Good morning. My name is Rob, and I will be your conference operator today. At this time, I'd like to welcome everyone to the LKQ Corporation's Fourth Quarter and Full Year 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Joe Boutross, Vice President of Investor Relations, you may begin your conference.

Thank you, operator. Good morning, everyone, and welcome to LKQ's fourth quarter and full year 2022 earnings conference call. With us today are Nick Zarcone, LKQ's President and Chief Executive Officer; and Rick Galloway, our Senior Vice President and Chief Financial Officer. Please refer to the LKQ website at lkqcorp.com for our earnings release issued this morning, as well as the accompanying slide presentation for this call. Now let me quickly cover the Safe Harbor. Some of the statements that we make today may be considered forward looking. These include statements regarding our expectations, beliefs, hopes, intentions or strategies. Actual events or results may differ materially from those expressed or implied in the forward-looking statements as a result of various factors. We assume no obligation to update any forward-looking statements. For more information, please refer to the risk factors discussed in our Form 10-K and subsequent reports filed with the SEC. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release and slide presentation. Hopefully, everyone has had a chance to look at our 8-K, which we filed with the SEC earlier today. And as normal, we are planning to file our 10-K 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 everybody on the call. This morning, I will provide some high-level comments related to our performance in the quarter and full year 2022, and then Rick will dive into the financial details and discuss our 2023 outlook before I come back with a few closing remarks. This month, we are celebrating the 25th anniversary of our company's founding in February 1998. What started with a few salvage facilities in the U.S. has grown to a Fortune 300 business with operations in 28 countries and over 45,000 employees, providing a wide array of aftermarket and recycled parts used to repair, maintain and accessorize vehicles. Our operations are leaders in their respective markets and are well positioned to continue their success in the future. Getting to this point has been the result of the dedication of our past and present teams. And I want to express my sincere appreciation for all of these efforts. I am excited to see what this team can deliver in the future, as the LKQ team is never satisfied, never rests on its laurels and has always pushing to be the best. When LKQ was founded, ESG was not the hot topic that it is today. But ESG has always been a vital part of our strategy. Through our recycling operations, we are enabling the circular economy in doing our part to reduce waste. I am proud of our contributions to date and I can assure you that our emphasis on sustainability will continue to be an integral part of our mission. Our success in ESG is being recognized by external parties. On December 05, 2022, MSCI upgraded LKQ to their highest ESG rating of AAA, placing LKQ in the top 5% of all companies that they rate globally. And…

Thank you, Nick, and good morning to everyone joining us today. Before I go into details of the fourth quarter, I'd like to reflect on what LKQ accomplished in the last year. We entered 2022 with a strong position based on the success of our operational excellence initiatives and solid balance sheet after reporting the highest profitability in the company's history in 2021. We expected there to be headwinds in 2022 from the areas Nick mentioned. As you can see on the bridge, on Slide 5, these headwinds did set us back, but the LKQ team drove operational improvements to produce roughly $0.40 of operating increases relative to 2021. We also sustained the positive momentum around cash flow generation, with free cash flow of just over $1 billion in 2022, and healthy conversion ratio of 60% of EBITDA. Our work on free cash flow in recent years supported some noteworthy accomplishments in the last year: LKQ achieved investment-grade ratings from all three major rating agencies; returned $284 million to shareholders through quarterly dividends and increased the quarterly amount by 10% in October; repurchased roughly 20 million shares of LKQ stock for just over $1 billion, which combined with the carryover benefit from 2021 purchases added $0.23 of EPS compared to 2021; and all while maintaining a net leverage ratio at less than 1.5 times EBITDA. In early January 2023, we replaced our prior credit facility, which included a $3.15 billion revolver, with a new unsecured facility, including a $500 million term loan and $2.0 billion revolver. Our confidence in the balance sheet and ability to generate robust cash flow factored into the decision to reduce the size of the facility. We were pleased to complete this new facility ahead of the prior facility becoming current and lock-in funding over the…

Thank you, Rick, for that financial overview. In closing, 2022 was another banner year for our company and again validated the strength of our strategy, our business model and, most importantly, our people. Let me restate our key strategic pillars, which continue to be central to our culture and objectives as we've entered the new year. First, we will continue to integrate our businesses and simplify our 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 gives us the flexibility to maintain a balanced capital allocation strategy. And fourth, we will continue to invest in our future. With these pillars in place, coupled with our industry-leading teams, we are well positioned to both face the challenges the new year presents and to continue to deliver positive year-over-year operating results for our shareholders. As always, I want to thank the over 45,000 people who work at LKQ for all they do to advance our business each day and for driving our mission forward regardless of the challenges. Time and time again, our teams have shown that these challenges are opportunities for growth, both for themselves and for the overall organization. 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 Craig Kennison from Baird. Your line is open.

Okay, thanks, and good morning. I wanted to ask about your recycling business in Europe after you've acquired Rhenoy. I mean, I know it's not large in the scheme of things, but perhaps you could just update us the recycling footprint you have today in Europe and whether the time is right to maybe make a bigger push, build something like your North American auto recycling business now in Europe?

Yes. Good morning, Craig, and thanks for the question. So, for many years, we've had an operation in Scandinavia, in Sweden. We call it Atracco. It's been operating quite well for quite some time. It's not a huge business. But it is a nicely profitable business. And we started in Scandinavia, and particularly Sweden, because that recycling market looks the most like the U.S. market, when you think about how the insurance companies participate in the industry and the utilization of recycled parts. And so that was our beachhead if you will. And it's proven to be a very nice investment. Obviously, Rhenoy is our maiden voyage on to the continent. And we anticipate that there will be incremental opportunities to expand the footprint. The recycling business in Europe, generally speaking, is different than in the U.S. It is largely driven by the commodities as opposed to parts sales. And as you know, as a distributor of parts, we're more focused on the parts side and the commodity side. And so, it's going to take some time for the European market to shift. There are some regulatory changes going on in Europe as it relates to the circular economy and utilization of green parts. We think this is going to be a good time to slowly kind of build up our presence. We've got a boatload of intellectual capital here in the U.S. We think it's going to be a good time to extend that to the other side of the Atlantic. But it's going to be a slow process, Craig. You should not expect any major shifts over the next year or two or three. But we think we're incredibly well positioned to expand our footprint on the recycling side in Europe. And it's all a matter of finding the right businesses to acquire, the right management teams, the right values, the right environmental practices, but we're optimistic that there'll be more tuck-ins like Rhenoy as time unfolds.

Thank you.

Your next question comes from the line of Scott Stember from ROTH MKM. Your line is open.

Good morning, guys, and thanks for taking my questions as well.

Good morning, Scott.

Can you talk about State Farm? What you're seeing? Early experiences? How fast it's ramping up? And then, also are you hearing anything about State Farm potentially expanding past the two or three SKUs that they're currently using right now?

Yes. So, State Farm made their announcement just in December. It's not like going over to the wall and flipping the switch, right? You have a couple of decades of history of repair shops being kind of driven into [their head] (ph) that State Farm did not use aftermarket parts. And so, it's going to be a slow transition. Our volumes of those three-part types on State Farm claims is moving up. And so, we think that it's on track for -- to hit the overall opportunity for 2023. I think we quantified that in our last call as being under $100 million. We've had one month, right, January, under our belt. If you kind of extrapolate that out, we think that they're going to continue to push their new policy throughout the marketplace, but it can take a little bit of time to get up to kind of full speed.

Got it. And then, just a follow-up...

There is no indication at this point in time, but again, we're not -- but -- what, sort of 45 days after the announcement that they're going to extend the program to new product types. That's certainly our hope. We think that is the logical thing to do, but we thought that was the logical thing to do for the last 20 years.

Got it. Well, clearly in a better spot than we were 10 years ago. So...

Absolutely.

And just if I could just slip one last question in Europe. I don't know if you gave granularly detailed by market. But what are you seeing -- the countercyclical benefits of the aftermarket -- or the mechanical parts aftermarket starting to kick in? Maybe just give us a little color there.

Yes. So, as Rick and I both indicated, organic growth in Europe in the fourth quarter was a little bit over 5% on a per day basis, on a same day basis, which was terrific. Every single one of our markets was up nicely and either in and around that mid-single digit range with the exception of one business, which is, we call, components business on a year-over-year basis, that was still negative, because that's the business that used to sell into Russia. And if you recall, we shut every single element of that down the day that proven they rolled tanks over the border. And so, on a year-over-year basis, that volume has just gone. But all the geographic platforms showed really good organic growth in the fourth quarter.

Got it. Thanks, guys.

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

Hey, good morning, guys.

Good morning, Bret.

Good morning.

You called out strength in alternative parts utilization in North America. Is that a tailwind from OE certification programs or what they're doing in collision on the OE side driving prices up to the point where it forces more alternative parts utilization, or what do you see as the tailwind of that mix?

Well, we believe that in the fourth quarter, the biggest part of that tailwind is that the aftermarket, including ourselves, by far the largest player, we actually had inventory to sell. As you recall, we had supply chain challenges coming out of 2021 into 2022 and our fulfillment rates, because of that, were down. I mean, historically, we've been in this the mid-90% range. And as we indicated in prior quarters, we're down into the low to mid-80%-s, right? The fact that we actually have the inventory need to be responsive to customer demand is the primary reason the whole aftermarket industry was able to grab over 2 percentage points of share back from the OEs. And we think that -- and we're very proud of that. Obviously, we're the largest player in the aftermarket parts space. We're charging hard to take share, not just from the OEs, but from our smaller competitors as well.

Okay, great. And then, on the recycling of batteries in North America, the partnership you talked about, can you give us a little more detail sort of is that something that you use your existing infrastructure? And obviously, not a lot of batteries in the vehicle park yet, but where do you see that being a contributor?

Yes, this is not a play for 2023 or even 2025, perhaps this is a 10-to-15-year play, right? And what, ultimately, we believe is it's pretty well documented that there's not enough lithium being mined to produce all these batteries that are going to go on the EVs that folks are anticipating going to be on the road. And so, recycling the key elements out of existing EV batteries can become critical. We don't have the technology to do that. We recycle parts, but we don't know how to recycle chemical elements, right? But that's where Korea Zinc comes in. I mean, they are truly a world-class organization when it comes to reclaiming and recycling all sorts of various non-ferrous metals. And we believe that's a combination of their ability and process technology on the one hand was our ability to source cores and batteries on the other hand is a -- it could be a great partnership. Now, it's a memorandum of understanding, right? It's not a joint venture yet. The goals over the next couple of years to figure out and work together to develop a plan that could be profitable for both companies. But it's moving us into the next generation of mobility and we're very excited about it. And we think Korea Zinc will be a terrific partner for us.

Great. Thank you.

[Operator Instructions] Your next question comes from the line of Brian Butler from Stifel. Your line is open.

Good morning, guys. Thank you very much for taking my questions.

Good morning, Brian.

Just on the first one on the guidance. When you think about the $975 million in cash flow, I mean, it sounds like that's kind of the minimum. And if you were to try to back up into an EBITDA number using the conversion of the 55% to 60%, that kind of puts you at $1.77 billion, kind of just under 13% margins. Is that kind of the right way to think of the low end of EBITDA?

Yes. So, we -- the way we're looking at it -- thanks for the question. The way we're looking at it is 55% is the minimum of where we're sort of guiding on the conversion piece of it. So, as we're driving into this thing, the mix between what happened year-over-year in the earnings with the interest payments, the tax payments coming down and the capital expenditures, I would -- I think we've got a gap, call it, 50 plus or minus, we kind of gear right in that range. That's where I would kind of look on the free cash flow piece. And then, backing into that, we've guided 55% to 60%. We think that's a pretty reasonable approach, where we hit the 60% in the prior year 2022, bringing that down a little bit with the CapEx expenditures in 2023 is how we end up getting to that $975 million.

Okay. But just think -- I mean, again, just kind of backing it into trying to guess on the EBITDA, I mean, as that gets to the 60%, you would expect the EBITDA to also be higher as well. Is that a fair way to look at it?

Yes, that's a fair way. Yes.

Okay. And then, on a follow-up question. When you think about the CapEx, the additional spend that kind of move from 2022 into 2023, I mean if you kind of even that out over the two years, you kind of were at $1 billion based on your guidance...

That's exactly...

It will be about $1 billion guidance. So...

Yes, that's exactly [indiscernible].

Okay. Great. Can you give a little color just kind of on what drove that? And then, maybe kind of what's the right way to think about CapEx on a longer-term basis?

Yes. So we look at 2% of revenue, 2% to 2.25% of revenue is usually the kind of guide that we've given. We have 1.75%, I think it was 1.77%, something like that in 2022 as things pushed out, primarily trucks, equipment pushed out with the supply chain issues. And then when you think year-over-year, we're right in that 2% range that we've been kind of guiding to. So, there may be ebbs and flows back and forth between different years, but that 2% to 2.25% is the right way to look at it.

Okay. Perfect. And then, just last one. Is there any risk on the inventory build at Specialty, if cars kind of that market, that demand remains soft, is that something we should be watching?

No, I don't think so. So, we have a traditional build throughout the year, and we ended up decreasing that a little bit and then driving that down toward the end of the year to end up virtually flat year-over-year on overall inventories, and it's something that we're watching very closely with the demand. And so, nothing to be concerned about in that area.

Okay. Great. Thank you for taking my questions.

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

Hey, good morning, everybody. Thanks for taking our questions.

Good morning, Daniel.

Nick, I want to start on the European side. I think at the end of your prepared remarks, you talked about Europe having some specific projects they're working on. Can you provide some more color just around what those are? Is that just the growth in the collision parts? Are there other costs projects that Varun and the team are working on? Any kind of quantification as we think about potential margin impacts from those initiatives?

The answer, Daniel, not to be snide, but the answer is yes, right? We've got a number of different projects over in Europe. Rick mentioned restructuring, the 2022 restructuring plan, that hits all of these segments, including the European segment. It's part -- folks should think about restructuring at LKQ as part of our continuous improvement plan that every year, we're looking to find ways to optimize our business and to get excess cost or better throughput and efficiency from each of our operations. And so, yes, there are some restructuring plans over in Europe, just like North America and Specialty. We're looking at programs to continue to drive organic revenue growth, particularly volume growth. And Varun and the team are focused on some key programs there. They pulled in headcount a little bit, particularly at the kind of at the head office level, not just in Zug, but across the operating platforms as well, just to make sure that our administrative costs are aligned with the realities of 2023 and the economic climate. So, it's a number of different initiatives, Daniel, none of which we're going to put a pinpoint as to what it means from a euro or dollar perspective, but it's all with the goal of continuing to drive organic revenue growth and better margins. And as I think Rick indicated in his prepared comments, we're anticipating that the margins in Europe will...

20 basis points to 30 basis points.

Will go up by 20 basis points to 30 basis points in 2023. And that's been included in the guidance that Rick set out.

Great. That's helpful color. And then, I wanted to just circle back on the potential battery remanufacturing JV. If you take a step back and just think about how State Farm handled the aftermarket after one accident 20 years ago, I mean, have you guys talked to the insurance companies? Do you think that they're actually going to reinsure remanufactured EV batteries? Or if there's one accident, does that become a category that insurance companies just won't touch because of the liability? Just trying to think through what the actual end market could be there. Can insurance companies actually do that?

Yes. So, Daniel, you need to separate the collision business from the mechanical repair business. And the EV batteries, what we're doing right now with Bumblebee and Green Bean, the two companies that we bought over the last year or so that remanufacture batteries, that has nothing to do with the collision business. That just has to do with the failure of the batteries and the life batteries to extend the life of the vehicle, okay? The memorandum of understanding on recycling with Korea Zinc, again, has nothing to do with remanufacturing. That is truly a recycling to get to the core elements that are inside that EV. And so, you need to keep -- there's a big difference between remanufacturing and recycling. Recycling, there's not a battery left to go back into another vehicle, right? Remanufacturing is where we truly look at the battery, we replace certain cells. That is not an insurance-driven profit. If you have a nine-year-old EV and your battery is failing, you're not going to get reimbursed a nickel from your insurance company to go replace that battery. That's going to be an out-of-pocket expense.

Got it. So, this is more on the -- it's on the mineral extraction or kind of recycling side, the potential...

Yes.

Okay. That's helpful. Thanks, guys.

Yes.

There are no further questions at this time. Mr. Nick Zarcone, I turn the call back over to you for some final closing remarks.

Well, as always, we greatly appreciate everyone's time and attention on this call. We know it's a busy reporting period, and we appreciate you spending the hour with LKQ. Again, I couldn't be more proud of our team and the results that we posted up not only in the fourth quarter of 2022, but the full year as a whole. We're looking forward to being back on line with you in about, I don't know, 60 days or so, in late April, when we announce our first quarter results. So, thank you for your time, and we'll be talking to you soon.

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