Varun Laroyia
Executive Vice President and Chief Financial Officer at LKQ
Thank you, Nick, and good morning to everyone joining us today. Before I go into details on the fourth quarter, I'd like to spend a moment to reflect on the last 2 years operating in the pandemic. Since the world was turned upside down in March of 2020, we leveraged LKQ's core strengths, namely our best-in-class inventory availability and service reliability, extensive distribution network, a rock solid balance sheet and most importantly, our people to be successful in adverse conditions.
We accelerated our operational excellence program to make the business more resilient and have delivered record annual results yet again while creating a strong position for the company to participate in the demand recovery. The performance of the past 3 years since the pivot to operational excellence and in 2021, in particular, highlights the benefits of our operating initiatives. By many measures, 2021 was an outstanding year. In terms of profitability, we generated record full year adjusted diluted earnings per share of $3.96, an increase of 55% compared to 2020, our previous high watermark. During the September 2020 Investor Day, I set the expectation that LKQ aimed to be a double-digit EPS compounder with about half coming from organic growth and productivity and the rest from judicious capital allocation.
With our 2021 results, we surpassed this expectation and picked up about 3 years of EPS growth in a single year. We have sustained the momentum built in recent years around cash flow generation with free cash flow of $1.1 billion in 2021 and successfully reset[Phonetic] the business model to operate at this higher level going forward.
At a conversion ratio of 60% of EBITDA, we are delivering free cash flow in line with our long-term expectation. Generating significant and sustainable free cash flow has accelerated various capital allocation options, including our share repurchase program maintaining investment-grade credit metrics and initiating a regular quarterly dividend.
With a focus on operational excellence, including integrating our acquisitions and converting profit to cash we have made significant progress in improving our return on invested capital. By our internal measure of ROIC, which essentially ignores the amortization of intangibles, we exceeded 15% in 2021 after running at approximately 10% just a few years ago. All of this reflects our commitment to delivering long-term value to our various stakeholders.
I'd also like to take this opportunity to extend my sincere thanks to the entire LKQ team for their dedication and hard work. It takes all 45,000 of us rowing in the same direction to deliver such outcomes. We have raised the bar on what LKQ can be, and we have more to come.
Now shifting to the fourth quarter. Our fourth quarter results reflect a solid finish to the year with improving revenue, net income and earnings per share year-over-year despite, as expected, the negative impact of metals, challenges to inflation, the global supply chain and the Omicron variant.
Gross margin remained a year-over-year benefit with improvement in Europe, offsetting metals driven softness in North America margins. Unlike the first 3 quarters of 2021, commodity prices had a negative effect on margins in the fourth quarter. We estimate that scrap steel and precious metal prices produced year-over-year decreases of approximately $16 million in segment EBITDA and $0.04 in adjusted EPS in the fourth quarter.
In 2020, we benefited from significant sequential increases in scrap steel and precious metal prices. during the fourth quarter, while 2021 showed roughly flat to declining sequential changes. Overhead expenses as a percentage of revenue increased 130 basis points year-over-year with over half driven by personnel costs. The tight labor market has pushed wages higher in many of our markets. Additionally, strong performance across all three segments contributed to increased levels of incentive compensation in 2021, which, of course, resets with new targets for 2022.
I'll now turn to segment operating results. Starting on Slide 10, North America produced an EBITDA margin of 15.1% for the quarter. Adjusted gross margin was unfavorable by 50 basis points, primarily related to the metals effect, which had a negative 210 basis point effect on gross margin in the fourth quarter. The benefits from ongoing margin initiatives in the wholesale business and improved pricing partially offset the metals impact.
Segment overhead expenses increased by 230 basis points, with the largest change going to personnel expenses. Roughly half of the 140 basis point increase in personnel expenses is attributable to higher incentive compensation with the remainder related to wages, temporary labor and medical costs. Higher freight and fuel costs drove a further 80 basis point increase in overhead expenses. With some of the overhead leverage benefit from higher revenue dollars offsetting a portion of the gross margin impact, metals had a negative 170 basis points effect on the reported 15.1% segment EBITDA margin. This result is consistent with our expectations for a mid-to-high 16% baseline without the metals impact. For the full year, the reported North America segment EBITDA margin of 18.3% benefited by roughly 100 basis points from metals prices mostly in the first half of the year.
Moving to Europe. Europe continued its strong performance with an 8.9% EBITDA margin, the highest fourth quarter figure since 2015 and finished the full year with 10.2%. As you can see on Slide 11, gross margin was the primary driver of the fourth quarter improvement with better net pricing. We are pleased with Europe's progress in delivering a double-digit full year segment EBITDA margin, and we are confident that there's further opportunity ahead.
Moving to Slide 12. Specialty held gross margin roughly flat despite inflationary pressures in the segment's one operations and a negative mix effect from the SeaWide acquisition with offsetting benefits in net pricing. Operating expenses increased by 80 basis points, driven mostly by personnel expenses, higher wages, medical costs and incentive compensation, which, of course, some of it will be reset to reflect 2022 targets. The specialty team made great progress on the SeaWide integration plan during the fourth quarter by moving all inventory into existing facilities in December and subsequently has exited three of the four acquired facilities in January, which, of course, will create cost savings going forward.
Income taxes in the fourth quarter of 2021 included discrete benefits of $0.07, primarily related to the reversal of certain valuation allowances and true-ups related to prior year tax return filings. There was a benefit of $0.025, reflecting the change in estimate of our effective tax rate as we closed out our 2021 financials. While the discrete benefit in the 2021 rate are nonrecurring, we expect to benefit from a lower effective tax rate going forward and have included 25.1% in our 2022 guidance assumptions.
Shifting to liquidity and capital allocation. We have been foreshadowing a cash outflow for full inventory whole year, as we've looked to rebuild our inventory levels in anticipation of demand recovery. The outflow has been delayed by supply chain issues, though we began to see some real progress in the fourth quarter. As you can see on Slide 31, we were able to grow our inventory balances in all three segments in the fourth quarter, an opportunity which drove a higher-than-expected cash outflow of $182 million.
While there are still some challenges getting aftermarket products to our locations, given the challenges with ocean freight and ongoing congestion at the ports here in North America, we saw robust activity at the auctions and grew our salvage inventory to support the strong growth in this category. We were also successful in increasing the inventory for our Specialty segment ahead of the key selling season with a number of shows that take place in the first quarter. We are confident that our inventory positions will enable each segment to continue to offer best-in-class availability and service relative to our competitors despite the ongoing supply chain challenges.
Our capital spending for the quarter was higher than what we've seen in recent years. With a backdrop of inflation continuing for the foreseeable future, the increase was driven by strategic capital deployment during the quarter as we identified a series of opportunities mostly related to our salvage business in North America to invest in real estate. These investments, which include site expansions and the purchase of a new facility for our Denver operation will provide room for growth in our salvage business. Additionally, we identified other high-return investments related to vehicles, equipment and systems to undertake in the fourth quarter, given the long lead times with the ongoing supply chain disruptions.
In total, the real estate and other strategic purchases totaled about $90 million for the quarter, which accounts for much of the growth in capital spending. Full year free cash flow, as I mentioned previously, was $1.1 billion, our second year in a row being above the $1 billion mark. At a 60% conversion ratio for free cash flow to EBITDA for the year, this was roughly $275 million above our original guidance flow of $800 million when we gave guidance for 2021 last February.
Following our balanced capital allocation philosophy, we repurchased 5.3 million shares in the quarter for $297 million and issued our first quarterly dividend with a $73 million payment in December. We also acquired businesses in the fourth quarter. SeaWide in our Specialty segment and a tuck-in business in the Benelux market for a total consideration of $57 million.
Our net leverage ratio came in at 1.4 times EBITDA and interest coverage now exceeds 28 times compared to the credit facility requirements of 4 times and 3 times respectively. We are well positioned with our credit metrics, which are consistent with an investment-grade profile, and we remain committed to achieving an investment-grade rating. As our earnings release of this morning indicated, the Board has approved the quarterly cash dividend of $0.25 per share, which will be paid to stockholders on record as of March 3.
I will wrap up my prepared comments with our thoughts on 2022. Over the past 2 years of living with the once-in-a-100-year health crisis, what has become clear is the resiliency of our end markets and our team's ability to deliver solid results utilizing the operational excellence toolkit. This, in effect, gives us the confidence to reinstate full year guidance, including organic revenue growth for the coming year.
Our guidance assumes that, one, there are no significant negative developments related to the COVID-19 in our major markets; two, foreign exchange rates hold near recent level for the remainder of the year. Three, scrap and precious metal prices trend lower than what we're currently seen in the month of February and an effective tax rate of 25.1%. So with that, we expect organic parts and services revenue growth of between 3% and 5% with higher growth rates in the second half of the year than the first half. With ongoing inflationary pressures exacerbated by the supply chain challenges, we remain confident in our ability to positively work through pricing changes as needed.
Second, we are projecting full year adjusted diluted EPS in the range of $3.72 to $4.02 with a midpoint of $3.87, this is a decrease of $0.09 or 2% at the midpoint relative to the 2021 actual figure.
Looking at Slide 19, you can see how we get from the 2021 actual EPS to our 2022 expectation. We've been transparent about the commodities benefit on our 2021 results. And with lower prices anticipated for 2022, we will face a headwind of roughly $0.27 related to scrap steel and precious metal prices, predominantly in the self-service operating unit.
The favorable discrete tax adjustments in 2021 will not reoccur, which will lower EPS by a further $0.06. Additionally, lower average foreign exchange rates will have a $0.04 negative effect year-over-year, and we had a $0.03 pickup of fair value adjustments related to certain equity investments that we're not projecting to reoccur in 2022.
Taking these factors into account, we're looking at a baseline EPS figure of $3.56. On a 2-year stack, we remain well above our long-term growth expectations in 2022, and we expect annual growth rates to normalize in 2023. The operational excellence initiatives have created a significantly stronger and more resilient business, which we believe will support our ability to improve operating results despite the current inflationary environment and supply chain challenges.
And finally, our balance sheet is solid. We continue to generate outstanding free cash flow through strong profitability and judicious use of trade working capital. We are projecting to generate free cash flow of at least $1 billion in 2022 as we sustain a healthy conversion of EBITDA to free cash flow.
Before I turn it back to Nick, I want to inform everyone that we are contemplating breaking out the self-service operating unit as a separate reportable segment in 2022. While we are not planning any changes in how self-service is operated or how it interacts with the wholesale business, we would like to provide investors even greater transparency into the North America business especially as it relates to the metals impact. We will provide further information on the decision ahead of our first quarter earnings call in late April.
Thanks for your time this morning. And with that, I'll turn the call back to Nick for his closing comments.