LKQ Corporation

Thank you for joining LKQ Corporate's First Quarter 2020 Earnings Conference Call. I would now like to turn the call over to your host, Joe Bouchos, LKQ's Vice President of Investor Relations.

Thank you, operator. Good morning, everyone, and welcome to LKQ's First Quarter 2020 Earnings Conference Call. With us today are Nick Zarconi, LKQ's President and Chief Executive Officer, and Varun Laroia, Executive Vice President and Chief Financial Officer. Please refer to the LKQ website at lkqcorp.com for 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 10Q in the next few days. And with that, I am happy to turn the call over to our CEO, Nick Sarconi. 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 first quarter, discuss the revenue headwinds we are facing in each of our segments related to the COVID-19 pandemic, provide an overview of the actions we are taking during this very challenging time, and finally describe some of the falls our industry is experiencing. Varun will dive into the financials with a key focus on the leverage we are pulling across the entire organization to right-size the cost structure and maximize cash flow. He will also discuss our liquidity and the strength of our balance sheet before I come back with a few closing comments. Clearly, a lot has changed in the last 60 days as we face this humanitarian tragedy Our hearts go out to all those impacted by the virus, both at LKQ and the population at large. The global effort to combat the virus would not be possible without those on the front line, doctors, nurses, first responders, and all those putting themselves at risk to serve their communities and the communities where LKQ operates across the globe. For that, I extend a big thank you and offer sincere appreciation from the LKQ family to those individuals for their heroic services. Taking as a whole, we got off to a great start in 2020 and are pleased with our first quarter results. In order to understand the first quarter activity, one needs to separate the pre-COVID-19 pandemic period of January and February from the month of March. Through February, each of our segments were in line or ahead of our revenue and profit expectations. The efforts by governments around the world to flatten the infection curve and slow the spread of the virus through social distancing, self-isolation, shelter at home orders and the like have had a profound negative impact on mobility and miles driven. While auto repairs and related parts supply has generally been deemed an essential service and we have continued to serve the needs of our customers, Activity levels at the repair shops in North America and Europe has dropped precipitously. The speed at which the economic fallout from the virus prevention measures has impacted all industries reflects a rate never seen before. It was like operating within two completely separate economies during a single quarter. We clearly lost operating leverage in March with the speed of the revenue decline outpacing our ability to reduce cost. I'm going to use adjusted earnings per share as the proxy. The February year to date adjusted earnings per share was up over 20% relative to the same period in 2019. while the month of March was down by more than 27% despite having an additional selling day. I will quickly address the Q1 results and then provide some detail on the revenue trends for each of our reporting segments during the first few weeks of April. As noted on slide 11, Total revenue for the first quarter was $3 billion, reflecting a 3.2% decrease from the level recorded in the comparable period of 2019. Global parts and services organic revenue declined 3.5% in the first quarter and 4.7% on a per day basis. The primary driver for this decrease was a 13.9% per day organic revenue decline in the month of March when all the stay at home mandates begin to take effect. From an earnings per share perspective, the first quarter results were solid with diluted EPS on a gap basis of 48 cents compared to 31 cents last year. On an adjusted basis, diluted EPS was $0.57 compared to $0.56 or a 2% increase. With the negative impact of COVID-19 on the March 2020 monthly results, we believe showing any year-over-year growth is an achievement and is a testament to the strength of our business coming into 2020. Now on to the segments. As witnessed during the financial crisis from 2007 to 2009, the automotive aftermarket is fairly recession resistant, exhibiting a decline of only 1% during a period that saw new car sales fall by 42%. Miles driven during that period declined less than 3%, but what we are witnessing today is entirely different. As you will note from slide 10, Organic revenue growth for parts and services for our North American segment in the first quarter declined 4.2% or 5.6% on a per day basis. Looking solely at January and February, North America organic revenue was down 1.1%, but the majority of that negative movement reflecting our decision to terminate the FCA battery contract in the fourth quarter of last year. and to a lesser amount due to a very warm winter season. CCC estimates that collision and liability-related repairable claims in the first two months of 2020 were down about 4%, so we continued to outperform the market as a whole. During March, we experienced organic revenue declines of 13.9% on a per-day basis, with most of that coming in the back half of the month compared to a CCC estimate for repairable claims in the month of March being down by approximately 20%. For the entire quarter, the 4.2% organic decline was significantly less than the 9.9% decrease in collision and liability-related auto claims reported by CCC for the first quarter as a whole. I'd like to highlight that over the last 44 quarters through the full year 2019, our North American segment has only witnessed two quarters of negative growth, a track record we are very proud of. I would also like to highlight that despite the revenue decline, EBITDA margins in North America hit a high of 16% in Q1. The organic revenue decline for parts and services for our European segment in the first quarter was 3.4%, or 4.5% on a per day basis. Again, this was mostly related to a 10.3% or 13.7% per day decline in the month of March. Importantly, not all regions were impacted by the COVID-19 pandemic at the same time, creating a different growth profile for each of our European businesses in the quarter. Italy was the first country to report a significant number of COVID-19 cases and the first to lock down the mobility of its citizens, particularly in the heavily industrialized areas in the northern part of the country. We saw an immediate impact on our Italian sourced revenue in the last week of February and the first week of March. The UK, on the other hand, did not issue stay-at-home orders until later in the month, and revenue was in line with budget until the week of March 23rd when it began a steep decline. Lastly, during the first quarter, our specialty segment had an organic revenue decline for parts and services of 1.4% or 2.9% on a per-day basis. Importantly, when looking at January and February combined, Specialty witnessed a 4.3% organic revenue growth rate with March declining 11%. It's important to look at the January and February performance in isolation given many were concerned that the weakness specialty witnessed in the fourth quarter would persist. And clearly that was not the case as we started 2020 very strong. I'd also like to acknowledge and congratulate our specialty team on being ranked the number one national RV parts distributor to do business with and number one for having the fastest delivery in the industry, both according to RVPRO's annual dealer survey. While Q1 results were reasonably strong, our industry totally left the quarter on a very soft note and the first few weeks of April were even weaker. So where is the activity level in our industry and for our company? According to a report published by McKinsey & Company, during the week of March 17th, the headwinds from social distancing reduced miles driven in the United States by 40 to 50% and accident frequency was down by up to 60% in certain key markets. Also, consumer surveys conducted by McKinsey show that U.S. households are trying to reduce their trips by roughly 50%, with 45% of the respondents expecting to delay any auto repair servicing. INRX, which provides vehicle traffic and parking data and analytics, reported that across the 98 metropolitan areas it is currently tracking, total travel during the week of April 4 was down 51% from what it was in the corresponding week in February. In addition, the U.S. Energy Information Administration has indicated gasoline consumption declined 50% from mid-March to April 3rd. Further evidence of low volumes, in the last month alone, the top five U.S. auto insurance carriers have given over $6 billion in rebates to their policyholders because of the dramatic drop in accident frequency from lower miles driven, which are pushing insurance loss costs lower. Snapsheet, an automatic insurance claims processor that works with 85 different insurance carriers, reported that collision-related claims in late March were down 40 to 50 percent, which could possibly be the bottom of the business in the last 50 years. Forty to 50% drop in claims in repair volume was echoed in a March 27 press release by the Boyd Group, which was one of the largest MSOs in the collision repair industry. Vault Service King, another large MSO, issued a release on April 15th indicating they had closed 40 of their repair facilities due to low demand. Europe is also witnessing similar headwinds. According to an Apple mobility trends report, during the first three weeks of April, driving declined over 50% in our top five European markets. With that as a backdrop, it should be no surprise that during the month of April, our daily revenue has been trending about 40% below 2019 levels. In North America, salvage revenue has been closer to the 35% down mark, with recycled engines and transmissions performing better than collision parts. Aftermarket collision parts is down more than 40%, while glass and paint are down about 42% and 36%, respectively. In Europe, the revenue declines in April vary by region, with our operations in Germany and Central and Eastern Europe reflecting declines of approximately 25%, the Benelux region being down about 40%, the UK being down 50%, and Italy being down over 60%. When taken together for the month of April, we are trending about 40% below last year. Our specialty unit started the month down 40% compared to last year. The last week saw an uptick in activity and April will likely come in down 30%. The main question all businesses are facing is how long these conditions will persist. And frankly, the answer is impossible to predict. What we can focus on is the here and now and address the dynamics that we can effectively control. Governments around the globe are trying to figure out both when and how to reopen their economies. When the lockdown measures are lifted, we do believe vehicles will start getting back on the road, but we don't anticipate miles driven will snap back to pre-COVID-19 levels immediately. Over the past week, we have seen slight increases in activity in most of our businesses relative to earlier in April. but those upticks are relative to the recent lows, and it's too early to determine whether they are sustainable. There is significant uncertainty in the market, but we are working under the assumption that these depressed levels will persist through a good part of Q2, with demand beginning to see a modest rebound in Q3 and heading towards more normalized levels in Q4, likely not back to 100% until sometime in 2021. As the pandemic began to accelerate and governments began to implement public safety measures, it was apparent that our mode of operation also needed to change because of the health and safety of our teams, our customers, and suppliers. Almost immediately, across our global footprint, every major operation developed a COVID-19 response team to share ideas and stay informed. Each of our segments has a group responsible for pushing valuable information throughout its ranks and for helping to ensure we are maintaining a safe workplace. Our efforts related to enhanced hygiene and sanitation, social distancing, and the use of PPE all has an impact on productivity, but it's the right thing to do. Simultaneous with these enhanced safety efforts, and as soon as revenue began to fall, we started to aggressively attack our cost structure. We have initiated a variety of headcount actions, including the elimination of all overtime and temporary workers, extensive employee furloughs, permanent reductions in our workforce, decreased hours for many still on the payroll, and participating in some of the social programs offered to employers in several European countries. Through these various efforts, as of last Friday, we had effectively neutralized the cost of over 16,750 employees. Said another way, In a matter of a few short weeks, we have largely removed the cost of approximately one-third of our global workforce. The numbers are both staggering and incredibly painful, particularly for a company that believes our biggest asset is our people. But payroll-related items in aggregate represent our single largest SG&A expense category, So these very difficult decisions were necessary to protect the long-term health of our company. In addition to the headcount adjustments, we have also instituted salary reductions effective in April, eliminate most all discretionary non-mission critical spending, instituted a ban on business travel, accelerated the pace of branch closures, both temporary and permanent, and focused on the overall efficiency of our distribution networks and route structures across each segment. When viewed on a company-wide basis over the past few weeks between our concerted actions and normal variable elements, the cost footprint of our company has been temporarily reduced by $80 to $90 million per month, reflecting an annualized run rate of approximately $1 billion. While we don't anticipate actually saving a billion dollars, as we will need to bring our people back onto the payroll and add costs back into the business as volumes begin to return to pre-COVID-19 levels, it highlights the magnitude of the cost adjustments we've made. With respect to the 1LKQ effort, in Europe, the new revenue environment has required us to hit the pause button on some elements of the program. like the new ERP deployment, which was going to require a large team of people to be in Italy, the location of our next deployment. We have also delayed some of the other organizational changes. We have, however, accelerated some other programs, such as the rationalization of some of our branches, particularly in Central and Eastern Europe. With revenue running at just 60% of pre-COVID-19 levels, it's virtually impossible to gauge the near-term benefits of the one LKQ Europe program, but we remain convinced it is a right long-term strategy for our business. Karun will provide more detail on the cost-saving initiatives in a few minutes. When COVID-19 first surfaced in China back in January, the immediate concern was the potential impact on the world supply chain. I am happy to report that our supply chain is intact. We have not experienced any major disruptions in terms of inventory shortages or stock outs. Indeed, we started 2020 with a high level of inventory as we headed into the seasonally strong selling period. We have been working with our suppliers to secure full availability of our aftermarket product range during the crisis. While some aftermarket parts suppliers furnishing our various businesses have experienced some reductions in capacity, we have reduced replenishment orders as our revenue has declined. On balance, we believe we will not have material issues with our aftermarket supply chain going forward. On the salvage side, as miles driven and the number of total losses have both decreased dramatically, the number of cars available at the auctions has declined as well. It will take some time for this particular supply chain to gear back up as it can often take up to 60 to 70 days for a total car to reach the auction. But we're confident that we can manage our purchasing and utilize existing inventory to meet customer demand for recycled products. I'd like to extend a sincere thank you to all of our supplied partners as they also confront this pandemic and are working hard to help us to continue to service our customers. Like any economic downturn, some businesses will suffer more than others. And given the absolute violent nature of this contraction, we believe it will be true even in the historically resistant auto parts sector. The speed and magnitude of the demand shift will be too much for some of the less well-capitalized distributors to endure. Already, there have been some smaller distributors in the U.S. that have shut their door, at least on a temporary basis, while waiting for federal funding to arrive. In Europe, one of the largest online parts distributors, ATP, declared insolvency. Lorraine, a large distributor in France, is in bankruptcy. And Hart, a large Polish distributor, closed its doors for several weeks before just reopening this past Monday. There will be more. While it does little in the near term, Longer term, it means that there will be a natural consolidation of industry demand amongst a fewer number of market participants. With leading positions in most all of our respective markets, I believe LKQ is well positioned to take advantage of these subtle shifts in the competitive landscape. To be sure, the downturn will also impact the repair shops And we would expect a similar reallocation of demand to the larger, better capitalized organization. We have a close watch on our receivables to ensure we get paid for the parts already delivered and installed. And not unlike during the Great Recession, we have seen a total collapse of new vehicles SAR across the globe. In the United States, new car sales fell about 13% in the first quarter, and 38% in the month of March. In the European Union, new car sales were even softer, dropping 25% in the first quarter compared to last year, with a 55% decline in March. We anticipate the April and May results on a global basis will look more like March than January, so the second quarter will likely be very soft as well. These massive declines in new car sales will ultimately lead to an older car park, which favors the aftermarket parts industry and will ultimately be good for LKQ. At this point, I will turn the call over to Varun.