Good morning. My name is Rex, and I'll be your conference operator today. At this time, I would like to welcome everyone to the LKQ Corporation's Second Quarter 2022 Earnings Conference Call. [Operator Instructions]. Thank you. Mr. Boutross, you may begin your conference.

Thank you, operator. Good morning, everyone, and welcome to LKQ's Second Quarter 2022 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-Q in the coming days. And with that, I am happy to turn the call over to our CEO, Nick Zarcone.

Thank you, Joe, and good morning to everyone on the call. This morning, I will provide some high-level comments relative to our performance in the quarter and then Varun will dive into the financial details and provide an update on our guidance before I come back with a few closing remarks. The second quarter of 2022 was one of the most unusual and complicated operating environments we've encountered maybe ever, but clearly, since the financial crisis. During the quarter, we were confronted with ongoing COVID risk and the issues associated with an uptick in positive cases in our workforce. Major labor constraints, ongoing supply chain disruptions, a challenging inflationary environment globally as evidenced by June being the highest level of inflation the United States have seen in some 40 years. Soaring energy prices, commodity price volatility, the unfortunate conflict in Ukraine and political unrest across the globe. And all this has resulted in major volatility in the foreign exchange markets with the euro weakening materially in the quarter and reaching parity with the dollar in July. I think I speak for all CEOs across all industries when I say the sheer number of cross currents and headwinds have created some very challenging business dynamics. Yet, the LKQ team delivered another quarter of solid performance, driven by excellent focus and execution, exceeding many expectations, both internally and externally. I am very proud of the hard work and dedication demonstrated by our 45,000 employees that enabled our company to deliver on behalf of our stockholders and our customers during the quarter. I am equally proud of the team's commitment to effectively immense the dynamics of our business, which they can control, while not losing focus on growing the business, developing our people and continuously looking for opportunities to generate leverage and synergies…

Thank you, Nick, and good morning to everyone joining us today. I'm excited to be able to report that we carried the momentum generated by our operational excellence initiatives through the second quarter and produced another strong set of financial results. As Nick described, there is a great deal of volatility in the market related to inflation, supply chain challenges, exchange rate fluctuations and commodity price movements on top of the geopolitical events and the ongoing pandemic. All these factors could easily have become a distraction and taken our focus away from executing on our operational priorities. I'm proud to say that the LKQ team did not let that happen, and our second quarter results reflect this ability to stay on point. Let me start with some highlights of the last quarter. As we announced in June, Moody's became the final of the 3 rating agencies to assign LKQ an investment-grade rating following previous upgrades by Fitch and S&P. We believe that we've taken the right actions over the last 3 years to strengthen our credit profile, and the Moody's upgrade to Baa3 with a stable outlook is further validation of our strategy. As discussed last quarter, achieving an investment-grade rating opens opportunities to improve free cash flow over the upcoming years, in addition to the immediate drop-off in the leans to the credit facility following the covenant suspension. With respect to free cash flow, we produced a healthy $288 million in the quarter, bringing the year-to-date figure to $638 million, and importantly, putting us on pace to achieve our full year guidance of $1 billion. I'm pleased that we were able to build our inventory towards the optimal level as shipping congestion eased a little bit which resulted in a net cash outflow for the quarter of $162 million…

Thank you, Varun, for that financial overview. Let me restate our key initiatives, which are central to our culture and our objectives. First, integrate our businesses and simplify our operating model. Second, focus on profitable revenue growth and sustainable margin expansion. Third, drive high levels of cash flow, which in turn will give us the flexibility to maintain a balanced capital allocation strategy. And fourth, to continue to invest in our future. As you can see from our results, we are committed to driving these metrics forward regardless of the operating environment. We are doing our very best to effectively manage the items which are under our control so as to offset the headwinds which are largely outside of our control. And for that, I offer a tremendous thank you to our team members across the globe that make it happen each and every day. They define what it means to be LKQ proud. And with that, operator, we are now ready to open the call to questions.

[Operator Instructions]. Your first question comes from the line of Scott Stember.

Congrats on the very strong results despite the nonstop headwinds that you're facing.

Thanks, Scott.

First question, I'm just going to jump right to State Farm. Obviously, they left the market more than 20 years ago and they've come back in dipping their toe in. Can you maybe just size this up versus prior attempts of them going back in the market? How real this feels and how tangible and how big this could be, if it really does come to fruition?

Yes. So let's put everything in perspective. Great question, Scott. State Farm is the largest automobile insurance company in the United States of America. They have roughly an 18% market share. They stopped using aftermarket collision parts back in the late 1990s, as a result of some policy language that certain of their customers took issue with. It had nothing to do with the actual parts, it just had to do with policy language. And they stayed on the sidelines really throughout the entirety of their litigation, which lasted for 20 years. And in 2019, they finally settled that suit for about $250 million, which is dropping the bucket, right? That was 20 years ago. And over the last 3 years, people have been wondering now that, that was settled, are they going to come back? State Farm is a very thoughtful, very conservative organization and they move pretty slowly. And this is just a pilot. It's a AV pilot in 2 states with 3 product lines. That said, it is encouraging that this is really the first time outside of some pilots with chrome bumpers for pickup trucks that they are actively looking at the market and evaluating the utilization of a broad array of parts. The reality is if they were to turn it on completely, all at once, which we don't think they will do, we think this is going to -- again, in classic State Farm fashion, this will draw out fairly slowly over time. There is a potential of an 18% increase in aftermarket demand because they're 18% in the marketplace. We don't anticipate any impact on our 2022 or 2023 results because, again, this will probably play out over a longer period.

All right. And just going back to North America, you talked about in June, you saw some encouraging results from a fulfillment standpoint. Could you just give a little bit more detail on that?

Certainly, historically, our fulfillment rates in North America have been well into the mid-90% range. And coming out of the pandemic of all the supply chain issues and the like, we fell below 90%. We picked up a couple of percentage points in the month of June, which was good. We're still well below where we want to be, well below where we used to be. But the fact that we're moving up is encouraging. And obviously, a lot of that has to do with the aftermarket product, which, as I indicated in my prepared comments, was -- is the 1 product line that has been most affected by the supply chain challenges. The volume of aftermarket parts is down. Pricing is very strong, but the volume is down. And we have a lot of inventory on the water, as I mentioned. We were very successful in getting containers filled and on ships in the second quarter. We won't -- given the supply chain, we won't see that until late summer or early fall. But with that, we believe we will be in a good position to continue to drive fulfillment rates back north. We do not believe we're going to get back to plus 95%, but we're moving in the right direction.

All right. And just lastly, your 4.5% to 6.5% parts and service organic growth rate has not changed, but has the composition by segment changed?

Not materially. Europe is right on track with where we would expect them to be, as I indicated. North America, in the first quarter and the second quarter, we're ahead of our expectations. And so there's a little bit more of a shift and impact from the North American business. The Specialty business, as we've seen given the monster comps that we had last year, was down, I think, 15% in the first quarter, 11% in the second quarter. We're trending in the right direction. Again, we've only got 20-some days of data on Q3. We're closing the gap. And our goal would be by the end of the year to be a lot closer to prior year numbers. So maybe a little bit of shift from out of specialty and into North America, but again, comfortable with that 4.5% to 6.5% range.

Your next question comes from the line of Craig Kennison.

First question, just on inflation. Nick, can you characterize the rate of inflation in your cost structure and whether that's easing at all?

Thanks, Craig. It's almost impossible to put a single number on inflation because it's coming at us from so many different corners at different rates. Fuel expenses are up dramatically. I mean gas used to be $3.50 a gallon. During the quarter, as high as over $5 a gallon. Now it's easing back a little bit. But that's not the 9% inflation that the rest of the -- that's being published about the United States inflationary factors, right? Labor rates are up significantly. The good news was in June, for example, we didn't have to go to the spot market for container shipment at all. It was all under contract. And so while it's still above where it was pre-pandemic, it wasn't quite as bad as we had feared. So it really varies almost by category of expense and by location. The experience in North America is different than in Europe. But overall, all of our costs are up. The cost of goods is up. All the SG&A expenses are up. Nothing is -- almost nothing is down other than what we can do to have productivity measures to reduce the consumption of SG&A type items. But it's a big headwind. There's no doubt about it.

Your next question comes from the line of Brian Butler.

Well, just the first one. Can we talk about the trade working capital opportunity? And how should we think about our model kind of some of the trade working benefits plays out in the second half of 2022?

Brian, it's Varun Laroyia calling. That's a great question and certainly a topic very close to my heart, but also over the past few years for the entire organization out here. It is a key element of the revised annual cash incentive program since 2019. And just tremendously proud of the shoulder that every single individual across the enterprise has put into it. And clearly, as you see, we are happy with the inventory build as some of the supply chain congestions eased. Again, it is all relatively speaking, it certainly isn't back to pre-pandemic levels. But if you think about where we've been over the past couple of years, the second quarter was a good quarter for us to be able to pick up inventory in our businesses. And that certainly is what we're here to do to ensure that the right part available at the right place and at the right time. So that really has been the key for us. As you think about the second half of the year, similar to what we've done in the first half, we don't believe that we need to build up inventory levels significantly above where we currently are. But as you know, we typically do, do an inventory build in the fourth quarter because of the seasonality of the overall business coming out of the winter season in Q1 and Q2. So we do expect to build up some inventory towards the back end of the year, but the single biggest piece, as you can think about is the payables offset. And you certainly saw that in the second quarter also. While there was inventory build, we certainly had a nice move on our accounts payable balances to offset that. And then the final piece really within trade working…

Okay. That's very helpful. My second question was on kind of looking at -- can you talk a little bit about price and volume mix when you look at the U.S. and the EU for the parts and service business for the second quarter?

Yes. The -- it's a great question. As we tried to indicate in our prepared comments, a lot of the organic growth, no surprise, given the inflationary environment that we're dealing with, has come through price. The volume question, again, like the inflationary question, it really depends clearly business by business, product line by product line. In North America, the aftermarket product volumes were down. Salvage collision volumes were actually up because we were able to transfer some of that demand for our aftermarket product into salvage product. The salvage mechanical side of things were kind of flattish. We had some uptick in the reman business. And so net-net, we had -- we were down in North America, but some things were down, some things were up. Same in Europe, you really have to go geography by geography. We had some of our businesses where the volumes were up low single digits, which is great. We had other areas where volumes were down, say, 1% or 1.25%. But pricing was very strong again. And specialty, with the 11.5% decline in organic volumes were down. But again, that's relative to the monster comp. So it really depends on business by business, geography by geography. I believe our teams are doing a great job of managing. We're always trying to get the most volume that we can because ultimately, that's important to sustaining the business. But equally it's important, particularly these days, is making sure that we're covering the inflationary pressures through our pricing actions. And so we're -- we believe the team is doing a nice job of balancing those 2 objectives.

Your next question comes from the line of Daniel Imbro.

I want to start on the North American wholesale side. So obviously, the State Farm development feel like they're positive for growth. But I also want to ask on pricing. I think most of the quarter was driven by pricing. Are we still seeing OEMs raise prices further, Varun? And as you look to the back half and maybe into next year, I mean, would the expectation be that given the broader inflationary backdrop, these pricing increases continue? Or is there a risk that pricing flows or probably have to come down on the OEM side?

Yes, Daniel, this is Nick. The OEs, they don't just increase all the prices on all their parts every month. That's not how they operate. They're very selective in how they're pricing their parts. Some prices go up significantly, some prices don't go up at all. And obviously, all the OEMs kind of have their own strategy. In general, their prices have gone up a little bit less than or generally less than overall inflation. And so we -- whenever they take their prices up, that provides us an opportunity, not just us as a whole, alternative parts industry as a whole, the ability to take pricing up a little bit as well. I can't predict what they're going to do in the future. Ultimately, they're dealing with the same types of inflationary pressures as all the other businesses as it relates to input costs, whether that be materials, commodities, labor, all the rest, right? All I can say is we will try -- we keep a very close eye as to how the OEs are pricing their product. We need to maintain a competitive stance. We think we're doing a good job of doing that in this current environment.

Great. That's helpful, Nick. And then Varun, maybe one on the European margins. I think we touched on demand a bit in the last question. But I think at the Analyst Day of our call, you guys noted that further margin expansion was possible and above 10% profit levels. Given the change in the last 30, 60 days and FX rates, economic backdrop, inflation, I mean, do you still think it's possible to see EBITDA margin expansion this year, next year for Europe as you look ahead?

Yes. Listen, great question, Daniel, and thank you for giving us the opportunity to respond to that. Listen, I think, as you know, Q1 with the Ukraine-Russia conflict, there were some challenges associated with that. But the underlying business operates in a very resilient market. Folks have kind of talked about the fact that energy prices have been moving up with what's happening further out there. But we really haven't seen a significant drop off on a VMT basis, number one. And that really is the key driver for our European business. So from that perspective, really happy with the way our European business continues to perform. Nick obviously gave some color on the broader platforms in terms of how they've been performing also. I think the key piece out here has been making sure that we have the inventory to satisfy the demand, which we do. But overall, very happy with the way the margin trajectory of the European business continues, and we feel comfortable and confident about the double digits on a full year basis. With regards to 2023, we haven't given any guidance as of now. But needless to say, if you kind of go back to our commitment to the markets way back in September of 2019 when we launched the 1 LKQ Europe Program, at that point of time, we said exiting 2021, we would be a sustainable double-digit margin business. We certainly delivered that in '21. We're delivering that '22. There's no reason for us to start to backslide at this point of time. So while we haven't given any guidance, we do expect there to be further goodness from a margin and profitable growth perspective across our European segment.

Your next question comes from the line of Bret Jordan.

On that last question, Varun, you said that VMT has remained pretty stable in Europe. Could you talk about the consumer demand trend, I guess, sort of the cadence in the quarter as obviously compounding volatility over there? Has it had any impact as we've progressed?

Actually, the back part of the quarter was much stronger than the first quarter, Bret, which we were heartened to see. Again, you got to keep in mind, we're largely in what would be deemed a consumer nondiscretionary business, right? We provide service parts that keep vehicles on the road. People need their cars for mobility to get to work, to conduct their daily life. And if the car can't operate, they're going to spend the money to put it back into operational mode. And everyone knows in tough times, you can probably stretch out your oil change for a bit, right? You can stretch out some of the service items for a bit. But sooner or later, you need to repair your car, you need to keep it serviced. And that's what we love about our business, right? It's largely consumer nondiscretionary. No business is totally recession-proof if you want to use that word. But we feel very comfortable with where we are. And again, our operating results in May and June were much better than they were in April. So we're optimistic.

Great. And then within specialty, could you sort of carve out the performance differences between RV, which I think you called out as being pretty stable versus the SEMA-related product is sort of within that total specialty decline. Could you give us a feeling on the pieces?

Yes. So the RV side of it, what I indicated was down less than the unit -- the business as a whole. Business as a whole was down 11.5%. RV was off less than that. And again, you really have to almost go product set by product set. So core RV products really are tied to less to the RV SAAR breadth, but more to the utilization of the RV and the size of the park. We've done a lot of correlation analysis over the years on this. And what we've always seen is that RV revenues tied a lot closer to campground spending than the RV SAAR because a lot of what we sell are replacements and consumables and that all relates to the utilization of those units. If you go back to the financial crisis, right, The Great Recession, campground spending was flat. It stayed -- hung right in there. And -- but there are some products like towing, which is a great example, which really crosses RV and marine and some of the SEMA product, towing was soft. And on the SEMA side, that's where probably a larger percent relative to RVs, large percent of the spend goes on to vehicles, right? People buy the new pickup truck, their new Jeep and they want to fit it out and pickup truck SAAR was off 12% in the quarter, which is the second quarter in a row that it was down, right? So that's where there is a little bit more pressure. But again, some of it is a comp against almost an unrealistic comp of what we did in 2021. And like I said, the specialty group, including all parts of the specialty group, are doing better and they're clawing their way back to prior year volumes at least in the first few days of the third quarter. We probably won't get there for the quarter as a whole, but we're closing the gap. And from our perspective, that's what's important.

Your final question comes from the line of Gary Prestopino.

Couple of questions here. First of all, Nick, you didn't cite the growth in collision claims in North America as a comparison to what you did in North America. Do you have statistic handy?

Yes. So repairable claims in the second quarter were up about 6% compared to 2021, but still down 6% compared to 2019. So the industry is still down relative to the pre-pandemic levels.

Okay. That's fine. And then Varun, on an absolute dollar basis, how much did -- was FX -- did FX positively impact SG&A?

We haven't called that piece out, but I will tell you from a North America perspective, clearly, there's little to none. But if you think about it, really where does the FX exposure come through, it's from our European business. And so if you think about where the European business, total SG&A was around $420-odd million. And if you then kind of go -- you can back into that number, Gary, and this is the way you should think about it. Within the slide deck, we obviously have on Slide #27, we obviously have the FX rates out there also. But essentially, the euro has been the big kind of decline. So roughly call it about a 10% decline on there. So kind of run that piece of the $420 million, but that basically is what the -- it's kind of strange to see a benefit, but the translation benefit, if that's what you're referring to from a lower conversion rate, that's really where it would come through.

And Gary, it's important to keep in mind that the FX issues that we're dealing with are translation issues, i.e., just converting the foreign currency in the U.S. dollars. By and large, they are not transactional issues. We do have some transaction exposure, some of the purchasing of parts in Europe is dollar-denominated, particularly things like oil-based products which are dollar-denominated. But those are things where we know in advance, we're going to be buying, and we can do some hedging of that. So total FX kind of exchange losses, if you will, from a transactional perspective in the quarter was less than $2 million. So it's all just translation of foreign currency results into U.S. dollar results.

There are no further questions at this time. Mr. Zarcone, I turn the call back over...

Well, we always want to thank everyone for their time and their participation in our call. We know you're all very busy. This is a busy time of the earnings season. We appreciate spending some time with us, and we look forward to joining back up at the end of October. We're going to be pleased to announce our third quarter results. So thanks for your time and attention, and we'll talk to you soon. Thank you.

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