LKQ CORP - 10-Q Quarterly Report

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

	For the Quarterly Period Ended September 30, 2004

	OR

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

	For the Transition Period from to

	Commission File Number 000-50404

LKQ CORPORATION

(Exact name of registrant as specified in its charter)

DELAWARE		36-4215970
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

120 NORTH LASALLE STREET, SUITE 3300, CHICAGO, IL		60602
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s telephone number, including area code: (312) 621-1950

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes o No ý

At November 9, 2004, the registrant had issued and outstanding an aggregate of 20,248,103 shares of Common Stock.

PART I
FINANCIAL INFORMATION

Item 1. Financial Statements

LKQ CORPORATION AND SUBSIDIARIES

Unaudited Consolidated Balance Sheets

	September 30, 2004			December 31, 2003
Assets

Current Assets:
Cash and equivalents	$	3,082,635		$	16,081,525
Receivables, net	26,410,518			22,542,049
Inventory	64,657,402			54,003,694
Deferred income taxes	1,259,100			421,600
Prepaid expenses	1,435,040			2,656,567

Total Current Assets	96,844,695			95,705,435

Property and Equipment, net	66,703,911			43,892,930
Intangibles
Goodwill	88,868,317			50,799,361
Other intangibles, net	43,372			46,910
Deferred Income Taxes	5,821,300			8,555,700
Other Assets	4,969,483			4,153,572

Total Assets	$	263,251,078		$	203,153,908

Liabilities and Stockholders’ Equity

Current Liabilities:
Accounts payable	$	7,680,573		$	6,831,288
Accrued expenses
Accrued payroll-related liabilities	5,664,198			4,661,126
Accrued procurement liability	1,196,000			1,179,000
Other accrued expenses	8,030,566			5,266,813
Deferred revenue	2,386,776			2,029,572
Current portion of long-term obligations	312,564			1,553,274

Total Current Liabilities	25,270,677			21,521,073

Long-Term Obligations, Excluding Current Portion	36,001,554			2,444,118

Other Noncurrent Liabilities	4,181,839			4,561,084

Redeemable Common Stock, $0.01 par value, 50,000 shares issued	617,027			617,027

Commitments and Contingencies

Stockholders’ Equity:
Common stock, $0.01 par value, 500,000,000 shares authorized, 20,187,553 and 19,476,831 shares issued at September 30, 2004 and December 31, 2003, respectively	201,875			194,768
Additional paid-in capital	199,634,867			191,602,265
Warrants	318,188			507,962
Retained earnings (Accumulated deficit)	(3,892,716		)	(19,432,889		)
Accumulated other comprehensive income	917,767			1,138,500

Total Stockholders’ Equity	197,179,981			174,010,606

Total Liabilities and Stockholders’ Equity	$	263,251,078		$	203,153,908

See notes to unaudited consolidated financial statements.

LKQ CORPORATION AND SUBSIDIARIES

Unaudited Consolidated Statements of Operations

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003

Revenue	$	106,045,357		$	83,472,462		$	310,996,327		$	243,745,537

Cost of goods sold	57,361,745			44,431,543			165,875,941			128,906,982

Gross margin	48,683,612			39,040,919			145,120,386			114,838,555

Facility and warehouse expenses	12,054,922			9,972,850			34,583,750			29,153,678

Distribution expenses	12,524,453			8,893,084			34,951,953			25,674,970

Selling, general and administrative expenses	14,333,426			12,288,176			43,580,100			35,014,550

Depreciation and amortization	1,795,464			1,325,306			5,017,306			4,070,511

Operating income	7,975,347			6,561,503			26,987,277			20,924,846

Other (income) expense:
Interest expense	318,400			643,356			1,130,124			1,845,805
Interest income	(7,398		)	(2,920		)	(28,451		)	(14,182		)
Other (income) expense, net	116,828			50,294			(29,569		)	(110,710		)

Total other expense	427,830			690,730			1,072,104			1,720,913

Income before provision for income taxes	7,547,517			5,870,773			25,915,173			19,203,933

Provision for income taxes	2,985,000			2,352,000			10,375,000			7,626,000

Net income	$	4,562,517		$	3,518,773		$	15,540,173		$	11,577,933

Earnings per share, basic	$	0.23		$	0.25		$	0.78		$	0.76

Earnings per share, diluted	$	0.20		$	0.22		$	0.69		$	0.68

See notes to unaudited consolidated financial statements.

LKQ CORPORATION AND SUBSIDIARIES

Unaudited Consolidated Statements of Cash Flows

	Nine Months Ended September 30,
	2004			2003

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	15,540,173		$	11,577,933
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	5,017,306			4,070,511
(Gain) loss on sale of property and equipment	114,820			(84,744		)
Equity-related compensation expense	33,750			15,000
Deferred compensation expense	—			65,626
Write-off of debt issuance costs	345,819			—
Deferred income taxes	2,614,300			1,356,000
Gain on early extinguishment of debt	(49,302		)	—
Gain on interest rate swap	(90,455		)	(27,367		)
Changes in operating assets and liabilities, net of effects from purchase transactions:
Receivables	(1,630,003		)	(2,367,542		)
Inventory	(1,544,186		)	1,065,924
Prepaid expenses and other assets	998,636			(2,615,725		)
Accounts payable	(3,475,883		)	956,397
Accrued expenses	2,344,519			1,596,593
Income taxes payable	224,412			535,252
Deferred revenue	330,299			590,454
Other noncurrent liabilities	(588,837		)	291,574

Net cash provided by operating activities	20,185,368			17,025,886

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment	(21,360,422		)	(5,460,983		)
Proceeds from sale of property and equipment	77,191			120,907
Expenditures for intangible assets	(3,597		)	—
Purchase of investment securities	(650,000		)	—
Cash used in acquisitions	(43,514,378		)	(3,284,526		)

Net cash used in investing activities	(65,451,206		)	(8,624,602		)

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the sale of common stock	2,511,876			624,700
Proceeds from exercise of warrants	1,192,782			—
Debt issuance costs	(249,275		)	(131,078		)
Net borrowings under line of credit	33,000,000			10,500,000
Borrowings under term loans	—			9,000,000
Repayments under term loans	—			(4,250,000		)
Repayments of long-term debt obligations	(4,188,435		)	(307,272		)
Repurchase of common stock	—			(22,902,486		)

Net cash provided by (used in) financing activities	32,266,948			(7,466,136		)

Net increase (decrease) in cash and equivalents	(12,998,890		)	935,148

Cash and equivalents, beginning of period	16,081,525			584,477

Cash and equivalents, end of period	$	3,082,635		$	1,519,625

Supplemental disclosure of cash flow information:
Notes issued in connection with business acquisitions	$	2,379,186		$	200,000
Stock issued in connection with business acquisitions	3,375,386			—
Redeemable common stock issued in connection with business acquisition	—			617,027
Repurchase and retirement of common stock in exchange for sale of assets	—			(560,000		)
Cash paid for income taxes, net of refunds	7,336,823			6,597,200
Cash paid for interest	653,453			1,678,481

See notes to unaudited consolidated financial statements.

LKQ CORPORATION AND SUBSIDIARIES

Unaudited Consolidated Statements of Stockholders’ Equity and Other Comprehensive Income

				Additional Paid-In Capital		Warrants			Retained Earnings / (Accumulated Deficit)			Accumulated Other Comprehensive Income			Total Stockholders’ Equity
	Common Stock
	Shares Issued	Amount

BALANCE, December 31, 2003	19,476,831	$	194,768	$	191,602,265	$	507,962		$	(19,432,889	)	$	1,138,500		$	174,010,606

Net income	—	—		—		—			15,540,173			—			15,540,173

Other comprehensive loss, net of tax	—	—		—		—			—			(220,733		)	(220,733		)

Total comprehensive income															15,319,440

Stock issued in acquisitions	186,698	1,867		3,373,519		—			—			—			3,375,386

Stock issued as director compensation	1,868	19		33,731		—			—			—			33,750

Expiration of warrants issued in acquisitions	—	—		11,500		(11,500		)	—			—			—

Exercise of warrants issued in acquisitions	50,000	500		882,500		(133,000		)	—			—			750,000

Exercise of stockholder guarantor warrants	221,391	2,214		485,842		(45,274		)	—			—			442,782

Exercise of stock options, including related tax benefits of $736,100	250,765	2,507		3,245,510		—			—			—			3,248,017

BALANCE, September 30, 2004	20,187,553	$	201,875	$	199,634,867	$	318,188		$	(3,892,716	)	$	917,767		$	197,179,981

See notes to unaudited consolidated financial statements.

LKQ Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

Note 1. Interim Financial Statements

The accompanying Unaudited Consolidated Financial Statements include the accounts of LKQ Corporation and its subsidiaries (the “Company”). All significant intercompany transactions and accounts have been eliminated. The accompanying Unaudited Consolidated Financial Statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission applicable to interim financial statements. Accordingly, certain information related to the Company’s significant accounting policies and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. These Unaudited Consolidated Financial Statements reflect, in the opinion of management, all material adjustments (which include only normal recurring adjustments) necessary to fairly state, in all material respects, the financial position, cash flows and results of operations of the Company for the periods presented.

Operating results for interim periods are not necessarily indicative of the results that can be expected for any subsequent interim period or for a full year. These interim financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Company’s most recent report on Form 10-K for the year ended December 31, 2003 filed with the Securities and Exchange Commission.

Note 2. Summary of Significant Accounting Policies

Inventory

A salvage part is a recycled automotive part suitable for sale as a replacement part. A core is a used mechanical part that is not suitable for sale as a replacement part without further remanufacturing work. Salvage inventory and cores are recorded at the lower of cost or market. Cost is established based upon the price we pay for a vehicle, and includes average costs for buying, dismantling, and where applicable, auction fees, towing and storage. Inventory carrying value is determined using the average cost to sales percentage at each of our facilities and applying that percentage to the facility’s inventory at expected selling prices. The average cost to sales percentage is derived from each facility’s historical vehicle profitability for salvage vehicles purchased at auction or from contracted rates for salvage vehicles acquired under certain direct procurement arrangements.

An aftermarket part is a new automotive part manufactured by a company other than the original equipment manufacturer (OEM). Aftermarket inventory is recorded at the lower of cost or market. Cost is established based upon the average price for purchased parts, and includes expenses incurred for freight and buying, where applicable. For items purchased from foreign companies, import fees and duties and transportation insurance are also included.

For all inventory, carrying value is adjusted regularly to reflect the age of the inventory and current anticipated demand. If actual demand differs from management estimates, an adjustment to inventory carrying value would be necessary in the period such determination is made.

Inventory consists of the following:

	September 30, 2004		December 31, 2003

Salvage parts	$	53,977,760	$	50,348,336
Aftermarket parts	7,377,722		—
Cores	3,301,920		3,655,358

	$	64,657,402	$	54,003,694

Intangibles

Intangible assets consist primarily of goodwill (the cost of purchased businesses in excess of the fair value of the net assets acquired) and covenants not to compete. The changes in the carrying amount of goodwill during the nine months ended September 30, 2004 are as follows:

	Total

Balance as of December 31, 2003	$	50,799,361
Business acquisitions	38,068,956

Balance as of September 30, 2004	$	88,868,317

Investments

In March 2004, the Company exercised its warrant to purchase 100,000 common shares of Keystone Automotive Industries, Inc. at $6.50 per share. The shares are restricted and therefore must either be registered or held for a period of one year in accordance with applicable securities laws. The Company classifies this investment as an available-for-sale investment security under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Accordingly, the Company has included the investment at its fair value of $2,200,000 in Other Assets at September 30, 2004, with the unrealized gain of $1,550,000 excluded from earnings and included in Accumulated other comprehensive income, net of applicable taxes of $613,700.

Segment Reporting

Over 99% of the Company’s operations are conducted in the United States. During the quarter ended June 30, 2004, the Company acquired a recycled OEM automotive parts business with locations in Guatemala and Costa Rica. Revenue generated and properties located outside of the United States are not material. The Company manages its operations geographically. Because over 90% of the Company’s revenue and earnings are derived from, and over 90% of all assets are used in, its automotive replacement parts operations, the Company has concluded that its business activities fall into one reportable segment.

Income Taxes

Income taxes provided are based upon the Company’s anticipated annual effective income tax rate.

Foreign Currency Translation

For the Company’s foreign operations, the local currency is the functional currency. Assets and liabilities are translated into U.S. dollars at the period-ending exchange rate. Statement of Operations amounts are translated to U.S. dollars using average exchange rates during the period. Translation gains and losses are reported as a component of Accumulated other comprehensive income in Stockholders’ Equity. Gains and losses from foreign currency transactions are included in current earnings.

Recent Accounting Pronouncements

In January 2003, the FASB issued Interpretation No. 46 (subsequently revised in December 2003) “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (FIN 46). FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional financial support from other parties. FIN 46 was effective for all variable interest entities or potential variable interest entities for periods ended after December 15, 2003. Application for all other types of entities was required in financial statements for periods ended after March 15, 2004. The Company has reviewed the interpretation and determined that its implementation will not have an impact on its consolidated financial position, results of operations or cash flows.

Note 3. Capital Structure

On January 1, 2003, in connection with a business acquisition, the Company issued 50,000 shares of its common stock. The Company granted a put option with a single exercise date of January 1, 2007 at a price of $15.00 per share and obtained a call option on those shares with a single exercise date of January 1, 2007 at a price of $22.50 per share. These shares are reflected as Redeemable Common Stock.

In February 2003, the Company repurchased 2,000,000 shares of its common stock from existing stockholders, including 1,878,684 shares repurchased from AutoNation, Inc., the Company’s largest stockholder at that time, for a total of $12,000,000 in cash. The Company partially funded the stock repurchase by obtaining a $9,000,000 term loan.

In May 2003, the Company repurchased 1,557,498 shares of its common stock from existing stockholders, including 1,500,000 shares repurchased from AutoNation, Inc., for a total of $10,902,486 in cash. The Company partially funded the stock repurchase by borrowing an additional $9,000,000 against an existing revolving credit facility.

In June 2003, the Company sold certain assets no longer deemed pertinent to its operations to an existing stockholder in exchange for 80,000 shares of the Company’s common stock. The shares, which were subsequently retired, were valued at $560,000.

On February 20, 2004, in connection with a business acquisition, the Company issued 84,345 shares of its common stock. If the average market price of the Company’s common stock on the five business days immediately preceding the first anniversary of such acquisition is below $16.00 per share, the Company must make an additional payment per share (in cash or in common stock, at the Company’s option) equal to $16.00 minus the average closing price over such five day period.

In August 2004, warrants to purchase 50,000 shares of the Company’s common stock at a price of $15.00 per share were exercised. Warrants to purchase 100,000 shares of the Company’s common stock at prices ranging from $25.00 to $35.00 expired on August 31, 2004.

Note 4. Stock-Based Compensation

The Company has three stock-based compensation plans, the LKQ Corporation Equity Incentive Plan (the “Equity Incentive Plan”), the Stock Option Plan for Non-Employee Directors (the “Director Plan”), and a separate stock option plan for its Chief Executive Officer (the “CEO Plan”). The Company accounts for its stock compensation arrangements under the provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), and related interpretations. The Company has adopted the disclosure-only provisions of SFAS 123, “Accounting for Stock-Based Compensation” (SFAS 123), as amended by SFAS 148, “Accounting for Stock-Based Compensation-Transition and Disclosures” (SFAS 148).

Under the CEO Plan, the difference between the fair market value of the option at the time granted in 1998 and the exercise price was recorded as deferred compensation expense and was charged to operations over the vesting period of the option which ended in November 2003. No stock-based compensation cost is reflected in net income for the Equity Incentive Plan or the Director Plan because all options granted under these plans had an exercise price equal to or greater than the market value of the underlying common stock on the date of grant.

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123 to the Equity Incentive Plan and the Director Plan:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003

Net income, as reported	$	4,562,517		$	3,518,773		$	15,540,173		$	11,577,933
Less: Total stock-based compensation expense determined using the Black-Scholes option pricing model, net of related tax effects	(370,600		)	(291,900		)	(1,415,400		)	(916,100		)

Pro forma net income	$	4,191,917		$	3,226,873		$	14,124,773		$	10,661,833

Earnings per share:
Basic - as reported	$	0.23		$	0.25		$	0.78		$	0.76
Basic - pro forma	$	0.21		$	0.23		$	0.71		$	0.70

Diluted - as reported	$	0.20		$	0.22		$	0.69		$	0.68
Diluted - pro forma	$	0.19		$	0.20		$	0.63		$	0.62

The fair value of options granted has been estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions:

	Nine Months Ended September 30,
	2004	2003

Expected life (in years)	7.5	7.5
Risk-free interest rate	3.7%	4.0%
Volatility (1)	40.0%	0%
Dividend yield	0%	0%

(1) A volatility assumption of 0% was used for options granted prior to the Company’s initial public offering.

The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting provisions and are fully transferable. In addition, this and other valuation models require the use of highly subjective assumptions. The Company’s stock options have characteristics significantly different from those of traded options and, in addition, changes in the subjective underlying assumptions can materially affect the fair value estimate. As a result, in the opinion of management, the existing option pricing models do not necessarily provide a reliable single measure of the fair value of the Company’s stock options.

Using a Black-Scholes option pricing model with the above assumptions, the weighted average estimated fair value of stock options granted was $9.04 and $1.52 per share for the nine months ended September 30, 2004 and 2003, respectively and $1.49 for the three months ended September 30, 2003. For purposes of pro forma disclosure, the estimated fair value of each option is amortized to expense over its vesting period.

A summary of transactions in the Company’s stock-based compensation plans for the nine months ended September 30, 2004 is as follows:

	Options Available for Grant		Number of Options Outstanding		Weighted Average Exercise Price

Balance, December 31, 2003	1,697,750		3,638,195		$	10.23

Granted	(628,500	)	628,500		18.24
Exercised	—		(250,765	)	10.02
Cancelled	9,300		(9,300	)	13.09

Balance, September 30, 2004	1,078,550		4,006,630		$	11.49

The following table summarizes information about outstanding and exercisable stock options at September 30, 2004:

	Outstanding				Exercisable
Range of Exercise Prices	Options	Weighted Average Remaining Contractual Life (Yrs)	Weighted Average Exercise Price		Options	Weighted Average Exercise Price

$ 1.00 - $3.00	418,600	6.1	$	2.87	243,550	$	2.78
8.00 - 10.00	1,489,480	6.7	8.78		816,253	9.12
12.50 - 15.00	1,469,050	5.8	13.81		1,270,600	13.88
15.83 - 18.87	629,500	9.3	18.22		62,950	18.22

	4,006,630	6.7	$	11.49	2,393,353	$	11.24

Stock options expire 10 years from the date they are granted. Options granted under the Equity Incentive Plan and the CEO Plan generally vest over a period of five years. Options granted under the Director Plan vest six months after the date of grant.

On October 2, 2004, the Company granted a total of 60,000 stock options at an exercise price of $18.55 per share to its non-employee directors in accordance with the terms of the Director Plan. Using a Black–Scholes option pricing model with an expected life of 5.25 years, volatility of 40% and a risk-free interest rate of 3.3%, the fair value of the options was $7.60 per share.

Note 5. Related-Party Transactions

The Company subleased its corporate office space from an entity owned by one of its principal stockholders for a percentage of the rent that was charged to that entity. The sublease expired on July 31, 2004. The total amounts paid to this entity were approximately $163,000 and $186,000 during the nine month periods ended September 30, 2004 and 2003, respectively.

A corporation owned by the Company’s Chairman of the Board, who is one of the Company’s principal stockholders, owns a private aircraft that the Company uses from time to time for business trips. The Company reimburses this corporation for out-of-pocket and other related flight expenses, as well as for other direct expenses incurred. The total amounts paid to this corporation were approximately $41,100 and $22,300 during the nine month periods ended September 30, 2004 and 2003, respectively.

The Company sells products to various repair facilities owned by a corporation that was previously one of its principal stockholders. The amount of such sales totaled approximately $2,030,000 during the nine month period ended September 30, 2003. This corporation ceased being a stockholder of the Company in October 2003.

In connection with the acquisitions of several businesses, the Company entered into agreements with several sellers of those businesses, who became stockholders as a result of those acquisitions, for the lease of certain properties used in its operations. Typical lease terms include an initial term of five years, with three five-year renewal options and purchase options at various times throughout the lease periods. The Company also typically maintains the right of first refusal concerning the sale of the leased property. Lease payments to a principal stockholder who became an officer of the Company

after the acquisition of his business were approximately $595,000 and $549,000 during the nine month periods ended September 30, 2004 and 2003, respectively.

The Company believes that the terms of the related party transactions described above are comparable to those available from unaffiliated third parties.

Note 6. Long-Term Obligations

Long-Term Obligations consist of the following:

	September 30, 2004			December 31, 2003

Revolving credit facility	$	33,000,000		$	—
Capital lease obligations, payable in monthly installments through March 2009, interest at 7.64% to 7.75%	—			2,841,613
Notes payable to individuals in monthly installments through November 2010, interest at 3.0% to 10.0%	3,292,586			1,155,305
Various equipment notes, payable in monthly installments through July 2008, interest at various rates up to 9.5%, secured by related equipment	21,532			474
	36,314,118			3,997,392
Less current maturities	(312,564		)	(1,553,274		)

	$	36,001,554		$	2,444,118

On February 17, 2004, the Company entered into a new unsecured revolving credit facility that matures in February 2007, replacing a secured credit facility that would have expired on June 30, 2005. As a result, the Company recorded a loss of $346,000 in 2004 from the write-off of debt issuance costs related to the previous secured facility. The new revolving credit facility has a maximum availability of $75,000,000. In order to make any borrowing under the revolving credit facility, after giving effect to such borrowing, the Company must be in compliance with all of the covenants under the credit facility, including without limitation a senior debt to earnings before interest, taxes, depreciation and amortization (EBITDA) ratio which cannot exceed 2.50 to 1.00. The revolving credit facility contains customary covenants, including, among other things, limitations on the payment of cash dividends, restrictions on the payment of other dividends and on purchases, redemptions and acquisitions of the Company’s stock, limitations on additional indebtedness, certain limitations on acquisitions, mergers and consolidations, and the maintenance of certain financial ratios. The interest rate on advances under the revolving credit facility may be either the bank prime lending rate, on the one hand, or the Interbank Offering Rate (“IBOR”) plus an additional percentage ranging from .875% to 1.375%, on the other hand, at the Company’s option. The percentage added to IBOR is dependent upon the Company’s total funded debt to EBITDA ratio for the trailing four quarters. The Company was in compliance with all covenants at September 30, 2004 and December 31, 2003. The weighted-average interest rate on borrowings outstanding against the Company’s credit facility at September 30, 2004 was 2.84%. Borrowings against the credit facility totaled $33,000,000 at September 30, 2004, and are classified as long-term obligations.

The Company’s previous secured credit facility consisted of a revolving line of credit (the “Revolving Facility”) with a maximum availability of $40,000,000 and a $20,000,000 term loan (“Term Loan A”). Term Loan A required scheduled quarterly repayments beginning December 31,

Note 8. Earnings Per Share

The following chart sets forth the computation of earnings per share:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003

Net income	$	4,562,517	$	3,518,773	$	15,540,173	$	11,577,933

Denominator for basic earnings per share-
Weighted-average shares outstanding	20,202,612		14,205,008		19,966,413		15,326,273
Effect of dilutive securities:
Stock options	876,358		396,008		907,873		300,758
Warrants	1,413,255		1,577,184		1,506,644		1,507,621
Denominator for diluted earnings per share-
Adjusted weighted-average shares outstanding	22,492,225		16,178,200		22,380,930		17,134,652

Earnings per share, basic	$	0.23	$	0.25	$	0.78	$	0.76

Earnings per share, diluted	$	0.20	$	0.22	$	0.69	$	0.68

The following chart sets forth the number of employee stock options and warrants outstanding but not included in the computation of diluted earnings per share because their effect would have been antidilutive:

	Three Months Ended September 30,		Nine Months Ended September 30,
	2004	2003	2004	2003
Antidilutive securities:
Stock options	200,000	1,297,650	200,000	1,735,650
Warrants	—	263,318	—	263,318

Note 9. Business Combinations

During 2003, the Company acquired a 100% equity interest in each of three automotive recycling businesses for an aggregate of $3,486,000 in cash, of which $100,000 is to be paid subsequent to September 30, 2004, and 50,000 redeemable shares of the Company’s common stock. The business combinations enable the Company to serve new market areas.

During the nine month period ended September 30, 2004, the Company acquired a 100% equity interest in each of five businesses (four in the recycled OEM automotive parts business and, on February 20, 2004, Global Trade Alliance, Inc., one of the largest suppliers of aftermarket collision automotive replacement parts in the Midwest) for an aggregate of $45,944,000 in cash, of which $2,373,000 is to be paid subsequent to September 30, 2004, and 186,698 shares of the Company’s common stock. The acquisitions enable the Company to serve new market areas, become a significant provider of aftermarket automotive collision parts and become a provider of self-service retail automotive parts.

The acquisitions are being accounted for under the purchase method of accounting and are included in the Company’s financial statements from the dates of acquisition. The purchase price was preliminarily allocated to the net assets acquired based upon estimated fair market values at the dates of acquisition, pending final determination of certain acquired assets and liabilities.

The preliminary purchase price allocation for the acquisitions completed during the nine months ended September 30, 2004 is as follows:


Receivables, net	$	2,238,466
Inventory	9,109,522
Prepaid expenses	323,634
Property and equipment	6,652,741
Goodwill	38,068,956
Deferred tax assets	758,300
Other assets	69,463
Current liabilities assumed	(7,407,321		)
Long-term obligations assumed	(494,811		)
Notes issued (see Note 6)	(2,379,186		)
Purchase price payable at September 30, 2004	(50,000		)
Common stock issued	(3,375,386		)

Cash used in acquisitions, net of cash acquired	$	43,514,378

The following pro forma summary presents the effect of the businesses acquired during the nine month period ended September 30, 2004 as though the businesses had been acquired as of January 1, 2003 and is based upon unaudited financial information of the acquired entities:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003

Revenue as reported	$	106,045,357	$	83,472,462	$	310,996,327	$	243,745,537
Revenue of purchased businesses for the period prior to acquisition	—		14,012,900		11,459,200		43,326,800
Pro forma revenue	$	106,045,357	$	97,485,362	$	322,455,527	$	287,072,337

Net income as reported	$	4,562,517	$	3,518,773	$	15,540,173	$	11,577,933
Net income of purchased businesses for the period prior to acquisition	—		235,000		490,200		832,200
Pro forma net income	$	4,562,517	$	3,753,773	$	16,030,373	$	12,410,133

Earnings per share-basic
As reported	$	0.23	$	0.25	$	0.78	$	0.76
Effect of purchased businesses for the period prior to acquisition	—		0.01		0.02		0.04
Pro forma earnings per share-basic	$	0.23	$	0.26	$	0.80	$	0.80

Earnings per share-diluted
As reported	$	0.20	$	0.22	$	0.69	$	0.68
Effect of purchased businesses for the period prior to acquisition	—		0.01		0.02		0.04
Pro forma earnings per share-diluted	$	0.20	$	0.23	$	0.71	$	0.72

These pro forma results are not necessarily indicative either of what would have occurred if the acquisitions had been in effect for the period presented or of future results.

Note 10. Comprehensive Income

The following table reconciles net income to comprehensive income:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2004			2003		2004			2003

Net income as reported	$	4,562,517		$	3,518,773	$	15,540,173		$	11,577,933
Other comprehensive loss, net of tax:
Unrealized loss on investment in equity securities	(355,800		)	—		(202,200		)	—
Foreign currency translation	(11,628		)	—		(18,533		)	—

Total other comprehensive loss, net of tax	(367,428		)	—		(220,733		)	—

Comprehensive income	$	4,195,089		$	3,518,773	$	15,319,440		$	11,577,933

Note 11. Subsequent Event

On October 26, 2004, the Company acquired a 100% equity interest in an automotive recycling business for an aggregate of approximately $19,000,000 in cash. The acquired company has seven primary locations, including three retail self-service facilities, serving the Oregon and Washington market areas.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

The repair of automobiles includes the purchase of automotive replacement parts. Buyers of replacement parts have the option to purchase primarily from three sources: new parts produced by original equipment manufacturers, which are commonly known as OEM parts; new parts produced by companies other than the OEM’s, sometimes referred to generically as “aftermarket” parts; and recycled parts originally produced by OEM’s, which we refer to as recycled OEM products. We have historically sold primarily recycled OEM products. In February 2004, we expanded our product lines by acquiring Global Trade Alliance, Inc. (GTA), one of the largest suppliers of aftermarket collision automotive replacement parts in the Midwest. GTA operates under the trade name Action Crash Parts.

Since our formation in 1998, we have grown through both internal development and acquisitions. For the first 18 months of our existence, we focused on growth through acquisitions. Our acquisition strategy has been to target companies with strong management teams, a record of environmental compliance, solid growth prospects and a reputation for quality and customer service. We believe it is important for former owners to remain active in our business and have frequently used equity as a significant component to fund acquisitions.

Internal growth is an important driver of our revenue and operating results. Since 1999, we have focused primarily on growing our sales and operating results within our existing organization. We have done so by developing our regional distribution networks and by creating overnight product transfers between our facilities to better leverage our inventory investment and to increase our ability to fill customer demand. We acquire salvage vehicles for dismantling from several sources, including salvage auctions, insurance companies and OEMs. We acquire most of our salvage vehicles from salvage auctions. A critical component of our operations is our ability to identify and value the recyclable parts on a damaged vehicle and rapidly determine the maximum price that we can pay for the salvage vehicle at auction in order to obtain our target margins on the resale of the recycled OEM products. Our ability to correctly assess the quality and ultimate sales prices for products when we purchase a salvage vehicle, as well as our ability to obtain the vehicle at a cost we determine to be reasonable in light of that assessment, directly impacts our profit margins subsequent to acquisition of the vehicle.

Our revenue, cost of salvage vehicles and operating results have fluctuated on a quarterly and annual basis in the past and can be expected to continue to fluctuate in the future as a result of a number of factors, some of which are beyond our control. Factors that may affect our operating results include, but are not limited to:

• fluctuations in the market value of salvage vehicles and pricing of new OEM replacement parts;

• the availability and cost of salvage vehicles;

• variations in vehicle accident rates;

• increasing competition in the automotive parts industry;

• changes in state or federal laws or regulations affecting our business;

• changes in the types of replacement parts that insurance carriers will accept in the repair process;

• our ability to integrate and manage our acquisitions successfully;

• fluctuations in fuel prices;

• changes in the demand for our products and the supply of our inventory due to severity of weather and seasonality of weather patterns;

• the amount and timing of operating costs and capital expenditures relating to the maintenance and expansion of our business, operations and infrastructure; and

• declines in the value of our assets.

Due to the foregoing factors, our operating results in one or more future periods can be expected to fluctuate. Accordingly, our results of operations may not be indicative of future performance.

Sources of Revenue

Our revenue from the sale of automotive replacement products and related services has typically ranged between 90% and 92% of our total revenue. We sell the majority of our automotive replacement products to collision repair shops and mechanical repair shops. Our automotive replacement products include, for example, engines, transmissions, front-ends, doors, trunk lids, bumpers, hoods, fenders, grilles, valances, headlights and taillights. The demand for our products and services is influenced by several factors, including the number of vehicles in operation, the number of miles being driven, the frequency and severity of vehicle accidents, availability and pricing of new parts, seasonal weather patterns and local weather conditions. Additionally, automobile insurers exert significant influence over collision repair shops as to how an insured vehicle is repaired and the cost level of the products used in the repair process. Accordingly, we consider automobile insurers to be key demand drivers of our products. We provide insurance companies services that include the review of vehicle repair order estimates, as well as direct quotation services to their adjusters. There is no standard price for recycled OEM products, but rather a pricing structure that varies from day to day based upon such factors as product availability, quality, demand, new OEM replacement part prices and the age of the vehicle being repaired. The pricing for aftermarket collision automotive replacement parts is determined based on a number of factors, including availability, quality, demand, new OEM replacement part prices and competitor pricing.

In addition, approximately 8% to 10% of our revenue is obtained from other sources. These include bulk sales to mechanical remanufacturers, scrap sales and the sale of extended warranty contracts.

When we obtain mechanical products from dismantled vehicles and determine they are damaged or when we have a surplus of a certain mechanical product type, we sell them in bulk to mechanical remanufacturers. The majority of these products are sorted by product type and model type. Examples of such products are engine blocks and heads, transmissions, starters, alternators, and air conditioner compressors. After we have recovered all the products we intend to resell, the remaining materials are crushed and sold to scrap processors.

We sell extended warranty contracts for certain mechanical products. These contracts cover the cost of parts and labor and are sold for periods of six months, one year or two years. We defer the revenue from such contracts and recognize it ratably over the term of the contracts.

Cost of Goods Sold

Our cost of goods sold for recycled OEM products includes the price we pay for the salvage vehicle, as well as auction fees, towing and storage, where applicable. Our cost of goods sold also includes other inventoried costs such as labor and other costs we incur to acquire and dismantle such vehicles. Our labor and labor-related costs related to buying and dismantling account for approximately 10% of our salvage cost of goods sold. The acquisition and dismantling of salvage vehicles is a manual process and, as a result, energy costs are not material.

Our cost of goods sold for aftermarket collision automotive replacement parts includes the price we pay for the parts, freight and other inventoried costs such as labor, and other costs to acquire, including import fees and duties, where applicable. Our aftermarket collision automotive replacement parts are acquired from a number of vendors located both overseas and in the United States, with the majority of our overseas vendors located in Taiwan.

Our revenue from products that we obtain from third party recyclers to sell to our customers, which we refer to as brokered product sales, ranges from 8% to 10% of our total revenue. We purchase these products when we do not have them available in our own inventory. The gross margin on brokered product sales as a percentage of revenue is generally less than half of what we achieve from sales of our own inventory because we must pay higher prices for these products.

Some of our mechanical products are sold with a standard six-month warranty against defects. We record the estimated warranty costs at the time of sale using historical warranty claim information to project future warranty claims activity and related expenses. Our warranty expense is approximately 1% of our total cost of goods sold. Our warranty reserve activity during the first nine months of 2004 was as follows:

Balance as of December 31, 2003	$	235,000
Warranty expense	1,467,650
Warranty claims	(1,422,650		)
Balance as of September 30, 2004	$	280,000

We also sell separately priced extended warranty contracts for certain mechanical products. The expense related to extended warranty claims is recognized when the claim is made.

Expenses

Our facility and warehouse expenses primarily include our costs to operate our processing, redistribution, self-service and warehouse facilities. These costs include labor for both plant management and facility and warehouse personnel, facility rent, property and liability insurance, utilities and other occupancy costs.

Our distribution expenses primarily include our costs to deliver our products to our customers. Included in our distribution expense category are labor costs for drivers, local delivery

We also sell separately priced extended warranty contracts for certain mechanical products. Revenue from these contracts is deferred and recognized ratably over the term of the contracts.

Warranty Reserves

We issue a standard six-month warranty against defects on some of our mechanical products. We record an accrual for standard warranty claims at the time of sale using historical warranty claim information to project future warranty claims activity and related expenses. We analyze historical warranty claim activity by referencing the claims made and aging them from the original product sale date. We use this information to project future warranty claims on actual products sold that are still under warranty at the end of an accounting period. A 10% increase in our historical annual warranty claims would result in an additional annual expense of approximately $190,000.

Inventory Accounting

Salvage Inventory. Salvage inventory is recorded at the lower of cost or market. Our salvage inventory cost is established based upon the price we pay for a vehicle, and includes buying, dismantling and, where applicable, auction fees, towing and storage. Inventory carrying value is determined using the average cost to sales percentage at each of our facilities and applying that percentage to the facility’s inventory at expected selling prices. The average cost to sales percentage is derived from each facility’s historical vehicle profitability for salvage vehicles purchased at auction or from contracted rates for salvage vehicles acquired under direct procurement arrangements.

Aftermarket Inventory. Aftermarket inventory is recorded at the lower of cost or market. Our aftermarket inventory cost is based on the average price we pay for parts, and includes expenses incurred for freight and buying, where applicable. For items purchased from foreign companies, import fees and duties and transportation insurance are also included.

For all inventory, our inventory carrying value is adjusted regularly to reflect the age and current anticipated demand for our products. If actual demand differs from our estimates, an adjustment to our inventory carrying value would be necessary in the period such determination is made.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. The allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts, the aging of the accounts receivable and our historical experience. Our allowance for doubtful accounts at September 30, 2004 was approximately $1.6 million, which represents 5.7% of gross receivables. If actual defaults are higher than our historical experience, our allowance for doubtful accounts may be insufficient to cover the uncollectible receivables, which could have an adverse impact on our operating results in the period of occurrence. A 10% change in the annual write-off rate would result in a change in the estimated allowance for doubtful accounts of approximately $100,000. Our exposure to uncollectible accounts receivable is limited because we have a large number of small customers that are generally geographically dispersed. We control credit risk through credit approvals, credit limits and monitoring policies. We also have certain customers that pay for products at the time of delivery.

Results of Operations

The following table sets forth statement of operations data as a percentage of total revenue for the periods indicated:

	Three Months Ended September 30,				Nine Months Ended September 30,
Statement of Operations Data:	2004		2003		2004		2003
Revenue	100.0	%	100.0	%	100.0	%	100.0	%
Cost of goods sold	54.1	%	53.2	%	53.3	%	52.9	%
Gross margin	45.9	%	46.8	%	46.7	%	47.1	%
Facility and warehouse expenses	11.4	%	11.9	%	11.1	%	12.0	%
Distribution expenses	11.8	%	10.7	%	11.2	%	10.5	%
Selling, general and administrative expenses	13.5	%	14.7	%	14.0	%	14.4	%
Depreciation and amortization	1.7	%	1.6	%	1.6	%	1.7	%
Operating income	7.5	%	7.9	%	8.7	%	8.6	%
Other (income) expense, net	0.4	%	0.8	%	0.3	%	0.7	%
Income before provision for income taxes	7.1	%	7.0	%	8.3	%	7.9	%
Net income	4.3	%	4.2	%	5.0	%	4.8	%

Three months ended September 30, 2004 compared to three months ended September 30, 2003

Revenue. Our revenue increased 27.0% to $106.0 million for the three month period ended September 30, 2004, from $83.5 million for the comparable period of 2003. The increase in revenue is primarily due to the higher volume of products sold and business acquisitions. Organic revenue growth was 8.3% for the three month period ended September 30, 2004 over the comparable period of 2003. We have continued to expand our services to the insured repair industry and added local delivery routes and transfer routes to our wholesale replacement parts operation that helped us to increase our market penetration. The revenue growth attributable to business acquisitions accounted for approximately $15.7 million of total revenue in the three month period ended September 30, 2004.

Cost of Goods Sold. Our cost of goods sold increased 29.1% to $57.4 million for the three month period ended September 30, 2004, from $44.4 million for the comparable period of 2003. The increase in cost of goods sold was primarily due to increased volume of products sold. As a percentage of revenue, cost of goods sold increased from 53.2% to 54.1%. The increase in cost of goods sold percentage was due primarily to a change in inventory mix to higher end salvage, higher costs in the Northeast due to tighter supply and lower recovery on our shipping and handling costs.

Gross Margin. Our gross margin increased 24.7% to $48.7 million for the three month period ended September 30, 2004, from $39.0 million for the comparable period of 2003. Our gross margin increased primarily due to increased volume. As a percentage of revenue, gross margin decreased from 46.8% to 45.9%. Our gross margin as a percentage of revenue decreased due primarily to the factors noted above in Cost of Goods Sold. We are currently shifting our buying to a lower average cost vehicle and refocusing our sales force to recoup more of our shipping and handling costs through higher billings. As a result, we expect our gross margins to stabilize or improve in future quarters.

Facility and Warehouse Expenses. Facility and warehouse expenses increased 20.9% to $12.1 million for the three month period ended September 30, 2004 from $10.0 million for the comparable period of 2003. Our 2004 acquisitions accounted for $2.2 million in higher facility and warehouse expenses. As a percentage of revenue, facility and warehouse expenses decreased from 11.9% to 11.4%. We had $0.2 million of lower rent expense due primarily to our exercise of purchase options on certain production facilities that we previously leased, along with $0.4 million in lower incentive compensation expense for field personnel, partially offset by higher wages.

Distribution Expenses. Distribution expenses increased 40.8% to $12.5 million for the three month period ended September 30, 2004 from $8.9 million for the comparable period of 2003. As a percentage of revenue, distribution expenses increased from 10.7% to 11.8%. Our 2004 acquisitions accounted for $2.1 million of the increase in distribution expenses. Our remaining distribution expenses increased as we have increased the number of local delivery trucks by approximately 5.8%. We also operated 11.4% more daily transfer routes between our facilities due to the increase in parts volume. During the quarter we increased the amount of product we moved between our facilities by approximately 24%, the majority of which was on our own transfer trucks. In addition, higher wages primarily from an increase in the number of employees, and increased fuel costs, truck rentals and repairs, delivery supplies, contracted salvage transfer services and freight costs accounted for the remaining growth in distribution expenses. We are in the process of renegotiating our freight rates with common carriers, and are refocusing our sales force to recoup more of our shipping and handling costs. We expect to slow the increase in our distribution costs in future quarters.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased 16.6% to $14.3 million for the three month period ended September 30, 2004 from $12.3 million for the comparable period of 2003. As a percentage of revenue, selling, general and administrative expenses decreased from 14.7% to 13.5%. Our 2004 acquisitions accounted for $1.7 million of the increase in selling, general and administrative expenses. The majority of the remaining expense increase was due to costs associated with being a public company, partially offset by $1.0 million in lower incentive compensation and by improved insurance and legal claims experience of $0.4 million. We incurred approximately $0.8 million in costs related to being a public company. These costs primarily included higher premiums for directors’ and officers’ liability insurance and higher accounting and legal fees. We expect these increased costs associated with being a public company to continue in 2004 and to be approximately $0.6 million in the fourth quarter, including additional costs to comply with the requirements of the Sarbanes-Oxley Act of 2002.

Depreciation and Amortization. Depreciation and amortization increased 35.5% to $1.8 million for the three month period ended September 30, 2004 from $1.3 million for the comparable period of 2003. Our 2004 acquisitions accounted for $0.3 million of the increase in depreciation and amortization expense. As a percentage of revenue, depreciation and amortization increased from 1.6% to 1.7%.

Operating Income. Operating income increased 21.5% to $8.0 million for the three month period ended September 30, 2004 from $6.6 million for the comparable period of 2003. As a percentage of revenue, operating income decreased from 7.9% to 7.5%.

Other (Income) Expense. Net other expense decreased 38.1% to $0.4 million for the three month period ended September 30, 2004 from $0.7 million for the comparable period of 2003. As a

percentage of revenue, net other expense decreased from 0.8% to 0.4%. Our 2004 acquisitions accounted for approximately $22,000 of net other income. Net interest expense decreased 51.4% to $0.3 million for the three month period ended September 30, 2004, from $0.6 million for the comparable period of 2003 due to both lower average debt levels and interest rates in 2004.

Provision for Income Taxes. The provision for income taxes increased 26.9% to $3.0 million for the three month period ended September 30, 2004 from $2.4 million for the comparable period of 2003 due to improved operating results. Our effective income tax rate was 39.5% for 2004 and 40.1% for 2003. The decrease in our effective tax rate was due primarily to a reduction in our expected annual effective income tax rate resulting from changes in the distribution of our taxable income for state income tax purposes.

Nine months ended September 30, 2004 compared to nine months ended September 30, 2003

Revenue. Our revenue increased 27.6% to $311.0 million for the nine month period ended September 30, 2004, from $243.7 million for the comparable period of 2003. The increase in revenue is primarily due to the higher volume of products sold and business acquisitions. Organic revenue growth was approximately 12.1% in the nine month period ended September 30, 2004 over the comparable period of 2003. We have continued to expand our services to the insured repair industry and added local delivery routes and transfer routes to our wholesale replacement parts operation that helped us to increase our market penetration. We increased the number of wholesale automotive recycled product customers by 9.2% over the same period of 2003. We also completed five business acquisitions in the first nine months of 2004. The revenue growth attributable to business acquisitions accounted for approximately $37.6 million of total revenue in the nine month period ended September 30, 2004.

Cost of Goods Sold. Our cost of goods sold increased 28.7% to $165.9 million for the nine month period ended September 30, 2004, from $128.9 million for the comparable period of 2003. The increase in cost of goods sold was primarily due to increased volume of products sold. As a percentage of revenue, cost of goods sold increased from 52.9% to 53.3%.

Gross Margin. Our gross margin increased 26.4% to $145.1 million for the nine month period ended September 30, 2004, from $114.8 million for the comparable period of 2003. Our gross margin increased primarily due to increased volume. As a percentage of revenue, gross margin decreased from 47.1% to 46.7%. Our gross margin as a percentage of revenue decreased due primarily to a change in inventory mix to higher end salvage, higher costs in the Northeast due to tighter supply and lower recovery on our shipping and handling billings. We are currently shifting our buying to a lower average cost vehicle and refocusing our sales force to recoup more of our shipping and handling costs through higher billings. As a result, we expect our gross margins to stabilize or improve in future quarters.

Facility and Warehouse Expenses. Facility and warehouse expenses increased 18.6% to $34.6 million for the nine month period ended September 30, 2004 from $29.2 million for the comparable period of 2003. Our 2004 acquisitions accounted for $5.1 million of the increase in facility and warehouse expenses. Our remaining facility and warehouse expenses increased primarily from higher wages due to increased headcount and higher repairs and maintenance expenses. This increase was partially offset by lower incentive compensation expense for field personnel and lower rent expense due to our exercise of purchase options on certain production facilities that we previously leased. As a percentage of revenue, facility and warehouse expenses decreased from 12.0% to 11.1%.

Distribution Expenses. Distribution expenses increased 36.1% to $35.0 million for the nine month period ended September 30, 2004 from $25.7 million for the comparable period of 2003. As a percentage of revenue, distribution expenses increased from 10.5% to 11.2%. Our 2004 acquisitions accounted for $4.9 million of the increase in distribution expenses. Our remaining distribution expenses increased as we have increased the number of local delivery trucks by approximately 5.9%. We operated 14.3% more daily transfer routes between our facilities due to the increase in parts volume. For the nine months ended September 30, 2004 we increased the amount of product we moved between our facilities by approximately 32%, the majority of which was on our own transfer trucks. In addition, higher wages primarily from an increase in the number of employees, and increased fuel costs, truck rentals and repairs, delivery supplies, contracted salvage transfer services and freight costs accounted for the remaining growth in distribution expenses. We are in the process of renegotiating our freight rates with common carriers, and are refocusing our sales force to recoup more of our shipping and handling costs. We expect to slow the increase in our distribution costs in future quarters.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased 24.5% to $43.6 million for the nine month period ended September 30, 2004 from $35.0 million for the comparable period of 2003. As a percentage of revenue, selling, general and administrative expenses decreased from 14.4% to 14.0%. Our 2004 acquisitions accounted for $4.0 million of the increase in selling, general and administrative expenses. The majority of the remaining expense increase was due to labor and labor-related expenses and costs associated with being a public company, partially offset by $0.6 million in lower incentive compensation and by improved insurance and legal claims experience of $0.8 million. Our selling expenses tend to rise as revenue increases due to our commissioned inside sales force. We incurred approximately $2.3 million in costs related to being a public company. These costs primarily included higher premiums for directors’ and officers’ liability insurance and higher accounting and legal fees. We expect these increased costs associated with being a public company to continue in 2004 and to be approximately $0.6 million in the fourth quarter of 2004, including additional costs to comply with the requirements of the Sarbanes-Oxley Act of 2002.

Depreciation and Amortization. Depreciation and amortization increased 23.3% to $5.0 million for the nine month period ended September 30, 2004 from $4.1 million for the comparable period of 2003. Our 2004 acquisitions accounted for $0.8 million of the increase in depreciation and amortization expense. Increased levels of property and equipment accounted for the remaining increase in depreciation and amortization expense in 2004 compared to 2003. As a percentage of revenue, depreciation and amortization decreased from 1.7% to 1.6%.

Operating Income. Operating income increased 29.0% to $27.0 million for the nine month period ended September 30, 2004 from $20.9 million for the comparable period of 2003. As a percentage of revenue, operating income increased from 8.6% to 8.7%.

Other (Income) Expense. Net other expense decreased 37.7% to $1.1 million for the nine month period ended September 30, 2004 from $1.7 million for the comparable period of 2003. As a percentage of revenue, net other expense decreased from 0.7% to 0.3%. Our 2004 acquisitions accounted for approximately $55,800 of net other income. Net interest expense decreased 39.9% to $1.1 million for the nine month period ended September 30, 2004 from $1.8 million for the comparable period of 2003. Included in interest expense in 2004 is $0.3 million in debt issuance costs that were written off. These costs were attributable to our previous secured bank credit facility that was terminated in February 2004. See “Liquidity and Capital Resources” below for further discussion of changes in our bank credit facilities. The decrease in net interest expense is due to both lower average debt levels and interest rates in 2004.

Provision for Income Taxes. The provision for income taxes increased 36.0% to $10.4 million for the nine month period ended September 30, 2004 from $7.6 million for the comparable period of 2003 due to improved operating results. Our effective income tax rate was 40.0% for 2004 and 39.7% for 2003. The increase in our effective tax rate was due primarily to changes in the distribution of our taxable income for state income tax purposes.

Liquidity and Capital Resources

Our primary sources of ongoing liquidity are our cash flow from operations and our credit facility. At September 30, 2004, we had cash and equivalents amounting to $3.1 million, and we had $42.0 million available under our unsecured bank credit facility. As of November 9, 2004, debt outstanding under our credit facility totaled approximately $50.0 million. Our credit facility was utilized to finance our October 2004 acquisition of an automotive recycling business for $19.0 million. Based on our current plan, we expect to generate positive cash flow from operating activities for 2004 and believe that cash flow from operating activities and availability under our bank credit facility will be adequate to fund our short term liquidity needs.

Our liquidity needs are primarily to fund working capital requirements and expand our facilities and network. The procurement of inventory is the largest use of our funds. We normally pay for salvage vehicles acquired at salvage auctions and under some direct procurement arrangements at the time that we take possession of the vehicles. We acquired approximately 19,600 and 63,000 wholesale salvage vehicles in the three and nine month periods ended September 30, 2004, respectively, and 17,400 and 55,400 in the comparable periods of 2003, respectively. We also acquired approximately 8,000 and 18,400 additional salvage vehicles for our self-service retail operations during the three and nine month periods ended September 30, 2004, respectively.

We intend to continue to evaluate markets for growth through the internal development of redistribution centers and processing facilities, and selected business acquisitions. Our future liquidity and capital requirements will depend upon numerous factors, including the costs and timing of our internal development efforts and the success of those efforts, the costs and timing of expansion of our sales and marketing activities, and the costs and timing of future business acquisitions.

Net cash provided by operating activities totaled $20.2 million for the nine month period ended September 30, 2004 compared to $17.0 million for the comparable period of 2003. Cash was provided by net income adjusted for non-cash items. Working capital uses of cash included increases in receivables and inventory, plus decreases in accounts payable and other noncurrent liabilities, partially offset by decreases in prepaid expenses and other assets, plus increases in accrued expenses, income taxes payable and deferred revenue. Receivables increased due to our increased sales volumes. We invested in additional inventory this year as we built up a larger backlog of unprocessed salvage vehicles during the more favorable winter and spring buying seasons that we had substantially worked down through the end of the third quarter. Accounts payable decreased as we accelerated payments to certain foreign vendors in order to realize improved pricing on certain aftermarket product purchases and also due to the timing of payments for certain facility construction projects and information systems licenses. Other noncurrent liabilities decreased primarily due to reductions in legal claim reserves partially offset by an increase in employee deferred compensation liabilities. Prepaid expenses and other assets decreased due primarily to amortization of directors’ and officers’ liability insurance. Accrued expenses increased primarily due to increases in our self-insurance reserves, property taxes, and

timing of wage payments. Income taxes payable increased due primarily to our higher levels of taxable income. Deferred revenue increased primarily due to higher sales of extended warranty contracts.

Net cash used in investing activities totaled $65.5 million for the nine month period ended September 30, 2004, compared to $8.6 million for the comparable period of 2003. We invested $43.5 million in five acquisitions in 2004 compared to $3.3 million in three acquisitions in the comparable period of 2003. Net property and equipment purchases increased $15.9 million in 2004, due primarily to exercises of purchase options on previously leased facilities and investments in facility expansions. We also exercised a warrant and paid an exercise price of $0.7 million in 2004. See Note 2 of the “Notes to Unaudited Consolidated Financial Statements” for further discussion of this warrant.

Net cash provided by financing activities totaled $32.3 million for the nine month period ended September 30, 2004 compared to $7.5 million used in financing activities for the comparable period of 2003. Exercises of stock options and warrants provided $3.7 million in 2004. We borrowed $33.0 million under our bank credit facility in 2004 primarily to fund acquisitions, while we repaid $4.2 million of long-term debt obligations. We also used $0.2 million in 2004 for debt issuance costs related to our new unsecured credit facility. In 2003, we repurchased 3,557,498 shares of our common stock for $22.9 million. Net borrowings under our credit facility for the nine month period ended September 30, 2003 totaled $15.3 million.

On February 17, 2004, we entered into a new unsecured revolving credit facility that matures in February 2007, replacing a secured credit facility that would have expired on June 30, 2005. The new revolving credit facility has a maximum availability of $75.0 million. In order to make any borrowing under the revolving credit facility, after giving effect to any such borrowing, we must be in compliance with all of the covenants under the credit facility, including, without limitation, a senior debt to EBITDA ratio which cannot exceed 2.50 to 1.00. The revolving credit facility contains customary covenants, including, among other things, limitations on our payment of cash dividends, restrictions on our payment of other dividends and on purchases, redemptions and acquisitions of our stock, limitations on additional indebtedness, certain limitations on acquisitions, mergers and consolidations, and the maintenance of certain financial ratios. The interest rate on advances under the revolving credit facility may be, at our option, either the bank prime lending rate, on the one hand, or the Interbank Offering Rate (IBOR) plus an additional percentage ranging from .875% to 1.375%, on the other hand. The percentage added to IBOR is dependent upon our total funded debt to EBITDA ratio for the trailing four quarters.

We may in the future borrow additional amounts under our revolving credit facility or enter into new or additional borrowing arrangements. We anticipate that any proceeds from such new or additional borrowing arrangements will be used for general corporate purposes, including to develop and acquire businesses and redistribution facilities, to expand and improve existing facilities, to purchase property, equipment and inventory, and for working capital.

In February 2003, we repurchased 2,000,000 shares of our common stock from existing stockholders, including 1,878,684 shares repurchased from AutoNation, Inc., our largest stockholder at the time, for a total of $12.0 million in cash. We partially funded the stock repurchase by obtaining a $9.0 million term loan, which originally matured on February 20, 2004. On October 9, 2003, we fully paid the balance on the term loan.

On February 28, 2003, in connection with a business acquisition, we issued two promissory notes totaling $0.2 million. The annual interest rate on the notes is 3.5% and interest

is payable upon maturity. The first $0.1 million note was paid on February 28, 2004 and the second $0.1 million note matures on February 28, 2005.

In May 2003, the Company repurchased 1,557,498 shares of its common stock from existing stockholders, including 1,500,000 shares repurchased from AutoNation, Inc., for a total of $10.9 million in cash. The Company partially funded the stock repurchase by borrowing an additional $9.0 million against an existing revolving credit facility.

On January 28, 2004, as part of the consideration for a business acquisition, we issued a promissory note in the amount of $1.0 million. The note is secured by certain real property owned by us. The annual interest rate on the note is 3.5%. Monthly payments of interest and principal totaling $9,889 are required, with the remaining outstanding principal balance due in a lump sum payment on January 28, 2009.

On February 25, 2004, as part of the consideration for a business acquisition, we issued two promissory notes totaling $1.3 million. The annual interest rate on the notes is 3.5% and interest is payable annually. The notes mature on February 25, 2006. At our option, the maturity of the notes may be extended to February 25, 2008. The annual interest rate on the notes during the extension period would be 5.0%.

We assumed certain liabilities in connection with a business acquisition during the first quarter of 2004, including two bankers acceptances totaling $1.2 million. The annual interest rate on the bankers acceptances, which were paid during the second quarter of 2004, was 2.94%.

On June 10, 2004, as part of the consideration for a business acquisition, we issued a note totaling $0.1 million. The annual interest rate on the note is 3.0% and the note, along with accrued interest, is payable at maturity on June 10, 2006.

As of November 9, 2004, we have approximately 1.6 million warrants outstanding at an exercise price of $2.00 per share that expire on February 14, 2006 and approximately 0.1 million warrants outstanding at an exercise price of $13.19 per share that expire on March 31, 2006.

We anticipate that net cash provided by operating activities for calendar year 2004 will be between $18.0 million and $20.0 million.

We estimate that our capital expenditures for calendar 2004 will be approximately $28.0 million, excluding business acquisitions. These capital expenditures consist of approximately $11.4 million to exercise options to acquire previously leased facilities and approximately $16.6 million for asset replacements, construction of new start up facilities, systems development projects and expansion of current facilities. As of November 9, 2004, debt outstanding under our credit facility totaled approximately $50.0 million. Our credit facility was utilized to finance our October 2004 acquisition of an automotive recycling business for $19.0 million.

We believe that our current cash and equivalents, cash provided by operating activities and funds available under our existing credit facility will be sufficient to meet our current operating and capital requirements. However, we may, from time to time, raise additional funds through public or private financing, strategic relationships or other arrangements. There can be no assurance that additional funding, or refinancing of our current credit facility, if needed, would be available on terms attractive to us, or at all. Furthermore, any additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants. Our

failure to raise capital if and when needed could have a material adverse impact on our business, operating results and financial condition.

Forward-Looking Statements

This Quarterly Report on Form 10-Q includes forward-looking statements. Words such as “may,” “will,” “plan,” “should,” “expect,” “anticipate,” “believe,” “if,” “estimate,” “intend,” “project” and similar words or expressions are used to identify these forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. However, these forward-looking statements are subject to risks, uncertainties, assumptions and other factors that may cause our actual results, performance or achievements to be materially different. These factors include, among other things:

• uncertainty as to changes in U.S. general economic activity and the impact of these changes on the demand for our products;

• fluctuations in the market value of salvage vehicles and pricing of new OEM replacement parts;

• the availability and cost of salvage vehicles;

• variations in vehicle accident rates;

• changes in state or federal laws or regulations affecting our business;

• changes in the types of replacements parts that insurance carriers will accept in the repair process;

• changes in the demand for our products and the supply of our inventory due to severity of weather and seasonality of weather patterns;

• the amount and timing of operating costs and capital expenditures relating to the maintenance and expansion of our business, operations and infrastructure;

• increasing competition in the automotive parts industry;

• our ability to increase or maintain revenue and profitability at our facilities;

• uncertainty as to our future profitability;

• uncertainty as to the impact on our industry of any terrorist attacks or responses to terrorist attacks;

• our ability to operate within the limitations imposed by financing arrangements;

• our ability to obtain financing on acceptable terms to finance our growth;

• our ability to integrate and successfully operate recently acquired companies and any companies acquired in the future and the risks associated with these companies;

• declines in asset values;

• fluctuations in fuel prices; and

• our ability to develop and implement the operational and financial systems needed to manage our growing operations.

Other matters set forth in this Quarterly Report may also cause our actual future results to differ materially from these forward-looking statements. We cannot assure you that our expectations will prove to be correct. In addition, all subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements mentioned above. You should not place undue reliance on these forward-looking statements. All of these forward-looking statements are based on our expectations as of the date of this Quarterly Report. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our results of operations are exposed to changes in interest rates primarily with respect to borrowings under our credit facility, where interest rates are tied to either the prime rate or IBOR. As of September 30, 2004 we had $33.0 million outstanding under our credit facility. Our previous secured credit facility required that we enter into an interest rate swap agreement to mitigate our interest rate risk on a portion of the balance outstanding. We do not however, as a matter of policy, enter into hedging contracts for trading or speculative purposes. The swap agreement, which expired on August 22, 2004, had a notional amount of $10.0 million under which we paid a fixed rate of interest of 2.65% and received payments based upon variable rates. The swap agreement was not designated as a hedging instrument and, as a result, changes in the fair value of the swap agreement were included in current period earnings. We recorded non-cash credits of $90,000 and $27,000 during the nine months ended September 30, 2004 and 2003, respectively, related to the change in fair value of the interest rate swap agreement.

The Company is also exposed to currency fluctuations with respect to the purchase of aftermarket parts in Taiwan. While all transactions with manufacturers based in Taiwan are conducted in U.S. dollars, changes in the relationship between the U.S. dollar and the New Taiwan dollar might impact the purchase price of aftermarket parts. We might not be able to pass on any price increases to customers. Under our present policies, we do not attempt to hedge our currency exchange rate exposure.

Our investment in our Central American operations is not material, and we do not attempt to hedge our foreign currency risk.

Item 4. Controls and Procedures

As of September 30, 2004, the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of LKQ Corporation’s management, including our Chief Executive Officer and Chief Financial Officer, of our disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were

Exhibit Number		Description of Exhibit

10.1		Stock Purchase Agreement dated as of October 26, 2004 between LKQ Corporation and Fred J. Hopp.

31.1		Certification of Chief Executive Officer Pursuant to Rule 13a-15(e) or Rule 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer Pursuant to Rule 13a-15(e) or Rule 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

	LKQ CORPORATION


	/s/ Mark T. Spears
	Mark T. Spears
	Senior Vice President and Chief Financial Officer
	(Principal Financial Officer)

	/s/ Frank P. Erlain
	Frank P. Erlain
	Vice President – Finance and Controller
	(Principal Accounting Officer)