Justin L. Jude
President and Chief Executive Officer at LKQ
Thank you, Joe, and good morning to everyone joining us on the call. I am deeply honored and excited to be able to speak with you today as the CEO of LKQ, a Company where I've spent the last 20 years working with dedicated colleagues to build a strong and vital business.
Before diving into the results for the quarter, I want to start by laying out my overarching priorities for our Company and the plans we are executing to enhance performance and drive value for LKQ shareholders. LKQ is a strong Company with market-leading businesses. We have been successful by leaning into our operational excellence strategy with a focus on profitable revenue growth, margin enhancement and cash flow generation.
Under my leadership, we will prioritize these strategic pillars, which are an integral part of LKQ's culture. However, this doesn't mean we'll follow the exact same playbook. I expect my team to challenge the status quo, to be innovative, to set goals and communicate them so we hold each other accountable and to learn from mistakes.
Rick and I have years of experience operating successful businesses, of which four were together running our North American Wholesale segment. We will work together with our global team to run an efficient organization, one that is focused on growing market share, while driving productivity and actively managing the cost structure.
In terms of capital allocation, our guiding principle is to direct our resources to the most value-enhancing opportunities. From our vantage point today, share repurchases will be a priority and a means of driving shareholder value. As you can see from our repurchase activity in the second quarter, we believe our shares are trading below their intrinsic value and repurchases represent our best use of funds. We see attractive return metrics in our shares and through our capital allocation priorities, you should expect to see ongoing programmatic share repurchasing activity.
We have paused any large-scale acquisitions and raised the hurdle rate for approving synergistic tuck-in transactions. In fact, we have walked away from deals in recent months because the returns on investment did not meet our new criteria. Rationalizing the asset base has been a key element of our strategic framework. We have routinely examined our assets from individual locations up to lines of business to determine if the assets align with our future plans. As part of this process, we identified certain lines of business that did not fit our strategic objectives and we took action, divesting 14 businesses in the last five years, which represented over $600 million in low-margin revenue. These transactions were done judiciously and following a disciplined process to achieve a favorable outcome, and we will continue to carefully evaluate whether we are the right owners for any of our businesses while we focus on our core strengths.
Finally, cash flow generation will remain central to our business. Delivering strong cash flow allows us to invest in our future through capital projects and to return value to shareholders through dividends and share repurchases while maintaining a manageable debt level and our investment-grade rating.
I'll now provide some comments on our results and then Rick will discuss our financials and guidance. Our second quarter results did not meet expectations on the top-line. In the first quarter, we faced revenue headwinds from a decrease in repairable claims in North America, which was influenced by mild and dry winter weather conditions. In our Q1 commentary, we noted there would be a carryover effect in the second quarter as shops had lighter backlogs than normal going into April. And we acknowledged a further risk to revenue if repairable claims didn't rebound as we were projecting. As you can see from our second quarter results, the revenue trends moved in an unfavorable direction in North America as well as our other three segments. On a per day basis, organic parts and revenue was down 2.9% overall and was negative in each segment.
Drilling down and starting with North America, organic revenue decreased by 5.3% with the largest drop coming from aftermarket collision parts. Similar to Q1, repairable claims were down in the second quarter by 7%, proving to be a headwind. Although not material, access to aftermarket inventory following the Panama Canal disruption and delays with inbound deliveries also had a negative effect.
As we continue to see a reduction in repairable claims during Q2, we dug deeper into the market to further understand the drivers of this sequential decrease. While weather was a contributing factor to the reduction in Q1's repairable claims, as we mentioned on the last call, we further researched the impact of rising insurance costs and declining used car values on the consumer's decision to repair their vehicle. We found the combination of these economic factors, rising insurance premiums and repair costs relative to the declining used car prices have the largest aggregate effect. In parallel, we also engaged a leading global consulting firm to conduct an independent assessment of the market and their findings lined up with our deep-dive analysis.
Based on these findings, we believe that most of these factors are temporary as weather conditions will fluctuate from year-to-year and economic conditions should normalize over time, allowing for insurance costs to moderate and used car prices to stabilize. We believe that an improvement in economic conditions will contribute to more cars being repaired.
The smaller impact to repairable claims is the ongoing effect of ADAS technology entering the car park, and we estimate that headwind to approximately be a 1% decrease in repairable claims per year. This is further supported by research from the Insurance Institute for Highway Safety and the Highway Loss Data Institute that states there is little evidence that partial automation systems are preventing collisions. However, the ADAS impact is not news to us, and it doesn't change our near and long-term outlook on the collision market as we believe there will continue to be offsets to collision volumes with revenue opportunities from an increase in parts per estimate, the cost of more complex replacement parts, expanding our services of calibration and diagnostics and continued growth in APU. Rick will discuss in more detail how we are factoring these temporary effects into our guidance.
We have taken decisive cost actions to address the revenue shortfall. As we discussed on the last call, we accelerated the FinishMaster integration and announced a global restructuring program in the first quarter. With revenue remaining soft in Q2, we implemented a further cost reduction plan, and I am pleased with the progress the North American team has made. Just as the team proved throughout the COVID pandemic, we know how to drive cost-out of the business and we exited Q2 with $60 million in run rate savings on the cost reductions. By making these actions quick, North America was able to generate a segment EBITDA margin above 17%, in-line with our previous guidance. Our actions have been careful and deliberate and we believe we are well-positioned to scale back up again as demand increases.
Switching to our Europe segment, organic parts and services revenue increased by 0.3% on a reported basis, but declined 1.3% on a per day basis due to volume reductions. There were several factors behind the negative trend with economic conditions being the most significant component. Modest economic growth and high inflation across many of our markets, including the UK and Germany have impacted demand contributing to a year-over-year decline in overall volume. Like North America, we expect the unfavorable economic conditions to be a temporary headwind, but one that will likely persist through the second half of 2024.
Other factors impacting revenue include the strike activity in Germany, and heightened competition from small distributors. With the pressure coming from soft consumer demand, we are seeing some of our smaller competitors aggressively lowering prices. LKQ has been a price leader, but we are also very disciplined. By resisting price decreases, we lost some volume in the quarter. However, we do not think the short-term pricing behavior of these competitors is sustainable or a rational strategy, and we believe our compelling value proposition will continue to be a key competitive advantage.
Europe has also taken actions to mitigate the revenue decline, including cost take-outs and productivity initiatives. Given local regulations, these efforts require more time to implement and thus the benefits weren't fully realized in the second quarter. We expect to see greater cost-savings as the year progresses and into 2025.
Additionally, the European team continues to advance our SKU rationalization project. The team has reviewed product groups representing about a third of our revenue and we believe there is an opportunity to reduce about 30% of the current SKUs in these groups. The SKUs would be delisted over a three-year period starting in 2025, with the large majority coming in the first two years.
As I noted in my introductory remarks, we continue to review our portfolio and look for opportunities to divest non-core businesses. In Q2, we reached an agreement to sell our operations in Poland to Mekonomen, and the transaction is expected to close in the third quarter. Combined with the previously announced sales of our Bosnian and Slovenian businesses, the Elit Polska divestiture reflects our ongoing efforts to streamline and simplify our operations while improving our margin profile. This sale represents a good strategic fit as both LKQ and Mekonomen operated in Poland, but neither had the scale to compete effectively with the larger players in the market. The combined operation will be better positioned to compete and we will share in the upside potential through our investment in Mekonomen.
Shifting to Specialty. Organic revenue was down 2.1% for the quarter, roughly in-line with the Q1 change. Softness in RV demand continues to be a headwind with uncertain economic conditions and high interest rates contributing to pressure on retail volume. We are seeing growth in some product lines, including marine. Consistent with the rest of the organization, specialty has taken cost actions to protect margins and is narrowing the gap in the year-over-year margin change.
I want to mention some other noteworthy items for the past several months. In May, we received a favorable ruling from the Federal Circuit Court related to design patents. We believe the ruling is a win for the aftermarket industry and consumers who benefit from the value proposition offered by aftermarket products. In June, the Verdi Trade Union and Employers Association in Germany entered into a new collective bargaining agreement. The new contract which runs through April 2026 covers approximately 5,000 of our employees and puts an end to the strike activity we experienced over the last year. We remain dedicated to providing the industry's best service to our customers and this agreement will improve our ability to deliver on this commitment. We have already seen an improvement in branch availability following the agreement, and we expect to get back to pre-strike levels in the second half of this year.
In the quarter, we did a handful of tuck-in acquisitions mostly by our Bumper to Bumper business in Canada, where a tax law change provided an incentive to finish deals prior to June 30th. As I noted earlier, we are deprioritizing M&A as we shift focus to share repurchase and other more accretive uses of capital.
On that note, we returned over $200 million to our shareholders through both dividends and share repurchases in the quarter. This included the highest number of shares repurchased any quarter in the past 18 months, and we are continuing to repurchase shares in Q3. Our Board of Directors approved a quarterly cash dividend of $0.30 per share to be paid in August.
Finally, from a governance standpoint, we regularly review the composition of our Board and ensure that we have members with the relevant experience and skills to support our mission. As part of this process last week, we added Andy Clarke as a new Board member. Andy is a former public company CFO and financial expert, and we are excited to add this expertise to the Board.
I'll now turn the call over to Rick for a review of the financials and guidance.
