Good day and thank you for standing by. Welcome to the LKQ Corporation's Second Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation there will be a question-and-answer session. [Operator Instructions] Please be advised that this conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Mr. Joe Boutross, Vice President of Investor Relations for LKQ Corporation. Sir, please go ahead.

Thank you, operator. Good morning, everyone, and welcome to LKQ's second quarter 2021 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're planning to file our 10-Q in the next few days. And with that, I'm happy to turn the call over to our CEO, Nick Zarcone.

Thank you, Joe, and good morning to everybody on the call. This morning I will provide some high level comments related to our performance in the quarter, and then Varun will dive into the financial details, as well as our improved outlook for 2021 before I come back with a few closing remarks. This was another quarter of significant operating progress, driven by excellent execution and improved business conditions. I could not be prouder of the LKQ team. A few years ago when we pivoted to operational excellence, we knew that there would be a transition period during which we would need to invest in our people and processes to improve the operating model. We also recognize that there would be difficult decisions needed to right size the cost structure and drive efficiencies. We undertook this shift with the expectation that we would come out the other side as a leaner, more nimble and stronger organization, one that could succeed in difficult conditions like we have seen with the pandemic over the past year, as well as thrive during the good times. Those expectations are being realized. While I'm not ready to proclaim mission accomplished, I believe we have made tremendous progress in our operational expense transition as evidenced by the continued outstanding results that we've delivered over the past year. Record outcomes don't happen by accident and the team has driven strong profitability and cash flow by among other actions applying a disciplined pricing approach, implementing permanent cost saving actions, including closing underperforming locations, consolidating delivery routes and reducing headcount. Timing our operating policies to reduce waste and increase yield, such as harvesting more catalytic converters per car, actively engaging with our vendor partners to ensure that we are receiving attractive pricing and market payment terms, and monitoring our…

Thank you, Nick and good morning to everyone joining us today. Before I cover the financial results, I want to highlight a number of significant events and accomplishments related to our capital allocation over the recent past. With the pivot to operational excellence in 2018, our approach to balance sheet and capital allocation moved towards targeting investment grade credit metrics. This strategy placed an emphasis on generating strong, sustainable free cash flow, maintaining a conservative leverage position and deploying capital to the highest return opportunities. I'm very pleased to report that we've made remarkable progress on all measures and getting the validation of an investment grade rating from Fitch this past May is a tremendous achievement for the organization. Looking back at the last 36 months, starting just after we completed the Stahlgruber acquisition, we have produced $3.8 billion in operating cash flow, which supports a nearly 80% conversion rate of free cash flow relative to EBITDA As shown on Slide 14 of the presentation we've used these funds to repay $2.1 billion of debt, which resulted in delevering the balance sheet from a 3.1 times net leverage as of June 2018 to 1.2 times as of June of 2021. Additionally, we have repurchased over $800 million of LKQ stock at an average price of approximately $33 per share or roughly 35% below the current share price. We have not sacrificed investment in the business during this period, with roughly $660 million of capital expenditures invested to support our growth and operate more efficiently. Transitioning from the consolidation phase of the company's evolution, acquisitions have been a relatively small part of the capital allocation, though we remain committed to targeted tuck-in acquisitions that deliver high synergies or critical capabilities. Our actions over the last three years have put the company…

Thank you, Varun for the financial overview. Let me restate our key initiatives, which continue to be central to our culture and our objectives. First, we will continue to integrate our businesses and simplify the operating model. Second, we will continue to focus on profitable revenue growth and sustainable margin expansion. Third, we will continue to drive high levels of cash flow, which in turn give us the flexibility to maintain a balanced capital allocation strategy; and fourth, we will continue to invest in our future. As you can see from our results, our company executed on each of these initiatives in the second quarter and for that I offer a tremendous thank you to each of our 43,000 plus team members across the globe that make it happen each and every day, really define what it means to be LKQ proud. And with that operator, we are now ready to open the call for questions.

Thank you, sir. [Operator Instructions] We have our first question from the line of Craig Kennison from Baird. Your lines are open.

Hey, good morning. Thanks for taking my questions. Lots of goodness to work with you, but I'll focus on your credit profile and the implications for cash flow, Varun what are the implications of an investment grade rating from Fitch on your vendor terms? I guess, I'm wondering will the Fitch decision cause any immediate change to your payable terms of key vendors which would be a positive for cash flow?

Good morning, Craig. Great question and great to hear from you. Yes, incredibly pleased with the company early firing on all cylinders, you know across revenue margin the goals of free cash flow conversion coming through and then also the way we have deployed it. With last year's specific question about the recent investment grade rating initiation by Fitch, in itself it makes no change to either our credit facility or for that matter vendor terms. But if you go back, and this is a public document, and go through our credit facility agreement, within that piece we have a prewired clause which essentially states that if one of the two currently named rating agencies were to make LKQ and award them -- award us a investment grade rating, the means of our senior secured facility drop off and that as you can imagine is a significant number which of course is the standard fee in our $1 billion credit facility, so that's one piece where the links drop off and it becomes unsecured. The second piece is, within the credit facility we have a current feeling that our indebtedness through for grade payables cannot exceed 180 days. So again, just to recap, the Fitch decision in itself does not change anything today, but clearly being one of the three key rating agencies out there, one of them has this view of us, I have no doubt that given the ongoing discussions with the other two rating agencies, they too will come around. I don’t believe it's a question of if, it's more a question of when.

Got it, so just so I'm clear, you need one of the other two to make a change in order to trigger some of those changes in your contracts?

That is correct.

Awesome, thank you.

Thank you. The next one is from the line of Daniel Imbro from Stephens Inc. Please go ahead.

Yes, good morning guys.

Good morning, Daniel.

I want to start on North America Varun, obviously, the gross margin was really strong and part of it that is driven by metal. But can you talk about how the team handled that strong revenue growth with the lower headcount? Have you been able to keep out as many of the expenses that you anticipated? And have there been any hiccups in hiring when you need to give him the employment backdrop?

Daniel, good morning. Yes, it is Varun Laroyia and listen, it's an excellent question. Before I get to the specifics of answering your question, I just want to make sure that all of our 43 plus 1000 associates globally are given a big shout out, what our field teams have done globally, from branch to a warehouse to a dismantling yard, has just been nothing short of phenomenal. Our success, LKQ's success is directly attributable to our field teams. And the last 17, 18 months have not been easy. But they are the ones that have kept this company humming along. And really exceeding everyone's expectations and putting up yet another record quarter. Yes, you're right, with regards to North America margins at 20.8% in the current quarter, or 19.9% in Q1, this is higher than what our long-term expectation has been, has been very clear, both in the first quarter and now most recently, in my prepared comments. Precious metals have been a benefit. And we estimate and if you go to see Slide 28 in the earnings deck, we've actually given transparency in terms of how scrap metal and precious metal prices have been trading. And really what level of benefit has come through, we estimate roughly 350 basis points of that 20.8% margin that North America has put is directly attributable to scrap and precious metal prices. Even if you were to get these out, the business is still delivered well north of 17 points. And so that really is what gives us a lot of comfort, could we have done better, perhaps, but there are inflationary pressures, I'd say the single biggest challenge at this point of time, not just for LKQ, but I'd say across the entire industry here in the United States has been labor, and labor, essentially, whether it be availability, or whether it'd be the cost to get that labor. It is leading to congestion at ports, it's leading to higher freight costs, because delivery drivers are incredibly difficult to find. But that has been the key piece. And that's why I come back full circle. In terms of giving a massive shout out to our field teams, we have been running short with regards to labor availability. We have taken wages up also, just to make sure that we are market competitive. But we have got branch managers, plant managers, DNs going and making deliveries because we want to make sure that while we have the right part of the right place, we continue to serve our customers. Without customers, we really don't have a business and just want to make sure that that is heard loud and clear our fee procedures and outstanding.

That’s great. Really helpful color and then just a follow up on the North American margin, obviously your right, metal prices, you called out the $51 million I think an EBITDA. But is that part of what's also raising your COGS in North America? If I looked at this via the thing, self service cost was up 53%, salvage vehicle drove 36%. So if metal prices roll over, should there be some natural offset in that as your cost to acquire vehicles at auction would go down as well?

Yes, absolutely, yes. I think that's what we've kind of said in the earnings call so that salvage prices have been running pretty high for quite some time. But again, it's partly to do with where the dollar has been creating. So lots of export trade has been taking place. As we know there's been a shortage of chips and so OEM sales have come down. As a result, huge cut prices in our precious metals around that is certainly flowing through our COGS also. There is no doubt about it.

Great. Thanks so much guys and best of luck going forward.

Thank you, Daniel.

Thank you. The next one, we have Brian Butler from Stifel. Your line is now open.

Good morning, thanks for taking my question.

Good morning Brian.

First one just kind of on that point of the labor and kind of inflation, could you maybe just kind of rank where you see it? I mean, looks like labor is at the top, but we're on and kind of put in perspective on magnitude, where does freight and fuel fall below that on the inflation pressures?

Yes, I would put that in probably that order labor first. Because you have to remember that over 60% of our operating expenses, ultimately come back to people, it's the biggest portion of the, on the P&L the biggest expense. And so, and we have 43,000 plus people around the globe, so that's number one. The second would be freight. And that not only relates to ocean freight, which is up significantly, but also, the domestic freight, whether it be in the U.S. or in Europe, and then, some people put fuel as part of freight, we try and separate it out, obviously, if you can track oil prices, they've been up as well. I'd point to you Page 7 of our deck, which kind of sorts out where we have saved money over the past year or so. And you know, most of the savings has been on the people side and then secondly on the delivery side and then finally kind of facilities and the like. So, again, I would put it in that order; think about people, freight, and then fuel.

Okay, that's helpful. And then just my follow up. When you think about the M&A pipeline, and your focus has been recently on kind of the operational excellence, can you give a little color on where that M&A pipeline stand and what might be targeted in the next year or two or what assets you're still looking at?

Absolutely. So I mean, we are always looking for ways to add to our strength as our organization and whether that comes in acquiring in new geographies where we don't have a presence, whether it comes from acquiring new product lines or new skill sets. Obviously, the focus currently is on kind of newer technologies. Right? So we've made a number of acquisitions over the last year in the whole diagnostics and calibration space. And we're building up a very nice business there. As you know, and we've mentioned in the call, the Green Bean acquisition in Q2, that relates to battery technologies. And, again, we all know that ultimately battery being able to service and deal with EV batteries, whether it's hybrids or battery electric vehicle batteries is going to become important, so you should expect additional investment in that area. So anything we can do to evolve our product and service set and the services is a key component there, relative to the evolution of the car park, that's what we're going to do. And so, you should expect that you will see additional acquisitions, probably smaller, because particularly in these newer technologies, there are no big companies out there to buy. So we can, again, make sure that we are on the cutting edge as it relates to what we can provide our customers.

Yes, and Brian this is very consistent with what we've been talking about for quite some time, including at our Investor Day that, M&A, while it may seem that the pace of M&A has slowed down, not really, really the focus has been different, rather than going whale hunting. As the European segment was built up, the focus has really been as Nick said, the focus has been on high synergy tuck-ins and building critical capabilities and that focus remains.

Great, thank you. I’ll get back in the queue.

Thank you. The next one is from Bret Jordan from Jefferies. Your line is now open.

Hey, good morning, guys

Good morning, Bret.

Hey, on the payables if you do get a second rating agency to tip your way, what would be sort of a shorter term impact? I think you're close to 50% accounts payable to inventory, but what kind of step up would you see if you got to investment grade?

Great question, Bret. The biggest uplift really will be from our European business. And just given the nature of the European business and how we compare that from April's optimization program relative to say the Big Four here on car parc site in North America. Our North American business per se, we have some opportunity. But if you think of the salvage business, whether self serve, or full serve, is just a different business model. Right? So if you think about the size and scale of a European business, which at this point of time is roughly half the company, that really is where the opportunity is, and we certainly see that there's further upside down there, not just with the fact that we would get the investment grade rating at some point of time. And so the 180 day, ceiling obviously gets lifted, that's more of a tactical piece, but more on an ongoing basis as the team how that continues. It's active discussions with a number of our vendor partners. The focus really had been let's get to the top 40 and then the team continues to go further down the chain, as part of the overall supplier rationalization discussions, making sure that we continue to get our calls at attractive prices, but also had what we believe to be market convention terms.

Okay, thanks. And I guess quick question on supply chain. Is the disruption and sort of inventory availability actually a positive for you in the sense that you're gaining share as others are maybe always or less available, and I guess give anything anecdotal on what percentage of repairs are now alternative parks in North America?

Yes. Great question. Obviously, the supply chain not just in our industry, but in most industries is under duress at the moment. For us, it really depends. Actually, the business and the product line, because there's significant differences across the, LKQ platform. Like in salvage, there's no impact, because all that products is here. And it's easy for us to get at the options. Our aftermarket business here however, most of the aftermarket collision products for the whole industry, not just us ours comes out of Taiwan and it's not an issue related to our ability to procure the product. The manufacturers have the ability to stamp out the parts. The issue is getting it from the warehouses in Taiwan to the warehouses in Tampa or Toledo or Topeka, or wherever we need them here in the US. And everyone knows what's going on the issues related to container capacity; Port congestion is a major issue. I mean, we've got ships sitting on the water, just waiting to be unloaded. There's a lack of capacity to unload the ships. There's a shortage of drivers to do the dredge within the ports that meaning moving the cans around. And then there's a shortage of trucking capacity to actually get the containers from the ports to our locations. So what's that doing, it's extending the timeframe of how long it takes us to get product. And it's costing a little bit more money. The good news is the vast majority of our ocean freight is under contract, at least for quite some time now and going into the future. Spot rates, as you know, are up anywhere from six to eight fold. The good news is, again we're under contract. We're bring in 15,000 containers a year, that's 300 containers a week.…

Great, thank you.

Thank you. The next one, we have Stephanie Moore from Truist. Your line is open.

Hi, good morning. Hi, Nick, hi Varun, hi Joe.

Good morning. Good morning.

I wanted to touch on the European margin performance and expectations kind of implied in the second half of the year, obviously as the record and [indiscernible] tremendous 2Q results. But if you just kind of back into even your updated guidance, it does account for a bit of a slowdown the back half off of the 2Q levels, but admittedly, nice improvement year-over-year. So I'd love to get some color just as you kind of updated your guidance, what your thoughts are for the back half in terms of the margin performance. And why there should be some kind of slowdown from the second quarter, just any puts and takes there would be helpful? Thank you.

Good morning, Stephanie. It's Varun out here, and let me take that question. So first of all, really pleased with how our European business continues to perform. If you go back when we initiated the one LKQ Europe program and formally gave margin targets. We basically call for exiting sustainable double digit margins at the end of 2021 backwards in September of 2019. Amazing how fast time goes by, but we are now in the last six months of that three-year journey. And the way the team has navigated these incredibly choppy and turbulent times, with a pandemic thrown in for good measure has been nothing short of phenomenal, really pleased with the team out there, as you obviously have made out, we do have a number of relatively new leaders out there also. But really, the point being in terms of the talent that we needed, we have out there this point of time, very optimistic about the future also, more to the point about your specific question about a slowdown in the second half. Not really, if you actually go back and see the European business historically, and obviously take our 2020 because that was the pandemic here, or at least and it's still continuing. But if you drill back historically, Q1 and Q2, typically are strong Q3 is also relatively strong. But then Q4 is typically, seasonally the weakest for our European business. So it's really it's kind of seasonal is what we are thinking about in terms of how we are forecasting that European business more than anything else, as of now. There obviously are, a lot of flip flop measures taking place as the country opens, as the country, not open yesterday morning, the United Kingdom said that EU and U.S. travelers that have had…

Great.

And Stephanie some of the seasonality just goes along with holiday patterns. Obviously, August tend to be a very soft month in this industry as people are on vacation in Europe. And then once you get to the holidays, things really shut down, really after the pretty close to the second half of December.

Great and that makes sense. Thank you so much for your time.

Thank you.

Thank you. Next one is Gary Prestopino from Barrington Research. Please go ahead.

Hey, good morning, everyone.

Good morning, Gary.

Gary.

Nick, could you give me those statistics on the collision claims in the quarter from CCC? I couldn't write it down fast enough, do you have that?

Absolutely. So we think that the best way to look at it given the I mean, the total disruption in 2020 is to compare our organic growth because collision claims actually in the second quarter of 2019, which was a normal year for CCC when comparing 2021 to 2019 was down 15%, 15% and LKQ organic was down 9%.

Okay, 9%. Thank you. Then, just in terms of you guys have done a lot of great work on getting the OpEx down a little, can you run the business starts growing again, when things do return in normal. I mean, can you run the business in a somewhat more of a growth mode, like say 4% to 7% while holding the personnel expenses as a percent of sales at that 15.6% or as you grow, you've got to add more people?

Well, there's no doubt, but as we grow from a overall dollar perspective than that means, more deliveries, more trucks on the road, more people in the warehouse. We can't just grow revenue and not add back any headcount. But I've been pretty straightforward with all of my direct reports that we need to see the revenue rebound prior to bringing and adding personnel or any really, any real expense back onto the P&L. And so, we think that on -- take North America, set our ongoing basis, we've reset sustainable margins in the high 16s. And if you recall, 2018, we are 12, 7 2019. We are 13, 7 at our Analysts Day in 2020. We -- addressing people to be north of 15. Last quarter, we told people in the low 16s and here what's on people on a permanent basis. Long term when you take out all the ancillary ups and downs related to them that [indiscernible] like high 16s is a good target. And so and we anticipate that we're going to have to bring some level of expense back to allow us to have the capacity to grow our revenue base.

Okay, thank you very much. I appreciate it.

Thank you. There are no further questions at this time. Mr. Nick Zarcone, please continue.

Well, we certainly appreciate your time and attention here this morning. Your interest in LKQ means a lot to us. We'd look forward to having another conversation with you in about 90 days when we report our third quarter results at the end of October. So we'll talk to everybody at that point in time, but again, we appreciate your interest and once again, a big shout out to the 43,000 folks who come to work every day at LKQ. You really make the magic happen. Thank you.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect. Have a great day.