Joseph P. Boutross
Vice President of Investor Relations at LKQ
Thank you, operator. Good morning, everyone, and welcome to LKQ's First Quarter 2022 Earnings Conference Call. With us today are Nick Zarcone, LKQ's President and Chief Executive Officer; and Varun Laroyia, Executive Vice President and Chief Financial Officer.. Please refer to the LKQ website at lkqcorp.com for our earnings release issued this morning as well as the accompanying slide presentation for this call. Now let me quickly cover the safe harbor. Some of the statements that we make today may be considered forward-looking.
These include statements regarding our expectations, beliefs, hopes, intentions or strategies. Actual events or results may differ materially from those expressed or implied in the forward-looking statements as a result of various factors. We assume no obligation to update any forward-looking statements. For more information, please refer to the risk factors discussed in our Form 10-K and subsequent reports filed with the SEC. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release and slide presentation. Hopefully, everyone has had a chance to look at our 8-K, which we filed with the SEC earlier today. And as normal, we are planning to file our 10-Q in the coming days.
And with that, I am happy to turn the call over to our CEO, Nick Zarcone. Thank you, Joe, and good morning to everyone. I will provide some high-level comments on what was a robust quarter for LKQ from many different perspectives before Varun walks you through some of the financial details and our increased financial guidance. I will then close with a few observations before opening the call to your questions. As we entered 2022, who would have thought the world would experience events more traumatic than the pandemic we all have been living through? Just when everyone thought we had turned the corner and we're headed towards the new normal, in late February, Russian tanks rolled into Ukraine, and everything changed overnight. In retrospect, issues related to tight labor markets, supply chain challenges and inflationary pressures pale in comparison to the needless loss of human lives. Yet out of the ashes, we are all able to watch the evening news and see true leadership and courage in action and incredible solidarity in a time of crisis. Yes, I'm talking about the Ukrainian people. But the same is true for the 950 people in Ukraine who are LKQ associates. These employees are truly remarkable. So too are their colleagues in Poland, Hungary, Slovakia and Romania who welcomed hundreds of family members of our Ukrainian employees at the border to provide food, housing, medical assistance and schooling to those fleeing the country. They are all defining what it means to be LKQ proud. As to the business, we exceeded our expectations for Q1 in terms of both revenue and profitability. And this gives us confidence to increase our financial guidance for the year. The key word in the economy in the past several quarters has been inflation. During periods like this, companies have a choice, wait and see the impact and play defense or anticipate the impact and play offense. LKQ chose to play offense, and the benefits of doing so can be found in our results. This is particularly true with respect to the exceptional organic revenue growth achieved in our North American wholesale and European segments. Both of which benefited from strong demand for automotive products as mobility and claims volumes increased, while pushing prices in an attempt to offset most of the inflationary pressures. Managing through this environment is hard. And I am extremely thankful for the efforts of the global LKQ leadership team, which is doing a terrific job of balancing the best interest of our customers, suppliers, employees and shareholders. Now on to the quarter. Revenue for the first quarter of 2022 was $3.3 billion, an increase of 5.6% as compared to $3.2 billion in the first quarter of 2021. Total parts and services revenue increased 5.9% in Q1, comprised of organic revenue increases of 6.9%, plus the net impact of acquisitions and divestitures of 1.7%, offset by foreign exchange rates, which decreased revenue by 2.7%. Net income for the first quarter of 2022 was $269 million as compared to $266 million for the same period of 2021, an increase of 1.1%. Diluted earnings per share for the quarter was $0.94 as compared to $0.88 for the same period last year, an increase of 6.8%. On an adjusted basis, net income in the first quarter of 2022 was $287 million compared to $286 million in the same period of 2021. Adjusted diluted earnings per share for the first quarter was $1 as compared to $0.94 for the same period of 2021, a 6.4% increase, driven by a reduction in the average share count. Let's turn to some of the quarterly segment highlights. And please note, this is the first quarter of separating the self-service business from the core North American wholesale business. Turning to North America. From Slide six, you will note that organic revenue for parts and services in our North American wholesale segment increased 13.6% in the quarter on a reported basis and 11.8% on a per day basis. During the first quarter, industry-wide overall claim counts increased 12.2% versus Q1 of 2021. According to the U.S. Department of Energy, during the first quarter of 2022, U.S. weekly supplied motor gasoline volume was approximately 4.9% above last year, but still 4.7% below the first quarter of 2019 pre-pandemic. And according to the Department of Transportation, highway miles driven during Q1 increased 4.9% above last year, but lagged 2019 levels by approximately 2.2%. From a product line perspective, recycled and remanufactured parts demonstrated higher growth, including gains in both volumes and price relative to last year. On the aftermarket front, we have been successful in passing through inflationary cost increases despite the supply chain challenges, which are causing volumes to be down relative both to last year and 2019. April has started off on a positive note, following the pattern established in Q1. We don't anticipate achieving double-digit revenue growth in our North America wholesale operation for the rest of the year, but we expect it to be in the mid- to high single-digits. In part due to headwinds from parts availability and more so due to labor constraints, during Q1, the national average scheduling backlog at collision repair shops reached 4.5 weeks, 2.5 times the length of the typical first quarter backlog. Additionally, since 2016, average vehicle repair costs have risen steadily every year with the largest increases occurring in the past two years, reaching an all-time high in 2021. Our parts provide a strong solution for shops and insurance carriers to manage costs. As we inevitably begin to witness some relief in the supply chain and a steadier flow of aftermarket product, the value proposition of our parts becomes even more attractive as shops continue to face headwinds related to labor costs and overall inflation. As we indicated in our last call, this quarter, we began reporting self-service as a separate segment. This new segment provides investors with greater transparency into the commodities dynamic of our business. Given the majority of our other revenue category, which primarily consists of scrap and precious metals, comes from our self-service operations. Varun will cover more details on the margins of this segment shortly. During the first quarter, total revenue for self-service was flat compared to last year reflecting the relative softness in metals pricing. Organic revenue for parts and services for this segment increased 14.6%, largely driven by price. Also, the average revenue per admission, a key productivity metric rose during the first quarter of 2022 relative to 2021. Moving to our European segment. Organic revenue for parts and services in the first quarter increased 6.9% on a reported basis and 6% on a per day basis. As the largest pure-play distributor of automotive aftermarket parts in Europe, this is a tremendous start to 2022 even in the face of an extremely challenging geopolitical environment on the continent. So we are quite pleased with the organic growth in Europe. While different by market, overall consolidated organic growth was split evenly between volume and price. According to the Apple Mobility Index, the trends in driving trips in our European markets was down earlier in the year due to normal seasonal patterns. As we progress through Q1, the index rebounded. Encouragingly, despite all the fear of a dramatic drop-off in demand due to global macro headlines, at this point we have not seen any notable shift in European mobility as we've entered the second quarter. Our regional operations experienced varying revenue performance in the quarter, but all posted positive growth with very solid year-over-year performance. The U.K. and Benelux operations were particularly strong with high single-digit organic growth, while Germany and Central Europe, excluding Ukraine, posted mid-single-digit organic growth. Italy also demonstrated progress, posting positive organic growth for the first time in several quarters. The Russian invasion of Ukraine had a direct impact on our revenue in late February and all of March due to having to close certain branches that we operate in Ukraine. And those that have remained open, as you would assume saw a significant drop in demand. Also, immediately following the invasion, we ceased all sales to Russian-based parts distributors. We estimate the impact of the war on European organic revenue growth during the quarter was approximately 60 basis points. And as these conditions continue, we anticipate the impact on our full year European growth to be about 120 basis points. We continue to pay our Ukrainian employees regardless of whether they are working. And we are supporting their families who have fled to neighboring countries. As I've always said, our people are our most important assets. And in Ukraine, the well-being of our people is our primary focus today. Varun will provide some additional financial related details to this unfortunate situation shortly. Now let's move on to our Specialty segment. Organic revenue for parts and services for our Specialty segment declined 8.3% in the quarter on a reported basis and 9.8% on a per day basis, largely due to a very tough year-over-year comp. You may recall, this segment reported 33% organic growth in Q1 of last year. So on a two-year stack, the annual revenue growth is still well into double-digits. We anticipate another tough comparison in Q2 against the 30% growth reported in the second quarter of last year with a positive recovery and a return to year-over-year organic growth in the back half of this year. A few other key highlights for Specialty during the quarter. In the first quarter, Specialty hosted our annual Big Show, a customer event, which is focused on SEMA-related parts, and [Indecipherable] hosted our annual RV Expo for our RV-focused customers. Both events booked solid year-over-year increases in attendance and sales, suggesting good demand in the future. Also, in March, our Specialty team opened a 210,000 square foot distribution center in Orlando, Florida. While it will create a very slight drag on near-term margins while it ramps up, this new distribution facility will help create higher revenue as it will service Florida and Georgia. Both of which are very attractive markets for our RV and marine-related product lines. The supply chain continues to provide challenges. And we're doing our best to get the inventory needed to service customer demand. During the quarter, key port cities in China were shut down for a while. This shifted container capacity to other countries like Taiwan, giving our North American team an opportunity to get some incremental inventory on the water. March was the second best container volume that we've witnessed in 24 months. We expect some of this benefit to continue into April and likely May and this inventory should be at our warehouses by mid to late summer. Once the China lockdowns reopen, we will likely see a regression back to the [Indecipherable] that we've endured over the past 12 months as the pent-up demand from China comes through. In Europe, product availability remained challenging through Q1 with back orders still running high, but we are witnessing some signs of improvement as we enter Q2. Turning to ESG. During the first quarter, we continued our environmental stewardship efforts by processing 193,000 vehicles, resulting in, among other things, the recycling of approximately 970,000 gallons of fuel, 562,000 gallons of waste oil, 501,000 tires and 178,000 batteries. During Q1, we also processed approximately 260,000 tons of scrap steel. On the social front, during the quarter, we focused on some key initiatives around the financial and mental health well-being of our employees. As an example, in North America, we implemented a profit-sharing plan, where we made a special contribution of $1,000 to the 401(k) accounts of all eligible team members. Alongside this contribution, we provided services to educate our team on how to think about and plan for retirement. From this initiative alone, we witnessed over 4,000 new 401(K) account openings. We want all employees to benefit from our success. And this plan allows us to reward and thank them for their relentless focus on results, which made a huge impact on our 2021 performance. In Europe, we launched a program called Inspire to Thrive that lets our team know that their mental well-being matters. The goal of this program is multifaceted including creating a supportive culture, addressing factors that may negatively affect mental well-being, addressing negative perceptions of mental well-being issues, providing support to colleagues suffering from mental health issues and developing management skills to address issues when they arise. Operationally, we believe this program will have many benefits, such as higher retention, reductions in sick leave and enhanced productivity. More importantly, however, it's simply the right thing to do for our team and helping them maximize their overall well-being. Lastly, from a corporate development perspective during the quarter we entered into a transaction to sell our PGW glass business. While a fundamentally solid operation, we had come to the conclusion that LKQ was not the best owner of this business and the margins were always going to be dilutive to the overall North American segment margins. This transaction closed last week and we are extremely pleased with the outcome. As we entered Q2, we are witnessing a healthy pipeline of potential tuck-in acquisitions. And since April 1st, we have closed on two small European transactions. And I will now turn the discussion over to Varun, who will run you through the details of the strong first quarter financial performance and our increased guidance. Thank you, Nick, and good morning to everyone joining us today.. While I'm excited to be able to present another strong set of financial results and I'll cover the details on the quarter shortly. I want to begin with comments on a very eventful start to 2022. As you know, LKQ entered the year with momentum coming off record revenue and profitability in 2021, but also anticipating challenges from the Omicron surge, supply chain constraints, inflationary pressures and volatile commodity prices. These factors created headwinds in the quarter and we've had to react quickly to counteract the effects. While there is more work to be done to improve our inventory availability and manage the cost pressures, we are comfortable with the direction we're headed and importantly our position relative to the competition. The Ukraine-Russia conflict has been a further source of volatility, both with its direct impact on our business and the indirect effects on currencies and commodity prices. As Nick mentioned, our revenue at risk owing to the conflict isn't material. But we experienced a negative effect of about $0.01 in Q1 and expect a further $0.05 headwind relative to our original EPS guidance over the balance of the year due to the ongoing conflict. Please note that the impacts associated with lost revenue and other indirect effects of the conflict are not being considered for adjustment in our calculations of segment EBITDA and adjusted diluted EPS. Direct impacts related to asset write-downs and/or reserves are being excluded from the calculations of these metrics. The Q1 exclusion totaled roughly $6 million. As expected, scrap steel and precious metal prices were a drag on results year-over-year. The prices were better than projected in the quarter and thus the negative impact was less severe than anticipated. Compared to Q1 of 2021, metals prices generated a $32 million negative effect on segment EBITDA and a $0.08 impact on adjusted EPS. As discussed on the fourth quarter call, we are now presenting the self-service operating unit as a reportable segment to provide investors with greater visibility into our operating results. I hope that you have had an opportunity to review our Form 8-K filed with the SEC on Monday, the 25th of April, which shows the segment financial information recast under the new presentation. As noted on prior calls, self-service generates a large portion of its revenue from scrap steel and the precious metals and catalytic converters, which makes its results more volatile than the wholesale North America segment. Of the $0.08 negative year-over-year impact from metals, approximately 2/3 is derived from the self-service segment. Last week, we completed the sale of our PGW aftermarket glass distribution business for gross proceeds of $362 million. PGW generated almost $400 million of revenue, and its EBITDA margin was approximately 10% in 2021. By divesting PGW, we'll see an improvement in EBITDA margin as the business generated a lower margin than the wholesale North America segment. We intend to use excess cash to repurchase shares in the coming months, though given the timing of the transaction, will be dilutive to full year 2022 EPS by approximately $0.04, which is built into our updated guidance. The full year share count reduction benefit in 2023 will further mitigate the lost PGW earnings. While we expect to report a gain on sale, our U.S. GAAP EPS outlook does not include a gain as the amount has not been finalized. Any gain would be deducted from U.S. GAAP EPS in the calculation of adjusted diluted EPS. Finally, S&P upgraded LKQ to BBB- with a stable outlook last week. Achieving an investment-grade rating from S&P, in addition to the same from Fitch ratings a year ago is a tremendous accomplishment for the organization and is a testament to our operational excellence program launched in 2019. This program has supported the consistent operating performance, robust cash flows and a resilient business model that S&P cited as reason for the upgrade. The immediate implication of the upgrade is that collateral requirements fall off our senior secured revolving credit facility. And over time, we expect the added flexibility to allow the company to drive even higher levels of free cash flow to invest in growing our business and returning capital to stockholders. Specifically, there will be opportunities to extend vendor payment terms and increase payables. And we expect this benefit to come through over the next few years. I'll now shift to the quarterly results. Our first quarter results reflect a solid start to the year with improving revenue, net income and EPS year-on-year, despite the negative impact of metals, challenges related to inflation and the global supply chain, the Omicron variant, the ongoing conflict in the Ukraine and foreign exchange volatility owing to a stronger U.S. dollar. Gross margin decreased by 30 basis points compared to the first quarter from 2021, with 40 basis points negative effect coming from the self-service margin, which declined owing to metals. Overhead expenses as a percentage of revenue rose 80 basis points year-over-year, with higher bad debt expense and inflationary increases in vehicle, freight and fuel expenses. Income taxes in the first quarter of 2022 were booked at 25.1%, consistent with our prior guidance. And finally, as Nick mentioned, diluted EPS was $0.94 for the quarter and adjusted diluted EPS was $1 even. I'll now turn to the segment operating results. Starting on Slide nine Wholesale North America produced an EBITDA margin of 18.1% for the quarter, down 30 basis points from the prior year period. Gross margin was roughly flat as pricing improvements were offset by unfavorable impacts from metals, which had a negative 70 basis point effect in the first quarter. Segment overhead expenses increased by 50 basis points, with the negative effects from inflation on personnel and freight costs. We've previously communicated our expectation for the North America margin to run in the mid to high 16 without the metal effects. With the new segment breakout and the sale of the glass business, we now believe that Wholesale North America EBITDA margin should run approximately 70 basis points higher after normalizing for metals effects. Europe reported an 8.8% EBITDA margin for the quarter, down 80 basis points from the prior year period. As you can see on Slide 10, the margin decrease was attributable to movements in both gross margin and overhead expenses, with negative effects from inflation, higher bad debt expense and effects from the Ukraine-Russia conflict. As mentioned, we anticipate a negative impact on Europe from lost revenue related to the conflict, though the team believes they can deliver a double-digit margin for the full year. Moving to Slide 11. Specialty gross margin grew 110 basis points, with benefits from net pricing and mix more than offsetting a 90 basis point negative effect from acquisitions, primarily SeaWide. Overhead expenses increased by 190 basis points, driven by personnel cost inflation and higher vehicle, fuel and freight costs. The overhead expense increases were partially offset by 60 basis points of benefit from operating expense synergies and leverage mostly generated from the SeaWide acquisition. While the specialty EBITDA margin of 12.6% is down relative to the prior year, it's important to acknowledge the progress the business has made over the last three years. Pre-pandemic, in Q1 2019, Specialty reported a segment EBITDA margin of 10.7%. The team has done a fine job rationalizing the cost structure and protecting its product margin resulting in a 190 basis point improvement from Q1 of '19 through to Q1 of 2022. Self-service reported an EBITDA margin of 20% for Q1 2022, a strong result for the segment, but below the record margin achieved last year. As you saw in the Form 8-K, with the recast historical segment results, self-services margins can be -- can vary significantly depending on metals prices. Since the beginning of 2019, we've seen a low point for the margin at 6.3% in the third quarter of 2019 and a high point of 27.9% in Q1 of 2021. While there are performance elements that we control, for example, car buying, product pricing and labor efficiency, the self-service business results are driven by trends in scrap steel and precious metals prices. When prices are moving higher, especially when it occurs rapidly with the strong margins in this business and we'll see the downside when prices go the other direction. We believe that breaking up self-service will provide greater clarity to investors. With that background, the decrease in self-services margins in Q1 of 2022 is driven by movements in metals prices and car costs, estimated at an 1,100 basis points negative effect partially offset by improved pricing. Shifting to liquidity and capital allocation. We sustained the positive momentum we've built in recent years around cash flow generation with free cash flow of approximately $350 million in the first quarter. At a conversion ratio of almost 80% of EBITDA, we are delivering free cash flow above our long-term expectation. For sure, there are some timing elements that will reverse over the course of the year. And we are confident in our ability to generate significant and sustainable free cash flow in line with expectations of converting EBITDA to free cash flow in the 55% to 60% range for the full year. We are cautiously optimistic about the progress we have made with inventory procurement. Access to aftermarket products and cars at auction improved relative to the same period in 2021. And we were able to deploy more cash to build inventory. As shown on Slide 24, we increased our inventory spend and purchased more salvage vehicles than we did in the first quarter of 2021. And as you can see on Slides 25 and 26, our inventory levels have increased in all four segments relative to December, excluding the impacts of the held-for-sale reclassification and foreign currency translation. As of the 31st of March, the Wholesale North America inventory excludes approximately $100 million of glass inventory, which is presented in the held-for-sale asset line on the balance sheet. We remain confident that our inventory position 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 of $59 million was in line with our expectation. And following our balanced capital allocation philosophy, we repurchased 2.7 million shares in the quarter for $144 million and issued our quarterly dividend with a $71 million payment in the month of March. We also paid down our debt balance by approximately $53 million in the quarter. Our net leverage ratio came in at 1.3 times EBITDA. And interest coverage exceeds 30 times compared to the credit facility requirements of four times and three times, respectively. In short, we are very comfortable with our credit metrics, which support our investment-grade rating. As our earnings release of this morning indicated, the Board has approved a quarterly cash dividend of $0.25 per share, which will be paid in June to stockholders on record as of the 19th of May. And finally, I will wrap up my prepared comments with our updated thoughts on 2022. Our guidance assumes that there are no significant negative developments related to COVID-19 in our major markets. Scrap and precious metal prices hold near the average for the first quarter. And the Ukraine-Russia conflict continues without further escalation. On foreign exchange, rates have been moving rapidly in recent days, with the euro hitting a five-year low on Wednesday. Our guidance includes weakening European rates in the second quarter, followed by a recovery in the second half of the year. We've dialed in a full year average rate for the euro at $1.09 and the pound sterling at $1.30. Since current rates are below these figures, we have about $0.03 of risk over the balance of the year if rates hold at their current levels. Having said that, with the strong start to the year, we are increasing our organic parts and services revenue growth expectation to between 4.5% and 6.5%. We are projecting full year adjusted diluted EPS in the range of $3.80 to $4.10, with a midpoint of $3.95. This is an increase of $0.08 compared to the prior midpoint. The raise is primarily attributable to our first quarter performance as the balance of year has mostly offsetting effects as shown on Slide 19 of the earnings deck related to benefits due to organic growth and related operating performance, metals prices above our original forecast and share repurchases, offset by headwinds from lost earnings tied to the Glass disposal in April, weakening FX rates and the impact of the Ukraine-Russia conflict. Please note that the share repurchase benefit is attributable both to the shares that we purchased in the first quarter, which will give us a benefit of roughly $0.03 on a full year basis and the anticipated repurchases from the proceeds of the Glass sale of approximately $0.05. While there are lots of puts and takes in the forecasted numbers, I want to specifically highlight the operating performance component. As I previously stated, our operational excellence initiatives have created a significantly stronger and more resilient business, which is helping us to improve operating results despite the current inflationary environment and supply chain challenges. And finally, we remain on track to deliver at least $1 billion of free cash flow for the year achieving strong free cash conversion in line with our expectations for the business. Thank you once again for your time this morning. And with that, I'll turn the call back to Nick for his closing comments.
