Varun Laroyia
Executive Vice President and Chief Financial Officer at LKQ
Thank you, Nick, and good morning to everyone joining us today. Our third quarter results reflect continued evidence of the benefits of the operational excellence initiatives we instituted a few years ago. Record profitability and continued robust free cash flow just don't happen by accident. The team's focus on getting the fundamentals right, continuous improvement and winning each day has driven these strong results under what are incredibly challenging conditions, with a congested supply chain and strong inflationary pressures. I'd like to start with a few highlights before getting into the details. As you heard from Nick, Europe achieved segment EBITDA of 11.5% for the quarter. This gives us the confidence to narrow the full year segment EBITDA range for 2021 further to 9.8% up to 10.3%, effectively lifting the floor by a further 30 basis points.
Specialty delivered yet another excellent organic revenue quarter at 13.7% despite the ongoing supply chain challenges. This is the fourth consecutive quarter of robust double-digit organic revenue growth for the segment. Cash flow generation remains strong. And the conversion ratio relative to earnings continues to be above our long-term expectation despite a challenging environment. The share repurchase program carried on with a further 4.3 million shares purchased in the quarter, bringing the year-to-date total to 12 million shares and the program to date of 29.3 million shares repurchased. And finally, the initiation of a regular quarterly dividend reflects the confidence in our strategy and the strength of our business, underscoring our commitment to deliver long-term value to our stockholders.
Now I'll move to the consolidated financial results. As Nick described, Q3 was another successful quarter with growth in revenue, EBITDA margin, cash flow and earnings per share. Gross margin was again a highlight for the quarter, increasing 150 basis points relative to the prior year. We continue to feel pressure on input costs across each of our segments, but we have been able to mitigate the effects by being nimble to adjust to the new reality of higher input costs by adjusting pricing. Gross margin also benefited from the tailwinds of commodity prices, although at a much lower level than we've seen in prior quarters. Car costs remain relatively high. And with the moderation of precious metal prices in the quarter as seen on Slide 27, the benefit dipped relative to the first half of the year.
We estimate that scrap steel and precious metal prices added roughly $12 million in segment EBITDA and $0.03 in adjusted EPS relative to last year. As a reminder, this benefit is well below the $57 million in segment EBITDA and $0.14 in adjusted EPS from metal prices experienced in the second quarter of 2021. Overhead expenses as a percentage of revenue increased 50 basis points year-over-year, largely driven by personnel costs. The tight labor market has pushed wages higher in many of our markets. Additionally, strong performance across all three segments is contributing to increased levels of incentive compensation in 2021, which represents 30 basis points of higher expense. Other overhead expenses are slightly favorable, as we're offsetting inflation in freight and fuel through operating efficiencies and leverage from higher scrap and core revenue.
I'll now turn to the segment operating results. Starting on slide 10, North America produced an EBITDA margin of 17.3% for the quarter, down 30 basis points from a year ago. Gross margin was favorable by 60 basis points, primarily coming out of the ongoing margin initiatives in the wholesale business and improved pricing. Self-service increased gross margin dollars compared to 2020 but generated a lower margin percentage due to an increase in car cost and moderating metal prices. Segment overhead expenses increased by 100 basis points, with the largest change owing to personnel expenses. Roughly half of the increase is attributable to wages and temporary labor, with the remainder in higher incentive compensation. At the segment EBITDA line, the metals prices benefit noted previously generated 20 basis points of improvement relative to last year.
I previously mentioned Europe's strong margin for the quarter, and slide 11 shows the details. Adjusted gross margin increased by 240 basis points to the highest level in recent years, primarily owing to better net pricing while overhead expenses grew by 30 basis points, driven by higher wages and incentive compensation. Moving to slide 12. Specialty grew EBITDA dollars though experienced 100 basis points of dilution in margin. The primary factors contributing to the decrease are: one, higher incentive compensation; inflationary pressures in the segment's one operations, which are behind the 30 basis point decrease in gross margin; and finally, duplicative costs associated with acquisitions done in the current fiscal year, which we expect to be transitory as the team integrates the acquired businesses over the remainder of the year and into early 2022.
Similar to the first half of 2021, we are also delivering benefits from our focus on the capital structure. The early redemption of the 2026 euro notes in April of this year created interest expense savings. Additionally, deploying free cash flow to debt paydowns and share repurchases generated interest expense savings and an EPS benefit from a reduced share count. We estimate that these factors added roughly $0.06 per share to our third quarter results. and based on the characteristics of these initiatives, are expected to continue to deliver over multiple periods. Additionally, income from our equity method and other investments generated a further $0.02 of year-over-year growth. Given the improved expectation for full year profitability, we decreased our projected effective tax rate in our outlook from 26.25% to 25.75%, which contributed to a $0.04 per share year-over-year benefit in the third quarter.
So to recap, our adjusted EPS of $1.02 is a $0.27 increase over the third quarter of 2020; the commodity benefits, as previously stated, were $0.03; investments generated a further $0.02; the tax rate, our capital deployment and a slight tailwind from foreign exchange produced about $0.10 of the improvement; the remaining $0.12 comes from our operating performance, by far the single largest contributor to the results. Shifting to liquidity and capital allocation. We continued the trend of robust cash flow generation in the third quarter with $429 million of operating cash flow and $384 million of free cash flow. Our conversion of EBITDA to free cash flow was a very strong 84%, roughly in line with our year-to-date ratio, as seen on slide 14. Our operating cash flows were driven by cash earnings and favorable movement in trade working capital balances.
Payables represented an inflow for the quarter as we benefit from extended payment terms, including our European vendor financing initiative. Inventory was an outflow of $60 million for the quarter. But similar to the second quarter, we were unable to increase our purchasing to the designed level owing to the supply chain issues that are affecting many sectors of the economy. We are actively working to rebuild inventory levels, and we believe that our excellent relationships with suppliers and liquidity on hand puts us in a good position to acquire the needed inventory when supply chain congestion finally eases. We deployed the free cash flow to repurchase 4.3 million shares in the quarter for $219 million, acquired two tuck-in businesses for $37 million and repaid $23 million in outstanding borrowings.
Our net leverage ratio dropped to 1.1 times EBITDA, and interest coverage now exceeds 24 times compared to the credit facility requirements of 4.25 times and three times, respectively. Or said differently, at this point in time, we do not need to devote further capital towards paying debt, and as you saw in the third quarter results also. With $1.6 billion in availability on our credit facility and approximately $400 million in cash, we have over $2 billion in liquidity to fund our strategic objectives. The liquidity amount is roughly $800 million below our December 31, 2020 figure, reflecting the use of liquidity to redeem the 2026 EUR0.75 billion euro notes, prepay our outstanding term loan balance of $319 million as well as the termination of the $110 million receivable securitization program earlier this year in July.
We felt comfortable reducing the overall capacity owing to our ability to sustainably generate robust free cash flow. As you can imagine, we have carefully considered our liquidity position and future cash flow generation prospects in reaching the decision to initiate the quarterly cash dividend. We are confident in the company's ability to convert earnings to free cash flow in a ratio of 55% to 60% on a long-term basis, which provides us with sufficient cash to fund a dividend while continuing to repurchase shares, reinvest in the business and make accretive acquisitions. Initiating a dividend is an important milestone in the company's history and reflects the Board and the management team's confidence in our near- and long-term prospects. The decision to pay a dividend is consistent with, and does not change, our approach to capital allocation, which prioritizes growth investments and return excess cash to shareholders to enhance their returns.
Our share repurchase program will run in tandem with the dividend program as part of our balanced approach to capital allocation.
I will wrap up my prepared comments with our updated thoughts on the full year 2021. Consistent with the level of detail we have provided in recent quarters, we are comfortable making the following statements, all of which that assume that there are no significant negative developments related to the COVID-19 in our major markets or foreign exchange rates and scrap and precious metal prices hold near recent levels in the remainder of the year. The first statement being, with yet another excellent quarter in Q3, we are projecting full year adjusted diluted EPS in the range of $3.78 to $3.88 with a midpoint of $3.83. This is an increase of $0.18 or 5% at the midpoint over our prior quarter guidance and an increase of $1.08 or 39% relative to our original 2021 full year guidance.
The increases reflect the benefits of our ongoing margin and operating expense programs and our strategic cash deployment, which have allowed us to mitigate strong inflationary headwinds related to labor, freight, fuel and inventory costs prevalent throughout the industry. While we expect our operational performance in Q4 to play out roughly in line with prior guidance, we are projecting a negative impact of roughly $0.02 a share, resulting from metal prices as these move lower going into the fourth quarter. As you think about the comparison to the fourth quarter of 2020, we are forecasting a $0.07 per share negative year-over-year effect related to sequential movements in metal prices. Additionally, having one fewer selling day in the North America and Specialty segments in the fourth quarter of 2021 creates a further $0.02 headwind.
A lower share count and tax rate in 2021 should mitigate some of the year-over-year headwinds. The second statement I would like to share with everyone is we are narrowing the range for full year European segment EBITDA margin to 9.8% up to 10.3%, effectively raising the floor by a further 30 basis points, similar to what we did roughly 90 days ago following the second quarter earnings. And finally, we continue to generate outstanding free cash flow through strong profitability and judicious use of trade working capital. With this in mind, along with higher projected net income for the year, we are raising our free cash flow guidance to a range of $1.15 billion to $1.3 billion, with $1.225 billion at the midpoint. Despite the supply chain challenges, we still anticipate an inventory increase in the fourth quarter, ahead of the traditionally strong Q1 and Q2 seasonal demand, although not to the level assumed in prior guidance, as a portion of the build would likely be deferred into 2022. With that, thank you for your time this morning. And I'll turn the call back to Nick for his closing comments.