Q3 2022 LKQ Corp Earnings Call
Good morning, My name is Dennis and I will be your conference operator today at this time I would like to welcome everyone to the LKQ Corporation's third quarter 2022 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.
If he would like to ask a question. During this time simply press Star then the number one on your telephone keypad to withdraw your question Press Star. One again, we ask that you. Please limit yourselves to one question and one follow up question.
I'd now like to turn the conference over to Joe Butros, Vice President of Investor Relations for LKQ Corporation. Please go ahead.
Thank you operator, good morning, everyone and welcome to Lkq's third quarter 2022 earnings conference call with US today are Nick Zarcone, Lkq's, President and Chief Executive Officer, Berlin, The ROI, our Chief Executive Officer of LKQ, Europe , and Rick Galloway, Senior Vice President and Chief Financial Officer.
Please refer to the LKQ website at LKQ Corp, Dot 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 of <unk>.
<unk> 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.
<unk> 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 .
Saar Kony.
Thank you Joe good morning to everybody and thank you for joining us on the call to discuss our third quarter results last month, we announced a couple of important leadership changes, including Brunella right I'm moving from the CFO chair to become the CEO of our European operations, and Rick Galloway, succeeding Barone.
Since that move happening with just a few weeks left in the quarter. After I provide some high level comments, Peru, and Brett will tag team on the financial details and the updated guidance for 2022 I will then provide some closing comments before opening the call to your questions.
Once again I'll take you recorded strong operating results notwithstanding a very difficult macro environment.
Pandemic is still creating challenges the labor market remains tight and the supply chain is less than optimal. So finally, starting to show some signs of improvement.
The war continues in Europe , and the economies around the globe are showing signs of softness as many governments tried to curb the runaway inflation created by the monetary stimulus utilized to support economies during the early days of the pandemic.
But the biggest current headwind is in the foreign exchange market with the U S dollar reaching levels, we haven't seen in over 20 years, while we can hedge much of our transactional exposure with about 46% of our revenue being sourced from our European segment, we cannot hedge the translation exposure.
To put things into perspective, the euro and pound Sterling fell approximately 7% relative to the dollar during Q3 and have fallen about 15% since the start of 2022 the volatility in exchange rates on a year over year basis had a material impact on our reported result.
During the quarter, reducing revenue by $228 million and adjusted EPS by about seven cents a share during the third quarter.
I believe when you focus on our local currency results you will agree that our company is performing extremely well and we're quite pleased to achieve our EPS goals in light of the ongoing and challenging environment.
The leadership changes announced in mid September are moving forward in a seamless manner and clearly demonstrates the depth and breadth of our talent as discussed in each of the past three investor day events talent management has been a key priority for LKQ and the benefits of that focus shine through at times like this.
Overall it was a strong quarterly result, and we continue to be optimistic about the future our decision to increase the dividend reflects the confidence that we have in our business now onto the quarter.
Revenue for the third quarter of 2022 was $3 1 billion a decrease of about five 9% as compared to $3 3 billion in the third quarter of 2021 on a constant currency basis third quarter revenue grew by about 1%, So a little over $3 3 billion.
Parts and services organic revenue increased four 8%, while the net impact of acquisitions and divestitures decreased revenue by two 3% and the foreign exchange rates decreased revenue by seven 4% for a total parts and services revenue decrease of five <unk>.
<unk>.
Other revenue totaled 17, 4% due to changes in commodity prices relative to the same period in 2021 and Thats. A reminder, P. GW was included in our third quarter 2021 results.
Net income for the quarter was $261 million as compared to $284 million for the same period in 2021 <unk>.
Diluted earnings per share for the quarter was <unk> 95.
Compared to 96 for the same period of 2021, a decrease of 1%.
On an adjusted basis net income for the quarter was $266 million as compared to 300 million for the same period of 2021, a decrease of 11, 4%.
Adjusted diluted earnings per share for the quarter was 97.
As compared to $1 <unk> for the same period of 2021, a decrease of four 9% importantly, please note that FX volatility and lower metals prices collectively created a <unk> <unk> per share headwind in the third quarter of 2022 when.
<unk> to the 2021 results now lets turn to the quarterly segment highlights.
In North America organic revenue for parts and services of our North American segment increased 10, 9% in the quarter on a year over year basis, which exceeded our expectations the impact of divestitures, primarily pre GW reduced revenue by 10, 6% in the quarter.
Organic growth performance is outstanding when you consider that the industry data suggests that collision and liability related auto claims were up only 2%.
Also North America delivered these results in the midst of decrease in miles driven which is largely due to the increase in fuel prices. According to the U S Department of transportation miles driven decreased three 3% in July and was up only seven tenths of 1% in August .
That said the long term trends for North America continue to be very favorable.
Continued technician shortages will benefit our diagnostics business as shops look to outsource their diagnostic repairs.
Total loss rates trending down into the high teens.
Parts per claim reaching over 12 parts per vehicle, a 20% increase from the third quarter of 2018 and office occupancy hitting nearly a three year high which ultimately lead to more congestion and claims frequency.
During the quarter, we were encouraged by the upward trend in our aftermarket volumes during the quarter, we experienced some relief in the aftermarket supply chain relative to Q2, which translated into an increase in our fill rates the.
The biggest challenge that exist on the domestic side of the supply chain, including the rail carriers and truckers all of which are out of our control.
In talking with several third party experts. They generally expect these domestic challenges will continue into the first half of 2023.
The spot market pricing for our containers used in ocean freight has softened measurably and our team is laser focused on active rate reductions from our contracted carriers.
Now onto our self service segment.
Gannett revenue for parts and services for our self service segment increased seven 2% for the third quarter the softness in commodity prices resulted in a decline in other revenue of 24, 8%. The soft metal prices also had a significant impact on segment EBITDA margins.
On a year over year basis. This was anticipated given the lag effect that for rune touched on during our second quarter call.
Moving onto our European segment organic revenue for parts and services in the third quarter increased four 8% on a reported basis and five 8% on a per day basis.
Acquisitions added one half of 1% growth in the quarter, while the exchange rates resulted in a 14, 7% decline on a year over year basis, I am quite pleased with the organic growth, albeit mostly driven by price in an environment facing high inflation continued supply chain hurdles and.
And energy crisis in Europe .
All of our European regional platforms recorded strong local currency organic revenue gains with some being in the low double digits. The only decline on a year over year basis related to the sale of product to Russian based jobbers, which as previously mentioned we completely stopped back in.
February when the war commenced.
Now, let's move on to our specialty segment organic parts and services revenue for specialty declined nine 1% in the quarter, a sequential improvement from Q2, but still down and below our expectations.
You May recall this segment reported 14% organic growth in Q3 of last year. So on a two year stack. The annual revenue growth is still positive.
The impact of acquisitions had a six 6% positive impact on revenue growth in specialty while as a predominantly U S business the exchange rates had a negligible impact.
During the quarter certain product groups, such as towing that have some exposure to new unit volume again underperformed during the quarter as the new RV unit sales have decreased year to date by over 23% through August .
As a reminder, the majority of our RV parts or replacement parts that are not tied to new unit volume, but are largely related to the size of the RV Park, which is still running at record levels.
Also some of the softness that the semi related products faced in the quarter was due to a year over year decrease in light truck and SUV vehicles sales in the United States, an important vehicle category for our specialty offerings.
Total U S light vehicle sales were flat year over year.
Importantly, I would like to congratulate our specialty team for receiving the RV Industry Association Award as the 2022 distributor of the year.
This is the second year in a row for this recognition further validation that our people are truly our greatest asset.
Let's move on to initial Q4 revenue trends.
Revenue for our North America wholesale operations has gotten off to a solid start largely driven by the improvement in aftermarket fill rates.
So we don't anticipate we will continue to run at these very high levels, particularly as we lap the pricing movements initiated last year.
Specialty revenue is also trending similar to the Q3 performance and then we will have easier comps in the fourth quarter compared to the rest of this year.
From a corporate development perspective in the third quarter, we divested our Florida Shredder as part of this transaction, we entered into a supply agreement to which our Florida self service yards will sell our offer to sell its cross vehicles to the new acquirer. We also divested our equity interest in a small subsidiary of <unk>.
We have a lot of data to analyze but the north American team had a 93% participation rate. Our independent advisor has mentioned this is extremely high for these types of activities and is generally indicative of a high level of engagement across the workforce I look forward to sharing more.
On this topic once the process is complete.
And I will now turn the discussion over to grown in Rec. Thank you, Nick and good morning to everyone. Joining us today I'm honored to take on the position of CFO of LKQ and I look forward to driving our financial and strategic initiatives to lead the company to even greater success.
As part of the North American leadership team I was heavily involved in rolling out and executing the operational excellence initiatives that has spurred significant improvement in profitability and cash flows over the last few years now.
Now lets CFO I will continue to drive the organization's focus on profitable revenue growth delivering strong margins and free cash flow generation from this new vantage point, especially.
Especially as we face the macroeconomic headwinds Nick mentioned, it will be critical to lean in on productivity and efficiency and I look forward to partnering with the segment teams to continue to drive this forward turning now to the consolidated results.
We reported diluted earnings per share of <unk> 95, and adjusted diluting earnings per share of <unk> 97.
Which was a 5% reduction relative to Q3 last year.
Our operational performance showed year over year improvement and was in line with our expectations. However, the solid operational performance was more than offset by unfavorable effects of <unk> from volatility in metals prices and <unk> <unk> from foreign currency exchange effects caused by the stronger dollar.
Additionally, we had negative effects of <unk> in total from one divesting the <unk> business in Q2 to higher interest rates and three a 20 basis point increase in the effective tax rate to 25, 5%.
We mitigated about seven.
Of the decline with the lower share count, resulting from our share repurchase program shifting to segment performance.
Much of the operational improvement in the quarter came from the wholesale North American segment going to slide 10. The segment EBITDA margin of 19, 4% is a record for the third quarter. We saw strong growth margin improvement of 190 basis points with a little over half from pricing and productivity initiatives and the remainder from the mix.
With the sale of the low margin ptw business.
Overhead expenses were favorable by 20 basis points, primarily related to nonrecurring expenses from Q3 2021.
We're very pleased with the way wholesale is performing and while we believe wholesale will continue to generate strong margins there will likely be moderation in upcoming quarters as we move towards the long term expectation, we presented at Investor day earlier this year.
On the Q2 call in July we noted that self service would face difficult conditions in Q3 and as expected.
Self service had a tough quarter with roughly breakeven segment, EBITDA and a two 6% margin.
With scrap metals prices falling we experienced a negative lag effect as we turn cars purchased in the second quarter when metals prices were higher and lower scrap prices.
We added a slide of the presentation to depict this effect.
Looking at Slide 29, you can see the delta between the average scrap metals price in Q2 of $279, which influenced the amount we paid for the cars purchased in the current quarter average of $198, which drove the amount we received when scrapping the Q2 cars we purchased.
We wanted to provide this depiction to help provide more clarity on the lag effect, but caution there isn't a perfect correlation between scrap steel prices and car costs as other market conditions will impact the purchase price of the cars.
The reduction in prices along with lower volume processed in Q3 produced the decrease in gross margin and the negative leverage effect on overhead costs. We expect improved sequential profitability in Q4, as we cycled through most of the higher cost Q2 purchases by the end of September I will turn the call to have a room to cover the other segments as well as cash flows and the balance sheet.
Thank you Rick I appreciate that introduction and overview of our North America wholesale and self service segments performance, let's move to slide 11 of the earnings deck.
Europe delivered an 11, 3% EBITDA margin for the quarter down 20 basis points from the prior year period gross margin improved by 10 basis points as we work to offset inflation with procurement initiatives and pricing Uber.
Overhead and other expenses increased by 30 basis points with inflation, when primarily on personnel freight and fuel costs. The segments solid third quarter performance reinforces our expectation that we will deliver double digit margin for the full year, despite the macroeconomic headwind.
<unk> around general inflation energy costs, and the Russia, Ukraine conflict.
While I have been in my new role as CEO of the European segment for a little over a month I have gotten an opportunity to get in on the ground view of our operations and the management team and I am even more impressed by the strength of our frontline businesses and despite the darkening macroeconomic clouds with judicious and decide.
The prioritization I am confident that we can achieve our long term operational and financial targets moving on to slide 12.
Specialties EBITDA margin of 10, 8% declined 30 basis points compared to the prior year coming from a decrease in overhead expense leverage driven by an organic revenue decline of nine 1% as the anniversary a tough comps from the prior year when the business delivered a nearly 14.
<unk> organic revenue grew three eight in the third quarter inflationary pressures also pushed overhead expenses as a percentage of revenue higher including passion now freight and fuel expenses.
Overhead expense increases were partially offset by a 70 basis point benefit from lower incentive compensation and 80 basis points of benefits from operating expense synergies largely generated from the <unk> acquisition of a year ago.
Shifting to cash flows and the balance sheet, we produced a healthy $224 million in free cash flow during the quarter, bringing the year to date total to $862 million we.
We have made good progress in rebuilding our inventory levels in wholesale North America and in Europe as shown on slide 32, we increased our inventory values. In these segments do please note that the dollar increase doesn't directly equate to a quantity change given the higher input costs using <unk>.
North America after market as an example, with higher per unit costs I E inventory balance in dollar terms is close to Q4 of 2019, while the total available quantity on hand is down approximately 20%. We still have some work to do to optimize inventory on hand, especially going into the <unk>.
Year Winter season, So we expect further fine tuning of inventory levels over the balance of the year.
Through September the cash conversion ratio is 64% conversion of EBITDA to free cash flow just above our target range of 55% to 60% that continues to be timing elements that will reverse over the course of the year. For example, the third quarter inventory build will result in higher outflows for <unk>.
<unk> in the fourth quarter, and we have confidence in our ability to generate sustainable free cash flow in line with our expectations.
As of September <unk>, we had net debt of $2 2 billion with a net leverage ratio of one three times EBITDA, which is comfortably inside our target range of being below two times, our effective borrowing rate rose to 3% for the quarter and with the effect of rate hikes in the U S and Europe .
We have $1 6 billion in variable rate debt. So a 100 basis point rise in interest rates would increase annual interest expense by approximately $16 million as you can imagine we are reevaluating our fixed versus floating rate mix as part of a larger review of our capital structure and credit.
<unk>, which matures in approximately 15 months and we expect to complete this assessment shortly.
Most of our transactions are conducted in the home entities functional currency for example, buying inventory for our U S locations in U S dollars or European entities borrowing funds in local currency to create a natural operating hedge as a result, our currency exposure is weighted to constellation.
Our foreign currency denominated results into U S dollars, rather than transaction gains and losses, where we have transaction exposures. We hedged through forward contracts. We are comfortable with our current approach to managing foreign exchange risks do we are monitoring market conditions to determine if a change.
And strategy is required.
With our strong free cash flow and the proceeds from the <unk> glass sale earlier. This year, we have been able to return a significant amount of capital to our shareholders. In 2022, we repurchased over 17 million shares for $891 million through September , including almost $7 million.
Shares for $343 million in the third quarter. Additionally, we paid quarterly dividends totaling $210 million year to date we.
Earlier this week, our board authorized a $1 billion increase to our share repurchase program for a total authorization of $3 5 billion and extended the term through October of 2025. We are pleased to have this program expansion to be able to continue to use share repurchases as part of our <unk>.
Balanced capital allocation strategy.
As our earnings release of this morning indicated the board also approved a quarterly cash dividend of 27, five cents per share, which will be paid on December 1st to stockholders of record as of November 17th. This reflects a 10% increase in the quarterly dividend.
Before I turn the call back to Rick I would like to take a moment to thank lkq's leadership.
Our global Finance organization, and all our dedicated employees across the organization.
It has truly been a great privilege to serve as Youll CFO over these last five years over that time. The company has achieved tremendous things with significant growth in profitability and free cash flow building, a rock solid fortress like balance sheet and generating robust shareholder returns I truly appreciate everyones efforts to reach.
At this point and I feel honored to have been a part of the team during this pivotal period.
I will conclude with our updated thoughts on projected 2022 results shown on slide six.
Our guidance is based on current conditions and recent trends and assumes that scrap and precious metals prices hold near September 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 recent European rates with the balance of the year rates for the euro of <unk> 97.
And the pound Sterling at $1 11.
Versus $1 <unk> and $1 20.
And the previous guidance effectively a 5% seven 5% decline.
We narrowed the organic parts and service growth rate range to 475% to 575% with the midpoint up slightly from a year to date growth at five 1%. Please note that we have one fewer selling day in Q4 this year.
We are projecting full year adjusted diluted EPS in the range of $3 85 to $3 95.
With a midpoint of $3 90.
We have narrowed the range as we are three quarters through the year and lowered the midpoint of our prior guidance by <unk> <unk>.
To understand why we reduced the midpoint. Please refer to slide seven in the presentation, which bridges our prior and current guidance figures operating performance remains solid and represents upside of <unk> relative to our prior guidance. The frontline businesses continue their resilience in difficult conditions.
Capital allocation is also a benefit of <unk> relative to our prior guidance primarily related to higher repurchase volume.
Note that we are including share repurchases through the week ended October 21, and our guidance.
The good news generally tied to the areas under our control.
Then there are the negatives, which are primarily external factors declining metals prices are projected to have a negative <unk> effect.
Headwinds from the weakening FX rates mentioned earlier contributed a <unk> <unk> reduction relative to prior guidance and unless the trend reverses will be a negative factor in 2023.
Taxes and interest drive another three <unk> negative effect, including the rate changes previously noted.
FX rates and metals prices can move significantly overtime.
We may have further upside or downside if the actual figures play out differently than we assume in our guidance.
We expect to deliver approximately $1 billion of free cash flow for the year, achieving free cash flow conversion in line with our expectations for the business.
Translation of foreign currency denominated cash flows we will have a negative effect given the lower euro and pound sterling rates used in our latest estimates, but we are still anticipating 55% to 60% EBITDA conversion to free cash flow adjusted for the ptw gain. Thanks for your time. This morning with that I'll turn the call to Nick for his closing comments.
Thank you <unk> for that financial overview.
Let me restate, our key initiatives, which are central to our culture and our objectives first to integrate our businesses and simplify our operating model.
Second to focus on profitable revenue growth and sustainable margin expansion.
Third to drive high levels of cash flow, which in turn give us the flexibility to maintain our balanced capital allocation strategy and fourth as always to continue to invest in our future.
All such as FX rates, the supply chain and labor market constraints, we don't have a crystal ball, but it appears we will be confronting these uncontrollable items as we enter 2023 that said I am confident our operational excellence efforts can navigate and effectively manage most any challenge.
Why.
Simply stated we have the best teams in each of our segments in the industry and their track record over the last three years speaks for itself 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 <unk> proud.
And with that operator, we are now ready to open the call for questions.
At this time I would like to remind everyone that in order to ask a question simply press Star then the number one on your telephone keypad as.
As a reminder, please limit yourselves to one question and one follow up question.
The first question is from the line of Daniel <unk> with Stephens Inc. Please go ahead.
Yeah, Hey, good morning, guys. Thanks for taking our questions and congrats on the quarter.
Good morning, Daniel.
Yes, Rick I wanted to touch on something you said around kind of North American margins I think the comment you made would you expect them to moderate going forward maybe for you into next year can you just provide more detail on what the drivers of that outlook is it a change in underlying core margin due to heavy wage are there cost pressure or kind of what what was driving that comment or a moderation going forward.
The margins we had in Q3.
We see very favorable a record that we had and so so very pleased with what the team has done one of the things that we've seen over the last.
Call. It 12 months or so is the competitive market and the ability of us to be able to pass through some pricing and do it pretty effectively early on so there's a couple of things that are happening one of the things that we'll see as the increase in our overall product cost inflation that we would expect them to come back to what we've seen.
And what we told you guys. In Q2 is the long term view for US is probably somewhere in the seven mid low to mid <unk> is where we would expect that to be.
With the inflationary increases that we keep seeing the ability to pass on that cost.
Our customers will be.
A little more challenged as we come into 2023, I would think that it would be a slow move a little bit slower move to those those numbers that we set on the long term piece, though so.
I don't know if you want to.
Add anything on that no thats good.
Your next question is from the line of Michael Hoffman with Stifel. Please go ahead.
Hi, Thank you so do you have to so.
So this one's a little out of left field, it's geopolitical so I'm curious about your views on.
Looking forward.
It appears the EU energy crisis peaked a bit we're at full capacity on natural gas supplies, maybe theres a little relief. So I'm curious about that and then the other part of that same question.
The China leadership changes.
Changes, but.
Nobody.
What the plan B, if China decides its going to embargo shipping out of Taiwan, and what's plan b related to that and then I have a question about 23 after that.
Okay. Michael This is Nick Thanks for your question.
As you know and as everyone knows the entire aftermarket collision parts industry moved to Taiwan decades ago.
There are no more material production capacity.
Outside of Taiwan, It just doesn't exist.
There are no plant city, and Mexico, or Vietnam, or India, sitting idle waiting for the Taiwanese machine to get shut down right. It doesn't exist now we play pay very close attention obviously to geopolitical events.
We're not overly concerned about the scenario that.
That you laid out where China was effectively shut down the Taiwan These economy because they wouldn't.
Pick out auto parts.
Specifically and the reality is.
If they were to shut down the economy and shutdown kind of shipments out of Taiwan auto parts is the least of everyone's concern.
65%.
All semi conductor.
Auction and 90% of all advanced chip production comes out of Taiwan. So if China were to embargo export shipments you would not be able to buy I phones, or new cars or medical equipment or anything that hasnt chip it out.
And we think that the Chinese leadership is.
They're very smart.
Taiwan.
<unk> represents in form of a of a really strong economy.
Our sense in talking with outside advisors is it would be more likely.
China would move kind of to a Hong Kong model first.
They would seek.
To have significant influence over the over the territory, but not just shut totally just shut down the economy.
Okay and then the second follow up question.
I realize you're still in budget process for 2003, but theres. Some knowns sitting here today, you know where your interest rates move to taxes FX freight.
What of those pieces of the waterfall what is the net plus or minus of those relative to the new midpoint.
Yes, so on the 'twenty to 'twenty three outlook you are absolutely correct. We are in the middle of our budget process and we have yet to see any submissions from the field and so we don't have a consolidated view at this time, what I can tell you. However is that nothing has changed materially from what we presented.
Back at the Analyst day in the Investor Day. This past June 1st in Nashville.
So on the revenue front.
As indicated in my prepared comments, we do not anticipate that the recent double digit.
Organic growth in North America wholesale business will be sustainable it's just it's too high.
Europe .
And solid service, assuming scrap prices stay where they are can sustain low to mid single digit growth as well for their parts and services business.
All of that obviously is based on what we talked about in Nashville, and that is market growth being in the low single digits a bit of share gain which we always are trying to achieve each and every year in each of our businesses.
And some boost from inflation.
As Rick indicated 2023 will have one fewer selling day and then 2022.
Which clipped you for a few basis points of growth.
40 basis points to be exact.
So hopefully that gives you a sense of local currency revenue trends.
The strong dollars that we have.
We had this year, that's going to carryover assuming rates stay about where they are next year.
So Michael when you and everyone else on the call are building your models.
Now in terms of margins.
As we just.
<unk> indicated in answering Daniels questions long term, we believe that our north American wholesale business can sustain margins in that low to mid 17% range. We don't expect to go from where we are today down to 17% next year, we think it's going to be a more gradual decline.
Some minor margin improvements with specially particularly if we can get some modest revenue growth and the self service margins, assuming no significant changes in scrap prices should get back to kind of mid teens.
Interest cost will be higher due to the impact of the higher rates on our floating rate line of credit balances as Bruce indicated that was about $1 billion six.
Now obviously your earnings per share will benefit from the 17 million shares repurchased thus far in 2022. So we've got a lot of work ahead of us on the budgeting front.
But hopefully that gives you enough to get into the right ZIP code when building your models for next year.
Hi, Good morning, Thanks for taking my question and then Brian and Rick Congrats again on the new roles. Thank you Ali.
So my.
My question is on used car pricing, obviously, we're seeing used car prices come down real time right. Now maybe you can remind us what the impact is of lower used car prices on your business.
Yes simply.
Lower used car prices generally translate into lower cost of the vehicles of the total loss vehicles at the salvage auctions because there is.
As prices come down.
Competition at the auctions includes Rebuilders and abused for car prices come down what they can pay for their feedstock. If you will that total loss vehicle has to come down as well if theyre going to maintain their margins and so yes, it's not a dollar for dollar.
A reduction if you will but we would expect that as used car prices settle down a little bit that the price. So we have to pay for the cars at auction will also come in a bit.
Yes.
Great. Thank you.
Yes.
Your next question is from the line of Craig Kennison with Baird. Please go ahead.
Hey, good morning, Thank you for taking my questions as well and congratulations to the whole team marooned I wanted to start with you and ask you about your priorities for Europe , and maybe frame them in the context of the LKQ, one strategy, where do you see.
An opportunity to double down on some of these initiatives and where might you dialed back your priorities in order to focus on what you see as the highest priority.
Good morning, Craig and 10-Q for the kind wishes Super excited both Rick and myself.
It truly is yet another testament to the work that we as a management team have done from a talent development perspective.
All the dominoes that kind of went through where all fulfilled internal with internal talent with regards to the European business now that had been on the ground for a little over a month at this point of time I Kid you not I am so excited about the opportunities we have both internal and external kind of freedom.
From a market perspective in any case, if you think about the limited new car inventory think about elevated used car prices.
Think about the aging car park. These are all supportive of a healthy demand in the after market. So thats just kind of framing the peace and despite the fact that BMT is under pressure given the energy prices over in Europe . This and people are still doing hybrid working so as you think about the go forward.
Run rate with regards to more people coming from Sandy.
<unk> will recover and hopefully at some point of time once the geopolitical crises also.
<unk> specific priorities.
Simple.
And we will grow the business faster than the market organic growth will be the key focus, though we always have the opportunity to look into highly accretive and selective acquisitions. So number one grow the business. The second one is be decisive about prioritization and then this flawlessly execute we have.
So much opportunity across Europe .
<unk> mobility and.
Coupled with an aging car park Super excited and this is before I get into some of the internal programs such as back office and private label.
Those continue to remain opportunities for us number one to grow the business faster than the market second be decisive about prioritization and flawlessly execute and the final one is developing talent, we have a tremendous management team our best Super Super I'd kind of put them up against absolutely anybody but.
To your question about the one LKQ Europe program. If you can actually pull up the presentation that Nick and myself had presented on the 10th of September 2019, there were full fundamental building blocks and one was procurement. The second one was private label a third was revenue optimization and then the fourth one was essentially.
Those are the key priorities and that is really where we are doubling down I feel super excited about where we are but clearly there is more work to be done and just making sure that we don't get distracted by the various I'd say.
Referral opportunities and really double down on what we had committed to doing so that really is where we are and as I said, yes.
The macroeconomic clouds are darkening, but in terms of our ability to execute through those given the sectorial a tailwind very very excited.
Your next question is from the line of Scott <unk> with MK and partners. Please go ahead.
Good morning, and I Echo my compliments as well.
You guys talked about Europe .
We're seeing some areas that are growing and low doubles.
And with regards to.
I guess, what Youre seeing right now are you seeing any signs that the counter cyclical bent.
Benefits of mechanical aftermarket are starting to kick in.
Scott just following actually let me let me answer your question listen in terms of the.
Other metrics of the Kpis that essentially kind of give you. The same result, whether it be congestion indices, whether it be fuel consumption diesel petrol things along those lines. So that is something that im keenly watching along with my team and yes, theyre offsetting pressures from that perspective, but having said that.
Pricing the higher input costs, that's coming through is being priced through across the entire market and that's kind of moving into call. It mid to high single digits and that is coming through you can see that through the gross margin side of things also so with regards to is there any deferral taking place at this point.
Do you have time, we really haven't seen any deferral other than the fact that service mechanicals you'd need to if you're driving an even if you're not driving once a year you need to get your oil and oil filter change for example, so from that perspective, the counter cyclical nature of what we do over in Europe is actually very very resilient and that really is what.
We are excited about pricing is sticking through at this point of time and I know given how we operate our businesses service reliability, having access to inventory, having a pristine balance sheet that supports us at my sense is there will be more stress in the broader market but.
The larger ones.
I think on a go forward basis, something to watch out for is inflation, okay and that set the wireless kind of gone through the Cogs side of it and that has stuck my sense is that certainly will be coming through on the labor side I think based on CPI numbers that we're seeing out of the various European markets that certainly is a key focus area for my team and myself.
And really driving the productivity side of things, where again, we have a tremendous opportunity as you know with the three advanced logistics distribution centers that we've already set up essentially to future proof our business, but again lots more to do on that and again it won't be plan ceiling for everybody, but really this is wayne.
Market leaders toward full leadership teams really rise to the top.
Alright, and just one follow up any update on state farm.
Sure.
The answer is yes, and no so as you recall Scott.
Last during the summer State farm initiated a 12 week pilot program in the state of Texas and Oklahoma.
Where they decided to start using aftermarket.
I'd like to highlight some bumpers.
That 12 week period has come to an end that said state farm has continued to keep the program alive in the state of Texas and in the state of Oklahoma and it's active today.
We're assuming that state farm is reviewing all the data from their pilot and certainly while there can be no assurances of any change we take the fact that the program is still in place and ongoing.
A month or so.
Perspective that being all aftermarket parts as opposed to just headlights, taillights and bumpers.
We have a continuous dialogue with all of the major insurance companies.
We're in constant communication and obviously, if if state farm decides to broaden their.
The aftermarket utilization, we will be sure to let everybody know so officially there is there's no news but.
We take as a positive as opposed to a negative.
Got it thanks.
Your next question is from the line of Bret Jordan with Jefferies. Please go ahead.
Hey, good morning, guys good morning, Brad.
<unk> now that you've been in Europe for a month and I guess, we were talking about the one LKQ plan, how do you handicap that ERP consolidation and maybe if you could talk about sort of.
Over what period of time, it seems like such a complicated mix of supply chain systems over there.
Having having lived with it.
Is that is that as.
Big an opportunity as you thought initially.
One of the key underpinnings of the one LKQ Europe program was to essentially integrate certain backend processes of the business. So maintaining the front end entrepreneurial local nature of our business and making sure we have best in class customer intimacy and also the last mile.
Delivery no change to any of that but in terms of.
One of the key enablers in unlocking the overall cost to serve is from a back office perspective, Nick and I have talked about this AD nauseum with regards to where we get our payables down from web payroll runs from that frankly.
One rig doesn't care about as much as long as it has done efficiently and effectively.
But really it's the case of having the ERP system, a bed, which unlocks all of these pieces nothing has changed on that front and if you go back to thinking about how we built up the European business largely bought through private equity companies and that has I think as all of US know typically have a very limited time horizon with regards to certain <unk>.
Investments so in terms of fab.
Making the investment on the ERP no change at all in fact that scenario that.
It's got its shoulder behind it rather than it being a technology project. So some do difference out of that in the first few weeks, but overall no change on that front in terms of where we're going.
Great and then a question on specialty when you think about the RV business versus the CMI type categories could you sort of talk about relative cyclicality and I think you'd expected sort of positive low single digit growth in 'twenty three.
It would be the impact of a recession, maybe is it sort of like as you look at the sema side of that business.
And so.
Unlike there are a couple of product lines as I indicated things like <unk>. There is a direct correlation to new unit sales because first time RV buyers usually need to get.
Hitches and related towing gear installed on their vehicle.
But again most of the RV.
The effective way of doing that on the <unk> side of the business.
There are a number of products.
Tied to.
New vehicle sales, particularly pickup trucks.
<unk> and other Suvs.
The enthusiast marketplace tends to hold pretty steady through the recessionary environments.
And so it.
At the end of the day brought it depends on how deep and how long the recession goes and we cant predict that we feel good about our market position as being the leader in that market and we will continue to work hard to drive profitable revenue growth wherever we can.
Your next question is from the line of.
Hey, good morning, all.
Quick question on.
The recycled side.
Could be looking at an unprecedented decline in used car prices.
For the next year or two how does that impact what youre buying at auction and then I guess the other question I would have there is.
Do you see do the prices of the parts is the cars come down on the recycled side do they come down concurrently with the decline in oil prices.
I'll take that and then I'll invite Eric to provide other than commentary that he may have.
The reality is.
As prices come down as I indicated.
The cost of the what we have to pay at auction tends to come down as well again, it's not dollar for dollar, but there is a correlation there. The reality is that doesn't make us buy more vehicles or are.
We're not we buy the vehicles that we need to have the inventory that we believe is required to fulfill customer demand.
Okay. We don't bid on every car that comes to the.
And so that's not going to change we're going to stay very focused on utilizing our our models, our AI and the like to buy the vehicles that we need to drive the <unk>.
<unk> margin just by bringing our total loss vehicle because it's for sale. If those two are going to sit on their warehouse shelf for the next year or two.
Theres no.
There's no utility to us doing that so we focus on buying what we need.
And if the car prices come down that is great we do not adjust.
In other parts based on the cost of the car because again, we price relative to where the oes have their prices, we need to maintain that value proposition.
For the insurance companies to continue to have them push the utilization of alternative parts.
And so our ability to price up.
In some parts based on what the Oes are doing but just because the price comes down doesn't mean, we automatically lower.
The price of the parts that we sell but Rick anything else.
Okay. Thank you and then lastly, brewing you mentioned something about or somebody did.
100 basis point increase in interest rates on your <unk> your interest expense yes.
I'm, the one who mentioned that Gary essentially at the end of September we had about $1 $6 billion of variable rate debt on the revolver. So every 100 basis points will essentially be $16 million of higher interest expense that was a simple math. So total debt was about $2 4 billion, we had cash on hand of about $270 million of net.
<unk> <unk>, two which as you know we've got two euro bonds.
$5 billion, and two and $250 million, so really D&B.
Change on that really would be on the variable rate debt.
Okay. Thank you.
Your next question is from the line of Michael Hoffman with Stifel. Please go ahead.
Thanks for letting me do the follow up when do we see or maybe you answered it by saying there would be a gradual decline back to normal margins in U S. The benefit of freight coming through on the inventory that has a margin plus.
Yes.
I appreciate the question so we've been seeing.
Obviously, the spike that we saw earlier in the year late last year earlier this year.
And so you'll start seeing the relative decline over Q4 going into Q1.
It sort of normalizes.
With a lot of offsetting items right. So there's the other inflationary increases that we're keeping a keen eye on along with product cost increases that are somewhat.
Flowing through that inventory level as well so.
The other thing to keep in mind is that as the spot market was was rapidly going up due to our size and scale, we were able to get a lot of contracted rates and so some of the increase that we saw would have been mitigated against competition.
So another way of thinking about that Michael is as the spot.
Spot pricing escalated from what was.
$2500 for a 40 foot container back in 2019 to as high as 20.
And parts of <unk> 21 in early 'twenty two.
Because so much of our volume came on contracted rates.
We were hurt less.
And then our smaller competitors when the.
That will all rolled through our inventory and then ultimately into two.
Cost of goods sold.
And this does conclude the Q&A portion of today's call I will now turn the call back over to Nick for any closing remarks.
Well obviously.
As always we really thank you for your time and attention we understand there's a lot of things going on.
Today and in the markets, we certainly look forward to providing another update in late February of 2023, when we report our fourth quarter and full year 2022 results.
[music].
Sure.
[music].