holsten

Good morning.

Mark Spears

Good morning Sam.

Sam Darkatsh

A few questions here; first of there was a fair amount of snowfall in Q4 and here in the Q1. Could you see if you could at least directionally help us with how that helped the total business? I know October was a little soft heading into the quarter and what you’re seeing in the Q1 here, Joe/

Joseph Holsten

Yes, good point. Certainly the crash part business, I think, got a little wind in the sail in early to mid December from some early winter activity and selective market size certainly continued into the first quarter. If you look at the belt between the Oklahoma, and the Kansas market up through was constant and Illinois, we enjoyed very strong results. They’re certainly in part weather related. Other parts of the country have not been blessed quite as much. You know, Texas after a really good fourth quarter has been fairly dry so far, and in the first couple of months of this year, the Florida market and southeastern US remain in drought conditions and when you see the mid atlantic states and New England, just over the last couple of weeks that we started to see some favorable kind of weather impacts in those markets. So, kind of balanced we've certainly enjoyed some good benefits in a number of markets, but a substantial part of the country has not really participated in what we’ve seen here in the Midwest.

Sam Darkatsh

In Q1, so far in the first couple of months, would you characterize your organic sales growth pretty similar to what you saw in Q4?

Mark Spears

Alan, I would say may be not quite strong as 13%, but I would say we’re happy with what we are seeing so far.

Sam Darkatsh

Okay. Second question, Mark, what are you looking at in terms of expected restructuring P&L impacts in ‘08 and then the tax rate in ‘08, how we should be modeling for those two items?

Mark Spears

Yeah, let me take the last part first. You know, our tax rate will be around 40%, and that’s why I started to put in my script a little bit talking about, when you pulled out life insurance proceeds and the things we had this year, what the real effect of rate was, and that would be included with Keystone merge. As far as the restructuring expenses hitting P&L, that’s stop while we planned out, what that will be. To the extent, we let people go that are on Keystone books, purchase accounting part of that is going instead well to extend it drivers on LKQ drivers, it could hit the P&L. So at this point, it’s pretty hard for us to tell you what that split is, even though we’ve laid out head count numbers and things like that that we are looking at.

Sam Darkatsh

Something perhaps similar what we saw in Q4 for the next couple of quarters?

Mark Spears

Yeah, I mean, that’s pretty small. I think the after tax was like $230,000 and was the effect of restructuring. It gets more until we start negotiating and get out of certain leases that they will have to look out in that. (Inaudible) we are not too worried about whether; we explain what it is and where it hits for me on statement of the balance sheet.

Sam Darkatsh

In terms of Keystones, if you had owned it both last year and this year in Q4, what was the organic sales growth in Keystone in the quarter and what are you projecting for ‘08 versus your organic business?

Mark Spears

Yeah, I mean, as we are doing various things here and negotiating discount whatever, we’re not really going to be disclosing that. We’re going to looked out as a combined company here, so we are not going to dig out Keystone’s Q4 revenue. Keep in mind, we had about 2.5 months not the whole quarter, and also keep in mind in their prior quarters they didn’t really end at the last day of a quarter, it was always five dice system. So it’s a little hard for us to dig right that out anyway, and as we start moving business between each other, it’s going to be even harder. So we are not – its going to be disclosing that.

Sam Darkatsh

Let me rephrase the question. Keystone’s organic sales growth in Q3 as I recall was a little soft and there was some talk that there was some – the reason for that was because there were some discounting in the industry and you talked about that you have modified a lot of the discounts in the integration process, are you at least seeing a bit of a recovery in Keystone’s sales growth rates from what you saw in the summer and late fall at present and if you have seen a bit of a pickup, would you expect that to continue?

Mark Spears

I think while we saw is going in to December, we started to see some acceleration and it got continued at the end of the first quarter. But, I think, what it was so far this year is it -- these are naturally pretty strong sale seasons for the after market side of the business. So it’s really hard for us to kind of segregate how much of the improvement is coming from the kind of rationalization of some of the markets as opposed to what was happened ordinarily because of the seasonality.

Sam Darkatsh

Would you be disappointed that Keystone didn’t provide a 10% sort of -- or close to company average sort of organic growth rate, which would be disappointed if that didn’t happen?

Joseph Holsten

You know, our overall goal for 2008 is for roughly a 10% organic growth. So lets probably set our internal budgets and management’s bonuses and pay outs fully based on that. Just be clear that there will be some account losses, we’ve made a lot of changes and we’ve moved our price list around, it’s settled with customer discount or merging businesses, moving deliveries from one driver to new drivers. There is bound to be some modest amount of customer you know, I will just tell you, I think we are on it, and our field management very in tune to and in accordance with the revenue base and a revised focused on protecting the customer base and growing our market share of that customer base.

Sam Darkatsh

Your 10% guidance for organic sales growth excludes Keystone by definition, or wouldn’t it for the vast majority of 2008, because it's organic?

Mark Spears

No. No, it’s going to happen in 2008, as we mix businesses. We are not going to know, actually organic, and if we start giving businesses Keystone and vice versa, -- in that context we are really talking about over the combined company.

Sam Darkatsh

Got you. Last question and I will refer to others. The acquisition pipeline, I know you made a couple of small deals after the Keystone deal was consummated in October, would you expect that sort of cadence or would you expect to be a little more reserved or circumspect with acquisitions in 2008, while you integrate the two businesses?

Joseph Holsten

I think it is fair to say, we will definitely say, focused on the Keystone acquisition, you know, the integration, I think last time I used the term, it would be actively on the sidelines and I think that’s still a fair characterization. During the quarter, we have submitted a couple of offers to acquire business, they were rejected. It is our intent to you know, what we charge it, we are going to negotiate, urge for and try to give what we think a fair price to our shareholders. We will be – I would say that next quarter or two we'll really be in a phase of evaluating alternatives to kind of set our priorities when we do fully reengage in the deal market.

Sam Darkatsh

Thank you, gentlemen.

Mark Spears

Thanks Sam.

Operator

Your next question will come from the line of Scott Stember with Sidoti & Company. Please proceed.

Scott Stember

Good morning.

Joseph Holsten

Hi, Scott.

Mark Spears

Good morning Scott.

Scott Stember

Could you disclose what Keystone sales were in the quarter?

Joseph Holsten

Yeah, I think again, we started merging businesses and moving accounts and revenue from LKQ operations within about 10 to 12 days after the close. So, unfortunately the revenue has been blended very quickly.

Mark Spears

Hey, going forward we are not going to be able to be breaking out Keystone versus the others. And keep in mind, we didn’t have all the whole fourth quarter, we had for two and half months. So that’s why we are not really getting into that disclosure.

Scott Stember

Fair enough. And just taking a high level look at the integration, I think some of things that you have to do yet, you guys touched on that already, but you had a stake where we are in a (9 inning) baseball game, how far we are with the integration and do you another look at your crystal ball as to when it would be done, just do that?

Joseph Holsten

I would say here in late February maybe we are in at kind of the third inning of that process. We talked about conversions on the prelude or well over 50% Dynamat, a lot of the heavy lifting remains to be done on the major warehouse consolidations. As we have said, we have 25 warehouses to be combined. We have done 9 so far and of those 9 that are completed as 6 or 7 of those were pretty easy consolidations. We would expect to have a warehouse consolidation completed by the end of the year. And the headcount area, to incorporate and I will call operating and non-operating positions with price band about a 125 people taken off the payrolls through the end of January, through the end of fiscal year '07 only a few route reductions have been achieved. So that scenario where significant work remains to be done is in the routing, you know, something we think we will achieve through attrition.

Corporate cost those are in the bank, reducing the board positions, lowering director and officer insurance cost, lowering audit fees, the general public company cost of Keystone, those have all been eliminated. And a area where a lot of work has been done, but the financial results phase in differently over 2008 would include things like – we have been able to lower the liability and insurance premiums for the company be leveraging our purchasing power. Third-party freight carrier rates have been negotiated down. That would include ocean freight that will be phasing in fairly early in the year. We have been able to lower the administrative cost associated with administering our medical benefits plan. But we won't see those cost benefits until second quarter or the middle of the year; same thing with administration of the 401(k) Plan. Those costs have been identified to come down but we won't start seeing that just quite yet.

We renegotiated lot of the costs of our products in the terms of obtaining volumes, discounts, and purchasing discounts. That really gets phased in as we turn the inventory at this point. Marketing costs have been reduced. Those are hitting pretty early in the year and then the reduction of some of the outside consultants being used by Keystone will start showing benefits here in the first of 2008. So it’s a pretty lengthy list of things and I would say third, third to fourth inning is probably a good characterization.

Scott Stember

Okay. And you talked about some of the bumper remanufacturing capabilities and what you plan to do. Can you talk about Keystone's facility that they had opened up in Mexico and where that stands and what your plans are for that?

Joseph Holsten

Yeah, absolutely. The facility in Mexico, our plans initially were just to get the production up on that which we did. Our business plan for next year calls for about another 10% increase in volume. So, we should see the facility running over 300 bumper covers a day. The work that's being done on the bumper covers there, essentially all covers will probably be disposed off in the US. So, a lot of there productivity in terms of the bumpers per person or bumpers per person per day is lots than what we see in the US markets. The people are repairing bumpers that would be non cost effective in the US.

I think probably the enhancements we've made there is that we've been able to leverage, I think the data points for LKQ, the recycled side of the business really understanding what product has actual demand and based on that we've been able to create a build list. We're doing all of our sorting in the US now linking the products to that build list to make sure that what goes Mexico we actually have demand for in the United States and accordingly we've seen the amount of actual scrap in Mexico come down to a pretty acceptable level. So that's the plan for 2008. We'll continue to focus heavily on the type of products that gets sent down there making sure that we will have strong demand for that product with good pricing in the US and to bring the production up by about 10%.

Scott Stember

Okay. Just two quick last questions. Could you just comment on the auction activity? It appears that it was robust for you guys at least at auction. And also talk about Ford and the ITC where that stands right now?

Joseph Holsten

Sure, on the auction front, I would say that the fourth quarter of 2007 was relatively normal. I would not characterize it as being particularly strong or weak. As we moved into the first quarter, however, I would characterize the salvage pool environment as robust. We don't attend all of the auctions in the U.S. but we are certainly the best snapshot, you can get unless Copart opens up their data to you. We've had some weeks where we've seen 50,000 to 52,000 vehicles at the auctions and we've probably increased the number of auctions we attend compared to last year. But last year, a typically week may have been 44 or 45,000 vehicles per week. So there is a lot of products out there, at least right now and we're taking advantage of that to build our backlogs up.

In the self service business the end-of-life vehicles -- the competition for those vehicles have accelerated throughout 2007. And that acceleration is continuing into 2008, given the pretty high scrap prices that we see. Regarding Ford ITC the appeals by both parties have been filed. There's a federal circuit court that's dedicated specifically to intellectual property claims. It's our view that they are going to delay reviewing these appeals until that court has reviewed another case which is known as the Egyptian goddess case. So, we don't think that it's likely that we'll see any decision from the federal court of appeals until very late this year, possibly even into 2009.

Both sides are, we do continue some mediation discussions with people of Ford with the, while I don't see personally that the mediation discussions are going to result in something that will resolve our dispute with Ford regarding the design patterns. I have been encouraged that mediation discussions may service some business opportunities. We think we enjoy pretty strong relationships with a number of OE's and we would love to also be in that position with the Ford Motor Company. So I knew we had been encouraged but there are some very modest business opportunities there being surfaced as a result of those discussions.

Mark Spears

Just wanting to follow-up on the procurement and (Inaudible) questions on it. Joe said Q4 wasn't really robust and I know the next question is, and then why did you buy 19% more cars year-over-year. You got to back to Q4 '06 and that was a quarter I think we actually bought 1% less cars in Q4 '06 then Q4 '05. So that’s kind of a more of a factor of what the environment was a year ago. And Q4 '06 and even Q1 '07 was a little weak for us in the purchasing as well as pricing.

Scott Stember

All right, that’s all I have. Thank you.

Joseph Holsten

Thanks Scott.

Operator

Your next question comes from the line of Tony Cristello with BB&T Capital Market. Please proceed.

Tony Cristello

Thank you. Good morning gentlemen.

Joseph Holsten

Hi, Tony.

Tony Cristello

I guess Joe, you only had a few months in and you've already adjusted cost savings to the higher end of your prior range. Can you comment maybe on some of the areas where you're finding even greater cost savings opportunities versus with what you've seen so far at Keystone?

Joseph Holsten

You know, you're talking about things other than what we just kind of went through and the cost lift.

Tony Cristello

Well certainly, I mean you had a prior guidance range of expectation and sounds like that’s been bumped up, and that there is certainly opportunity for more. And I'm just wondering is there anything in particular that you found, perhaps some wasteful spend areas at Keystone or maybe a different approach to spend on their business than you would have done that a forging opportunity for greater cost savings?

Joseph Holsten

Well some of the areas that we've think so far, we've really hadn't counted on some of the consulting costs that we've identified. So those have been kind of upside items for us. Some of the expenditures in the marketing area have, were greater than what we had expected that’s been clear. I think in the administrative management of benefits healthcare for 1-K, those are other areas where the costs savings are surprising us a little bit on the upside. And quite frankly some of the head count moves that our team running the business have achieved, there coming in slightly stronger than maybe we had initially expected.

And some other areas that -- yeah I think we will continue to look at because we are focused heavily on them and certainly in the bumpers and the wheel area. We believe we haven’t completed our assessments in these areas, but we think there is likely some additional benefits to the company that will come out of those areas over the next one to two years as we are able to dig a little deeper into those production facilities.

Tony Cristello

Do you think, you will continue with the cross-talking processes that Keystone have implemented?

Joseph Holsten

Yeah, it’s a good question. The first observation you will make is our view first of all during the first quarter, when it is kind of you know, otherwise swinging their elbows to try to service the customer when things are pretty busy, it is not a great time to settle with your distribution systems. So, we left this distribution system kind of untouched here and we will focus little bit more on that when the peak business activity falls off a little bit. But since we closed on the deal, we have been reviewing the positives and negative aspects of the cross-talks and it is pretty difficult to apply one set of rules, if you will to review the viability of those. We think we have a cost pretty well isolated and understand those. Its benefits that may not be quite so obvious and those benefits can be cut the measures, such as refill rates or inventory return and the avoidance of relocating entire facilities to larger warehouses.

For our 2008 plan is that we expect to be able to improve the leverage from the existing cross-talk structure by putting the same or more volumes through that investment with really very nominal increases in cost. Our plans for 2008 do not specifically imposing any cross-talks, our plans do not include opening up any new ones either nor do we are spending any effort accepting the opening the new cross-talks. One thing we will do definitely in 2008 is we will go more containers direct to the major warehouses and circumvent sending as much product through the cross-talks. We estimated perhaps 10% of the volumes is going through the cross-talks today, perhaps that can be moved to container direct by taking advantage of our Taiwan trading company and avoiding the double handling.

Tony Cristello

And that should serve, wish you of a more evaluation process and then will see some potential changes in 2009 with respect to that?

Joseph Holsten

I think it has a fair assessment Tony.

Tony Cristello

Okay. And another question was very different compensation structure in place for Keystone sales force versus what you had in place for LKQ?

Joseph Holsten

Yes, number of the inside Keystone service center people are generally hourly paid people, where as I think 100% of the LKQ in action sales people are commission based. To the contrary the driver reps on historically in Keystone are compensated kind of a combination of a base pay plus a fairly modest commission, where as the LKQ drivers are virtually all straight hourly paid people.

Tony Cristello

And are you in a process of converting everyone too, is that part of the sort of plan to have one of the same page at some point?

Joseph Holsten

While, what we have done is to make, as the work gets shifted from one business activity to other business activity, it’s our plan to kind of re-cut the commission levels. So people who are doing more work are going to get paid slightly more for it. But the people who are getting kind of windfall of additional revenue to manage don’t necessarily get a windfall in their pay.

Tony Cristello

Okay.

Joseph Holsten

We are seeking kind of share of that between our shareholders and the employees.

Tony Cristello

Okay. And just two quick ones and I let someone take over. Facility and warehouse on a margin basis saw a big improvement this quarter. Mark is that something we should think is sustainable going forward and the second question would be you made small acquisition with respect to company that specializes in buying OE repair parts. Can you maybe give a little bit more explanation on that and how you intend to grow that business?

Mark Spears

Yes about facilitating warehouse and that's why I added a little point in my script. You got to be a little careful just baking in margin improvement for us when we didn’t have Keystone, and how we ended up with Keystone, when that’s one of your stronger Keystone quarters, Q4. So we will continue to get margin improvement, but it was kind of drastic. And as you know, just asked by ourselves in some of the slower quarters, we don't get quite the same kind of margin improvement. So, if that extra volume is coming through your given footprint and that's not a quarter that really hurt us from their margins have been lower than us, but in that period they are not. So kind of watch that when you kind of model out. As far as to the company, we bought -- that's a small company and the company was able to go out and get some bulk buys of certain types of OE products. And they can had an expertise of getting it and that we are selling and I will bring that expertise of getting it and we want to be the guys, who sale for the most part. It was more of a supply type arrangement.

Tony Cristello

Okay, great. Thank you guys.

Mark Spears

Thanks Tony.

Operator

Your next question comes from the line of Scott Ciccarelli with RBC Capital Markets. Please proceed.

Scott Ciccarelli

Hi guys, it’s Scott Ciccarelli. How are you?

Mark Spears

Good.

Scott Ciccarelli

Good. Couple of questions, first of all can you guys give any kind of description, I know it's still early, but you know what kind of impact improved in stock rates or having with customers. I know, there is obvious cost synergies here, but can you give us a description on what's going on the improved in stock rates?

Joseph Holsten

Yeah that’s really a tough to answer at this point. We are moving products from one warehouse to another. We are increasing the number of SKUs that we hold in most warehouses and particularly we are introducing a value line specifically into the Keystone operations that's a new product present to sale which we hope, we will help them achieve their top line growth goals for the year and finally the methodology historically used in Keystone to measure in stock, we don't think is really probably the most meaningful measurement, so we are redeveloping the measurement tools to be used to evaluate in-stock levels.

Scott Ciccarelli

Okay. It sound like, it is still early.

Mark Spears.

It was so in the quarter, it is busy anyway. So that's not the best quarter, you want in a snapshot measure your fill rate anyway.

Scott Ciccarelli

Alright that's fair. Now that the push back that you had from customers, where you had customers kind of turned away from you guys, was it pricing or were there other facets. They don't want to be so tied to the combined company. Is there anything else that may have impacted those relationships there?

Mark Spears

Yeah, I hope I didn’t kind of over state that as an issue or a concern. But we have noticed for the last two years frequently when we acquired businesses, revenue growth can go sideways or get stalled. And a lot of that where businesses acquired brokered, like in the recycled business, a lots of sales, other yards, or the ability to broker parts from other yards frequently comes to a halt or at least temporarily stalled, when we have acquired businesses. So this is really something we have been kind of working through for several years now. What is the sort of situations, we may see here would be where there are jobbers who were acquiring parts from Keystone or LKQ and they have made a decision now that they would prefer to buy from someone other than our company or may be even try to go container direct.

Keystone did have a fairly modest business, where they were selling after market parts to other retail recyclers' traditional competitors of LKQ, a very small piece of business, but a lot of those recyclers they don't want to do business with parts and they'll seek out other suppliers and that's fine with us. Really, may be the other thing that we witnessed on some occasion is that a lot of the professional repair shops will want to use two top suppliers and prior to the acquisition, Keystone may have been the top supplier and LKQ was a backup supplier. Now, that we've put the businesses together some of those shops are looking for a new second supplier.

In theory, if we have our inventory working right and delivery systems working well, we should not suffer really much or any revenue loss associated with that. Concerned with the pushback from what we have done with our price list or discounts, I would say that's been a very negligible issue for us. We will be starting a process to scale over the next couple of weeks, where we'll be kind of going back to the full process the second time reviewing activity on an account-by-account basis and making a determination whether or not we need to make further adjustments. I think we're on.

Scott Ciccarelli

Alright. That's helpful. And, then just one last quick question? It sounds like you guys still have more expense reductions kind of in the back pocket that's going to be implemented during the course of '08. Are there are any big incremental costs outside of restructuring that you may still need to incur?

Mark Spears

You mean in terms of capital?

Scott Ciccarelli

Yeah.

Mark Spears

Well, we did put in that we are going to spend all 4.8 million at extra CapEx, because of merging businesses together. We are going to have some talk and they're in our cash flow outlook numbers kind of mixed in there. We're going to have cost to get us some leases. We're talking about merging 25 warehouses. We're going to have to, you know, some of them may be almost up. So, we just finished paying rent for a little while and that's going to be those kinds of restructuring costs. If it's an LKQ lease it's going to go to P&L. If it's Keystone and if there is goodwill on the purchase accounting. So, we're going to have that, but that is built on our cash flows.

Scott Ciccarelli

Okay. And, I'm assuming the same on IT, as you roll out systems et cetera.

Mark Spears

Yes. I mean, that's in our numbers. I mean, we did detail budgets for 2008, for them and us combined, so that would be include in our numbers. But I can't think of anything that's big enough that would come out of the ordinary that would mess us up on the cost side.

Scott Ciccarelli

Okay. That's what I was trying to get to. Alright, thanks a lot guys.

Joseph Holsten

Okay. We've run over a little bit. I think we would take one more question and then call it a call.

Operator

Your next question is from the line of Bill Armstrong with CL King & Associates. Please proceed.

Bill Armstrong

Thanks. Most of my questions have been answered. I just have two housekeeping questions really for Mark. For '08, what's your best estimate for depreciation and for interest expense?

Joseph Holsten

We haven't put those out. I mean, you know our bank loan is LIBOR plus 225 and you kind of see what that is looking at up. You know, we're looking at some potential interest rate swaps here. You can probably find all that information, that's kind of open information out in the market. I don't want to put out a depreciation guidance, right now. We don't really put our guidance to that level.

Bill Armstrong

Okay. And then in terms of working capital, you just sort of back the envelop looks like you're working approval will be a net use of cash by may be 40 million or something thereabouts.

Mark Spears

Well, we said cash flow from operations would be at or above $85 million positive.

Bill Armstrong

Right. So, when you think your net income and depreciation as that is which is well above the 85 million, I would imply that working capital being use of cash. So, will you be basically increasing inventories on a per location basis?

Mark Spears

That's seasonal. We had actually done that. Our inventory went up quite a bit in Q4 from sellers and aftermarket, because we hit that in Q1 side of the business. To say, we're going to be increasing inventories from December to December '08. Yes, as we grow we put that in there, but not any faster than our revenue growth.

Bill Armstrong

Okay. So, pretty much just growing inline with revenue.

Mark Spears

Yes.

Bill Armstrong

Okay. Alright, thanks. That's all I had.

Mark Spears

Okay.

Joseph Holsten

Alright. I would like to thank everyone for calling in. I apologize, we've run over here. I know there's a lot of earnings releases going on today, since you all have pretty busy scheduled. So I look forward to talking to you in about 60 days to update you on the first quarter of '08.

Operator

Ladies and gentlemen, this concludes your presentation. You may now disconnect and have a great day.

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