Good morning and thank you for joining LKQ Corporation’s Second Quarter 2023 Earnings Conference Call. I am your operator, Jiao. [Operator Instructions] I will now turn the conference over to Joe Boutross, VP of Investor Relations. Please go ahead.

Thank you, operator. Good morning, everyone and welcome to LKQ’s second quarter 2023 earnings conference call. With us today are Nick Zarcone, LKQ’s President and Chief Executive Officer; and Rick Galloway, Senior 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 maybe 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 10-Q in the coming days. And with that, I’m happy to turn the call over to our CEO, Nick Zarcone.

Thank you, Joe and good morning to everybody on the call. I hope you are all having a safe and enjoyable summer. This morning, I will provide some high level comments related to our performance in the quarter and then Rick will dive into the financial details and provide an overview of our updated guidance before I come back with a few closing remarks. The second quarter of 2023 was a continuation of what we delivered in the first quarter, where again the resilience of our businesses shined through with an exceptional organic revenue growth and strong margins in our North American and European segments, which more than offset the impact of the headwinds experienced by our Specialty and Self-Service segments. The non-discretionary nature of the parts these core segments distribute, coupled with our ongoing operational excellence initiatives, highlights the strength of our business model and our ability to generate robust profitability during periods of challenging macroeconomic conditions, including flat declining economic growth in several of our markets, decreases in commodity pricing, the ongoing conflict in Ukraine and its impact on the broader European markets, and the continued increases in interest rates and its subsequent impact on consumers. The strength of our North American and European segments is evidenced by the fact that in the second quarter of 2023, North America and Europe collectively represented roughly 90% of our total segment EBITDA versus 79% for the second quarter of 2022 and just 74% in 2021. The variance in performance across our operating segments this quarter again validates our long-term diversification strategy, both with respect to geography and product and speaks to the true strength of our organization and our portfolio of businesses. Now on to the second quarter 2023 results and year-over-year comparisons. Revenue for the second quarter was $3.4…

Thank you, Nick, and welcome to everyone joining us today. The second quarter was another solid performance from the business with highlights including record high segment EBITDA margin of 20.6% in North America and at 11.5%, the highest quarterly margin in a decade for Europe, organic revenue growth in the high single digits in North America and Europe, operating improvements countering headwinds from commodity prices and interest costs. Strong free cash flow of $414 million in the quarter and the completion of a $1.4 billion bond offering to secure financing for the pending Uni-Select acquisition. I want to reiterate Nick’s thanks to the global LKQ team for delivering exceptional results in difficult conditions. To provide further details on these results, I will start with comments on segment performance. Going to Slide 10. North America continued its strong performance, posting a segment EBITDA margin of 20.6%, a 190 basis point improvement over last year. We saw gross margin improvement of 150 basis points driven by lower freight costs, pricing and productivity initiatives and a favorable mix effect with the sale of the lower-margin PGW business. Overhead expenses were favored by 40 basis points, primarily due to lower freight, vehicle and fuel expenses. With the continued strong performance in our North American segment, we believe the full year segment EBITDA margins will finish the year in the low 19% range with some moderation in the second half of 2023 with salvage margins tightening, along with some normal seasonality. Europe also delivered terrific results with a segment EBITDA margin of 11.5%, up 70 basis points from the prior year period. As seen on Slide 11, gross margin improved by 20 basis points, while overhead expenses decreased by 50 basis points with the effect of improved leverage due to the 9.8% per day organic…

Thank you, Rick, for that financial overview. In closing, the second quarter was another solid performance for team LKQ. I am beyond proud of the results we delivered for the first half of the year, particularly how the teams are diligently planning and positioning their respective businesses for the balance of 2023 as we continue to be challenged by certain uncontrollable dynamics. As we move into the second half of the year, let me restate our key strategic pillars, which remain central to our culture and our objectives. First, we will continue to integrate our businesses and simplify our operating model. Second, we will continue to focus on profitable revenue growth and sustainable margin expansion. Third, we will continue to drive high levels of cash flow, which in turn will give us the flexibility to maintain a balanced capital allocation strategy. And fourth, we will continue to invest in our future. As always, I want to thank the over 46,000 people who work at LKQ for all they do to advance our business each day and for driving our missions and our delivers values forward regardless of the challenges. And with that, operator, we are now ready to open the call to questions.

Thank you. [Operator Instructions] Your first question comes from the line of Scott Stember of ROTH MKM. Please go ahead.

Good morning, guys. Congrats on the quarter and thanks for taking my questions.

Thanks, Scott.

In North America, I just wanted to touch on State Farm. I think in previous calls, you had talked about, I guess, based on those three SKUs throughout the country, about $100 million in benefit, getting a lot of questions from investors about what the potential is with California and Arizona now going fully live with the whole program.

Sure. I’ll take that. Obviously, we are delighted by the movement State Farm is making in terms of utilizing our high-quality aftermarket parts, new pair of policyholders vehicles. You’re correct. We previously mentioned that the upside from headlights, tail lights and bumper covers was about $70 million to $100 million on an annual basis once everything gets up and running. We are tracking toward that number. So quite frankly, probably towards the midpoint as there appears to be a little bit of cannibalization on the salvage side in addition to the significant cannibalization on the OEM parts side. These three-part types represent the highest volume of aftermarket parts as almost every collision requires the replacement of lights and bumper covers. If you think about three equal sized baskets, Scott, of lighting, bumpers and everything else, adding everything else to the bucket would add another 50% or so to our original estimate, which would push you towards somewhere in the $125 million to $150 million on an annual basis over time. Now that’s probably a little bit higher than some preliminary guesstimates that some of you have had likely due to the fact that State Farm will only use CAPA-certified parts. And CAPA parts only represent about $1 billion of our overall aftermarket sales. When you add on top of that, that the $1 billion includes chrome bumpers, basically bumpers for pickup trucks that State Farm has been using for the last several years. So if you apply, roughly there is 16% to 17% market share on that lower base, you get back to that $125 million to $150 million on an annual basis of incremental revenue over time. So that’s the number that we’re comfortable with right now. I would also say that, that’s a very nice revenue pickup. And because there is a limited amount of required SG&A to deliver all those incremental parts, we think there will be really good margins on that incremental State Farm business.

So that $125 million to $150 million, is that an all-in number? Or that’s an additional amount just for California and Arizona?

No. That’s all in. Again, everything else is about third of the bucket lights are about third and bumper covers or about third.

The pilot, Scott, won’t mean much for us as a product to the pilot. So we’re – the numbers that Nick just quoted are assuming they go live at some point in time.

Okay. I am sorry for blithering the point here, but does that assume that the whole country goes live with all parts 100%?

Yes.

Okay. Got it. And maybe just walk over to Europe for a second. Obviously, tremendous growth there, it sounds like the volume has picked up nicely. Maybe just talk about some of the things that are really pushing growth there? I know that you guys are taking share and doing a better job. But are you seeing signs of the countercyclical nature of the business to kick in?

I wouldn’t say countercyclical, Scott. I mean the reality is the economies in Europe are in much worse shape than the U.S. economy. If you just look at some of the published statistics, Germany is in a recession, they have had two quarters now of negative GDP growth. The UK is probably the worst off of any of the economies, the impact of the war, the impact of energy prices inflation. While inflation has come down a bit in the U.S., inflation is hanging pretty high over in Europe. And quite frankly, that’s having an impact on the consumer. The fact that we are continuing to grow our business, both from a volume perspective and a price perspective tells us that while may not be countercyclical, we are more than holding our own as it relates to the overall economic backdrop in Europe. Again, good growth, we are highly confident that what this means is, over time the car park is going to age. And if you talk to anybody in our business, an older car is our friend. So, we think that longer term, these soft economic conditions in Europe will actually bode to our favor.

Thank you. Your next question comes from the line of Craig Kennison of Baird. Please go ahead.

Hey, good morning. Thanks for taking my questions. Rick, I had a question for you. North American fulfillment rates, is there any way to quantify the year-over-year increase you saw this quarter? And then how long do you expect tailwinds from that improving fulfillment rate to impact North American organic growth?

Yes, it’s a good question. Thanks – Craig, thanks for the question. Fulfillment rates are back to the mid-90s, which is kind of our target, as we have kind of talked in the past, we were low-90s when we think about where we were just a year ago in Q2, actually, we are in high-80s as I am looking at the numbers, and so we have got about 5 points of improvement. As far as quantification, the difficulty in doing that is that it’s a bit of a mixed bag. So, I would hate to quote what the overall benefit was as far as dollars go. As there is a little bit of a movement, and we have talked about this before between the salvage side and the aftermarket. So, there has been a little bit of a flip. So, when some of the volume went away from aftermarket when the availability wasn’t there, it went over to salvage. It’s kind of gone back the other way. So, we are happy with where we are at. We don’t think we need to go much more of where we are at as we are continuing to balance the free cash flow impacts of holding the additional inventories.

Thanks. And as you look at like Q3 and Q4 and then 2024, do you still expect tailwinds, or do you think that has abated from a year-over-year perspective?

Yes. I think were minor improvements, but nothing that’s going to be meaningful for us at this time. I mean we are back to not quite where we were pre-pandemic, but I mean it’s really, really close.

Thank you. Your next question comes from the line of Bret Jordan of Jefferies. Please go ahead.

Hey. Good morning guys.

Good morning Bret.

With a bit more visibility now, I guess of the Uni-Select business, could you talk about how you see the synergies having a North American mechanical business in Canada?

Yes. So, as we outlined back in late February when we announced the transaction, Bret, we are highly confident that there is $55 million of cost synergies that we will be able to get our hands on over the first kind of 3 years post-transaction. Most of that will come in the second year with only a few of those dollars needing a full 3 years to access. We are going to start the process just as soon as we can and trying to deliver the synergies very quickly. And again, there is facility savings. There are some procurement benefits and kind of all the corporate overhead and the like that we don’t need. And so nothing has changed from the presentation that we gave everybody back on February 27th, 28th, when we announced the transaction. Again, we are highly confident in our ability to do that. Obviously, much of the synergies are going to come in the U.S. That’s where the FinishMaster operations and our paint operations overlap. That’s where a lot of the synergies come from. We have no plans on eliminating, changing or shutting down facilities up in Canada because we don’t do what they do in Canada today, right. They are distributing small mechanical parts. That’s the business that we have over in Europe. We do think that there will be benefits, revenue benefits that we can glean by broadening out their product line, giving them some incremental inventory to cover all car types that are used up in Canada by giving them some capital to grow their business. But none of that is included in the $55 million of benefits that we outlined when we announced the transaction.

Okay. And then you didn’t mention Leadtech [ph] in your prepared remarks. Could you give us an update on the third-party diagnostics developments?

Leadtech, yes, so we love our services business. The reality is it’s growing about 25% a year, which is obviously significantly higher than any of our other businesses, and it has really strong margins. And so we are very, very happy about that. I mean if you look at some industry data, about 75% of all repairs at the MSOs are scanning the car for some of that technology. And about 18% of the repairs actually have some sort of calibration work being done on the vehicles. Now the 18% may sound low, but you got to remember that there is only a – today, there is only a small portion of the car park that has all the technology on it. Average price of a scan is running about $140. Average price of the calibration is running close to $400. And so it is a really attractive business. And the market is going to continue to grow because every year, there are simply more cars out on the roads with some of that more advanced technology on the car. That’s where we got into the business several years ago. We have created what we believe is a market-leading offering, providing a high level of service to our existing customers. By providing some of those services actually in their shops, and we are optimistic about the future.

Thank you. Your next question comes from the line of Brian Butler of Stifel. Please go ahead.

Hi guys. Thanks for taking my question.

Good morning Brian.

Just when you think about specialty, it doesn’t sound like there is a bounce from the bottom, but do you feel like we have kind of reached the bottom and how to think about where the margins ultimately settle out, maybe kind of back half of ‘23 and then thinking about ‘24?

Yes. So, it’s – we are not predicting that we are at the bottom yet. The reality, it’s been a rough couple of quarters for our specialty business. We have not seen a catalyst that that’s going to turn quickly. Obviously, as we start to get into 2024, we have got better, easier comps that we will be working against. And so the numbers from a growth perspective may not look as soft, but from an absolute dollar perspective, we are not anticipating a significant uptick. The good news is they did some restructuring earlier in the year. They are going aggressively at their cost structure. And so the month of June, they were actually back to double-digit margins even though they weren’t there for the quarter. And so I would suggest that margins in and around the 10% range. It’s something that we are striving to achieve even though the revenues may be challenged now for several more quarters.

Alright. That’s helpful. Thank you very much. And second question, how do you bridge the free cash flow outlook staying the same with the higher interest expense, what’s offsetting that?

Yes. So, if you look at the overall pieces that we have got, the trade working capital for us has been a nice improvement. We continue to see a nice improvement. We saw a really good improvement within Q2 as well. And then the earnings side is the other side of it. So, we are really happy with where we ended up in Q2. Overall, trade working capital improved roughly a little less than $180 million, and we expect to continue to drive that throughout the rest of the year.

Thank you.

We now have the next question from the line of Gary Prestopino of Barrington Research. Please go ahead.

Hey. Good morning everyone.

Good morning Gary.

Good morning Gary.

A couple of questions here. With your – some of the puts and takes on your adjusted EPS guidance, the changes here, which is rather minimal. But in looking at it, it looks like this does not really impact the consolidated segment EBITDA or the consolidated EBITDA that you generate for the year. Is that kind of a correct assumption? It looks like there will be very little impact from these – some of these changes.

The metals will be an impact. But you are right, on the interest side – on the taxes side, those will be avoided. But the metals impact, you should feather that in.

Right. But you are also getting $0.05 from operating results, right?

Yes, exactly. And it’s roughly the same, Gary. I mean it’s minimal as far as the difference go on the EBITDA side.

Okay. And then Nick, could you – it seems like Varun has got things really humming over in Europe. Could you maybe talk about some of the actions that they have taken over there that have led to the margin improvement and the segment EBITDA generation in the quarter that were at record levels?

As Rick indicated, a lot of the focus came on SG&A. We – of the 70 basis point improvement, I think we split 20 basis points in gross margin and 50 basis points in SG&A. So, taking a really hard look across all of our platforms to make sure that we are doing the best job possible to control our overhead expenses. Now, when you have 9.8% per day organic revenue growth, that helps. But make no mistake, Gary, the inflationary environment, as I indicated over in Europe, is much more intense than it is here in the U.S. And so they have needed productivity gains to offset a lot of that increase and allow us to actually get to a lower SG&A percent as it relates compared to revenues. Rick did indicate that we have got some wage inflation coming at us in Europe in the second half of the year. We know that already. Certain other countries, particularly the Netherlands has another wage increase coming at them. We experienced already a couple of days strike in Germany as the unions over there and the work consoles have their members to use short-term strikes to try and position for better wages. And so those are all things we are going to have to deal with in the second half of the year.

Okay. Thank you.

Thank you. Your next question comes from the line of Daniel Imbro of Stephens. Please go ahead.

Yes. Hi. Good morning everybody. Thanks for taking my question.

Good morning Daniel.

Good morning Daniel.

Rick, I want to start on North American EBITDA margins. Obviously, I think you had guided earlier this year that was set down as smaller competitors got inventory and may be used price to get share back, but they have held in much stronger. So, I guess what’s playing out differently than you thought? Are smaller peers being more rational, or is there something else driving North American wholesale margin up to offset some of that price competition?

Yes. Thanks for the question, Daniel. It’s a combination of several different things. One is productivity initiatives have been something that we focused on for a while that are helping to offset any of the risks we are seeing on the pricing side. The other thing is that competition, we believe has a decent amount of inventory and has been pretty good about holding pricing. So, we haven’t been looking at a drop in the pricing piece as we were kind of expecting earlier. And as you heard in the prepared remarks, as we think about the back half of the year, there is a little bit more seasonality than anything else and kind of pulling away from the idea of how bad – how low could the margins go relative to where they are at right now. We are just not seeing it. So, I think productivity is one of the biggest things that is offsetting that. And we are continuing to drive it. So, we think we will end up in the low-19s for the full year number as we are coming into the back half of the year.

Thank you for that color. And then maybe a related follow-up on North America, I think Nick, you mentioned 400 basis points of APU improvement. That should have been on a guess just a nice tailwind to volume, but could you break out the 8.5% comp? How much was ticket versus like more ticket growth versus more traffic growth? And then are you seeing any change in OEM pricing? I think that’s an investor concern out there as OEM production picks up. So, how is that side of the pricing backdrop been related to the traffic first ticket discussion?

Yes. North America, more than half of the year-over-year growth of volume, which is really good to see. Obviously, a lot of that has to do with the aftermarket volume, as we talked about, having the inventory in stock, getting the fulfillment rates up, the State Farm program, all that leads to higher volumes. And the OEs, they have kept – generally kept their prices steady. They certainly haven’t dropped prices. And we don’t think that they will. They have never shown a propensity to lower prices, if you will. I mean there was a period of time where they didn’t increase prices for quite a bit. And then they started like everyone else, with inflation and everything else, we are taking some prices up. And so we did – we follow their tracks. So, our expectation is that they are going to keep pricing pretty moderate here going forward, and we will just continue to sell it at a discount to the OE list as we have done forever. People shouldn’t anticipate any significant movement on behalf of the OEs or that having an impact on our pricing.

Thank you. There are no further questions at this time. I would now like to turn the call back over to Nick Zarcone for closing remarks. Please go ahead, sir.

Well, I would certainly like to thank everyone for your time and your attention this morning. Again, we are very proud of the Q2 results that we were able to report earlier today, and we are looking forward, obviously, to the back half of the year. We certainly look forward to chatting with you again in late October when we announce our third quarter results. And until then, I hope you all have a wonderful fun into your summer. Thank you everyone.

And that concludes today’s conference call, you may now disconnect.