LKQ Corporation (NASDAQ:LKQ) Q1 2024 Earnings Call Transcript

LKQ Corporation (NASDAQ:LKQ) Q1 2024 Earnings Call Transcript April 23, 2024

LKQ Corporation misses on earnings expectations. Reported EPS is $ EPS, expectations were $0.94. LKQ isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning everyone. My name is, Angela, and welcome to the LKQ Corporation First Quarter 2024 Earnings Conference Call. I’ll be coordinating your call today. [Operator Instructions] I will now hand you over to your host, Joe Boutross, Vice President of Investor Relations for LKQ. Joe, please go ahead.

Joe Boutross: Thank you, operator. Good morning, everyone, and welcome to LKQ’s first quarter 2024 earnings conference call. With us today are Nick Zarcone, LKQ’s President and Chief Executive Officer; Rick Galloway, Senior Vice President and Chief Financial Officer; and Justin Jude, Executive Vice President and Chief Operating 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 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.

Nick Zarcone: Thank you, Joe, and good morning to everybody listening to our earnings call for the first quarter of 2024. I will provide a few introductory remarks. Justin will then provide some highlights to our Q1 segment activities. Rick will provide a review of the financial details of the quarter and our guidance for the year before I have a few closing remarks. I’m turning 66 in a few days and as reported in late November, I will be retiring as CEO of LKQ on June 30th. With that, this will be my 38th and final quarterly earnings call with all of you. It has been an absolute honor and privilege to serve LKQ and to interface with the investment community since joining the company in early 2015. I am incredibly proud of the organization, my team and all we’ve achieved over the years.

We are very different company today than the one I joined almost 10 years ago, one that is focused on operational excellence, balanced capital allocation, improved returns on capital and the development of our most important asset, our people. The first quarter of 2024 proved to be a difficult environment for our business and our results came in below expectations. While we did a reasonable job of managing the items under our control, we experienced soft overall market conditions largely due to incredibly mild winter weather in North America, which reduced demand for collision parts and the continued soft demand for our specialty products. These market factors created pressure on revenue and overall operating leverage. We have already made adjustments to our cost structure in light of the current levels of demand.

Related to Europe and our business in Germany, there has been no material progress with our union negotiations in Germany. To help insulate our customers in that market, we have increased our temporary workforce to largely mitigate the revenue impact with the risk of ongoing strikes, and we’ve opened a second, albeit a much smaller distribution facility in Bielefeld, Germany, which is outside of Bavaria and not impacted by the union activity. Overall, we remain optimistic about the remainder of the year. Now on to the quarterly results. Revenue for the first quarter of 2024 was $3.7 billion an increase of 10.6% compared to the $3.3 billion for the first quarter of 2023. For the first quarter of this year, parts and services organic revenue decreased 0.3% on a reported basis, but increased 0.5% on a per day basis.

Foreign exchange rates increased revenue by 0.8% and the net impact of acquisitions and divestitures increased revenue by 11.6% year-over-year for a total parts and services revenue increase of 12.1%. Other revenue for the first quarter of 2024 fell 14.6% primarily due to weaker precious metal prices relative to the same period in 2023. Diluted earnings per share for the first quarter of 2024 was $0.59 compared to $1.01 for the same period of 2023. Adjusted diluted earnings per share was $0.82 for the first quarter of 2024 compared to $1.04 for the same period of 2023. Lastly, on April 22nd, the Board of Directors declared a quarterly cash dividend of $0.30 a share of common stock payable on May 30, 2024 to stockholders of record at the close of business on May 16, 2024.

And now let me turn the call over to Justin.

Justin Jude: Thank you, Nick, and welcome, everyone, to the call. As Nick mentioned, we are not pleased with the results delivered in the first quarter. However, I do think the team is focused and on the right track to confront some of the anomalies we faced, and I’ll detail some of those action plans on this call. During our February call, Rick discussed our guidance for the year and indicated that we expected a softness in Q1 and our full year guidance was back end loaded. Rick’s comment was correct as we did experience a soft Q1, but it was beyond what we and the overall markets in which we operate anticipated. That said, we are a continuous improvement company and we know how to drive improved operational and financial performance across our entire global footprint.

While we got off to a slower than expected start for the year, our team has 3 more quarters to recover the shortfall, and we are confident we have actions in place to achieve the previously communicated EPS guidance. Rick will cover more of these in his prepared remarks. Now for a few high-level segment comments. In Wholesale North America, organic revenue decreased 3.3% due to a few key factors. First, we are coming off a strong comp of 14.4% growth in Q1 of last year. Second, there was an 8% decline in repairable claims. While this decline was largely driven by the extremely mild winter weather that Nick had mentioned, as the U.S. experienced the 5th warmest quarter on record, there were several other dynamics such as abnormal changes in auto insurance rates and used car pricing that we believe also had a negative impact.

Finally, we experienced some challenges with aftermarket inventory entering the East Coast ports due to the ongoing Panama Canal disruption. We have yet to witness any disruption from the Baltimore tragedy, but we are closely monitoring this situation. Offsetting some of the aftermarket inventory delays, the salvage business posted positive growth in the quarter. As the North American team faced the soft demand, John Meyne and his team immediately shifted their focus to accelerating the integration of FinishMaster. This swift action resulted in the consolidation of 65 branches in Q1, bringing the total to 99, which represents two-thirds of the acquired locations. We initially communicated the rationalization of the FinishMaster locations that would take us 3 years to reach this synergy level, and I’m impressed the team was able to accomplish this within the first 8 months following the acquisition closing.

Today, 100% of FinishMaster sales and operations have been fully integrated. And through this process, the team uncovered additional synergies allowing us to increase the previously disclosed estimate amount from $55 million to $65 million. This effort caused some short term strain on the team slightly impacting margins, but it was the right thing to do long-term. And we continue to make strides with our Bumper to Bumper business in Canada by leveraging the European procurement size and scale. I want to again emphasize that Uni-Select was a unique opportunity that will enable us to widen the mode around our North American business and capitalize on revenue synergies that exist with paint and hard parts. I am confident and committed to this transaction generating positive financial metrics for all stakeholders.

In Europe, organic revenue increased 2.7% on a reported basis and 4.4% on a per day basis, the best across our operating segments. Rick will cover the EBITDA results in his remarks, but let me cover several actions taking place to drive improved performance. I have made 4 different trips to our European operations in the first quarter to meet with the broader leadership team and look for improvement opportunities. I am pleased to see how focused the team is to drive integration and improve performance, all with a goal of enhancing our margins. Andy Hamilton and his team have deployed new detailed tracking tools that are actively being reviewed. These tools include pricing actions, productivity initiatives, a restructuring plan focused on taking costs out of the business, portfolio divestments and implementing a new technology within our distribution centers to lower the total cost of delivery to our customers.

In Germany, we expanded our distribution capacity by opening a second highly automated regional distribution center, which will reduce the strain on our primary distribution center in Bavaria where the strikes have been occurring. Specific to divestitures and after careful and thorough analysis of our European business model, market trends and the overall economic environment, we made the strategic decision to divest our operations in Slovenia to a long-term value partner of LKQ. That sale closed last week. Additionally, we entered into an agreement to divest our operations in Bosnia and we expect to complete that sale in Q3 subject to the receipt of regulatory approval. We will continue to assess our business and our European market mix to determine if we are the best operator and whether we should fix or exit certain underperforming markets.

Given the small size of these divestitures, we are not disclosing the terms of these two transactions. One of the biggest projects we plan to update on a quarterly basis is our European SKU rationalization program. Today, little product commonality exists across the entire European platform which prevents us from maximizing the leverage of our pan European footprint. This project will reduce the total number of SKUs, reduce our complexity, simplify the offerings to our customers and drive several benefits which include improved fulfillment rates, improved gross margins, reduced inventory levels and a decrease of our cost to serve our customers. When Andy kicked this project off in early Q1, we had over 900,000 SKUs across our European operations with less than a 7% overlap.

Based on the first phase of this project, we believe we can achieve a 35% reduction in overall SKUs over the next 2 to 3 years. We look forward to Andy providing a deeper dive into this program on our September 10th Investor Day this year. Now turning to specialty. Their organic revenue decreased 1.4% in the quarter, tracking closely to plan and showing improvements month to month within the quarter. Certain product categories witnessed positive year-over-year growth. Automotive products, which includes truck and off road parts and accessories, increased 2.5% despite pickup truck and Jeep sales being down 5.6% and 11.4% respectively. Also, marine posted growth in the quarter. RV-related products decreased 8.5%, the smallest revenue decrease when compared to the 2023 quarterly growth rates.

Our specialty team has focused their efforts on targeting margin actions relating to price and cost controls, some of which we saw in the quarter with year-over-year improvements in SG&A. Turning to self-serve, they had an organic revenue decrease of 10.5% in the quarter, primarily driven by commodities and inclement weather in key markets, but margin performance exceeded our expectations. On the corporate development front, during the quarter we closed on 2 tuck-in acquisitions including a heavy duty truck parts supplier and an aftermarket parts distributor in Belgium. We also made an equity investment in a startup recycler of lithium ion EV batteries. Now, let me turn it over to Rick for a detailed overview of our financials.

Rick Galloway : Thank you, Justin, and welcome to everyone joining us today. We released our full year guidance in February. We expected Q1 earnings to be challenged by the impact of weather conditions in January, very low catalytic converter prices and year-over-year decrease in selling days due to the timing of Easter. The actual results reflect lower than forecasted revenue mostly due to a reduction in North America aftermarket product volumes, which were predominantly related to a significant decrease in the number of repairable claims. On a consolidated basis, gross margin fell short of target as pricing did not fully cover input cost increases. Overhead expense actions were taken and others are currently in process, but the benefits will be seen in the balance of the year rather than Q1.

Despite the Q1 results, we remain committed to our full year earnings guidance. We have 9 months to make up the shortfall and the core strength of the business are still there. We are digging deep on the operational excellence principles that drove our growth and margin expansion over the last 5 years and are taking decisive actions. As Justin described, each of the segment teams have detailed action plans in place to deliver the full year numbers. Turning now to the first quarter consolidated results. Adjusted diluted earnings per share of $0.82 were $0.22 lower than the prior year figure. Operating results were the largest individual factor with a $0.12 reduction, mostly related to North America. This figure includes the anticipated Uni-Select headwind as the integration efforts were ongoing.

We expect the Uni-Select impact to flip to accretion going forward in 2024 as the synergies Justin mentioned are realized. Movements in commodity prices, primarily precious metals contributed a $0.06 year-over-year decrease. Other items including investment performance and taxes drove a 4% decrease. Now for segment results. Going to Slide 9. North America posted segment EBITDA margin of 16.3%, a 420 basis point decrease relative to last year. During the last call, we projected the full year margin would be around 17% for the full year impact of the Uni-Select dilution. The reported margin was below the full year expectation due to leverage impact from the lower revenue in Q1. Relative to the prior year, in addition to the communicated anticipated Uni-Select dilution effect on gross margin, salvage margins were down reflecting unfavorable revenue and vehicle cost trends compared to the prior year period and lower catalytic converter prices in Q1 2024.

Overhead expenses partially offset the gross margin reduction with lower costs for freight, charitable contributions and incentive compensation. Q1 2023 also included a nonrecurring benefit from an eminent domain settlement that created a year-over-year negative variance. North America is executing action plans to recover the profitability miss in Q1 and we expect the full year EBITDA margin to be around 17%. Looking at Slide 10, Europe reported a segment EBITDA margin of 8.7%, down 100 basis points from last year. Gross margin excluding restructuring costs improved by 60 basis points, but was offset by higher overhead costs including personnel costs tied to wage inflation in markets such as Germany, the UK and the Benelux region. While we have grown gross margin, we have not covered the overhead cost increases and we have work to do on pricing and productivity to mitigate the cost inflation.

We still expect to achieve double-digit margins in Europe for the full year. Moving to Slide 11. Specialty’s EBITDA margin of 6.4% declined 150 basis points compared to the prior year driven by a 170 basis point decrease in gross margin. Competitive pricing pressure remains a challenge for the business and we are evaluating options and implementing changes to improve our net pricing. We believe the full year Specialty EBITDA margin will be flat to a slight increase as we work through the lingering gross margin pressures. As you can see on Slide 12, self-service generated an 11.7% EBITDA margin in Q1 2024 compared to 13.2% last year. In dollar terms, segment EBITDA decreased by $6 million. The impact from commodities represented a $16 million headwind.

However, the efforts to manage vehicle costs helped mitigate a portion of the commodities impact and overhead cost controls produced a year-over-year benefit. We have not seen double-digit segment EBITDA margin in percentage or dollar terms since Q1 2023. So we are pleased to reach this level again this past quarter. We implemented a global restructuring program in the first quarter focused on enhancing profitability. The largest portion of the activity will come from the European segment. And as Justin mentioned, will include exiting certain businesses or markets which do not align to our strategic objectives. Initially, this includes exiting businesses in Slovenia and Bosnia, which are relatively small with under $40 million in combined annual revenue and evaluations of other markets are ongoing.

We recorded $27 million in charges in the quarter including $17 million in asset impairments and $8 million in inventory write downs. Other charges are expected in future periods for severance, lease termination costs and other shutdown related expenses. Shifting to cash flows and the balance sheet. We produced $187 million of free cash flow during the quarter and we remain on track for a full year estimate of approximately $1 billion. As of March 31, we had a total debt of $4.3 billion with a total leverage ratio of 2.3x EBITDA and we remain committed to reducing our total leverage ratio below 2.0x. In March, we successfully completed a EUR750 million bond offering with a 7-year maturity and a fixed 4.125% interest rate. The offering was completed to pay off the existing EUR500 million bonds that were scheduled to mature on April 1, 2024.

We upsized the offering by EUR250 million in response to very strong demand from fixed income investors reflecting LKQ’s strong credit profile and solid cash flows. The additional proceeds were utilized to pay down a portion of our euro revolver debt. The larger offering allows us to lock in capital at an attractive rate for an extended period and diversify our maturity profile. The bonds are publicly tradable and listed on NASDAQ. We do not have significant debt maturity until January 2026. Our effective borrowing rate was 6.0% for the quarter, an increase of 20 basis points relative to Q4 2023. We have $1.7 billion in variable rate debt of which $700 million has been fixed with interest rate swaps at 4.6% and 4.2% over the next 1 to 2 years respectively.

In the first quarter, we repurchased roughly $6 million shares for $30 million and paid a quarterly dividend totaling $81 million further validating that as we reduce our debt levels, we are migrating to a more balanced capital allocation strategy. I will conclude with our current thoughts on projected 2024 results. Our guidance is based on current market conditions and recent trends and assumes that scrap and precious metal prices hold near March prices and the Ukraine/Russia conflict continues without further escalation or major additional impact on the European economy and miles driven. On foreign exchange, our guidance includes rates in line with the first quarter. The global tax rate remains unchanged at 26.8%. Our full year guidance metrics on Slide 4 remain mostly unchanged from the Q4 earnings call.

We expect reported organic parts and service revenue in the range of 2.5% to 4.5% which is a 100 basis point decrease in the range. The softness in Q1 organic growth drove the decision to lower the full year range. We believe that mild winter weather conditions were a major contributing factor to the revenue softness and will have some carryover effects into Q2, but otherwise will be a temporary headwind relative to repairable claims. However, if repairable claims in North America do not rebound to a more normalized level, we would expect to be closer to the low-end of the full year range. We are closely monitoring monthly claims data and the team is ready to take decisive cost actions if claims remain depressed. We still expect adjusted diluted EPS in the range of $3.90 to $4.20 with the revenue volatility there is heightened risk to the profitability estimate.

But we are confident in the action plans being implemented in all segments to address controllable factors such as our cost structure to keep us inside the previously issued range. The free cash flow expectation of $1 billion, 50% to 60% annual EBITDA conversion remain in place. Improved profitability over the balance of the year and diligent balance sheet management should support achievement of the full year target. Thanks for your time this morning. But before I turn the call back to Nick for his closing comments, on behalf of our LKQ team globally, I’d like to thank Nick for his leadership, vision and integrity during his tenure as our CEO. Nick, you left a tremendous mark on LKQ and have positioned us well for the next chapter of our evolution.

We wish you and the growing Zarcone family all the best.

Nick Zarcone: Thanks, Rick, for those very kind comments. When I took the seat as CEO in 2017, I believed it was my responsibility to be the primary advocate for our greatest asset, our people, and to place them at the center of LKQ’s mission. I am incredibly thankful to all my past and current colleagues who served each other in pursuit of being an employee focused organization. Collectively, we made great progress over the years, which carry forward in the first quarter, when we were awarded Mental Health America’s Bell Seal for workplace mental health at the gold level. And we were again selected as a 5-star employer by Workbuzz for our U.S., Indian, Mexican and Canadian businesses. It is with tremendous pride and humility that I depart knowing that the entrepreneurial culture that was established in 1998 when the company was founded lives on today and that every day our 49,000 global employees never lose sight of the passion needed to serve our customers and our communities.

They are committed to not only grow the company, but themselves as individuals. The gratitude I have from my fellow employees is immeasurable and I cannot thank them enough for creating an incredible journey for me. And with that operator, we are now ready to open the call to questions.

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Q&A Session

Operator: [Operator Instructions] We have the first question from Craig Kennison with Baird.

Craig Kennison: Nick, all the best to you. It’s been a pleasure working with you. My questions go to the comments around insurance prices. I’m just curious if you could walk through how higher and really significantly higher insurance prices impact your business overall?

Justin Jude: Yes. And just talking to, this is Justin Craig by the way. And talking to different folks in the industry, when we saw the insurance increasing 20% to 22% year-over-year, we saw deductibles increasing and so in some cases it caused folks not to necessarily repair their car. We still think the majority of our issue that we saw in Q1 from repairable claims was weather, but there’s a lot of other commentary that we heard from other folks such as used car pricing, which saw huge decreases and huge increases in insurance rates. So we still think the primary driver for the repairable claims being down is weather. But when anything when we see huge swings like that with used car pricing or once again insurance rates, it has some effect on us.

Operator: The next question is from Gary Prestopino with Barrington Research.

Gary Prestopino: Could you maybe just unpack a little bit more on this decline in the gross margin in North America? I know Rick went through a couple of things there, couldn’t write them down quickly enough, but some of this was Uni-Select, but what were some of the other factors there that impacted that margin to so much to go down close to 500 basis points or over 500 basis points?

Rick Galloway: Yes, Gary, fair question. So when we talked about it in the closing of Q4 for the guidance for this year, we said we’d be around 17% for the year with the dilution on Uni-Select. The product offering that we have for the various products that we sell for Uni-Select, the paint products and the hard part side of the business makes a different margin profile including the base business that we had before makes a similar margin as far as that paint side of the business goes. So with the increase in revenues that’s one component. We thought we’d be down around 17% for the year. We still think we’ll be at around 17% for the year. The major contributing factor for being below 17% for Q1 is primarily related to leverage.

With the volume decline that we saw, significant volume on the repairable claims, we said about 8% on repairable claims and our overall volume is down a little over 3%. That’s mostly a leverage component. And as we said, the team has really put some strong efforts in to work on the integration consolidation of various Uni-Select integrations, 65 different facilities that we consolidated. So some of that extra cost, little duplicate cost that will go away as we go into the rest of the year. And that’s where we have that confidence of bouncing back and getting back to that 17% number that we’ve been talking about.

Gary Prestopino: Yes. But I was asking about the gross margin, Rick. Is that I understand you were talking about the same margin. So No, I just the gross margin had a pretty big decline. So I just want to unpack that a little bit more.

Rick Galloway: Yes, most of that is mix. The other component that we have that we’ve been talking about for about 12 months, maybe 18 months is the salvage margin. So, what we talked about was there would be this squeeze in the salvage margin. So, as we thought about where we were at last year, which is about 20.5% of EBITDA, most of that gross margin piece that we see on the decline is that salvage margin squeeze. And so, what we don’t do is we don’t talk about it being revenue versus the cost side because everything is so unique in that industry. So we’ve been seeing that squeeze. It started happening in Q3 of last year and it continued in Q4 and then again in Q1 as expected. Those items are as expected what we’ve been kind of communicating externally to everyone.

Operator: The next question is from Scott Stember with Roth MKM.

Scott Stember: Nick, I echo what was said before. It was great working with you and wish you nothing but the best of luck.

Nick Zarcone: Thanks, Scott.

Scott Stember: Can we talk about Europe for a second? How did the individual regions perform? Just trying to get a sense if there was any regional weakness or if anything stood out on the positive side.

Rick Galloway: So let me just go high level and then I’ll turn it over to you, Justin. I know you’ve been spending a lot of time out there. So, Scott, appreciate the question. If you think year-over-year, the biggest impact that we had on overall EBITDA margins is really the inflationary impact of wages. So that happened throughout the year, but primarily starting in Q2. So it’ll sort of calendarize as we start getting into Q2. There’s roughly 200 basis points down that you have on overall wage inflationary increase. What the team has been able to do was improve on pricing and productivity initiatives to call back roughly half of that. And so, we’re on a trajectory that we’re pretty pleased with. Of course, we’d always like to have a little bit more, but the overall margins that we had, the 8.7% in Q1, reflects that really low year-over-year impact on the wage increases. And Justin, I don’t know if you want to talk a little bit more about the various different regions.

Justin Jude: Yes. And Scott, like some of the markets such as the Benelux area or even in Germany, we’re seeing mid teen increases in labor rates and it’s a market issue. That happens immediately. The team has been actively working on pushing price out, but we’re very also conscious to make sure we don’t impact the market and start to lose market share. And so we’ll continue to push pricing through Q2 to cover that up. We do typically pass it on. We are a humble distributor as you may have heard Nick say before, but we just saw immediate increases in labor rates and it’s just taken us some time to pass those prices through to cover that.