Good morning. My name is Chris and I'll be your conference operator today. At this time, I would like to welcome everyone to the LKQ Corporation's Fourth Quarter and Full-Year 2020 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]. I would now like to turn the call over to Joe Boutross, Vice President of Investor Relations for LKQ Corporation. You may begin your conference.

Thank you, Operator. Good morning everyone, and welcome to LKQ's fourth quarter and full-year 2020 earnings conference call. With us today are Nick Zarcone, LKQ's President and Chief Executive Officer; and Varun Laroyia, 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 8-K, which we filed with the SEC earlier today, and as normal, we're planning to file our 10-K in the next few days. And with that, I'm happy to turn the call over to our CEO, Nick Zarcone.

Thank you, Joe, and welcome to everybody on the call. This morning I will provide some high-level comments related to our performance in the quarter, and then, Varun, will dive into the financial details and discuss our 2021 outlook before I come back with a few closing remarks. A year-ago on this call, we mentioned the Coronavirus a couple of times, mostly related to supply chain considerations. With a year of hindsight, I can safely say that we, like the rest of the world, vastly underestimated the impact that COVID-19 would have on our way of life. I want to express my condolences to all those who have suffered a personal loss of this unfortunate pandemic. And my sincere thanks to all those on the frontline, the doctors, nurses, first responders, teachers, and all those putting themselves at risk to serve their community. We simply cannot thank you enough. During the fourth quarter, we faced the second wave of the pandemic and related restrictions on mobility. Yet, we still produced very strong results, which were materially ahead of our expectations when we chatted with you on our third quarter call. As we mentioned at the outset of 2020, and reiterated throughout the pandemic, we were focused on a few key initiatives. And I'm proud to say our segment teams again embraced and executed on many of these initiatives, not only in the fourth quarter, but for all of 2020. And let me restate our key initiatives, which continue to be central to our culture and our objectives as we've entered 2021. First, we'll continue to integrate our businesses and simplify our operating model; second, we'll continue to focus on profitable revenue and sustainable margin expansion; third, we'll continue to drive high-levels of cash flow, which in turn will give us…

Thank you, Nick, and good morning to everyone joining us today. While there is a lot to share from our fourth quarter results, full-year 2020, and outlook for 2021, I'll keep my prepared comments brief, as there is a lot more detail in the accompanying earnings presentation. While 2020 proved to be an extremely challenging year for a variety of reasons, LKQ's resilience shone through in tough times, as evidenced by the following highlights: one, record high annual earnings per share, including the two highest quarterly results in the company's history, those being the third and the fourth quarter; two, record high annual segment EBITDA margin for North America and for the company since 2015; three, record free cash flow at well over $1 billion, the first time we've exceeded $1 billion, and now the third in a row, record free cash flow year in the company's history; and finally, net leverage dropped to 1.9 times, the first time it's been below two times since 2015, which was well before the Rhiag, PGW, Stahlgruber and several other acquisitions. To put these results in perspective, consider we beat the mid-point of our pre-COVID adjusted EPS and cash flow guidance despite falling well short of our organic revenue growth range of 0.5% to 2.5%. In dollar terms, that's over $1 billion shortfall on revenue relative to our original guidance at the mid-point. Our profitability and cash flow results are a testament to the ongoing margin and cash programs that we accelerated and actions we prioritized at the onset of the lockdown measures last March. Now we all know such outcomes don't happen by accident. And so a massive thank you to all my LKQ colleagues for their tireless efforts over the last year to deliver a truly outstanding outcome for our company,…

Thank you, Varun for that financial overview. In closing, if you asked me in late March 2020, after the onset of the pandemic, predict the financial results that we would achieve in 2020, and how we end-up the year, I would likely have not even come close to guessing at such a remarkable outcome. But the one thing I never question are the capabilities of my team. These results are a clear testament of the pride, dedication, resiliency and capabilities of the LKQ team members across the globe. One famous college football coach said ability is what you're capable of doing. Motivation determines what you do. But it's the attitude that determines how well you do it. Despite the challenges and unknowns we face, it is the positive, nothing will stop us attitude that our 44,000 dedicated team members bring to work each day. And that carried us through the headwinds of 2020 that simultaneously generated favorable outcomes that allowed us to reach certain key milestones. We right sized the North American segment and generated record margins. We made solid progress on our 1 LKQ Europe program and generated higher second half margins than projected at our September 2020 Investor Day. The uniqueness of our diversified portfolio of businesses allowed us to benefit from the rising demand for RV replacement parts. We effectively managed our working capital and generated almost $1.3 billion in free cash flow, an annual record for the company. And the excellent free cash flow allowed us to pay down a record $1.4 billion of debt, reducing our leverage ratio below two times. We continued our Talent Acquisition initiatives by adding individuals to key roles across our broad and diversified portfolio of businesses. We made good progress on our global sustainability programs and we continue to provide the best-in-class customer service, in spite of the pandemic and importantly, all while focusing on the health and safety of our team. As I've said both internally and externally, we'll come out of this pandemic period, a stronger, better organization, further solidifying our market leading position. And with that operator, we're now ready to open the call for questions.

Thank you. [Operator Instructions]. Your first question comes from Craig Kennison of Baird. Your line is open.

Hey, good morning and thanks for taking my question. Congratulations on navigating a tough year. My question is on inflation here, just curious how your business is set-up to absorb inflation and where you see your most important sensitivities, whether it's gas prices, metals or other factors?

Good Morning, Craig. It's Varun out here. Absolutely, I think it's a great question. And I'd say over the past couple of months, we've especially seen inflation move up, whether it be ocean freight, which we know is running at record high for the moment, we know wages, here in the U.S., it's difficult to find delivery drivers. So I think you kind of get the message in terms of the inflationary pressures that are building up, and also with oil prices now moving up in the higher 50s, close to $60 a barrel in any case. We have navigated, as you know, not just this past quarter, but I'd say starting 2018, when we put in place our margin programs, and obviously kind of accelerated our OpEx program, in conjunction with a cash program, our teams have navigated those inflationary pressures pretty darn well. We're proud of what they do. And, we believe we have the ability to continue to drive a number of the permanent cost reductions that our North America business has taken the lead on, but I do know that our European team is also following up with. So long story short, yes, are there inflationary pressures, absolutely. Are we well set up to undertake those inflationary pressures? Yes, up to a certain point. It really depends in terms of what kind of comes through the next call it, several weeks such but we do expect a number of these inflationary pressures to begin to ease-up for example, a notion phrase, as the MTs get back to the appropriate positions, back up in Asia, and things along those lines. Nick, anything to add from your end?

No, I think that was great, Varun.

And, Craig, if there's any follow-up question, we're happy to kind of take it now. Or if you'd like to get back in the queue, we can certainly take it there also.

Your next question comes from Scott Stember of CL King. Your line is open.

Good morning, guys. And I echo to Craig's comments on a great job navigating the very tough year.

Thank you.

Thank you.

Let me talk about the North American business, I know that much of this is based on mileage driven and people getting out in mobility. But we look out the window, the weather has been quite awful the last six weeks, I'm trying to figure out whether you guys have seen any change in demand there. And if you think that maybe this could be a tail, a potential tail to that, as we go from the first and then to the second quarter?

Great question, Scott. And again on the weather has been nasty particularly the last couple of weeks. I'm actually sitting in Austin, because I got iced-in going back the Sunday. The reality is our business is very much driven by total miles driven. And as you saw in the chart, we included in the earnings deck, kind of the revenue trends, not just for fourth quarter, but also for January. And you could see that January kind of picked-off where September left-off or picked-up where December left-off, right. So until there's a really meaningful movement in mobility, we think we're going to be kind of in this level of activity. Ultimately, we've gotten a number of questions in the past about what's going to drive an increase in mobility and clearly getting through the pandemic, and people getting out of their homes and returning to their daily lives, this will be the biggest impact. We don't believe that everyone is going to work-from-home forever. We don't think everybody on this call to permanently be working from home. And while we've all become fairly efficient and be productive in the working from home, there's clearly a lack of community that is hard on organizations. And we may not get back to 100% of folks being back in the office. But we do think a number of folks will get back into the office. We think kids are going to get back into school. And when all that happens, we think the use of public transportation will remain depressed for a longer period of time, just because of the safety issues related to the virus and the life. So as some of those workers begin to head into the office or back into their workplaces, those who took public transportation may opt to take private transportation, which means instead of hopping on a train or a bus, they're going to hop in a car. So, we're cautiously optimistic that miles driven will move back north and that will help our business. Clearly with the ice storms in the like have hit the last couple of weeks throughout the United States that should ultimately create demand for our business. I'll tell you here in Texas and based on the new stories of the pile-ups in Dallas and Austin and Houston, that is probably going to create a bigger opportunity from a salvage buying perspective and a parts perspective because lot of those salvages are anticipated when they sent an ice storm 40 miles an hour. But again we’re cautiously optimistic that we'll get back to more normal levels of miles driven which will lead to a more the normal level of demand. It's going to take some time, we don't think it’s going to just pop back in the second or third quarter but hopefully by 2022, we'll be back at historical levels of miles driven.

Got it. And then last question on the Specialty side, you talked about RVs really leading the way I guess that's more retail driven. But you also last year like expanded your warranty program, could you talk about how that contributed and how that probably will contribute even more as we move through the next year or two more RVs on the road, many of which will potentially be easily built and just more, just opportunities on that side?

Yes, absolutely. I mean, there was an enhancement, I think we noticed a massive shift in discretionary spending, away from things like restaurants and lodging and air travel, theaters, sporting events, all those group events right. And outdoor recreation camping has absolutely been a huge beneficiary of that shift in discretionary spending. Our RV business historically has not been tied to the RV SAR in any particular year. It has been very highly correlated to campground spending. In 2020, the OEMs produced about 425,000 RV units which was a great year; the expectation for 2021 is over a half a million units will be all-time record high. The key there is that the size of a part, the number of RVs in the part is expanding. And that's great for the Specialty business, as all those incremental units that will be on the road for years and years to come will create demand for the parts that we sell. So even if the SAR ultimately settles down over the next two or three years, the units are still going to be on the road, in that larger base is going to provide a great opportunity for us to sell profitably parts for many years to come. So the growth may ultimately slow down. We don't think we're going to continue to grow at 16% year-over-year like we did in the fourth quarter. But we don't anticipate substantial declines in the overall revenue base.

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

Sort of big picture question here around parts demand for EVs. And obviously Europe's got a jump on it; you did a lot of business in Norway. But could you talk a little bit about how you see the different parts that versus internal combustion and what this does to demand down the road long-term?

Sure. And it's a great question, obviously, one that's been kind of floating around the industry now for the better part of the year. The reality is we believe that the supply chain, really the manufacturers of the EV parts will ultimately look alike -- look pretty much the same as the supply chain for internal combustion engine. Now, there's going to be a lot of overlap in suppliers, and we fully anticipate that some of the bigger vendors like Bosch, or Continental or Shutter will absolutely develop parts for electric vehicles. And while we're going to start with the OEMs as their focus, what they know today is that their current aftermarket business makes better profit margins than their OE parts business. And so it won't be long before they take that OE manufacturing capacity and start making parts for the aftermarket. We'd have very strong relationships with all those vendors. We got the leading distribution capabilities as related to Europe and it's a natural fit for us to do business together. Secondly, a lot of the conversion over the next 10 years or so, Bret, on electrification is going to come through hybrids. And hybrid, as you know, is a combination of an internal combustion engine and electric motor. And the opportunity for LKQ there is two-fold. First, there's all sorts of new part types that we would be able to sell, things like Stanley [ph] coolant -- coolant fans, electric air conditioning compressors, electric driven motor inverter coolers, I mean just a whole new set of products that we can ultimately distribute. And then what we also know is that hybrid parts related to the internal combustion engine side of the power train are more expensive than similar parts on a non-hybrid car. So like an AC…

Thanks. Thanks for that. And a question on the technology as well. So you're standing in diagnostics program that you just talked about? Could you sort of talk about the revenue expectations and maybe the margin structure of a more service-based business like Elitek?

Yes. So this industry is nascent. It's pretty small. The typical competitor is somewhere between 6 and 12 technicians that have banded together to provide services to the marketplace. Okay. Our business is just shy of the $50 million mark today, and it's growing. The great thing about the services business, it has better EBITDA margins than our North American parts business. And so that should help as that business continues to grow. Now, we're not going to be able to grow that business by necessarily through acquisition to gain significant scale, because like I said, most of these operators are tiny, they're tiny. So we'll buy and look to buy perhaps some of the larger groups, even though they're still pretty small, and rollout on a Greenfield basis by really educating technicians and then putting them out in the field as part of our Elitek service offering. So we're excited about the business.

Your next question comes from Stephanie Benjamin with Truist. Your line is open.

Congratulations again, in a really nice year. I wanted to touch on, you kind of brought up in the beginning of your prepared remarks that really the fourth quarter exceeded your expectations, and even kind of how you outlined things, the last time we spoke. We'd love to hear some color about what moved in your direction during the quarter and kind of how you're seeing things turned out in beginning of 2021? Thanks.

Sure, great question. The revenue didn't help us. And if you go back to that page, when we laid out the last four months, you can see that say for the Specialty Group, which just rocked during the fourth quarter, the revenue in both North America and Europe were down pretty consistently from the prior-year levels. So Europe is doing better than North America because of our collision focus here. So really wasn't revenue that lead to the outperformance, Stephanie, it was our operating margin. We've had good improvement on the gross margin line. And while on a consolidated basis, it looks like gross margins came in a couple basis points. That's just a mix shift, because the North American business has margins north of 46%, the Specialty business has margins around 28% and the high margin business kind of falling 13% and the low margin, gross margin business dropping 16%. So you shouldn't take anything from that at all. The key is the operating leverage that we got out of that. Each of our segments worked hard to get the cost structure to reflect the current state of demand. And we're very proud of what our folks have done. Unfortunately, a lot of that has come on the back of labor. We're down substantially from a total number of employees today versus what we were a year-ago. But that's what just what attract to right size the business. And those are permanent reductions, we're going to be very cautious to add people and/or expense back to the SG&A line until we see the revenue rebound. And then we'll need to add some people back just to keep our customer service levels where they need to be. So think about the intense focus on controlling our costs, because we're in an environment where we don't necessarily control our revenue.

Absolutely, that's really helpful. I'll get back in the queue. Thank you.

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

Good morning, everyone.

Good morning, Garry.

Couple of questions here. Varun, what is your priority for your free cash flow? I assume you would be paying down debt this year?

Yes, I think it's a great question, Gary. Simply put, if you kind of go back to our Investor Day presentation from September. So probably about four, five, six months ago, we were very clear in terms of; we expected our free cash flow generation on a sustainable basis to kind of continue. We kind of reset the overall business model. So that kind of starting off is a great option to have as a business. We've always said that the key priority is investing in our own business. So capital expenditures will be kind of priority number one. Following that, we've set high synergy tuck-ins and building up critical capabilities. There was a question earlier on the call about scanning and diagnostics. That is a business that we’re investing heavily into. Again, as Nick said they are very small transactions, 6 to 12 technicians, on a market-by-market basis. So certainly wherever we have the ability we certainly acquiring those but really also supplementing it with capital expenditures to kind of expand that specific service. We do not have any large platform transactions on the horizon. We do not see we need those at this point of time, which essentially leads us to a point where the excess free cash flow really would go towards either debt pay down, although, as you've seen, we've certainly made a tremendous amount of progress being at $1.04 billion in 2020, we're well within our target leverage at this stage of time. So really, it becomes the highest return on capital opportunities, and we still believe that our shares are undervalued. And we certainly see no reason given the authorization we have from the board to be able to repurchase our stock.

Okay, thank you. And then just, just, lastly in terms of, what you've done with the cost structure and what you can do obviously, in the future, as you move from an acquisition growth strategy to more of just integrating and bettering your operations, do you every year, I would assume you're really pushing your divisional heads to get the costs down. And I just wondered, where is the biggest component of costs going to come out in the future for the company, and I assume you're going through a program every year, we need to get our costs better in line on an annual basis?

Absolutely, Gary, it's Varun out here. Two years ago, as you rightly pointed out, we pivoted to an operational excellence mode. And ever since that, we've essentially been driving productivity through integration. And these programs you really see in terms of how our North American business has taken the lead on that front. Just look at the fourth quarter operating expenses, that business, yes, we certainly had challenges in terms of what the VMT has been in, so collision rates have come down. But as we think about how our collision business has performed relative to the data we're getting in from CCC, we're performing much better than what the repairable claims are out there. So that's kind of good. But really, it is the productivity piece of it that our North American leadership team has just did an outstanding job. You then kind of move over to say for example, the next large component of our overall business, and that's in Europe. And Europe also has kind of begun to make some progress, they'll be setting so some operating expenses come down in the fourth quarter, there's a lot more productivity to go get out there. And that really is the overall 1 LKQ program. We need to make investments out there, for example in the European ERP program, setting up a back office for example, that really the longer-term productivity really is from our European business. And that is something that we know our European team has a laser like focus in making sure that they certainly follow from, within the portfolio companies, as we shared best practices between our businesses and our divisions, I know our North American leadership team has spent time with our European team also. It's just one thing Nick and I kind of pushing and pulling certain levers. But as the peers speak with one another, largely, it's the base similar business, it's the distribution business, and that certainly has helped a lot also. But yes, you're right, overall productivity programs, every business of ours, every function of ours has productivity programs to essentially offset the inflationary pressures that typically come around in any case, but it's the nimbleness and the agility that we're tremendously proud of, and that really came through in spades, with the onset of the pandemic. I hope that response to your question.

Sure, it does. Thank you.

[Operator Instructions]. The next question comes from Daniel Imbro with Stephens. Your line is open.

Yes, good morning, guys. Thanks for taking the questions.

Good morning.

I wanted to start on a broader supply chain question. Obviously, you mentioned varying time rates are much higher, there's a problem getting things over from overseas, how has that impacted your aftermarket supply here in North America. And related to that with limited supply at auction and potentially disruptions in the aftermarket side, do you think your supply chain can support the anticipated return to growth in North America? Or could that be a pinch point this year as you look forward?

Yes, listen Daniel, good morning to you, it's Varun out here. I think it's a great question. We've got tremendous vendor partners on the aftermarket side of the business, they have been tremendously supportive, not just now, but ever since we got into the business. So that's just kind of one thing. With regards to kind of ocean freight and the challenges associated with it, whether it be the number of carriers that are more outside of the Port of LA, Long Beach for example, or for that matter, getting those empty cans back to Asia to kind of get refilled and come over. We have long-term contracts with vessel providers, but also with certain brokers. So we're still being able to get space without -- while we're having to pay up for it, we still being able to get space for it on those carriers. And then the other one, as you probably know is LKQ has always had a class-leading inventory and fill rates. And so we've made sure that we always have the product. Yet, there are certain areas where we're having to run local or shuttles between within the region, for example, so we want to ship something from say New England to California. But say within the region, we're kind of making sure that our fill rates remain. So we do have the inventory, it may not always be in the right part. But we certainly learned a lot over the past few years in terms of making sure our fill rates remain. But at the same time, we're not kind of taking on excessive costs associated with it. Over time, we know that the Chinese New Year had kind of cost us certain splurge in terms of the amount of ocean freight that was coming over. We expect that to abate level in the coming weeks and months. But clearly that is a risk. But as I said previously, we had product, we have more product on the way in any case, we think this will even itself out as we return to a growth mode starting Q2, which is largely kind of easy comps but really getting back to growth in the second half of the year.

Okay, that's helpful. And then --

Daniel, we just think we're better positioned than the typical competitor out there, given the size and scale, depth and breadth of the inventory coming into this. This time we're shipping is an issue. We'll be able to work our inventory to be a competitive advantage.

That's helpful. Thanks Nick. And then the related follow-up would be a follow-up on an earlier question on inflation. Obviously, cost inflation is coming and we just talked about it happening. Are you seeing any signs of being able to pass that through on like-for-like pricing amidst cost inflation? And if not, what do you think is going to take to see that revenue tailwind return considering the cost pressures right now feel pretty broad? Thanks.

Yes, listen again just to kind of add to what I had answered earlier in the call, Daniel, we are -- we have a dynamic pricing model. And we certainly make sure that, while we have a certain threshold, or at least a ceiling associated where OEM parts are, clearly if those kind of begin to move, that would certainly help. But we do know that our teams are doing a fantastic job on the pricing side. As I said previously, also our salvage business has been doing really well. From an aftermarket perspective, there is limited supply in the market. We do have the product. And listen, we want to help everybody, specifically the carriers and our customers to making sure we get the right parts at the right time. So associated with kind of having the product, the second one clearly is making sure that we're that much more productive in the cost that we've been able to take out initially what was temporarily in the second quarter, and kind of then switching that independent cost reductions. That is certainly working out well for the entire enterprise. But obviously, we can't wait for kind of growth to return. It certainly helps us get more of our folks back in the field. But as of now, we're happy with the way our teams are navigating the various puts and takes that are out there.

Your next question comes from Brian Butler of Stifel. Your line is open.

Good morning, thanks for taking my questions.

No problem.

Just first one on the cash flow and outlook of the minimum kind of $800 million coming from the $1.3 billion that you saw in 2020, can you maybe break out the buckets that go from the $1.3 billion to $800 million? Obviously, inventory is a piece of it, you talked about DSOs is a little bit of an offset in CapEx. But could you give a little bit more color on that?

Yes, listen, it's actually very simple and it was in my prepared comments. During 2020, we essentially realigned our inventory base with what demand projections were. Our inventory balances came down by over $400 million. And that really is the kind of delta between call it the $1.3 billion and the minimum $800 million that we're talking about.

So it's all inventory. It's really, I'm guessing little bit of CapEx?

CapEx is about $100 million.

Yes.

It's basically inventory about over $400 million and CapEx is about $100 million. I mean that basically kind of $500 million right there from the $1.3 billion to the $800 million.

Okay, that's good. And then follow-up just on the kind of the pace of the growth kind of going into or through 2021, I expect first quarter remains kind of weak, based on the January revenue that we -- you showed, but how should we think about that kind of pace of growth for second quarter and then into the second half?

Yes, great question. So as you indicated, we're anticipating Q1 is going to be down year-over-year, largely because we started-off last January and February of 2020 very strong. And obviously, you can see the January numbers are down, February will be down and then March is an easier comparison. Second quarter will obviously be up because even if we just stay at these levels of revenue, the revenue came off so dramatically in Q4 last year, second quarter will be up. And then the third and fourth quarters, those are obviously hard to predict they're further away. We're anticipating a little bit of upward movement on a year-over-year basis. But again, not back fully to 2019 kinds of levels.

Great, thank you.

And just one additional piece to kind of highlight, we do have one less selling day in Q1 across the entire enterprise. So in North America, there's one fewer selling day in Q1, a second fewer selling day in the fourth quarter. And in Europe, we have one fewer selling day in Q1 but we make up that day in Q2 for the European business. So just to kind of think about, this is something we've talked about previously and just wanted to make sure that you had that into your models.

There are no further questions at this time. I'll now turn the call to Mr. Zarcone.

Well, as always we greatly appreciate your time and attention. We know this is very busy for everybody on the call earnings season, lot going on. We appreciate your listening to our story. We're incredibly proud of what we've been able to deliver in 2020, particularly given all the challenges that companies around the globe have had to deal with and we had our fair share of challenges as well. The team I could not be more proud of, they came through beyond any expectations and I could not be more proud to be -- to work alongside all them. We look forward to sharing with everybody at the end of April when we will announce our first quarter results and again it's going to be more of the same, we're going to keep our head down, we're going to drive as much revenue out of the market that we can, but it's really going to be more focus on keeping our cost under control and generating cash. And with that, we'll bring the call to a close and hope you all have a good day and we'll speak again in April. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.