Thank you for joining the LKQ Corporation Third Quarter 2023 Earnings Call. [Operator Instructions] I’d like to go ahead and introduce our speaker today, Joe Boutross, with LKQ Corporation. Please go ahead.

Thank you, operator. Good morning, everyone, and welcome to LKQ’s third quarter 2023 earnings conference call. With us today are Nick Zarcone, LKQ’s President and Chief Executive Officer; and Rick Galloway, 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-Q in the coming days. And with that, I’m happy to turn the call over to our CEO, Nick Zarcone.

Thank you, Joe. Good morning to everyone on the call, and thank you for joining us. This morning, I will provide some high-level comments related to our performance in the quarter, and then Rick will dive into the financial details and provide an overview of our updated guidance, before I come back with a few closing remarks. The third quarter of 2023 represented some mixed results, which collectively fell short of our expectations. Wholesale North America continued to outperform, all while working on the integration of the Uni-Select acquisition. However, we experienced some unusual transitory events that, in aggregate, affected the short-term performance of our European operations. We also had continued pressure on commodities, which impacted Self Service, along with less-than-expected demand for our specialty products. The LKQ culture is one that takes accountability for results and is humble enough to understand that this quarter’s results fell short of both our expectations and the expectations that may view on the call. Make no mistake, the shift to our operational excellence strategy implemented in 2019 has not changed. Structurally, our business model and financial outlook are sound, and we continue to be very optimistic about the future of LKQ. One quarter does not define the resiliency of our business model, the uniqueness of our global enterprise or the long-term opportunities that lie ahead for LKQ. The perpetual challenging macroeconomic conditions are not unique to LKQ, and they will continue to persist, but the LKQ team will move forward. On the positive side, we continue to experience strong organic revenue growth in our North American and European businesses achieving same-day growth of 5.8% and 6.2%, respectively. North America achieved excellent EBITDA margins, which were ahead of expectations, and our free cash flow was excellent, particularly in North America and Europe. On the…

Thank you, Nick, and welcome to everyone joining us today. As Nick mentioned, our third quarter results reflected a mix of positives and negatives, but on balance was below our expectations. Our cash flow generation in our North America segment margins continue to be bright spots for us, and we will continue to build on these strengths. The earnings pressure was attributable to a combination of unusual items, softness in precious metal prices, and difficult market conditions impacting our Specialty and Self Service segments. While we expect challenges around economic conditions, commodity prices and exchange rates to impact the fourth quarter, we remain highly confident in the prospects of the overall business as the fundamental strengths that have driven strong results since we implemented our operational excellence strategy in 2019 remain intact. I will now provide further details on the financials, starting with cash flows and the balance sheet. As of June 30, we had total debt of $4.0 billion, including the $1.4 billion bond offering from May, with a total leverage ratio of 2.3 times EBITDA. With the August 1 acquisition of Uni-Select, we drew down a CAD700 million term loan and approximately $150 million on our revolving credit facility to complete the funding. By hedging the Canadian dollar exchange rate after announcing the transaction, we were able to save almost $50 million [ph] on the U.S. dollar equivalent of the purchase price, which is a terrific outcome. Factoring in the proceeds from the hedge settlement and the cash acquired, our net cash out for the Uni-Select acquisition dropped down from $2.1 billion to $2.0 billion. We committed to paying down debt post acquisition to bring our total leverage ratio below 2.0 times again within 18 months, and we got to work on this pledge in August and September,…

Thank you, Rick, for that financial overview. Before we open the call for questions, I want to reiterate what our global team has accomplished since starting the operational excellence journey back in 2019. In 2022, North America adjusted EBITDA margins reached their highest full year level in the company’s history at 18.7%. Excluding the impact of Uni-Select, we are on track to beat that record again this year. As a reminder, North America ended 2018, which segment EBITDA margins at 12.6%. The 1 LKQ Europe Program has generated tremendous results since introducing the plan in September 2019, and the segment is on track to consistently drive full year double-digit EBITDA margins. Importantly, there is further runway for leveraging our scale and unparalleled distribution network. This is demonstrated by the strong organic revenue growth in the quarter and the first nine months of the current fiscal year and a significant year-on-year increase in segment EBITDA of $40 million after taking into account the two unusual items that cost the segment $19 million in aggregate. We’ve generated free cash flow at or above $1 billion for three years in a row, and we are on target to make 2023 the fourth. We’ve divested 16 businesses, representing over $625 million of revenue that did not fit our strategic objectives. We’ve achieved investment-grade ratings from each of Standard & Poor’s, Moody’s and Fitch. We’ve repurchased $2.4 billion of stock since initiating our first repurchase plan in October of 2018. We’ve distributed $578 million in quarterly dividends to our shareholders. And we’ve achieved a AAA ESG rating from MSCI and built out a team to drive our global sustainability effort forward with targeted objectives. So yes, we are very LKQ proud. As we move forward towards the end of 2023, let me restate the key strategic pillars, which remain central to our culture and objectives. 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, give us the flexibility to maintain a balanced capital allocation strategy. And lastly, we will continue to invest in our future. As always, I want to thank the over 49,000 people who work for LKQ for all they do to advance our business each day and for driving our mission and our LKQ Delivers Values forward regardless of the challenges. Without a doubt, our people are LKQ’s biggest asset. And with that, operator, we are now ready to open the call to questions.

[Operator Instructions] We have our first question from Bret Jordan of Jefferies. Your line is now open.

Hey, good morning guys.

Good morning, Bret.

Good morning, Bret.

Could you give us a little more color, I guess, on the UK asset sale, maybe some either quantified or maybe EBITDA multiple you got for that sale?

Sure, Bret. Great question as – anticipated. The definitive sale agreement includes a provision wherein we are not allowed to disclose any of the terms of the transaction. What I will tell you is that we ran a full and complete auction process that started out with dozens and dozens of potential buyers. We closed the transaction at the highest value that was – that came out of the option process. We had fully anticipated that the multiple that we would receive for GSF would be materially less than the multiple that we paid for the other businesses. And we built that into all the original analysis and that exactly proved to be the case. All things considered, we’re happy to get the transaction behind us. As Rick indicated, we’re going to use the proceeds to repay debt. And the other thing I would say is the multiple reflects the current M&A environment and the impact of higher interest rates. Particularly for leveraged transactions, we sold this to a PE shop over in the UK but again, it was generally in line with what our going expectations were. Maybe a little bit on the skinny side, but not materially different.

Okay. And then a follow-up, I guess, the Canadian business, could you maybe talk about where you see working capital trending there? I mean, obviously, it should be a source of cash. Can you talk about maybe what their working capital investment is and how you might lever that?

Yes. Thanks, Bret, for the question. I’ll take that one. So one of the things that we’re pretty excited about is the ability that the CAG Group or Bumper to Bumper Group has with the vendor financing program. We got about $65 million in the vendor financing program as one of the components to drive performance. It was underutilized and something that we think we can grow fairly significantly. The overall trade working capital that we inherited from the transaction, roughly, call it, $200 million that we think we can continue to enhance and benefit within the payables, similar to what we’re doing over in Europe.

Okay, great. Thank you.

Next question comes from Craig Kennison from Baird. Your line is now open.

Hey, good morning. Thanks for taking my question.

Good morning, Craig.

Hey Nick. Good morning. So in the guidance walk, you pegged the Uni-Select impact at a $0.05 headwind. I think, Rick, you said $0.04 to $0.06. I believe that last quarter, that was a $0.04 headwind projection. I know that’s a small move, but it’s in the wrong direction. I’m just wondering if you uncovered something that wasn’t as good as you hoped? Or is that just a function of rounding?

Hey Craig, I’ll take that one. When we were analyzing and negotiating the transaction some nine to 10 months ago, we were working off of the Uni-Select annual budget for 2023, we had to make some estimates on our side as it relates to the quarterly phasing of how their business was going to unfold. We’re now sitting here in October and we recognize that our estimates, as it relates to the seasonality and the phasing of their business, were off a bit, with kind of more of their activity hitting earlier in the year than we anticipated and a little bit less late in the year. In response, we’re working hard to realize the synergies sooner rather than later, as Rick indicated. From our perspective, nothing really changes in a material manner related to the long-term economics of the transaction. And what I’d also highlight for you, as Rick mentioned, is between the benefits of the FX hedge on the original purchase, some of the higher-than-expected cash on the balance sheet at closing, the transaction value actually declined by about $100 million, which helps offset some of that earnings difference from a return perspective, not necessarily from a, from an EPS perspective.

And maybe I’ll just add just a little bit more to that. You talked about the synergy piece. Craig, it’s important to understand on the synergy piece, we’ve accelerated some stuff. We’ve talked about how we closed 10 facilities within the FinishMaster business. As far as the overall synergies, we’re roughly 20% of our synergies have already been achieved on a run rate basis as of today.

As a follow-up to that, Rick, I thought a lot of those synergies were tied to leases, which maybe three years before their expiration. So how are you able to accelerate what are essentially contractual agreements?

Yes. They weren’t all tied to that. There’s a fair amount on the FinishMaster side that go throughout the period. So if there’s something that is a little bit tighter, a little bit closer, that’s the area that we were able to identify and say a pull in that opportunity and close those facilities at an earlier time.

Thank you.

Yep.

Our next question comes from Scott Stember from MKM Partners. Your line is now open.

Good morning guys. Thanks for taking my questions as well.

Good morning, Scott.

Can you talk about in Europe and Germany, you mentioned that it sounds like there was some progress in negotiations, I guess, later in the quarter. Are we trending in the right direction? Just trying to get a sense of how long this could potentially last and how far into 2024?

Are you talking about the strike in Germany?

Yes, sorry about that. Yes, the strike in Germany.

Yes. So look, employees or certain employees at our big distribution center in Sulzbach-Rosenberg, which fulfills all of our branches in Germany, a number of those folks belong to a union or a works council as they’re called over on the other side of the pond. We don’t have advanced warning as to when they decide to call a strike. It’s very episodic. The issue is we’re down in headcount. Not all the members go on strike, but probably we lose about 40% of our workforce when they are out in strike. And that creates significant issues in trying to move product into and out of the distribution center. But we need to replenish our branches on a daily basis. Because if the product is not out in the branch the next morning, it can’t be sold. And some of the key bottlenecks are actually on the inbound movement of goods, as you can imagine, with less people to bring all that product in. The vendor delivery trucks get stacked up out in the drive, et cetera, et cetera, right? We have a phenomenal team at Stahlgruber that’s doing everything possible to mitigate the issues. We are in flight in bringing in a second DC [ph online up in Bielefeld, which is in the northern part of Germany, but that’s not going to come online in time to help with the strikes. The branch and corporate personnel in Bavaria, we pulled some of those folks into the distribution center to help with staffing. We’re still down even after that from an overall headcount perspective, and obviously, those employees are not as productive because they’re doing new things. We’re trying to push more inventory out into the branches on non-strike days, but there are limits as to how much the branches…

Scott, maybe just to throw a couple of numbers to that. In Q2, we saw about $0.02 a share. In our guidance, we essentially doubled that for Q4. So we’re optimistic that it will close out in 2023 and not have an impact on 2024. But as of right now, in our guidance, we have a total of $0.06, $0.02 in Q3 and then $0.04 in Q4.

Okay. Got it. And then just a quick last question on the bumper to bumper business. I don’t know if you’ve mentioned this before. Can you just give us an indication of how the organic sales growth has been running just some of the industry dynamics up in Canada on the mechanical repair side?

Yes, the bumper to bumper is pretty much right on track, right on plan. So we are really pleased with that business and with the team. As I mentioned, we’ve got a couple of small tuck-in acquisitions that we’ve already completed and another one that will happen in Q4. So we anticipate nice growth up in Canada.

To throw a number at it, Scott, high single digits is the way you should kind of think about that business right now.

Organically?

Yes, organically. Yes.

Okay. Good enough. Thank you guys.

Thank you.

Our next question comes from Gary Prestopino from Barrington Research. Your line is now open.

Hey, good morning everyone.

Good morning, Gary.

Rick, could you maybe go into some of the issues. I mean you mentioned pricing, but what exactly is going on for the 140 basis point decline in gross margin in Europe that you cited. You talked about something pricing in Eastern Europe was having some issues, could you maybe go in a little more detail on that?

Yes. So if you think about what’s going on over there with the recessionary environment and the activities going on, there is a little bit of price sensitivity. So what I was talking about in my prepared remarks is some price sensitivity in Europe that is – think of the good, better, best product brings that we offer. The customers are moving from the best to the better, better to the good, and we’re seeing that come down. What we have seen and what we think the opportunity is in our overall category management. Think of things like private labeling, right? So private labeling, we have businesses not in Central and Eastern Europe that are getting in, call it, 35%, north of 35% on private labeling. And we also have businesses in Central Eastern Europe that are at single digits. Mid- to high single digits in that private labeling branding. As those customers move down to a different product offering, that’s where we think we’re going to be able to really drive overall profitability to move them over to a different product offering that actually helps us out. So it’s just that consumer price sensitivity. The really good news, Gary, that I would tell you is our products are nondiscretionary. As we’ve been saying, volume is really solid. That continues to be the case, both in Central and Eastern Europe. The team is doing a fantastic job as far as delivery performance and all of that. It’s just a little bit of sensitivity on that recessionary environment that is squeezing the margins a bit that we think we’re going to be able to rectify here in the next couple of quarters.

Okay. Thank you. And then versus the EPS bridge that you put in Q2 to Q3, it looks like, operationally, you were looking for a $0.05 positive in Q2. It’s now slipped to $0.05 negative in – with the Q3 guidance. Is that all specialty that is making that shift?

It’s primarily actually self-serve. So Nick talked about some of the changes that we’re making within self-serve, it’s self-serve and specialty that makes up that $0.05, Gary, but it’s over weighted on the self-serve side. So think of the car cost that need to come down. What Nick did and the team did is put some new leadership in, that he talked about in his prepared remarks, to drive down that overall procurement and enhance the overall margins. The good news is that early in the quarter, we actually saw negative performance, negative EBITDA. That flipped to a decent-sized profitable September as we’re going into Q4. So we’re seeing the trends in the right direction, but it’s still that squeeze between the car cost and what the commodities have done. So think over weighted on self-serve versus what’s going on in specialty. Specialty, what I talked about if you think about especially in Q4, we’ve tightened up the margins. What we’ve done is we’ve tightened up both the revenue side and the margin side as we’ve gone through the year, when you think year-over-year. And we think Q4 – we believe Q4 will be pretty much on par on a margin basis versus what Q4 was last year.

Thank you.

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

Hey good morning. Thanks for taking my questions.

Good morning, Brian.

Good morning, Brian.

Just on the first one back to Specialty there. Can you maybe break it down, how much of this is macro driven higher interest cost and buying cars, versus just tough compares from what was a stronger 2022?

Yes. It’s a little bit of both, Brian, to tell you the truth. As you know, our North American and European businesses largely sell nondiscretionary parts that are used to repair vehicles, while Specialty primarily sells parts to accessorize the vehicles. As had Specialty is going to be more directly impacted by the broader macroeconomic environment, things related to economic growth, interest rates, consumer balance sheets and the like. The sale of light trucks, jeeps and SUVs has been reasonably okay, while the sale of new RV units has been very depressed, as you know. So with that, it shouldn’t be a surprise that the sale of RV accessories and related products like hitches and other towing equipment have been much softer than the traditional SEMA product. We believe that retail sales of RV units is probably a better leading indicator for the potential demand for our RV accessories than wholesale shipments from the OEs to the dealers, because unsold units sitting on a dealer lot doesn’t do anything to generate demand for the types of parts that we sell. And so with interest rates going higher and the financial health of the consumers eroding, that’s why I said we don’t see a near-term catalyst for a quick rebound in the RV marketplace. Now as we get into next year, we obviously have an easier set of comps because 2023 has been very soft. And so we wouldn’t anticipate the same kind of negative growth in 2024 than – as compared to what we have here in 2023.

On the free cash flow side, working capital as year-to-date kind of $150-plus million benefit. When you look at that $25 million increase in the free cash flow outlook for the full year, can we go back to that and just – and what kind of – is that just working capital, all of that benefit? Or is there some other pieces within there that’s driving that slightly higher free cash flow outlook?

Yes. No, it’s a great question. I mean you look at the free cash flow, you think year-over-year, when you combine three items – interest, CapEx and Uni-Select [ph] transaction costs, $250 million come down off of last year’s number, where we were at roughly $1 billion, making all of that up and delivering a fantastic result. It’s a little bit higher than $150 million if you think about the trade working capital. It’s more like $180 million as we go into Q3. It’s things like our vendor financing program that the European team does. The operational excellence initiatives span way beyond just the P&L side, they go to the balance sheet side as well. The team is doing a fantastic job driving the performance. They’re up 12% versus year-end, up about $35 million on the vendor financing program, up 10% in payables. And so driving that over and over again is something that we see as a continuous improvement. So I would tell you, the performance is good, really solid performance year-over-year, and that trade working capital really is the catalyst behind driving that performance.

Okay. And if I can maybe slip one last one in. How much debt do you expect to repay in the fourth quarter?

To repay?

Yes. How much debt paydown?

We should have roughly about $150-ish million. About $150 million debt pay down in the fourth quarter.

Okay. Thank you.

Our next question comes from Bret Jordan from Jefferies. Your line is now open.

Hey guys. Second round here. You gave us the auto claims number year-over-year. Could you give us the total loss rate for Q3?

Yes, total losses, at least according to our best sources that we have here, Bret, was approximately 20.6% in Q3 of 2023, which was up a bit from both 2022 and 2021. So total losses were up a bit. That in part is why we think repairable claims was down 4.6%, right, because you had a few more total losses. As we’ve always said, we’re agnostic to the total loss rate. Because in reality, the more cars that roll through the auctions, creates more pine opportunities for our salvage operations at reasonable prices. The key, we believe, is what’s powering the overall demand for products. And while repairable claims may be down a little bit, APU is going north. And APU is going north in part because the average number of parts required to repair a vehicle is at an all-time high of 15.7 parts in the third quarter. Obviously, the industry is fully recovering from our aftermarket parts availability. As we said, our fulfillment rates were back to over 93%, which is pretty close to our target. And then you’ve got things like the benefit of the State Farm program, which will take a little bit of share away from the OEs as well. So our sense is that our same-day organic of 5.8% outstripped what we believe would be the net impact of all the other headwinds and tailwinds, giving us confidence that we’re continuing to take share.

Okay. And then one quick question. In the prepared remarks, you talked about FinishMaster having a slightly higher MSO mix. Could you give us more color on that? Is that – is pricing on FinishMaster products lower on average than your traditional paint business?

There’s no doubt that the way that the accounting works and the way the contracts are – and that the margin on MSO business is less than the margins on a non-MSO. Because it’s basically a service quotient to service fee, if you will, even though we have to record the full value of the product that are sold. And as I mentioned in my comments, MSO volumes were a little bit higher as a percent of the total than they’ve been in the past. And that, quite frankly, that happens every time one of the MSOs buys an independent shop, right? It switches from – it switches the volumes. All in all, we’re happy with the – with where we stand with the paint business.

Okay, great. Thank you.

Our next question comes from Daniel Imbro from Stephens. Your line is now open.

.:

We believe absolutely. The reality is we posted up 5.8% on a same-day basis in the third quarter. Again, as I just mentioned in answering Bret’s question, that’s coming from better APU, it’s coming from taking share from some of the smaller competitors. Our guess is that North America will probably have some similar growth in the fourth quarter as in the third quarter. On the one hand, obviously, the comps get harder, right, because last – Q4 of last year, we were starting to get back to our fulfillment rates into the low 90% range in the fourth quarter. Wherein earlier in the 2022, we’re still well down in the 80s. So the comps were easier at the beginning of the year than they are going to be here at the end of the year. And on the other hand, though, we’ve got the benefits associated with State Farm and some of the benefits related to the UAW strike. And there’s no doubt that the UAW strike helps our North American business. On a long-term basis, we absolutely are confident in all the expectations we set, including those back in our Analyst Day in 2022. And what we think a couple of percentage points of growth, excluding inflation, is absolutely within our capability.

That’s helpful. And then maybe just a follow-up. Rick, so you mentioned in your scripts that buybacks are part of capital deployment. But it does feel like you guys have done more M&A, whether it’s a small one in Canada, you just bought Uni-Select. Can you maybe talk about like what just the strategic rationale is at buying at this point in the cycle? Could you – do you typically get better prices if we do enter a downturn? And just, I guess, how you plan on spending the $1 billion of free cash? You have $150 million of debt pay down of work to do, but what do you plan to do with the rest of it?

Yes. It’s good question, Daniel. Thanks for as you start thinking about the overall capital allocation strategy, that hasn’t changed. So if you think about it on an ongoing basis, $1 billion, we have $300 million roughly for dividend. We obviously raised the dividend 9% based off of what the Board has approved and the solid cash performance that we have. Then we earmark about, call it, $200 million annually for tuck-in acquisitions. And then the remainder, about $500 million to do kind of what we want with it, right, whether we do share repurchases, whether we do some debt pay down. What we’ve said is we’d be over weighted – until we get below two times, we’ll be over weighted on that remaining $500 million on debt paydown. So that’s going to continue. But we constantly are looking at our opportunities, whether there is an opportunity on the share price, if there’s some timing that offers us, we’ll continually look at that. But what we’re committed to is, within 18 months, we’ll get down below that two times. And so that’s something that’s weighing in the back of our mind. So that’s the way you should think about that capital allocation.

Great. Thanks so much.

Yes. Thank you.

There are no further questions at this time. I’d like to turn back the call to Nick Zarcone. Thank you.

Well, certainly, we want to thank everybody for your time and attention this morning. We know this is a busy reporting period, and we certainly appreciate spending some of your time here with LKQ. We obviously look forward to chatting with you again in February – late February of 2024 when we’re going to announce our fourth quarter results, full year 2023 results. And obviously, we’ll set the guidance for next year with all of you. So again, thank you for your time and attention, and we’ll be talking in February.

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