LKQ Q2 2022 Earnings Results & Report

LKQ EPS Results

• Actual EPS: $1.09
• Consensus EPS: $1.02
• Beat/Miss: Beat by +$0.07
• One Year Ago EPS: $1.13
• EPS Beat Rate: 2 of last 8 quarters

LKQ Revenue Results

• Actual Revenue: $3.30 billion
• Expected Revenue: $3.39 billion
• Beat/Miss: Missed by -$91.22 million
• YoY Revenue Growth: -3.90%

LKQ (NASDAQ:LKQ) is a global distributor of automotive parts and accessories. The company supplies replacement parts, components and equipment to professional repair shops, collision-repair businesses, insurers, dealerships and other commercial customers. Its product offerings include recycled original-equipment parts, aftermarket parts, specialty vehicle products, tools and equipment.

LKQ’s operations include the procurement, dismantling and distribution of salvaged vehicles, allowing it to provide recycled engines, transmissions, body panels and other components. It also distributes new aftermarket parts and specialty products for cars, trucks, recreational vehicles, performance vehicles and other applications.

Founded in 1998, LKQ serves customers primarily in North America and Europe, with additional operations in other international markets, including Taiwan. The company sells through distribution centers, branch locations and online channels, supporting vehicle repair and maintenance markets across the regions where it operates.

LKQ Q2 2022 Earnings Call Transcript

Key Takeaways

• Reported Q2 revenue of $3.3 billion with parts & services organic growth of 3.8%, and delivered adjusted EPS of $1.09 (GAAP EPS $1.49 including a $127 million one-time gain on the PGW sale).
• North America parts & services organic revenue rose 10.7% as pricing actions offset inflation, supply chain headwinds eased modestly with June fill rates improving, and State Farm launched an 8-week pilot using aftermarket collision parts.
• Europe parts & services organic revenue grew 4.2% (4.9% per day) with double-digit segment EBITDA margins driven by pricing, procurement initiatives and the ongoing One LKQ Europe integration program.
• The Specialty segment saw an 11.5% organic revenue decline versus a tough prior-year 30% gain, though RV parts demand remained resilient and two-year stacked growth remains in double digits.
• Generated $288 million in Q2 free cash flow (YTD $638 million), repurchased $404 million of shares, paid $70 million in dividends, maintained net leverage at 1.2× and reaffirmed full-year guidance including a $1 billion free cash flow target.

Presentation

[Operator]

Good morning. My name is Rex, and I will be your conference operator today. At this time, I would like to welcome everyone to the LKQ Corporation second quarter 2022 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press the star one. Thank you. Mr. Boutross, you may begin your conference.

[Joe Boutross, VP of Investor Relations at LKQ Corporation]

Thank you, operator. Good morning, everyone, and welcome to LKQ's second 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.

[Joe Boutross, VP of Investor Relations at LKQ Corporation]

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. As normal, we're planning to file our 10-Q in the coming days. With that, I am happy to turn the call over to our CEO, Nick Zarcone.

[Nick Zarcone, President and CEO at LKQ Corporation]

Thank you, Joe, and good morning to everyone on the call. This morning, I will provide some high-level comments relative to our performance in the quarter, and then Varun will dive into the financial details and provide an update on our guidance before I come back with a few closing remarks. The second quarter of 2022 was one of the most unusual and complicated operating environments we've encountered maybe ever, but clearly since the financial crisis. During the quarter, we were confronted with ongoing COVID risk and the issues associated with an uptick in positive cases in our workforce, major labor constraints, ongoing supply chain disruptions, a challenging inflationary environment globally as evidenced by June being the highest level of inflation the United States has seen in some 40 years, soaring energy prices, commodity price volatility, the unfortunate conflict in Ukraine and political unrest across the globe.

[Nick Zarcone, President and CEO at LKQ Corporation]

All this has resulted in major volatility in the foreign exchange markets, with the euro weakening materially in the quarter and reaching parity with the dollar in July. I think I speak for all CEOs across all industries when I say the sheer number of crosscurrents and headwinds have created some very challenging business dynamics. Yet, the LKQ team delivered another quarter of solid performance, driven by excellent focus and execution, exceeding many expectations, both internally and externally. I am very proud of the hard work and dedication demonstrated by our 45,000 employees that enabled our company to deliver on behalf of our stockholders and our customers during the quarter.

[Nick Zarcone, President and CEO at LKQ Corporation]

I am equally proud of the team's commitment to effectively manage the dynamics of our business which they can control while not losing focus on growing the business, developing our people, and continuously looking for opportunities to generate leverage and synergies across our operating segments. This effective management will serve the company well as we progress through the balance of 2022 and continue to confront many of the same headwinds. Our confidence in our team's ability to manage through this environment is validated by the reaffirming of our 2022 guidance, which Varun will discuss shortly. Now on to the quarter. Revenue for the second quarter of 2022 was $3.3 billion, a decrease of 2.7% as compared to $3.4 billion in the second quarter of 2021.

[Nick Zarcone, President and CEO at LKQ Corporation]

Parts and Services organic revenue increased 3.8% on a reported basis and 4.2% on a per-day basis. The net impact of acquisitions and divestitures decreased revenue by 1%, and foreign exchange rates decreased revenue by 5.6% for total Parts and Services revenue decrease of 2.7% on a reported basis or 2.4% on a per-day basis. Other revenue fell 2.9%, driven by a decline in precious metal prices. Net income for the quarter was $420 million as compared to $305 million for the same period of last year. Diluted earnings per share for the quarter was $1.49 as compared to $1.01 for the same period of 2021, an increase of 47.5%.

[Nick Zarcone, President and CEO at LKQ Corporation]

These amounts reflect a $127 million gain on sale of the PGW Auto Glass business in April or $0.45 a share. On an adjusted basis, net income in the quarter was $307 million as compared to $340 million for the same period of 2021. Adjusted diluted earnings per share for the quarter was $1.09 as compared to $1.13 for the same period last year, a 3.5% decrease. The adjusted results exclude the impact of the PGW Auto Glass sale. Now let's turn to some of the quarterly segment highlights. In North America, organic revenue for parts and services for our North American segment increased 10.7% in the quarter on a year-over-year basis, which exceeded our expectations.

[Nick Zarcone, President and CEO at LKQ Corporation]

This performance confirms the resiliency of our business model and our team's ability to effectively implement pricing initiatives to offset inflationary pressures. As it relates to volume, during the quarter, we saw some weakness which was consistent with a 2.6% decrease in second quarter fuel consumption as measured by the U.S. Department of Energy. Additionally, vehicle miles traveled saw little year-over-year growth, and Q2 growth was down relative to Q1. The largest pressure point in North America continues to be the aftermarket collision parts product line, which experienced reduced year-over-year volumes due to lower fulfillment rates associated with the supply chain disruptions. During the quarter, we benefited from some minor relief in the aftermarket supply chain relative to Q1, which translated into a very modest increase in our fill rates, with June aftermarket fill rates reaching the highest levels of 2022.

[Nick Zarcone, President and CEO at LKQ Corporation]

While we are still well below historical levels, we are encouraged by this modest positive trend in the supply chain, which is also evident by the decrease of spot container costs the market witnessed during the quarter. Albeit these shipping costs are still multiples above pre-pandemic levels. During the quarter, we were successful in getting a higher level of aftermarket collision parts shipped from Taiwan, but most all of that inventory is still on the water and won't be received in our warehouses until late summer or early fall. Our salvage collision part volumes were up a bit compared to last year as we were able to shift some of the aftermarket demand over to recycled parts. Recycled and remanufactured mechanical part volumes were generally flat on a year-over-year basis.

[Nick Zarcone, President and CEO at LKQ Corporation]

The value proposition of alternative parts could not be more attractive as insurance carriers face loss pressures from increased parts costs, rising labor costs and technician shortages at repair shops, broader supply chain issues, and decreased availability and increased cost of rental cars. During the quarter, collision repair costs increased 11.6% year-over-year, with cycle times still being over double their historical averages. Recently, the value proposition of CAPA certified aftermarket parts is being recognized by the largest auto insurer in the United States, that being State Farm, through a small pilot program. On June 20th, State Farm began an eight-week program where it introduced aftermarket bumper covers, headlights, and taillights when preparing repair estimates and settling auto claims in the Oklahoma and Texas markets. As you all know, State Farm historically has not utilized aftermarket collision parts.

[Nick Zarcone, President and CEO at LKQ Corporation]

We cannot predict the outcome of the pilot or estimate how this will impact State Farm's parts strategy going forward, and neither should you. That said, as with many things, the first step is the widest and tallest, and we are cautiously optimistic that aftermarket parts could potentially become a larger portion of State Farm's parts spend over the long term as they work through the outcomes of this pilot program. Moving on to our European segment. Organic revenue for Parts and Services in the second quarter increased 4.2% on a reported basis and 4.9% on a per day basis. Our regional operations continued to experience varying revenue performance in the quarter, but every geographic market was positive year-over-year with our Benelux, UK, Central and Eastern European and salvage businesses being the top performers.

[Nick Zarcone, President and CEO at LKQ Corporation]

Importantly, Italy realized year-over-year growth, which reflected the second consecutive quarter of positive revenue performance in that region. As mentioned last quarter, we halted all sales of parts into Russia when the war commenced. This decision reduced same-day organic growth for the European segment during the second quarter by approximately one half of one percent. Excluding the impact of the lost Russian revenue, same-day organic growth in Europe was 5.4%. When taken as a whole, the European volumes were down a bit during the quarter, but pricing was strong. We continue to make great progress with our One LKQ Europe program. Alongside solid organic growth during the quarter, our European segment achieved double-digit segment EBITDA margins, which represented incremental improvements both sequentially and year-over-year. Our European team's focus on pricing actions, private label branding, and procurement initiatives generated positive results in the quarter.

[Nick Zarcone, President and CEO at LKQ Corporation]

As I've said before, the execution element of the One LKQ Europe program will be with us forever, and it will be the driving factor behind the productivity improvements in years to come. Given all the current operating challenges in Europe, including the foreign exchange and geopolitical dynamics, I am very pleased with Europe's performance in the quarter. Now let's move on to our specialty segment. Organic revenue for parts and services for specialty declined 11.5% in the quarter, largely due to a tough year-over-year comp. As you may recall, this segment reported 30% organic growth in the second quarter of last year. On a two year stack, the annual revenue growth is still well into double digits. Indeed, specialty revenue in the second quarter would have been a record for the team, if not for the buoyant performance in 2021.

[Nick Zarcone, President and CEO at LKQ Corporation]

Our RV parts category performed better than the segment level growth as a whole during the quarter, as demand for the majority of our RV parts offerings is driven more by the size of the RV park and not new RV unit volume. That said, certain product groups, such as towing, that have some exposure to new unit volume underperformed in the quarter. Also, some of the softness that the SEMA-related products faced in the quarter was due to a year-over-year decrease in light vehicle sales in the U.S. In particular, pickup truck sales were down nearly 12% in the quarter, an important vehicle category for our specialty offerings. Now on to self-service. Organic revenue for parts and services for our self-service segment increased 13.2%.

[Nick Zarcone, President and CEO at LKQ Corporation]

There were some softness towards the end of the quarter in precious metals prices, which also impacted segment EBITDA margins year-over-year. Self-service also had increased vehicle procurement costs as we were challenged to source inventory. The recent volatility in commodities further validates the rationale for breaking out this non-distribution self-service business as a separate segment, given it represents the vast majority of the other revenue category. Let's move on to the initial Q3 revenue trends. Revenue for Wholesale North America operations have gotten off to a solid start, though we don't anticipate it will continue at the double-digit growth rates experienced in the first half of the year. Our European segment is also witnessing a good start, with growth rates continuing at second quarter levels.

[Nick Zarcone, President and CEO at LKQ Corporation]

Lastly, specialty revenue is slowly trending back towards prior year levels now that it has lapsed the incredibly strong growth rates experienced in the first half of 2021. We are experiencing some level of supply chain shortages and disruptions across all of our segments. These disruptions are creating product scarcity and freight delays that are resulting in meaningful availability pressures. While supply chain challenges are also driving product inflation across all our segments, we have been very effective in passing along these higher costs, as witnessed by our margin performance. Alongside supply chain inflationary pressures, like many businesses across the globe, we are facing wage inflation and increased competition for labor.

[Nick Zarcone, President and CEO at LKQ Corporation]

We are constantly looking at our wage structure and turnover rates across all of our segments to ensure that we stay ahead of any competitive pressures and help backfill the open positions with the best candidates we can attract. Our focus on the total rewards received by LKQ employees, not just compensation, is helping us navigate the difficult labor markets. From a corporate development perspective, in the second quarter, we acquired four businesses. In the United States, we acquired Bumblebee Batteries, another EV battery remanufacturing operation. In Europe, we acquired a workshop concept in the Netherlands, two very small former Hess Automobile branch locations in Germany, and the equity interest of our former JV partner in a small aftermarket parts business in Germany. In addition to closing on the sale of our PGW business during the quarter, we also divested our equity interest in two small joint ventures.

[Nick Zarcone, President and CEO at LKQ Corporation]

Lastly, on the ESG front, on May 23rd, we released our 2021 sustainability report and unveiled our new brand identity, reflecting the company's transformation from a salvage dismantler and recycler to a leading global value-added and sustainable distributor of vehicle parts, accessories, and services. LKQ is widely known and respected for our environmental stewardship. Within our 2021 CSR, we provided a deeper understanding of our social impact initiatives and strong governance structure, both of which underpin the long-term strength and success of our business. This year's report is another step in evolving our holistic ESG focus across our global organization with new and robust disclosures and accomplishments. Also during the quarter, 50/50 Women on Boards, a leading education and efficacy campaign driving the movement towards gender balance and diversity on corporate boards, recognized LKQ as a three plus company.

[Nick Zarcone, President and CEO at LKQ Corporation]

This award acknowledges our efforts in understanding the importance and advantages of having a diverse board that ultimately benefits stockholders, customers, employees, and communities. I will now turn the discussion over to Varun, who will run you through the details of the strong second quarter financial performance.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

Thank you, Nick, and good morning to everyone joining us today. I'm excited to be able to report that we carried the momentum generated by our operational excellence initiatives through the second quarter and produced another strong set of financial results. As Nick described, there is a great deal of volatility in the market related to inflation, supply chain challenges, exchange rate fluctuations, and commodity price movements on top of the geopolitical events and the ongoing pandemic. All these factors could easily have become a distraction and taken our focus away from executing on our operational priorities. I'm proud to say that the LKQ team did not let that happen, and our second quarter results reflect this ability to stay on point. Let me start with some highlights of the last quarter.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

As we announced in June, Moody's became the final of the three rating agencies to assign LKQ an investment-grade rating following previous upgrades by Fitch and S&P. We believe that we've taken the right actions over the last three years to strengthen our credit profile, and the Moody's upgrade to Baa3 with a stable outlook is further validation of our strategy. As discussed last quarter, achieving an investment-grade rating opens opportunities to improve free cash flow over the upcoming years in addition to the immediate drop-off in the liens to the credit facility following the covenant suspension. With respect to free cash flow, we produced a healthy $288 million in the quarter, bringing the year-to-date figure to $638 million, and importantly, putting us on pace to achieve our full-year guidance of $1 billion.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

I'm pleased that we were able to build our inventory toward the optimal level as shipping congestion eased a little bit, which resulted in a net cash outflow for the quarter of $162 million on this specific account. Strong free cash flow, along with the proceeds from the PGW glass sale, allowed us to return a significant amount of capital to shareholders. We repurchased over 8 million shares for $404 million and paid a quarterly dividend totaling $70 million. In just the last twelve months, we have repurchased over 20 million shares for approximately $1.1 billion and paid $215 million in dividends. In May, our board authorized a further $500 million increase to our share repurchase program to a total of $2.5 billion being authorized.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

We had about $600 million available as of the end of June, and we have remained active in the market in July. As previously stated, in April, we completed the sale of the PGW aftermarket glass distribution business for gross proceeds of $361 million. We recognized a pretax gain on sale of $155 million or $127 million after tax. Our U.S. GAAP EPS reflects the $0.45 gain, though we have deducted the gain from the calculation of adjusted diluted EPS. I'll now shift to the quarterly results. As expected and previously communicated, precious metal prices were a drag on results year-over-year, generating a $32 million negative effect on segment EBITDA and an $0.08 headwind on adjusted diluted EPS.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

Most of the impact related to the precious metals found in catalytic converters, the prices of which were near record levels in the second quarter of 2021. Roughly $20 million of the negative effect was reflected in the self-service segment. Exchange rates created a further headwind as the average rates for the euro and pound sterling decreased by 12% and 10% respectively compared to Q2 of 2021. The currency impact reduced segment EBITDA by $20 million and adjusted diluted EPS by $0.04 relative to last year. Finally, not having the PGW business for the full quarter was a further $12 million headwind to segment EBITDA versus the prior year. Keeping those external factors in mind, our second quarter results reflect a solid operating performance.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

While gross margin decreased by 30 basis points compared to a year ago, a 70 basis point negative effect came from the metals prices alone. Benefits in pricing and mix partially offset the metals impact. Overhead expenses as a percentage of revenue rose 60 basis points year-over-year due to inflationary pressures. Income taxes were booked at 25.3% for the year-to-date period, a 20 basis point increase over our prior guidance, reflecting the shift in the geographic mix of US dollar earnings as impacted by the significant shift in FX rates since we spoke 90 days ago. As Nick mentioned, diluted EPS was $1.49 for the quarter, including the $0.45 PGW gain, and adjusted diluted EPS was $1.09. I'll now turn to the segment operating results.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

Starting on slide eight, Wholesale North America produced an EBITDA margin of 18.7% for the quarter, down 90 basis points from the prior year period. Gross margin declined by 80 basis points. Inflationary increases in material and freight costs were offset by higher parts pricing and productivity initiatives. Segment overhead expenses were roughly flat owing to lower personnel costs from incentive compensation and productivity initiatives to mitigate inflationary pressures. Europe reported a 10.8% EBITDA margin for the quarter, up 10 basis points from the prior year period. As you'll see on slide nine, gross margin improved by 80 basis points, primarily from procurement initiatives and pricing. Overhead expenses increased by 60 basis points from higher personnel, freight, and fuel costs. The segment's strong second quarter performance reinforces the team's expectation that they will deliver a double-digit margin for the full-year. Moving to slide 10.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

Specialty's EBITDA margin of 13.4% declined 150 basis points compared to the prior year, mostly coming from a decrease in overhead expense leverage, driven by an organic revenue decline of 11.5% as they anniversary a very tough comp from the prior year when the business delivered over 30% organic revenue growth in the first and second quarters of 2021. Inflationary pressures also drove overhead expenses higher, including personnel, freight, and fuel expenses. The overhead expense increases were partially offset by 60 basis points of benefits from operating expense synergies, mostly generated from the SeaWide acquisition. To provide some context to the segment's performance, pre-pandemic in Q2 of 2019, Specialty reported a margin of 12.7%.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

Since then, the team has made great progress on pricing and productivity, resulting in a 70 basis point improvement from the second quarter of 2019 through to Q2 of 2022, in addition to growing the business by over $100 million in revenue. Moving to Self Service. Self Service reported an EBITDA margin of 15.3% for the second quarter of 2022. A solid result for the segment, but below the heightened margin achieved a year ago. The decrease in Self Service's margin in Q2 of 2022 was driven by movements in metal prices, estimated as an 840 basis point negative effect year-over-year, higher car costs, and inflationary increases related to freight, fuel, and personnel expenses.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

The third quarter will be markedly tougher for the segment as the higher car costs from the second quarter cycle through in a significantly lower pricing environment for metals before stabilizing in the fourth quarter. I touched on liquidity and capital allocation in the highlights, so I'll reference a few other items of note. As shown on slide 13, our year-to-date conversion ratio of free cash flow to EBITDA is roughly 70%. Noting that the glass proceeds and the gain on sale are not reflected in these figures. There continue to be timing elements that will reverse over the course of the year, and we are confident in our ability to generate sustainable free cash flow in line with expectations of converting EBITDA to free cash flow in the 55%-60% range for the full-year.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

We have made further progress in rebuilding our inventory levels to achieve our fill rate targets. As you can see on slides 31 and 32, we have increased inventory in 3/4 segments since December 2021. Specialty was flat through December, but was in a stronger position than our other segments and thus hasn't required a similar inventory build. We remain confident that our inventory positions will enable each segment to continue to offer best-in-class availability and service reliability relative to our competitors. Moving on to capital allocation. We paid down our debt balance by $248 million in the quarter. Our net leverage ratio came in at 1.2x EBITDA, and interest coverage exceeds 30x.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

It's worth noting that our net leverage ratio of 1.2x is in line with the June 2021 figure, despite the use of $1.3 billion for share repurchases and dividend payments over the last 12 months. 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 on September first to stockholders of record as of August eleventh. I will wrap up my prepared comments with our updated thoughts on projected 2022 results. Our guidance assumes there are no significant negative developments related to the COVID-19 in our major markets, scrap and precious metal prices hold near average June prices, and the Ukraine-Russia conflict does not escalate further.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

On foreign exchange, our guidance includes recent European rates with the balance of year rates for the euro of $1.02 and the pound sterling at $1.20. Starting with the revenue outlook. We remain comfortable with our revenue outlook and are holding our organic parts and services growth range between 4.5% and 6.5%. We are projecting full-year adjusted diluted EPS in the range of $3.85 up to $4.05 with a midpoint of $3.95. We have narrowed the range as we are halfway through the year, but maintained the midpoint of our prior guidance.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

To understand why we held the midpoint, please refer to slide 18 in the presentation, which bridges our prior and current guidance figures. We generated operational benefits in the second quarter and expect further upside in the second half of the year. The total operational improvement is $0.11, which highlights the resilience of the business in difficult trading conditions. While the Ukraine-Russia conflict is still a negative on a full-year basis, we have seen better than expected results as areas of the country reopen with fighting concentrated in the eastern part of Ukraine. We are honored to be able to support critical mobility needs in the country where feasible and are very proud of the work being done by our colleagues in Ukraine. Capital allocation is also a benefit of $0.03 relative to our prior guidance, primarily related to timing.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

Note that we are including share repurchases through the week ended the 22nd of July in our guidance, and as in prior periods, not assuming any further share repurchases for the balance of the year. That's the good news, mostly tied to the areas directly under our control. Then there are the negatives, which are primarily external factors. Headwinds from the weakening FX rates I mentioned earlier contribute a $0.06 reduction relative to prior guidance. Declining metals prices are expected to have an additional negative $0.07 impact, primarily in the third quarter as we turn cars purchased in the first and second quarters when metals prices were higher at the lower projected scrap and precious metal prices. FX rates and metals prices can move significantly over time.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

We may have further upside or downside if the actual figures play out differently than we have assumed in our guidance. 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. We haven't increased the minimum given the negative exchange rate effects and the projected tax payment for the PGW gain, which in the aggregate, are estimated to be approximately $50 million. We expect to overcome both factors to meet or exceed the $1 billion estimate. Thank you once again for your time this morning. With that, I'll turn the call back to Nick for his closing comments.

[Nick Zarcone, President and CEO at LKQ Corporation]

Thank you, Varun, for that financial overview. Let me restate our key initiatives, which are central to our culture and our objectives. First, integrate our businesses and simplify our operating model. Second, focus on profitable revenue growth and sustainable margin expansion. Third, drive high levels of cash flow, which in turn will give us the flexibility to maintain a balanced capital allocation strategy. Fourth, to continue to invest in our future. As you can see from our results, we are committed to driving these metrics forward regardless of the operating environment. We are doing our very best to effectively manage the items which are under our control so as to offset the headwinds which are largely outside of our control. For that, I offer a tremendous thank you to our team members across the globe that make it happen each and every day.

[Nick Zarcone, President and CEO at LKQ Corporation]

They define what it means to be LKQ Proud. With that operator, we are now ready to open the call to questions.

[Operator]

At this time, I would like to remind everyone, in order to ask a question, press star and then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Scott Stember. Your line is open.

[Scott Stember, Managing Director and Senior Research Analyst at Roth MKM]

Good morning, guys. Congrats on the very strong results despite the nonstop headwinds that you're facing.

[Nick Zarcone, President and CEO at LKQ Corporation]

Thanks, Scott.

[Scott Stember, Managing Director and Senior Research Analyst at Roth MKM]

First question, I'm just gonna jump right to State Farm. You know, obviously, they left the market more than 20 years ago, and they've come back in, dipping their toe in. Can you maybe just size this up versus, you know, prior attempts of them going back in the market, how real this feels and how tangible and how big this could be if it really does come to fruition?

[Nick Zarcone, President and CEO at LKQ Corporation]

Yeah. Let's put everything in perspective. Great question, Scott. State Farm is the largest automobile insurance company in the United States of America. They have roughly an 18% market share. They stopped using aftermarket collision parts back in the late 1990s as a result of some policy language that certain of their customers took issue with. It had nothing to do with the actual parts. It just had to do with policy language. They stayed on the sidelines, you know, really, throughout the entirety of their litigation, which lasted for 20 years. In 2019, they finally settled that suit for about $250 million, which is a drop in the bucket, right? That was three years ago.

[Nick Zarcone, President and CEO at LKQ Corporation]

Over the last three years, you know, people have been wondering, and now that that was settled, are they going to come back? State Farm is a very thoughtful, very conservative organization and they move pretty slowly. This is just a pilot. It's an eight week pilot in two states with three product lines. That said, it is encouraging that this is really the first time outside of some pilots with chrome bumpers for pickup trucks, that they are actively looking at the market and evaluating the utilization of a broader array of parts. You know, the reality is, you know, if they were to turn it on completely all at once, which we don't think they will do, we think this is gonna, again, in classic State Farm fashion, this will draw out fairly slowly over time.

[Nick Zarcone, President and CEO at LKQ Corporation]

You know, there is the potential of an 18% increase in aftermarket demand because they're 18% of the marketplace.

[Scott Stember, Managing Director and Senior Research Analyst at Roth MKM]

Got it.

[Nick Zarcone, President and CEO at LKQ Corporation]

We don't anticipate any impact on our 2022 or 2023 results because, again, this will probably play out over a longer period.

[Scott Stember, Managing Director and Senior Research Analyst at Roth MKM]

All right. Just going back to North America, you talked about in June, you saw some encouraging results from a fulfillment standpoint. Could you just give a little bit more detail on that?

[Nick Zarcone, President and CEO at LKQ Corporation]

Certainly. Historically, our fulfillment rates in North America have been well into the mid 90% range. You know, coming out of the pandemic with all the supply chain issues and the like, you know, we fell below 90%. We picked up a couple of percentage points in the month of June, which was good. You know, we're still well below where we wanna be, well below where we used to be. But the fact that we're moving up is encouraging. Obviously, a lot of that has to do with the aftermarket product, which as I indicated in my prepared comments, is the one product line that has been most affected by the supply chain challenges. The volume of aftermarket parts is down.

[Nick Zarcone, President and CEO at LKQ Corporation]

Pricing is very strong, but the volume is down. You know, we have a lot of inventory on the water, as I mentioned. We were very successful in getting containers filled and on ships in the second quarter. Given the supply chain, we won't see that until late summer or early fall. But with that, we believe we will be in a good position to continue to drive fulfillment rates back north. We do not believe we're gonna get back to, you know, +95%, but we're moving in the right direction.

[Scott Stember, Managing Director and Senior Research Analyst at Roth MKM]

All right. Just lastly, your 4.5%-6.5% parts and service organic growth rate has not changed, but has the composition by segment changed?

[Nick Zarcone, President and CEO at LKQ Corporation]

Not materially. Europe is right on track with where we would expect them to be. As I indicated, North America in the first quarter and the second quarter ran ahead of our expectations. There's a little bit more of a shift in impact from the North American business. The specialty business, you know, as we've seen, given the monster comps that we had last year, was down, I think 15% in the first quarter, 11% in the second quarter. We're trending in the right direction. Again, we've only got, you know, 20 some days of data on Q3. We're closing the gap. Our goal would be by the end of the year to, you know, be a lot closer to prior year numbers.

[Nick Zarcone, President and CEO at LKQ Corporation]

Maybe a little bit of shift from, you know, out of specialty and into North America, but again, comfortable with that 4.5%-6.5% range.

[Scott Stember, Managing Director and Senior Research Analyst at Roth MKM]

Got it. That's all I have. Thanks for taking my questions.

[Nick Zarcone, President and CEO at LKQ Corporation]

Thanks, Scott.

[Operator]

Your next question comes from the line of Craig Kennison. Your line is open.

[Craig Kennison, Director of Research Operations and Senior Research Analyst at Baird]

Hey, good morning. Thanks for taking my questions, and thanks for the great slides. Super helpful. First question just on inflation. Nick, can you characterize the rate of inflation in your cost structure and whether that's easing at all?

[Nick Zarcone, President and CEO at LKQ Corporation]

Thanks, Craig. It's almost impossible to put a single number on inflation because it's coming at us from so many different corners at different rates. You know, fuel expenses are up dramatically. I mean, gas used to be $3.50 a gallon. You know, during the quarter, it hit as high as over $5 a gallon. Now it's easing back a little bit, but that's not the 9% inflation that the rest of the you know, that's being published about the United States inflationary factors, right? Labor rates are up significantly. You know, the good news was in June, for example, we didn't have to go to the spot market for container shipment at all. It was all under contract.

[Nick Zarcone, President and CEO at LKQ Corporation]

While it's still above where it was pre-pandemic, it wasn't quite as bad as we had feared. You know, it really varies almost by category of expense and by location. You know, the experience in North America is different than in Europe. Overall, you know, all of our costs are up. The cost of goods is up. All the SG&A expenses are up. Almost nothing is down other than what we can do to have productivity measures to reduce the consumption of SG&A type items. You know, yeah, it's a big headwind. There's no doubt about it.

[Operator]

Your next question comes from the line of Brian Butler. Your line is open.

[Brian Butler, Equity Research Analyst at Stifel]

Hey, good morning. Thank you for taking my question.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

Good morning, Brian.

[Brian Butler, Equity Research Analyst at Stifel]

Well, just the first one, can we talk about the trade working capital opportunity and how should we think about our model, kind of some of the trade working benefit, you know, plays out in the second half of 2022?

[Varun Laroyia, EVP and CFO at LKQ Corporation]

Brian, good morning. It's Varun Laroyia calling. A great question. Certainly a topic very close to my heart, but also over the past few years for the entire organization out here. It is a key element of the revised annual cash incentive program since 2019, and just tremendously proud of the shoulder that every single individual across the enterprise has put into it. You know, clearly, as you see, we're happy with the inventory build as some of the supply chain congestions eased. Again, it is all relatively speaking. It certainly isn't back to pre-pandemic levels.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

If you think about where we've been over the past couple of years, the second quarter was a good quarter for us to be able to pick up inventory in our businesses. That certainly is what we're here to do, to ensure that we have the right part available at the right place and at the right time. That really has been the key for us. As you think about the second half of the year, similar to what we've done in the first half, we don't believe that we need to build up inventory levels significantly above where we currently are. As you know, we typically do an inventory build in the fourth quarter because of the seasonality of the overall business coming out of the winter season in Q1 and Q2.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

We do expect to build up some inventory towards the back end of the year. The single biggest piece, as you can think about, is the payables offset. You certainly saw that in the second quarter also. While there was inventory build, we certainly had a nice move on our accounts payable balances to offset that. The final piece really within trade working capital is receivables. On the back of some strong organic revenue growth, North America, as you would have seen, on slide number five, reporting a 10.7% organic revenue growth rate, Europe at 4.2% on a constant currency basis at 4.6%.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

You know, we do expect receivable balances to move up, and I'm perfectly okay with that, as long as our teams continue to manage the past due receivables. From that perspective, if the only big build-up is on the receivable side, that's okay. That's the sign of a good, healthy, growing business. Overall, while we've had a good solid start in the first six months with free cash at about $638 million, we feel comfortable about hitting the minimum $1 billion that we have committed. You do need to note that with the FX challenges from a European perspective, the free cash that gets translated back into US dollars, that obviously is lowered as a result of that, number one.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

The other piece really is if you think about the PGW divestiture that we did in the second quarter, there are taxes to be paid, estimated taxes to be paid in the third quarter. Those two elements, as I mentioned in my prepared comments, amount to about $50 million. We'll overcome that and hence we're still kind of maintaining our minimum of $1 billion of free cash for the full-year.

[Brian Butler, Equity Research Analyst at Stifel]

Okay. That's very helpful. My second question was. Can you talk a little bit about price and volume mix when you look at the U.S. and the EU for the parts and service business for the second quarter?

[Nick Zarcone, President and CEO at LKQ Corporation]

Yes. It's a great question. As we tried to indicate in our prepared comments, a lot of the organic growth, no surprise, given the inflationary environment that we're dealing with, has come through price. The volume question, again, like the inflationary question, it really depends literally business by business, product line by product line. In North America, the aftermarket product volumes were down. Salvage collision volumes were actually up, because we were able to transfer some of that demand for aftermarket product into salvage product. The salvage mechanical side of things were kind of flattish. We had some uptick in the reman business. Net-net, we had, you know, we were down in North America, but some things were down, some things were up. Same in Europe.

[Nick Zarcone, President and CEO at LKQ Corporation]

You really have to go geography by geography. We had some of our businesses where the volumes were up low single digits, which was great. We had other areas where, you know, volumes were down, say 1% or 1.25%. Pricing was very strong again. Especially, you know, with the 11.5% decline in organic volumes were down. Again, that's relative to the monster comp. It really depends business by business, geography by geography. I believe our teams are doing a great job of managing. We're always trying to get the most volume that we can 'cause ultimately that's important to sustaining the business.

[Nick Zarcone, President and CEO at LKQ Corporation]

Equally as important, particularly these days, is making sure that we're covering the inflationary pressures through our pricing actions. We believe the team's doing a nice job of balancing, you know, those two objectives.

[Operator]

Your next call, your next question comes from the line of Daniel Imbro. Your line is open.

[Daniel Imbro, Managing Director and Equity Research Analyst at Stephens]

Yeah. Hey, good morning, guys. Thanks for taking our questions.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

Good morning, Daniel.

[Daniel Imbro, Managing Director and Equity Research Analyst at Stephens]

Yeah, I wanna start on the North American wholesale side. Obviously the State Farm developments feel like they're positive for growth, but I also wanna ask on pricing. I think most of the quarter was driven by pricing. Are we still seeing OEMs raise prices further, Varun? As you look to the back half and maybe into next year, I mean, would the expectation be that given just the broader inflationary backdrop, these pricing increases continue, or is there a risk that pricing slows or could you have to come down on the OEM side?

[Nick Zarcone, President and CEO at LKQ Corporation]

Yeah, Daniel, this is Nick. You know, the OEs, they don't just increase all the prices on all their parts, you know, every month. That's not how they operate. They're very selective in how they're pricing their parts. Some prices go up significantly, some prices don't go up at all. And obviously all the OEMs kind of have their own strategy. In general, their prices have gone up a little bit, less than or generally less than overall inflation. And so whenever they take the prices up, you know, that provides us an opportunity, not just us, the whole alternative parts industry as a whole, the ability to take pricing up a little bit as well. You know, I can't predict what they're going to do in the future.

[Nick Zarcone, President and CEO at LKQ Corporation]

You know, ultimately, they're dealing with the same types of inflationary pressures as all the other businesses as it relates to input costs, whether that be materials, commodities, labor, all the rest, right? All I can say is we will try. We keep a very close eye as to how the OEs are pricing their product. We need to maintain a competitive stance. We think we're doing a good job of doing that in this current environment.

[Daniel Imbro, Managing Director and Equity Research Analyst at Stephens]

Great. That's helpful, Nick. Varun, maybe one on the European margins. I think we touched on demand a bit in the last question, but I think at the end of the day of our call, you guys noted that further margin expansion was possible, and above 10% profit levels. Given the change in the last 30, 60 days in FX rates, economic backdrop, inflation, I mean, do you still think it's possible to see EBITDA margin expansion this year, next year for Europe, as you look ahead?

[Varun Laroyia, EVP and CFO at LKQ Corporation]

Yeah. Listen, great question, Daniel, and thank you for giving us the opportunity to respond to that. Listen, I think as you know, Q1 with the Ukraine-Russia conflict, there were some challenges associated with that. The underlying business operates in a very resilient market. You know, folks have kind of talked about the fact that energy prices have been moving up with what's happening further out there. We really haven't seen a significant drop-off on a VMT basis, number one, and that really is a key driver for our European business. From that perspective, really happy with the way our European business continues to perform. Nick obviously gave some color, you know, on the broader platforms in terms of how they've been performing also.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

I think the key piece out here has been making sure that we have the inventory to satisfy the demand, which we do. Overall, very happy with the way the margin trajectory of the European business continues. We feel comfortable and confident about the double digits on a full-year basis. With regards to 2023, we haven't given any guidance as of now. Needless to say, if you kind of go back to our commitment, to the markets, you know, way back in September of, 2019 when we launched the 1 LKQ Europe program. At that point in time, we said exiting 2021, we would be a sustainable double-digit margin business. We certainly delivered that in 2021. We're delivering that in 2022. There's no reason for us to start to backslide at this point of time.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

While we haven't given any guidance, we do expect there to be further goodness, you know, from a margin and profitable growth perspective across our European segment.

[Operator]

Your next question comes from the line of Bret Jordan. Your line is open.

[Bret Jordan, Managing Director at Jefferies LLC]

Hey, good morning, guys.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

Good morning.

[Daniel Imbro, Managing Director and Equity Research Analyst at Stephens]

Good morning.

[Bret Jordan, Managing Director at Jefferies LLC]

On that last question, Varun, you said that VMT has remained pretty stable in Europe. Could you talk about the consumer demand trend, I guess, sort of the cadence in the quarter as, you know, obviously compounding volatility over there. Has it had any impact as we've progressed?

[Varun Laroyia, EVP and CFO at LKQ Corporation]

Actually, the back part of the quarter was much stronger than the first part of the quarter, Bret, which we were heartened to see. Again, you got to keep in mind, we're largely in what would be deemed a consumer non-discretionary business, right? We provide service parts that keep vehicles on the road. People need their cars for mobility to get to work, to you know, to conduct their daily life. If the car can't operate, they're gonna spend the money to put it back into operational mode. Everyone knows, you know, in tough times, you can probably stretch out your oil change for a bit, right?

[Varun Laroyia, EVP and CFO at LKQ Corporation]

You can stretch out some of the service items for a bit, but sooner or later, you know, you need to repair your car, you need to keep it serviced. That's what we love about our business, right? It's largely consumer non-discretionary. No business is totally recession-proof if you wanna use that word, but we feel very comfortable with where we are. Again, our operating results in May and June were much better than they were in April. We're optimistic.

[Bret Jordan, Managing Director at Jefferies LLC]

Great. Then within specialty, could you sort of carve out the performance differences between RV, which I think you called out as being pretty stable, versus the SEMA-related product? You know, just sort of within that total specialty decline, could you give us a feeling on the pieces?

[Nick Zarcone, President and CEO at LKQ Corporation]

Yeah. The RV side of it, what I indicated was down less than the unit, the business as a whole. The business as a whole was down 11.5%. RV was off less than that. Again, you really have to almost go product set by product set. You know, core RV products really are tied less to the RV SAR breadth, but more to the utilization of the RV and the size of the park. We've done a lot of correlation analysis over the years on this, and what we've always seen is that RV revenue is tied a lot closer to campground spending than the RV SAR. 'Cause a lot of what we sell are replacements and consumables, and that all relates to the utilization of those units.

[Nick Zarcone, President and CEO at LKQ Corporation]

If you go back to the financial crisis, right, the Great Recession, campground spending was flat. It stayed right in there. There are some products, like towing, which is a great example, which really crosses RV and marine and some of the SEMA product. You know, towing was soft. On the SEMA side, that's where probably a larger percent relative to RVs, a large of the spend goes onto vehicles, right? People buy their new pickup truck, their new Jeep, and they wanna fit it out. Pickup truck SAR was off 12% in the quarter, which is the second quarter in a row that it was down, right? That's where there's a little bit more pressure.

[Nick Zarcone, President and CEO at LKQ Corporation]

Again, some of it is a comp against almost an unrealistic comp of what we did in 2021. Like I said, the specialty group, including all parts of the specialty group, are doing better, and they're clawing their way back to prior year volumes, at least in the first few days of the third quarter. You know, we probably won't get there for the quarter as a whole, but we're closing the gap, and from our perspective, that's what's important.

[Operator]

Your final question comes from the line of Gary Prestopino. Your line is open.

[Gary Prestopino, Managing Director at Barrington Research]

Hey, good morning, everyone.

[Nick Zarcone, President and CEO at LKQ Corporation]

Good morning, Gary.

[Gary Prestopino, Managing Director at Barrington Research]

A couple questions here. First of all, Nick, you didn't cite the growth in collision claims in North America as a comparison to what you did in North America. Do you have that statistic handy?

[Nick Zarcone, President and CEO at LKQ Corporation]

Repairable claims in the second quarter were up about 6% compared to 2021, but still down 6% compared to 2019. The industry is still down relative to the pre-pandemic levels.

[Gary Prestopino, Managing Director at Barrington Research]

Okay. That's fine. Varun, on an absolute dollar basis, how much did FX positively impact SG&A?

[Varun Laroyia, EVP and CFO at LKQ Corporation]

We haven't called that piece out, but I will tell you from a North America perspective, clearly there's little to none. If you think about it, really where does the FX exposure come through? It's from our European business. If you think about where the European business total SG&A was at around $420 million. If you then kinda go, you can back into that number, Gary, and this is the way you should think about it. Within the slide deck, we obviously have on slide number 27, we obviously have the FX rates out there also. Essentially the euro has been the big kinda decline. Roughly call it about a 10% decline on there.

[Varun Laroyia, EVP and CFO at LKQ Corporation]

You know, kind of run that piece of the $420 million. That basically is what the. It's kinda strange to say a benefit, but the translation benefit, if that's what you're referring to, from a lower conversion rate, that's really where it would come through.

[Nick Zarcone, President and CEO at LKQ Corporation]

Gary, it's important to keep in mind.

[Operator]

There are no further questions at this time.

[Nick Zarcone, President and CEO at LKQ Corporation]

It's important to keep in mind that the FX issues that we're dealing with are translation issues, i.e., just converting the foreign currency into U.S. dollars. By and large, they are not transactional issues. We do have some transaction exposure. Some of the purchasing of parts in Europe is dollar-denominated, particularly things like oil-based products, which are dollar-denominated. Those are things where we know in advance we're gonna be buying, and we can do some hedging of that. Total FX kind of exchange losses, if you will, from a transactional perspective in the quarter was less than $2 million. It's all just translation of foreign currency results into U.S. dollar results.

[Operator]

There are no further questions at this time. Mr. Zarcone, I turn the call back over to you.

[Nick Zarcone, President and CEO at LKQ Corporation]

Well, we always wanna thank everyone for their time and their participation in our call. We know you're all very busy. This is a busy time of the earnings season. We appreciate you spending some time with us, and we look forward to joining back up at the end of October, when we're gonna be pleased to announce our third quarter results. Thanks for your time and attention, and we'll talk to you soon. Thank you.

[Operator]

This concludes today's conference call. You may now disconnect.

Participants

Executives

• Joe Boutross, VP of Investor Relations
• Nick Zarcone, President and CEO
• Varun Laroyia, EVP and CFO

Analysts

• Bret Jordan, Managing Director at Jefferies LLC
• Brian Butler, Equity Research Analyst at Stifel
• Craig Kennison, Director of Research Operations and Senior Research Analyst at Baird
• Daniel Imbro, Managing Director and Equity Research Analyst at Stephens
• Gary Prestopino, Managing Director at Barrington Research
• Scott Stember, Managing Director and Senior Research Analyst at Roth MKM