Joe Boutross, VP of Investor Relations, began the LKQ Corporation's Second Quarter 2023 Earnings Conference Call by thanking the operator and introducing Nick Zarcone, the company's President and CEO, and Rick Galloway, Senior Vice President and Chief Financial Officer. He then discussed the safe harbor statement and the use of both GAAP and non-GAAP financial measures, and concluded by introducing Nick Zarcone to speak.

In the second quarter of 2023, the North American and European segments experienced exceptional organic revenue growth and strong margins, which more than offset the headwinds experienced by the Specialty and Self-Service segments. The non-discretionary nature of the parts these core segments distribute, combined with operational excellence initiatives, highlights the strength of the business model. Revenue for the quarter was $3.4 billion, an increase of 3.2% and parts and services organic revenue increased 4.8% on a reported basis and 5.4% on a per day basis.

In the second quarter of 2023, total parts and services revenue increased 5.4%, however other revenue fell 23.9% due to weaker precious metal prices. Net income decreased 29.5% to $281 million and diluted earnings per share decreased to $1.05 compared to $1.49 the previous year. North America reported the highest quarterly EBITDA margin on record, with organic parts and services revenue increasing 8.3%, a combination of price and volume improvements.

The volume of aftermarket product sales increased significantly due to two main factors: the industry supply chain issues had been largely worked through, resulting in higher fulfillment rates, and State Farm's program allowing the use of aftermarket parts, including sheet metal products and side mirrors, is being piloted in California and Arizona. This increase in aftermarket sales is consistent with a rise in alternative part usage, which had returned to pre-pandemic levels in the second quarter.

In the second quarter of 2023, the APU of recycled parts increased by 140 basis points year-over-year, while the total loss rate decreased to 20.4%. Europe reported the highest quarterly revenue, EBITDA, and EBITDA margin percentage ever, and saw high single-digit to low double-digit reported organic growth in Benelux, German, and Eastern European operations, due to positive movements in both price and volume. The enthusiasm of top performing general managers and salespeople at an event for the North American business was energizing.

In the second quarter, LKQ Europe entered into a strategic partnership with Mobivia, Europe’s largest independent provider of automotive maintenance and repair services. This agreement is meant to leverage the strengths of both companies to provide a differentiated solution in the marketplace. Despite cost inflation, the European team has taken structural and efficiency actions which resulted in year-over-year improvements in SG&A. The Specialty segment reported a decrease in organic revenue of 12.9%.

In the second quarter, the demand for various parts in the specialty segment was down, especially for RV and towing related products which saw a 50% and 20% year-to-date decline in wholesale shipments and retail sales, respectively. The Self-Service segment saw an increase of 4.7% in organic revenue for parts and services, though it was challenged by low commodity pricing. The company completed several small acquisitions during the quarter, as well as divested a small non-core business in the Specialty segment. Additionally, they entered into a definitive agreement to acquire all of Uni-Select’s issued and outstanding shares.

In the second quarter, the required approvals were received from shareholders, the court, and antitrust regulators in the US and Canada. The UK's Competition and Markets Authority issued a Phase 1 decision on the transaction, and the closing conditions relating to regulatory approvals have been waived. The acquisition of Uni-Select is scheduled to be completed on or around August 1, and the divestiture of GSF is set to be completed in the third quarter. LKQ has also taken steps to ensure the health, safety, and wellbeing of employees, such as expanding their wellness program and installing dash cams in their fleets. They also implemented two diversity, equity, and inclusion initiatives, 25 by 25 and PAVE.

Nick and Rick discussed the progress of LKQ's ESG efforts, which had been validated with an AAA ESG rating. They also announced a quarterly cash dividend of $0.275 per share of common stock. Rick then discussed the company's strong performance in the second quarter, including record high segment EBITDA margins of 20.6% in North America and 11.5% in Europe, organic revenue growth, operating improvements, and strong free cash flow. He attributed the success to pricing, productivity initiatives, and a favorable mix effect.

The North American segment had strong performance and is expected to have a low 19% EBITDA margin for the full year with some moderation in the second half. Europe had an EBITDA margin of 11.5%, up 70 basis points from the prior year period. Specialty's EBITDA margin declined 390 basis points compared to the prior year, due to increased price competition and unfavorable product mix. Self Service profitability declined sequentially to 4.1% and decreased relative to the 15.3% reported in Q2 2022. The teams are taking actions to align the cost structure with revenue trends and are hoping for 20-30 basis points of margin expansion for the full year.

Metals prices had a net negative effect on results in Q2 2023, resulting in a $50 million reduction in EBITDA and a 620 basis points reduction in operating leverage. Catalytic converter prices were down 39% and scrap steel fell by 20%, creating a gross margin headwind. Adjusted diluted earnings per share were flat to Q2 2022, with a net increase of $0.11 per share on an adjusted basis driven by gains in North America and Europe, partially offset by the decline in the specialty business. However, this was offset by a $0.08 impact from metal prices, a $0.05 increase in interest expense, and a $0.02 increase in the effective tax rate due to non-deductible Uni-Select transaction costs. The Uni-Select transaction affected various parts of the second quarter financials, and the income statement effects of the pre-acquisition net financing expenses and transaction costs were excluded from adjusted diluted EPS.

In Q1, the company completed a $1.4 billion bond offering and a CAD700 million term loan to finance the Uni-Select transaction. The interest earned from the bond proceeds is reflected in interest and other income, and the company also hedged the interest rate risk prior to the issuance of permanent financing in the bond market. The company also entered into foreign exchange forward contracts to purchase Canadian dollars at a specified rate, and incurred M&A advisory costs of $6 million which are presented in restructuring and transaction-related expenses. Interest expense will be reflected in adjusted diluted earnings per share going forward.

In the quarter ending June 30, the company had $1.9 billion in cash, total debt of $4.0 billion, and a total leverage ratio of 2.3x EBITDA. The increase in leverage ratio triggered a 12.5 basis point increase in the company's credit facility margin. They had $1.7 billion in variable rate debt, of which $700 million was fixed with interest rate swaps. Free cash flow was $414 million, and they are on track for an estimated $975 million for the full year. Interest payments will be a larger headwind than originally projected due to higher interest rates and the impact of Uni-Select financing.

The company has paused its share repurchase program and used free cash flow to pay down debt and make small acquisitions. They also paid a quarterly dividend. For 2023, they are expecting organic parts and service revenue to be between 6.0% and 7.5%, with adjusted diluted EPS in the range of $3.90 to $4.10. The primary factors contributing to the EPS guidance change include lower specialty segment performance, declining metals prices, and higher interest and tax expenses.

LKQ reported a solid performance in the second quarter and the first half of the year, and they plan to continue to integrate their businesses, focus on revenue growth and margin expansion, drive high levels of cash flow, and invest in their future. They expect to close on the acquisition of Uni-Select on August 1, which will be dilutive to adjusted diluted EPS by $0.02 to $0.04 per share in fiscal 2023, but they expect it to become accretive over the first 12 months.

Nick Zarcone of LKQ discusses the potential benefit of State Farm's utilization of the company's aftermarket parts. He states that the upside from headlights, tail lights and bumper covers is estimated to be around $70-100 million annually once the program is fully up and running, and that this number could increase to $125-150 million when other parts are added to the bucket.

Nick Zarcone explains that State Farm's use of CAPA-certified parts will result in an annual revenue of $125 million to $150 million, with good margins due to the limited required SG&A. He then clarifies that this number assumes that State Farm will go live with all parts across the country. Finally, he states that the growth in Europe is due to taking market share, but not countercyclical nature of the business.

Rick Galloway reports that fulfillment rates in North America have improved by 5 points, from the mid-90s to the high-80s, compared to a year ago. He notes that this improvement will likely have a positive impact on organic growth in the region in the long-term.

The Uni-Select business has provided more visibility, and the company is confident in their ability to access $55 million in cost synergies over the first three years post-transaction. Most of the cost savings will come in the second year, with only a few needing the full three years to access. The company will start the process as soon as they can and try to deliver the synergies quickly, which will come from facility savings, procurement benefits, and corporate overhead.

FinishMaster and the company's paint operations in the US are expected to create synergies, but the $55 million of benefits outlined when the transaction was announced will not include revenue benefits from broadening out the Canadian product line or giving them capital to grow their business. The Leadtech third-party diagnostics business is growing 25% a year and has strong margins. 75% of repairs at MSOs involve scanning the car and 18% involve calibration work. The average price of a scan is $140 and the average price of a calibration is $400.

The specialty business has experienced a tough couple of quarters, and there is not yet a catalyst for a quick turnaround. However, the company has done restructuring and is aggressively cutting costs, leading to double-digit margins in June. Going forward, the company is striving for 10% margins, even though revenues may remain challenged for several more quarters.

Rick Galloway and Nick Zarcone answer Gary Prestopino's questions about the impact of the changes to the company's adjusted EPS guidance on their consolidated segment EBITDA. They explain that the metals impact should be taken into account, but that the interest and tax side will be avoided. They also mention that Varun has been successful in improving the company's operations in Europe.

Nick Zarcone and Rick Galloway discussed the margin improvement and EBITDA generation in the quarter, attributing it to a focus on SG&A and productivity gains. They noted that organic revenue growth helped, but they also had to deal with inflationary pressures and wage inflation in certain countries, such as the Netherlands and Germany, where unions have used short-term strikes to advocate for better wages. Rick also mentioned that North American EBITDA margins have held in much stronger than expected, despite smaller competitors using price to get share back.

Rick Galloway explains that the North American wholesale margin is being offset by productivity initiatives and competition that is holding pricing. Nick Zarcone adds that North America saw more than half of the year-over-year growth in volume, which is a positive sign. Additionally, OEM pricing has not seen any major changes.

The OEs have kept prices steady and are not expected to drop them, so the company will continue to sell at a discount to the OE list. Nick Zarcone thanked everyone for their time and attention and looks forward to reporting third quarter results in October.

This summary was generated with AI and may contain some inaccuracies.