LKQ Corporation

Good morning. My name is Laura, and I will be your conference operator today. At this time, I would like to welcome everyone to the LKQ Corporation's third quarter 2020 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. Please limit questions to one question and re-queue for follow-up. I would now like to turn the call over to Joe Boutrous, Vice President of Investor Relations. Sir, you may begin your conference.

Thank you, Operator. Good morning, everyone, and welcome to LKQ's third quarter 2020 earnings conference call. With us today are Nick Sarconi, 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 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 8K, 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'm 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 operating highlights related to the third quarter before discussing some key metrics that are impacting the revenue trends in each of our segments. Varun will then dive into the financials with a key focus on the impact of the measures we initiated in late March across the entire organization to right-size the cost structure and maximize cash flow. He'll also discuss our liquidity and the strength of our balance sheet before I come back with a few closing remarks. It's hard to believe that just six months ago in early April, we were facing revenue declines of 40 to 45% as economies around the world went into lockdown. Today, we are enjoying a material improvement in demand, year over year margin improvements in each of our segments, and over a billion dollars of free cash flow generated in just the first nine months of this year. In light of the challenging environment we have confronted throughout the year, our team delivered a terrific outcome in the third quarter. These results clearly highlight the true strength of LKQ. This performance was achieved in the midst of having to make mission critical decisions to protect the business while simultaneously maintaining the morale of our most important asset, our people. I could not be prouder of the effort of Team LKQ. As noted on slide four, total revenue for the third 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 4.5% in the third quarter, while currencies and the net impact of divestitures and acquisitions collectively accounted for a 1.1% increase. Notwithstanding the soft revenue environment, our team reached a monumental milestone by delivering the highest level of quarterly earnings in the company's history. During the third quarter, diluted earnings per share on a gap basis was 64 cents compared to 49 cents last year, a 31% year over year increase. On an adjusted basis, diluted EPS was 75 cents compared to 61 cents or a 23% increase. Now on to the segments. As you will note from slide six, parts and services revenue in North America declined 12.1% during the third quarter with organic revenue growth for parts and services declining 11.3%. The lower organic demand is reflective of reduced levels of mobility as evidenced by meaningful year-over-year declines in both vehicle miles driven and fuel consumption. According to CCC, Collision and liability-related repairable claims in the third quarter were down 24%. So again, we are clearly outperforming the claims data. When looking at product-specific data, while both were down, our salvage revenue trends outperformed aftermarket, largely due to the demand of our mechanical parts, predominantly engines and transmissions. Still, our aftermarket collision-based revenue performed materially better than the CCC statistics for repairable claims, suggesting that we continue to experience share gains in the collision marketplace. There was particular strength in our remanufactured product line as many market participants were disrupted by the component supplier's ability to provide product. Given the depth and breadth of our remanufactured parts inventory, we were able to keep pace with demand and believe we gained share from our direct remand competitors in the third quarter. I would also highlight that despite the revenue decline, the segment EBITDA margin in North America was 17.6%, the highest quarterly level achieved in the company's history. Also, North America operational efficiency efforts continue to capture the $80 million in annualized permanent cost reductions that we've discussed over the past few quarters. At the end of the third quarter, over 90% of those cost actions have been completed, with the balance scheduled to be finalized in the fourth quarter. Barun will dig deeper into the puts and takes of these numbers shortly. Regarding the competitive landscape, As many of you on the call know, in August, AutoNation announced that it will be closing its aftermarket collision parts business. This headline is both a commentary on the difficulty of growing a profitable aftermarket parts business, and more importantly, a true testament to the strength of LKQ's aftermarket collision parts operations with our market leading fulfillment rates, service reliability, nationwide coverage, and unrivaled depth and breadth of inventory. From a supply perspective, we have minimal issues sourcing product for our aftermarket crash parts business, and our Taiwanese supply partners are well positioned as we prepare for the winter season. We have seen some tightness getting adequate space on ships for our containers, causing some delay on product coming in from Taiwan and an uptick in freight expense. Depending on the supplier and product, we have witnessed delays anywhere from one week to 30 days. Having said that, our overall inventory is in good shape and heading in the right direction. On the salvage front, auction volumes are still depressed, but we've seen a slight increase in activity over the past month. We did experience a rapid uptick in pricing during the quarter as used car prices surged and the exporters resurfaced at the auctions. But our team has done a fantastic job at combating these price increases by harvesting more parts per vehicle and executing our price optimization strategy. When combined with the rise in precious metals prices, Our efforts have allowed us to recapture a significant portion of the increased pricing at auction. As we enter Q4, we have seen little change in pricing, but we are optimistic that this trend will reverse over the next few quarters as volumes return to historical levels. While these pricing dynamics may put some pressure on salvage margins in the near term, when taken together with our productivity gains, Over the longer term, we believe North America EBITDA margins will settle out well above 2019 levels. Now let's turn to Europe. Total revenue for our European segment during the third quarter rose 2.2% compared to the prior year. Organic revenue for parts and services in the third quarter decreased 7 tenths of 1%, while the negative impact of acquisitions and divestitures was a negative 1.5%, and currencies added 4.5%. Throughout the quarter, most regions witnessed stronger than anticipated volumes, a very encouraging trend. As I stated in our second quarter call, not all regions were impacted by the COVID pandemic at the same time or to the same degree, creating a different growth profile for each of our European businesses. This difference in growth profile continued in the third quarter, but the variability in growth across the businesses were not as disparate when compared to Q2. Importantly, certain key markets, such as the UK, Germany, and the Netherlands, posted single-digit organic revenue growth on a per-day basis, with September generally reflecting the best month of the quarter. Italy continued to be the softest region, posting the largest year-over-year declines, followed by the Central and Eastern European operations, which collectively were also down on a year-over-year basis. In the UK, we have completed the restructuring of the Andrew Page branches, with nearly 30 unprofitable branches closed and all remaining branches running on ECP's IT infrastructure. While this branch restructuring likely cost us bit in terms of revenue growth, it enabled the ECP to post double digit EBITDA margins for the first time in the last 17 quarters. As the leading aftermarket mechanical parts distributor in the UK, we believe ECP has the best margins in the market, given the scale advantages and the operational efficiency as a result of our investments. Local management has done a terrific job of delivering on the key operational initiatives of profitable growth and enhanced margins. Additionally, our Brexit contingency plan is in place and being thoughtfully executed despite the significant uncertainty around the Brexit negotiations. The team continues to effectively manage any safety stock risk in the UK. Our European team continues to right-size their inventory levels in the midst of the lower demand. As of late, we have seen softness in sourcing product broadly across our supply chain. And daily, we actively review line by line our inventory levels to assure our customer service and fulfillment rates continue to be industry leading. I am happy to report At this time, neither of those has been impacted largely because of our levels of safety stock. Lastly, on Europe, the execution of our 1LKQ Europe program remains on track. As mentioned at our September 2020 investor day, we have pulled forward some activities relative to the original plan and have seen slight delays in other areas. Again, we've accelerated our platform rationalization, innovation and shared services development, talent acquisition efforts, and the build out of our digital strategy. While our ERP harmonization projects, procurement and product and yield management activities have been delayed by a quarter or two. In total, we remain comfortable with both the magnitude and the cadence of the margin improvements set forth in the comprehensive review that Arndt and Yannick provided last month during the investor day event. Moving on to specialty. During the third quarter, our specialty segment had total revenue growth of 1.4% composed of organic revenue growth for parts and services of 1.1% and acquisitions and currencies making up the balance. Given some industry-wide inventory challenges, our organic growth rates were clearly hindered by the low availability of product to meet the robust demand. And we believe the lost revenue due to significant gaps in the supply chain. That said, we believe that our market-leading position allowed us to fare better than our competitors. And as you would expect, we are in constant communication with our suppliers to work with them and help wherever we can to get more product out on the road. Over the past few weeks, we have seen an increase in product receipts and we have finally started to increase our specialty inventory levels with sales growth rates increasing as a result. In particular, we are encouraged by the extended RV season with this particular product group continuing to perform well. From a corporate development perspective, during the quarter, we acquired a mobile diagnostics business that provides our existing diagnostics business entry into the Virginia market, and also add some technicians that will serve key markets throughout North Carolina. Also during the quarter, Stahl Gruber entered into an agreement to divest its 51% ownership stake in two small businesses located in Poland. These transactions represent our ongoing effort to rationalize our asset base through the divestiture of non-core lower margin businesses and finding new opportunities to grow our customer offerings. The net consideration related to these transactions was negligible. From an ESG perspective, during the third quarter, our recycling businesses processed 209,000 vehicles resulting in, among other things, the recycling of 990,000 gallons of fuel, 581,000 gallons of waste oil, 542,000 tires, and 191,000 batteries. During Q3, we also processed approximately 286,000 tons of scrap steel. You can see that our businesses help preserve significant levels of natural resources reduce the demand for scarce landfill space, and reduce air and water pollution, all of which helps protect the environment. So where do we go from here? Similar to the second quarter, we have clearly benefited from a solid rebound in demand during Q3. But as widely publicized, there has been a resurgent in COVID cases across the globe with positive test rates reaching all-time highs. It is impossible to predict how the recent surge may impact our business as it depends on how the governments around the globe react. Some countries are headed back to strict lockdowns, but most appear to be focused more on curbing certain activities, such as attending sporting events and other group functions, limiting in-restaurant dining, in utilizing virtual schooling, all of which will continue to dampen mobility. While the horizon of the overall market demand remains foggy, we are hopeful that the industry will not return to the extreme market conditions experienced early in the second quarter. With that as a backdrop, we do not expect any material improvement in mobility or overall industry demand in the fourth quarter. as there are no catalyst apparent to drive meaningful increases in miles driven. Until improvement is evident in our business, we remain intensely focused on controlling our cost and generating significant levels of cash flow. And at this point, I'll turn the call over to Varun.