Good morning. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the LKQ Corporation’s First Quarter 2022 Earnings Conference Call. [Operator Instructions] Thank you. Joe Boutross, Vice President of Investor Relations for LKQ Corporation, you may begin your conference.

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 maybe 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…

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 will 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…

Thank you, Varun, for that financial overview. We believe our unique competitive position across all of our operating segments continues to translate into strong results for our company during difficult conditions. I am extremely proud of how our team of 46,000 employees tackle the headwinds we faced over the past 2 years, which subsequently positioned us well as we entered 2022. Our strong first quarter performance and raising our guidance for 2022 is a true validation of our confidence and commitment to creating long-term value for our stockholders. And again, I would like to acknowledge the bravery and courage of our Ukrainian team as they operate in an unthinkable environment. Our thoughts and hearts are with you all. And with that, operator, we are now ready to open the call for questions.

[Operator Instructions] And your first question comes from the line of Bret Jordan from Jefferies. Your line is open.

Hi, good morning, guys.

Good morning, Bret.

Good morning, Bret.

Varun, now that you’ve got the investment grade rating and you called out the opportunity to extend payment terms do you have any better visibility as to how far you might be able to extend them here? I mean, obviously, you’ve got a – you have the rating now. So have you had conversations around those terms?

Yes. Absolutely. And Bret, thank you for raising that piece and acknowledging LKQ is now an investment-grade company. It’s taken a lot of time. And the overall pivot to operational excellence has certainly been looking at every aspect of our business, income statement, functions and also the overall balance sheet. Yes, we do anticipate several hundred million upside related to getting the investment grade. However, it will not happen overnight. If you think about our European vendor financing program, which is coming along incredibly well, we still have a gap. And really, what we do is we benchmark ourselves given the product assortment with, say, what the folks in the U.S. are doing, right? And so in terms of even being able to get to a one to one with regards to AP, offset by inventory or inventory offset by AP, we have a gap, a significant gap. And that runs into a fair bit. So again, it won’t happen overnight. We obviously do have these contractual negotiations with our vendors. On an annual basis, the team is moving in the right direction. And so, we really don’t see it in the short-term, i.e., within 2022. But I think from 2023 onwards, we certainly will see that piece continue to climb further.

Okay. And then a quick question. I think you said March was one of the best shipping volume months in the last couple of years. But is there a way to quantify your North American aftermarket in-stock levels? Where you are on inventory fill versus target?

Bret, this is Nick. Thanks for the question. Our fill rates are not where we would like them to be. We tend to run well into the 90s. We are not in the 90s today. We’re probably in the mid to high 80s. So there is progress to be made. It all relates to the supply chain challenges. Again, it has nothing to do with our suppliers being able to produce the product. It all has to do with transporting the product from Taiwan into the U.S. and Canada. Again, we’ve got some incremental containers on the water in March. We’re hoping for a few incremental containers in April, May as well. But it takes – with the port congestion and transportation issues here in the U.S., we won’t see any of that inventory until mid to late summer. When that hits, it should help a little bit. From a fulfillment perspective, we do not believe it’s going to take us back to our historical levels, but it will help. What we do feel very confident about is our fulfillment levels are the best in the industry even with the challenges that we are facing. The reality is our smaller competitors are struggling to get product. And from an overall perspective, from a competitive perspective, we think we’re still leading the pack.

Your next question comes from the line of Michael Hoffman from Stifel. Your line is open.

Hi, thank you very much. And great opening round here, thanks. I appreciate it. On the wholesale side, just to dig a little deeper, total volumes were down, just the mix inside whether it was a new aftermarket versus a recycled remanufactured. Is that correct?

That’s correct. We had good volume growth in our salvage products, our recycled products, particularly as it relates to mechanical parts. Transmissions were particularly strong. We had great growth from a volume perspective and our remanufactured products, again, largely engines and transmissions. It was the aftermarket collision parts where we saw volumes down. And of course, that’s the largest share of our North American revenue.

Okay. But the good news is you’re able to shift around even if fulfillment came down. That’s part of your competitive advantage, is you’re able to shift around to support volume.

We’re the only folks who have the ability to sell recycled product if we don’t have the aftermarket product in-house.

Got it. And then, Varun, on the guidance, so everything goes up except the free cash flow. I’m assuming, versus February, you’re planning on spending more on inventory, and that’s the difference? And what is that delta?

Well, listen, it’s – well, inventory, certainly, as we’ve said, we’re trying to build that piece up, and we’re making some good progress. In Q1, Michael, every segment of ours, so all four segments were actually able to generate more inventory and secure more inventory. I think when you look at the numbers specifically, North America was up, specialty was up, self-service was up, as was Europe. In the case of Europe, obviously, the stronger dollar clipped the translation piece of it and also in North America with the held-for-sale classification for PGW. It seems as if it did not grow, but that also grew. But with regards to free cash specifically, any inventory increase, we see ourselves being able to offset with our payables program. But really, if you think about why has free cash not kind of gone up despite all of the $0.08 center raise on a full year basis. From a cash perspective, it really is from a receivables perspective, but the strong organic growth that we are now forecasting, from a midpoint of between 3% to 5% previously and now taking that up by 150 basis points at both the bottom end and the top end, at receivables. And that’s a good problem to have because with higher economic activity, we see higher receivables coming through. We saw that come through in Q1 also. And so it will just be a cycle more than anything else, that economic activity will raise receivables. But in terms of inventory, yes, it will go up. But we believe we can offset that with payables.

Your next question comes from the line of Daniel Imbro from Stephens. Your line is open.

Hey, congratulation guys in the quarter and thanks for taking our questions.

Thanks, Daniel.

Nick, I wanted to ask. You mentioned during your prepared remarks, but given the inflationary environment, are you seeing insurance companies opt more often for alternative parts? I mean are we seeing or do you expect the APU finally take a meaningful step higher? I guess while we are on that topic, how State Farm progressing, or are they still increasing their alternative part usage? And what does that mean for your North American wholesale growth?

Yes. So, at this point in time, based on the backlog that I mentioned in the repair shops, the insurance companies just want to get parts on the car. And whether it’s an aftermarket part or recycled part, or quite frankly, an OEM part, because every day that, that car is in the shop, they are generally paying a rental car fee and which clearly increases their prices. So, it’s not that they are trying to aggressively move to a higher APU given the inflationary environment because it’s whatever part is available. We do believe, as I mentioned in my formal comments, that once the supply chain kind of works its way through and some of the challenges we have from a fulfillment perspective begin to normalize that our product set provides a great opportunity for shops and for insurance carriers to lower their overall cost. And they can use the price benefit that we have relative to OEM pricing has helped offset some of the other inflationary costs.

Got it. That’s helpful. And then I guess I also wanted to just follow-up on the competition side. You just mentioned the smaller guys are struggling with inventory. Do you expect – I mean how does that play out? Are they going to not be able to compete longer term? Do they start using price to try to gain share back? Just kind of trying to think through what the derivative impacts are of the smaller guys continuing to struggle to keep up with you?

Our sense is that at some point in time, and we can’t put a timeframe on it, Daniel. At some point in time, the supply chain will balance itself out. And that will obviously help us and it will help the smaller folks as well. Nobody is trying to buy volume these days because it’s a shortage of product. And so pricing is strong. So, we don’t anticipate anybody, not us, not our – even our smaller competitors are trying to buy volume through price. Because when there is not enough inventory to go around to begin with, that would not be a smart move, right. They will continue to compete. We will continue to compete. We think we have got significant advantages from a product growth perspective, from a product perspective and from our service capability. And that’s how we are going to continue to compete and grow our market share in the months and quarters to come.

Your next question comes from the line of Stephanie Moore from Truist. Your line is open.

Good morning Stephanie.

Hi, good morning. Congrats on a great start to the year.

Thank you.

I wanted to touch on the European margin expectations for the year. Clearly, some headwinds that I think were not originally expected, but still looks like we will continue to move forward with nice double-digit margins. So, maybe just talk through levers that you have been able to pull on your end to offset some of these headwinds as well as maybe give us an update on where we stand on the 1 LKQ program?

Stephanie, let me start off with the European margin piece of it and then Nick will pick up on where we are with the 1 LKQ Europe program. Yes. Listen, in terms of where European margins came in, slightly softer. But I think it’s fair to know the fact that the Ukraine-Russia conflict was not anticipated. So, that certainly has clipped the margin trajectory of the business in Q1. And there was the odd customer bankruptcy also. But really, on a full year basis for balance of year, the team, all of us, we are very confident of being able to hit what we have put out there from a public commitment perspective of hitting our sustainable double-digit margins. And so while Q1 kind of clipped it for about just over $0.01 in – with the Ukraine-Russia conflict, on a full year basis, we think it will kind of clip us about six. So, there is another five yet to go. And that’s really what you see in the earnings deck where we have given a walk from the prior original guidance to what we are now suggesting. But in terms of how the business is progressing, the organic growth is coming through strongly. And we expect the operational side of things with the higher organic revenue growth that Europe has put up and really what it continues to forecast, which again is not all price, it’s actually a good mix of volume and price and – which is actually incredibly heartening. And the same thing, as Nick mentioned, about North America. They are the ones that do have good product availability. We would like to have some more. But in terms of our investments that we have been making those are certainly beginning to bear fruit and really shows the resiliency of the business that we have built up on both sides of the pond. But again, Nick, if anything else you would like to add from a 1 LKQ Europe perspective?

Yes. The 1 LKQ Europe program is right on track. Organizationally, we have gotten that behind us now for several quarters. Arnd has his full team in place, a wonderful set of management talent. The individual platforms are working together much more on a day-in, day-out basis. We are getting the benefits that we were hoping to achieve. From a procurement perspective, there is still room to go there. We are not remotely done. There is still room to go. And the focus in the future is getting a little bit better labor efficiency by consolidating some of the roles in our shared service centers, whether that’s in Southern Poland or in Bangalore. And we think there are some further opportunities there. And then the IT rollout, that’s going to be, like we said originally, that was going to be kind of a 4-year journey. We are a couple of years into it. But it’s right on track and just about on budget, so we are really pleased there.

Great. Thank you. That’s very helpful. And then maybe lastly for me, if you wanted to just touch on kind of a longer term view as the vehicle dynamic changes across the globe, changing from ICE to EVs, and how you think you are positioned with some just recent investments that you have made?

Yes. So, there is no doubt that there are changes to the car park, both in North America and in Europe. But they are evolutionary, very evolutionary. They are not revolutionary. The reality is the impact of EVs probably won’t be felt until well into the 2030s. And our goal – and if you were to read some of the materials we put out there for our European business, the goal is to be – first, as it relates to being able to supply repair shops with parts for electric vehicles, EV first. And Arnd and the team are putting plans in place to do that. We suspect that most – everybody in Europe, folks like us is trying to figure out a way to support electric vehicles because they will grow from being 2% or 3% of the car park to maybe 10% of the car park over the next 10 years. And it’s going to be a real opportunity. We don’t view it as a big – as a huge threat. We view it more as an opportunity to expand the product set and to provide our customers with even a broader array of products. Same in North America, though I think the EV shift is going to be a little bit slower here in North America. And just like we have made the acquisition of a battery remanufacturing business, we are in the process of buying a second battery technology-related business. Again, these are small nascent operations. But they will give us key technology that we will need as we move forward to provide a good set of products and services to our customers.

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

Hey, good morning. Thanks for taking my questions as well. I wanted to follow-up, Nick, on 1 LKQ Europe. Could you just shed a little more light on progress you are making on your private label program in Europe?

Sure. So, the first thing we did, Craig, on our private label front is we had to rationalize and consolidate all the various brands. Because when you take a look at all the companies we had acquired in Europe, essentially, we had 90 different private label brands that we have bought along the way. And there is no need for us to have 90 different brands. So, we have rationalized that out significantly. We have put all of our private label product activity and the growth of that business under the leadership of a single person on a pan-European basis. We refer to it as our components business. And we have an individual who came out of the Stahlgruber organization that is focused on growing that business across the European platform. Some countries are ahead. Like the UK, we have the highest penetration of owned brand or private label products. In other countries, like in Germany, it’s significantly lower. Our goal is to raise the total so to have a higher penetration in each of the countries in which we operate. And it’s not going to happen overnight. Part of it is making sure that the private label product that we put out there is extremely high quality, because the – ultimately, the customers will not react well with low-quality products. So, we are working with all of our vendors to make sure we have great quality product. And then the goal is in each of the countries where we operate, to get the percentage of private label revenue up. When we do that, okay, private label is less expensive and very price competitive for the customer. And so that will have a little bit of an impact on revenue, but the margins are significantly better. And that’s all part of the thought process.

And just as a follow-up. First, are you willing to share like the percentage of private label today and what that margin differential looks like? And then second, do you need to make investments in a single unified European private label brand, or will there be multiple brands in multiple countries?

We will probably have multiple brands, but we are consolidating it down significantly from what we started with. And we do have a brand called the E-Motive that we have in the very, very early stages. Maybe not even – maybe kind of batting practice warm-ups where we are starting to roll that brand out across the European platform. We have not disclosed our private label penetration in Europe. Again, we are the highest in the UK and probably the lowest in Germany and all the other countries are somewhere in between. In total, today it’s probably around 10%.

Your next question comes from the line of Gary Prestopino from Barrington Research. Your line is open.

Good morning Gary.

Good morning all. Hey. Now that you have got this investment grade on your debt, I mean, have – would you say that your priorities could shift to more aggressive share repurchases overall? I mean is there a real need to continue to pay down debt as you have done?

Great question, Gary and good morning. No, I don’t think anything really changes on a day-to-day basis. If you think as to we have been operating with the investment-grade credit metrics now for probably six quarters, right. And so from that perspective, debt is well kind of arguably under-leveraged at this point of time, but kind of following our balanced allocation product, capital allocation policy. We have been kind of talking about the fact that we are not prioritizing debt pay-downs at this point in time. With the investment grade rating that comes through, I think there was a previous question on the call also. Over time, it doesn’t happen overnight, but as we go, renegotiate client-vendor partner contracts, that higher level of trade payable days certainly lifts. And that certainly will release a few hundred million dollars of incremental free cash flow over the next few years. With debt levels arguably below where they need to be, we are happy with what the overall debt leverage is. So, nothing really changes because we have been operating at those metrics for quite some time. The key piece really is that we continue to look for opportunities to grow our business. Organic is obviously that much better. Seeing the level of organic revenue growth coming through our businesses is incredibly heartening. So, that really is the key focus, making sure that we provide all the capital required to continue to stretch out our lead from an organic perspective. And as and when opportunities come up to do some corp dev activities, we will certainly do that. But again, we are not going out that whale fishing or elephant hunting. It’s basically high synergy tuck-ins, building up incremental adjacencies, critical capabilities. And then whatever is the excess free cash, yes, having a share repurchase program is incredibly helpful.

Okay. Thank you. And then last question. Nick, you mentioned that because of supply chain issues, some aftermarket parts, particularly on collision repair, are in short supply, are you starting to see or be close of this a shift where salvage parts are being substituted for what could have been at more of an aftermarket part usage just because of this supply chain?

Yes, absolutely. I mean every time we have a customer on the phone, if we do not have the aftermarket part in stock, but we do have a recycled part in stock, we try and cross-sell. Again, we are the only company that can do that because. We are the only company that offers both recycled and aftermarket parts. And our salespeople have the inventory screens for both product sets right in front of them when they are talking to their customers. So, we try and cross-sell every opportunity we have.

Materials, I think it’s fair to say it really shows the power of what we have built up out here. No one at this level of size and scale has the dual sourcing strategy of kind of aftermarket and recycled parts. And so that really is where we have been investing a lot. Our salvage recycled business is doing an outstanding job. And as you kind of saw from the slides in the earnings deck, we are certainly investing more, whether it be buying Dutch to kind of set up our salvage yards, or for that matter, making sure that we continue to be a very active player in the salvage market with regards to the number of total loss vehicles that we are purchasing. That business is rock solid.

And your final question comes from the line of Ryan Brinkman from JPMorgan. Your line is open.

Hi. Thanks for taking my questions.

Good morning Ryan.

Good morning. You mentioned getting ahead of inflation as opposed to waiting to see what the impact might be. I am just curious what measures you may have taken, whether it’s primarily passing along higher costs or maybe proactively taking price in anticipation of higher future costs. Maybe it’s a combination of pricing and cost containment efforts. And then as you are taking price, presumably, you are testing the elasticity of demand for various different products and different markets. And I would be interested what you might be learning in terms of the customers’ ability or willingness to pay higher prices for the various different products that you distribute. So, for example, are you seeing greater ability to pass along price for more non-discretionary products relative to discretionary products, or are you better able to raise price for higher-end products versus lower end products, or is it the other way around, or so whatever insights you might be gleaning as you go through this process?

Yes. So, a lot of questions there, Ryan. The reality is, again, we did – I wouldn’t say that we took prices up in anticipation of higher costs later. Not that we were ahead of it, but we didn’t wait to see our costs go up and then do prices. So, I would say we – I think we timed it pretty well. Again, it’s a very competitive market out there. And at the end of the day, your ability to push price ultimately is dependent upon overall market pricing. Like I said, supply is short. That’s true with all different types of parts. And so nobody out there is leading with price as a way to buy volume, right. Everyone, I think is trying to hold their prices tight. Again, we knew inflation was coming. It was no surprise. And so we weren’t shy. The reality is no customer likes prices to go up, just like nobody listening to this call likes to pay more for anything, right. But the reality is governments around the world have $32 trillion of capital into the marketplace as a result of the pandemic. And when you have more units of currency chasing a fixed – faster goods and services, prices go up. And there is not probably a country in the world that hasn’t seen the negative impact of inflation. And if you don’t stay on top of it, you fall behind, and you never catch up. And we made a conscious decision not to come out of the box behind the curve. Yes. So, I am not – I don’t want to imply that we are leading the curve, but we are staying constant. I think we are doing the good job of matching the ability to push prices along with…

And there are no further questions. Mr. Nick Zarcone, I will turn the call back over to you for some closing remarks.

Well, I want to thank everyone for your time and attention this morning. And we certainly look forward to continuing the discussion with you. I think as everyone knows, we are hosting our Investor Day on June 1st. And we would hope to be able to see most of you there in Nashville. We are hosting at our national – at our North American headquarters. It will be a live event. We understand that some of you may not be able to find your way to Nashville. And for those, the event will also be virtual in nature. It will be telecast, and you will have the ability to come in via the Internet. Again, that’s June 1st in Nashville. And then again, obviously, we will be speaking with everyone in late July when we report second quarter results. So, with that, I would like to bring this call to a close. Again, we thank you for your time and attention. And we hope you have a great day.

This concludes today’s conference call. Thank you for your participation. You may now disconnect.