LKQ Corp

NASDAQ:LKQ

Earnings Call Transcript 2020-Q1

[Operator]

Thank you for joining LKQ Corporate’s First Quarter 2020 Earnings Conference Call.

I would now like to turn the call over to your host, Joe Boutros, LKQ’s Vice President of Investor Relations.

[Joe Boutros, Vice President-Investor Relations]

Thank you, operator. Good morning, everyone, and welcome to LKQ’s first quarter 2020 earnings conference call. With us today are Nick Zarcone, LKQ’s President and Chief Executive Officer; and Varun Laroyia, Executive Vice President and Chief Financial 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 next few days.

And with that, I’m happy to turn the call over to our CEO, Nick Zarcone.

[Nick Zarcone, President and Chief Executive Officer]

Thank you, Joe and good morning to everybody on the call. This morning, I will provide some high level comments related to our performance in the first quarter, discuss the revenue headwinds we are facing in each of our segments related to the COVID-19 pandemic, provide an overview of the actions we are taking during this very challenging time, and finally describe some of the fallouts our industry is experiencing. Varun will dive into the financials with a key focus on the leverage we are pulling across the entire organization to right size the cost structure and maximize cash flow. He will also discuss our liquidity and the strength of our balance sheet before I come back with a few closing comments.

Clearly a lot has changed in the last 60 days as we face this humanitarian tragedy. Our hearts go out to all those impacted by the virus both at LKQ and the population at large. The global effort to combat the virus would not be possible without those on the frontline; doctors, nurses, first responders, and all those putting themselves at risk to serve their communities and the communities where LKQ operates across the globe. For that, I extend a big thank you and offer sincere appreciation from the LKQ family to those individuals for their heroic services.

Taken as a whole, we got off to a great start in 2020 and are pleased with our first quarter results. In order to understand the first quarter activity, one needs to separate the pre-COVID-19 pandemic period of January and February from the month of March. Through February, each of our segments were in line or ahead of our revenue and profit expectations. The efforts by governments around the world have flattened the infection curve and slow the spread of the virus through social distancing, self-isolation, shelter-at-home orders and the like have had a profound negative impact on mobility and miles driven.

While auto repairs and related parts supply has generally been deemed an essential service, and we have continued to serve the needs of our customers, activity levels at the repair shops in North America and Europe has dropped precipitously. The speed at which the economic fallout from the virus prevention measures has impacted all industries, reflects a rate never seen before. It was like operating within two completely separate economies during a single quarter.

We clearly lost operating leverage in March with the speed of the revenue decline outpacing our ability to reduce costs. I’m going to use adjusted earnings per share as the proxy. The February year-to-date adjusted earnings per share was up over 20% relative to the same period in 2019, while the month of March was down by more than 27% despite having an additional selling day. I will quickly address the Q1 results and then provide some detail on the revenue trends for each of our reporting segments during the first few weeks of April.

As noted on Slide 11, total revenue for the first quarter was $3 billion, reflecting a 3.2% decrease from the level recorded in the comparable period of 2019. Global parts and services organic revenue declined 3.5% in the first quarter and 4.7% on a per day basis. The primary driver for this decrease was a 13.9% per day organic revenue decline in the month of March when all the stay at home mandates began to take effect. From an earnings per share perspective, the first quarter results were solid with diluted EPS on a GAAP basis of $0.48 compared to $0.31 last year. On an adjusted basis, diluted EPS was $0.57 compared to $0.56 or a 2% increase. With the negative impact of COVID-19 on the March 2020 monthly result, we believe showing any year-over-year growth is an achievement and it’s a testament to the strength of our business coming into 2020.

Now on to the segments. As witnessed during the financial crisis from 2007 to 2009, the automotive aftermarket is fairly recession resistant, exhibiting a decline of only 1% during a period that saw new car sales fall by 42%. Miles driven during that period declined less than 3%, but what we are witnessing today is entirely different. As you will note from Slide 10, organic revenue growth for parts and services for our North American segment in the first quarter declined 4.2% or 5.6% on a per day basis.

Looking solely at January and February, North America organic revenue was down 1.1%, but the majority of that negative movement reflecting our decision to terminate the FCA battery contract in the fourth quarter of last year and to a lesser amount due to a very warm winter season. CCC estimates that collision and liability-related repairable claims in the first two months of 2020 were down about 4%, so we continued to outperform the market as a whole.

During March, we experienced organic revenue declines of 13.9% on a per day basis, with most of that coming in the back half of the month compared to a CCC estimate for repairable claims in the month of March being down by approximately 20%. For the entire quarter, the 4.2% organic decline was significantly less than the 9.9% decrease in collision and liability-related auto claims reported by CCC for the first quarter as a whole.

I’d like to highlight that over the last 44 quarters through the full year 2019, our North American segment has only witnessed two quarters of negative growth, a track record we are very proud of. I would also like to highlight that despite the revenue decline, EBITDA margins in North America hit a high of 16% in Q1. The organic revenue decline for parts and services for our European segment in the first quarter was 3.4% or 4.5% on a per day basis. Again, this was mostly related to a 10.3% or 13.7% per day decline in the month of March.

Importantly, not all regions were impacted by the COVID-19 pandemic, at the same time creating a different growth profile for each of our European businesses in the quarter. Italy was the first country to report a significant number of COVID-19 cases and the first to lockdown the mobility of its citizens, particularly in the heavily industrialized areas in the northern part of the country. We saw an immediate impact on our Italian sourced revenue in the last week of February and the first week of March.

The UK on the other hand, did not issue stay at home orders until later in the month and revenue was in line with budget until the week of March 23, when it began a steep decline. Lastly, during the first quarter, our Specialty segment had an organic revenue decline for parts and services of 1.4% or 2.9% on a per day basis. Importantly, when looking at January and February combined, specialty witnessed a 4.3% organic revenue growth rate with March declining 11%.

It’s important to look at the January and February performance in isolation given many were concerned that the weakness – specialty witnessed in the fourth quarter would persist and clearly that was not the case as we started 2020 very strong. I’d also like to acknowledge and congratulate our specialty team being ranked the number one national RV parts distributor to do business with. And number one for having the fastest delivery in the industry, both according to RV Pro’s annual dealer survey. While Q1 results were reasonably strong, our industry certainly left the quarter on a very soft note and the first few weeks of April were even weaker.

So where is the activity level in our industry and for our company? According to a report published by McKinsey & Company, during the week of March 17, the headwinds from social distancing reduced miles driven in the United States by 40% to 50% and accident frequency was down by up to 60% in certain key markets. Also consumer surveys conducted by McKinsey show that U.S. households are trying to reduce their trips by roughly 50% with 45% of the respondents expecting to delay any auto repair servicing.

INRIX, which provides vehicle traffic and parking data and analytics, reported that across the 98 metropolitan areas it is currently tracking total travel during the week of April 4 was down 51% from what it was in the corresponding week in February. In addition, the U.S. Energy Information Administration has indicated gasoline conception declined 50% from mid March to April 3. Further evidence of low volumes in the last month alone, the top five U.S. auto insurance carriers have given over $6 billion in rebates to their policy holders because of the dramatic drop in accident frequency from lower miles driven, which are pushing insurance loss costs lower.

Snapsheet an automatic insurance claims processor that works with 85 different insurance carriers reported that collusion-related claims in late March were down 40% to 50%, which could possibly be the bottom of the business in the last 50 years. The 40% to 50% drop in claims and repair volume was echoed in a March 27 press release by The Boyd Group, which was one of the largest MSOs in the collision repair industry.

While Service King, another large MSO issued a release on April 15, indicating they had closed 40 of their repair facilities due to low demand. Europe is also witnessing similar headwinds. According to an Apple Mobility trends report during the first three weeks of April, driving declined over 50% in our top five European markets. With that as a backdrop, it should be no surprise that during the month of April, our daily revenue has been trending about 40% below 2019 levels.

In North America, salvage revenue has been closer to the 35% down mark with recycled engines and transmissions performing better than collision parts. Aftermarket collision parts is down more than 40%, while glass and paint are down about 42% and 36% respectively. In Europe, the revenue declines in April vary by region with our operations in Germany and Central and Eastern Europe reflecting declines of approximately 25%, the Benelux region being down about 40%, the UK being down 50% and Italy being down over 60%. When taken together for the month of April, we are trending about 40% below last year.

Our specialty unit started the month down 40% compared to last year, the last week saw an uptick in activity and April will likely come down 30%. The main question all businesses are facing is how long these conditions will process. And frankly, the answer is impossible to predict. What we can focus on is to hear and now and address the dynamics that we can effectively control. Governments around the globe are trying to figure out both when and how to reopen their economies. When the lockdown measures are lifted, we do believe vehicles will start getting back on the road, but we don’t anticipate miles driven will snap back to pre-COVID-19 levels immediately.

Over the past week, we have seen slight increases in activity in most of our businesses relative to earlier in April, but those upticks are relative to the recent lows and it’s too early to determine whether they are sustainable. There is significant uncertainty in the market, but we are working under the assumption that these depressed levels will persist through a good part of Q2 with demand beginning to see a modest rebound in Q3 and heading towards more normalized levels in Q4, but likely not back to 100% until sometime in 2021.

As the pandemic began to accelerate and governments began to implement public safety measures, it was apparent that our mode of operation also needed to change because of the health and safety of our teams, our customers and suppliers. Almost immediately across our global footprint every major operation developed a COVID-19 response team to share ideas and stay informed. Each of our segments has a group responsible for pushing valuable information throughout the tranche and for helping to ensure we are maintaining a safe workplace. Our efforts related to enhanced hygiene and sanitation, social distancing and the use of PPE all has an impact on productivity, but it’s the right thing to do.

Simultaneous with these enhanced safety efforts and as soon as revenue began to fall, we started to aggressively attack our cost structure. We have initiated a variety of headcounts actions, including the elimination of our overtime and temporary workers, extensive employee furloughs, permanent reductions in our workforce, decreased hours for many still on the payroll and participating in some of the social programs offered to employers in several European countries.

Through these various efforts, as of last Friday, we hit effectively neutralize the cost of over 16,750 employees. Said another way, in a matter of few short weeks, we have largely removed the cost of approximately one-third of our global workforce. The numbers are both staggering and incredibly painful, particularly for a company that believes our biggest asset is our people. The payroll related items in aggregate represent our single largest SG&A expense category. So these very difficult decisions were necessary to protect the long-term health of our company.

In addition to the head count adjustments, we have also instituted salary reductions effective in April, eliminate most all discretionary non-mission critical spending, instituted a ban on business travel, accelerated the pace of branch closures both temporary and permanent and focused on the overall efficiency of our distribution networks and routes structures across each segment. When viewed on a company wide basis, over the past few weeks between our concerted actions and normal variable elements, the cost footprint of our company has been temporarily reduced by $80 million to $90 million per month, reflecting an annualized run rate of approximately $1 billion.

While we don’t anticipate actually saving $1 billion as we will need to bring our people back onto the payroll and add cost back into the business as volumes begin to return to pre-COVID-19 levels, it highlights the magnitude of the cost adjustments we’ve made. With respect to the 1 LKQ effort in Europe, the new revenue environment has required us to hit the pause button on some elements of the program, like the new ERP deployment, which was going to require a large team of people to be in Italy, the location of our next deployment. We have also delayed some of the other organizational changes.

We have however, accelerated some other programs such as the rationalization of some of our branches, particularly in Central and Eastern Europe. With revenue running at just 60%, our pre-COVID-19 levels, it’s virtually impossible to gauge the near-term benefits of the 1 LKQ Europe program, but we remain convinced it is the right long-term strategy for our business. Varun will provide more detail on the cost saving initiatives in a few minutes.

When COVID-19 first surfaced in China back in January, the immediate concern was the potential impact on the world supply chain. I am happy to report that our supply chain is intact. We have not experienced any major disruptions in terms of inventory shortages or stock outs. Indeed, we started 2020 with a high level of inventory as we headed into the seasonally strong selling period. We have been working with our suppliers to secure full availability of our aftermarkets product range during the crisis. While some aftermarket parts suppliers, furnishing our various businesses has experienced some reductions in capacity. We have reduced replenishment orders as our revenue has declined. On balance, we believe, we will not have material issues with our aftermarket supply chain going forward.

On the salvage side as miles driven and the number of total losses have both decreased dramatically. The number of cars available at the auctions has declined as well. It will take some time for this particular supply chain to gear back up as it can often take up to 60 to 70 days for a totaled car to reach the auction. But we’re confident that we can manage our purchasing and utilize existing inventory to meet customer demand for recycled products. I’d like to extend a sincere thank you to all of our supply partners as they also confront this pandemic and are working hard to help us to continue to service our customers.

Like any economic downturn, some businesses will suffer more than others and given the absolute violent nature of this contraction, we believe it will be true even in the historically resistant auto parts sector. The speed and magnitude of the demand shift will be too much for some of the less well capitalized distributors to endure. Already, there have been some smaller distributors in the U.S. they have shut their door at least on a temporary basis while waiting for federal funding to arrive.

In Europe, one of the largest online parts distributors, ATP declared insolvency. Loren, a large distributor in France is in bankruptcy and HART, a large Polish distributor closed it stores for several weeks before just reopening this past Monday. There will be more. While, it does little in the near term, longer term, it means that there will be a natural consolidation of industry demand amongst a fewer number of market participants.

With the leading positions in most all of our respective markets, I believe, LKQ is well positioned to take advantage of these subtle shifts in the competitive landscape. To be sure the downturn will also impact the repair shops and we would expect a similar reallocation of demand to the larger, better capitalized organization. We have a close watch in our receivables to ensure we get paid for the parts are already delivered and installed. And not unlike during the great recession, we have seen a total collapse of new vehicle SAAR across the globe.

In the United States, new car sales fell about 13% in the first quarter and 38% in the month of March. In the European Union, new car sales were even softer, dropping 25% in the first quarter compared to last year with a 55% decline in March. We anticipate the April and May resolves on a global basis for what more like March than January, so the second quarter will likely be very soft as well. These massive declines in new car sales will ultimately lead to an older car park which favors the aftermarket parts industry and will ultimately be good for LKQ.

At this point, I will turn the call over to Varun.

[Varun Laroyia]

Thanks, Nick, and good morning to everyone joining us on the call. What difference 60 days can make? We ended February feeling really good about the start of the year and our prospects for 2020, and now we are working through a global pandemic that has impacted lives and economies in ways that have not been seen in generations. In these unusual circumstances, I will deviate from the usual commentary and focus on forward-looking matters as opposed to our latest quarterly results.

Nick has already commented on the revenue trends. So I will handle the cost actions. We have taken as well as our liquidity position. However, to start, I am going to briefly discuss the financial highlights from our first quarter. North America reported segment EBITDA margin of 16.4%, a 280 basis point improvement relative to the prior year. The improvement is driven by gross margin expansion, while a portion of the benefit is attributable to the several ongoing margin initiatives, increased revenue from precious metals and better pricing realized sequentially on scrap metal represented the largest incremental growth driver.

Continuing a trend discussed on last quarter’s call, precious metals prices surged to record levels in early 2020 providing significant upside in both our wholesale and self service businesses. In April trading, we’ve seen moderating prices of precious metals going to lower new car sales and do not expect the same level of upside in the near term.

Overall gross margins and wholesale operations and self service increased by 210 and 90 basis points respectively, with a further 20 basis point improvement for the mix effect resulting from the disposal of our aviation business in the third quarter of 2019. Europe segment EBITDA margin of 5.7% represented a 160 basis points decrease relative to 2019.

Do note that this includes approximately 30 basis points of incremental transformation expenses incurred in the quarter. On a positive note, gross margin for the segment increased by 40 basis points. The negative leverage effect from the sales decline in March as the stay in shelter programs began. The incremental transformation expenses and certain unfavorable reserve adjustments pushed overhead expenses up 220 basis points compared to 2019.

Specialty reported a segment EBITDA margin of 9.2%, a 150 basis point decrease relative to the prior year. Gross margin declined by 110 basis points due to unfavorable mixed effects and an increase in inventory reserves. At a consolidated level, net interest expense decreased by $10 million going to the lower average debt level and it lower average interest rate. This variance is the direct result of the excellent work our teams have done over the past 18 plus months.

To focus on cash flow, allowing us to pay down debt in the trailing 12 months. We have also benefited from the redemption of our four and three quarters U.S. senior notes in January of this year, financing it with cash and borrowings from lower cost facilities. Our effective tax rate was 29.2% for the quarter, which included a 250 basis points increase over the annual effective rate assumed in our guidance, resulting in a $0.02 per share negative effect on adjusted diluted EPS, again, relative to prior guidance.

The rate increase is primarily attributable to the impact of lower projected full year pretax income, which results in higher suspended interest deductions in certain foreign jurisdictions. We expect volatility in the tax rate, this year given the potential for varying outcomes in our full year results.

Operating cash flows in the quarter were $195 million, which represented a 10% increase over the same period in 2019. Free cash flow of $150 million was a 21% improvement over the prior year leading to a net debt to EBITDA ratio of 2.5 times, based on our credit facility definitions. We use our free cash flow along with cash on hand to rebate $230 million of debt and return $88 million to our stockholders in the quarter. We were happy to see the momentum of 2019 cash flow generation carry through into the first quarter.

Now I’ll move into our plans for the remainder of 2020. As Nick referenced earlier, the growth in revenue during March took place very quickly as governments’ implemented measures to contain the outbreak. With restrictions and movement puts in place across multiple countries. We understood that demand would decline for reasons that were outside of our control. And so we shifted our attention to what we could control. That is, one, reducing costs to reflect the new level of market demand, and two, continuing the focus on cash flow generation.

Each of our segments took immediate action to develop an implemented plan to rationalize their respective cost structure. Nick described the key aspects of our cost reductions, which essentially fall into three categories. One, personnel-related actions, two, variable cost decreases that follow the lower projected revenue, including route consolidations and brand rationalizations, and three, the elimination of discussed of discretionary and non-mission critical spending.

Our current estimates indicate run rate savings of roughly $80 million to $90 million per month. More than half that production is attributable to headcount related actions as it is the largest line item in our operating costs. We won’t reach the full run rate savings during April, as we will continue to incur employee costs related to paid time off until those hours are exhausted and the continuation of healthcare benefits for a further period. Our plans are dynamic and we will be adjusting them based on developments with the outlook on the COVID-19 virus. We will be diligent in not bringing the expense back early and intend to wait for a sustained revenue improvement before adding costs back into the business.

To reinforce a point Nick made earlier, the cost actions include the deferral of certain elements of our 1 LKQ Europe program also. The decision to delay portions of the project including the establishment of our head office in Switzerland was it difficult one, given the long term benefits anticipated from the program. However, our current focus is to protect our employees and the business during this market disruption. We are committed to fully returning to the program once conditions have stabilized.

The deferral along with the impact of COVID-19 on our volume, compromises our ability to deliver on the margin goals that we presented in our September 10, 2019 Investor Presentation. However, as the full lift on the duration and the severity of the COVID-19 induced disruption, we will reassess and communicate the project timeline and our margin expectations.

In addition to the COVID-19 cost actions, we have also initiated a restructuring program. These plans reflect a further round of rightsizing and integration in our North America and European operations and focused on closing underperforming operations. We expect to incur costs related to severance facility closures and asset impairment charges, amounting to a range of $50 million to $60 million of which approximately 20% will be non-cash.

The benefits of the program are anticipated to begin in the second quarter, but have not projected to reach the full run rate benefit until early next year. We often ask what percentage of our overhead cost of fixed versus variable. And there’s not really a simple answer. We have fixed costs such as facility rent, variable costs such as fuel consumption and sales commissions. And then finally, hybrid costs that can be adjusted at different levels of activity, but do not flex up and down with every revenue dollar change.

For example, we may be able to run a warehouse with 10 employees at a certain level of revenue. If the revenue increases or decreases by say 3%, we may not need to add or cut any headcount. However, if the revenue were to decline by 20% we would expect to reduce our warehouse headcount and potentially the number of drivers too. Reacting to the pandemic has highlighted this dynamic as we have had to come deep into a hybrid cost pool in an attempt to align the cost structure with the projected demand.

As shown on Slide 6, forecasted reductions in variable and hybrid costs represent approximately 30% of our monthly overhead expenses. While we pleased with the team’s efforts to reduce costs, it will be difficult to only cut our way to profitability. We retain a certain fixed cost base including facility rent and administrative expenses that will be more challenging to decrease.

Additionally, we must cover approximately $175 million of annual depreciation and amortization expense, excluding amortization of acquisition related intangibles which we add back in calculating adjusted diluted EPS, and approximately $115 million of annual interest expense that can’t be easily flexed. We are currently projecting the largest negative impact from the COVID-19 virus in Q2 with a gradual revenue and profitability improvement as the year progresses. So as you all know, this could easily change as the pandemic and the global response plays out over time.

Moving to liquidity, we feel that we’re in a good position to withstand the COVID-19 disruption. As I referenced earlier, there has been a significant shift in the world in the last couple of months. On February 20 of this year, we reported over $1 billion in operating cash flows for 2019 and set guidance at a similar level for 2020. Our net leverage ratio was 2.6 times compared to the maximum allowed ratio of 4.25 times.

As our cash flow generation programs have taken hold since 2018 and continued to increase the absolute level of cash being generated by each of our businesses, liquidity and debt covenants were low on the list of concerns going into 2020. Then the COVID-19 outbreak spread across the globe and folks became interested in everyone’s ability to comply with their respective financial covenants and retain access to the credit markets.

I’ll address our liquidity stats in two pieces, first, our current liquidity position and efforts to conserve cash, and second, the compliance requirements for all financing arrangements. We believe that our current liquidity and positive operating cash flow in future periods will be sufficient to meet our current operating and capital requirements. To support our liquidity position, during the COVID-19 pandemic, we’re focused on preserving cash during the expected period of reduced demand.

Our action plans to strengthen our current position include approximately 40% reduction or more than $100 million deferral of growth driven and non-mission critical capital projects, reductions in inventory replenishment rates to reflect current demand, active monitoring of customer receivables and terms, the continuation of the European vendor financing program, tax payment deferrals were allowable, and hold in our share buyback program, in addition to the cost saving measures previously discussed.

With $1.9 billion of total liquidity as of March 31, 2020, and $91 million of current maturities, we have access to funds to meet our near term commitments even if the pandemic effect extends longer than current expectations. We have a surplus of current assets over current liabilities of over $2 billion, which further reduces the risk of short term cash shortfalls.

Our total liquidity includes availability on our senior secured credit facility, which includes two financial maintenance covenants, maximum net leverage ratio and minimum interest coverage ratio. The maximum leverage ratio will be four times effective, our compliance certificate to be filed for the second quarter of 2020.

We are confident that we will be in compliance with the financial covenants in the second quarter though out of an abundance of caution and as an effective insurance policy, we have commenced discussions with our bank group regarding continued access to borrowings under our credit facility, if the impact of the COVID-19 pandemic has a severe and prolonged negative impact on our profitability.

Our euro notes do not include financial maintenance covenants and the indentures will not restrict our ability to draw funds on the credit facility, nor will the indentures prohibit our ability to amend the financial covenant under the credit facility as needed. By limiting our capital spending to mission critical projects and the strategic central distribution center in the Netherlands, we will preserve cash to support day-to-day operations, while generating a benefit to a depreciation expense for the year.

We will be judicious in balancing the cash generation while continuing to invest thoughtfully into the business and creating a long term sustainable advantage. And we are confident of being cash flow positive for the full year. Interestingly, while April is expected to be the worst month for revenue and profitability, I’m happy to report that the company did not need to drawdown on the credit facility and instead, we were able to pay down further debt in the month.

Finally, I’d like to close with a few comments regarding our outlook for the remainder of the year. As you know, we withdrew our full year guidance last month given the uncertainty created by the COVID-19 outbreak. Presently, there are too many unknowns to be able to provide full year guidance on revenue and profitability measures.

However, to prepare a March financials, we made a good faith estimate of the full year results based on information currently available and our resumptions include is severe short term impact followed by a gradual return to prior levels by 2021. This projection supports our analysis underlying the March financial statements including our interim goodwill impairment test, other impairment tests of intangible assets, assessments of the recoverability of inventory, calculation of the annual effective tax rate and evaluations of the realizability of deferred tax assets.

As the economic impact of the pandemic is dependent on variables that are difficult to project and in many cases outside of our control, it is possible that the estimates underlying our analysis may change in future periods. We are committed to providing investors with care and comprehensive disclosure regarding our results and future prospects, and we will share developments as appropriate going forward.

With that, I will turn the call back to Nick for closing remarks.

[Nick Zarcone, President and Chief Executive Officer]

Thank you, Varun. In closing, it is clear that our focus on profitable growth, enhanced margin and better free cash flow generation positioned as well as we entered this unexpected turn of events. Our teams have been agile and have done a fantastic job of tackling the cost structure, which is no easy task, especially when confronting the human element of these actions in a culture that is rooted in pride and comradery.

Our teams have embraced the idea that not all progress is measured by ground gained, but sometimes progress is measured by losses avoided. And for that, I am tremendously proud and thankful of everyone’s efforts to confront these very difficult times. What I know is one of the pandemic is in the rear view mirror and the economies around the world settle into the new normal, whatever that may be.

There will still be more than 275 million vehicles in the United States and over 305 million vehicles in Europe. The average age of these cars will increase and the resulting heightened demand for alternative repair parts and accessories will be serviced by a slightly smaller number of competitors. There inlays the opportunity for LKQ. That is why I have been coaching our leadership teams to focus both on getting this through the near term headwinds and to also keep one eye open for the longer term opportunities to gain market share and create more efficient operating models.

I’m confident that I’ll take you will not just survive the pandemic but will thrive in the post-pandemic economy. In my communication with a broader employee base, I have indicated we will get through this together and we’ll come out a stronger, wiser and better positioned organization that continues to be LKQ proud.

Operator, we are now ready to open the call for questions.

[Operator]

[Operator Instructions] Our first question comes from Stephanie Benjamin with SunTrust.

[Stephanie Benjamin, SunTrust]

Hi, good morning. I really appreciate all the extra color that you guys provided, particularly as you broke out, just the performance kind of through the first half of the quarter or more than that and then kind of how it deteriorated in March, including the CCC numbers? I was hoping maybe you could provide a little bit of color. I mean, it was such a strong outperformance versus the industry during those periods, whether it was the January through February and then also in March, so maybe you could provide some color on what you believe was driving that outperformance versus the overall just kind of volume numbers from the CCC numbers? I think that would be helpful. Thanks.

[Nick Zarcone, President and Chief Executive Officer]

I’ll take a shot at that that, Stephanie. Well, we offer to the North American collision repair industry, it is an ability to provide best-in-class service, and that goes to items like delivery times, the number of deliveries, on-time deliveries, the depth and breadth of our inventory, which – what we have nobody else can match. And we believe that we have always outperformed the marketplace because we offer a different value proposition as in most of our smaller competitors. And particularly when things started to slowdown and a number of businesses were really having to pull-in quickly, our capital base allows us to continue to provide what we believe as world class customer service, and over time that wins. But make no doubt, we always believe that the depth and breadth of our inventory is perhaps our biggest competitive advantage in the North American marketplace and the ability to get those parts to our customers on a reliable basis and on a very quick basis separates us from many in the industry.

[Stephanie Benjamin, SunTrust]

Got it. Well, for the sake of time, I’ll pass it on from there. Thank you.

[Operator]

Your next question comes from Bret Jordan with Jefferies.

[Bret Jordan, Jefferies]

Good morning, guys. On the North American gross margin, you called out metal scraps and precious metals driving a big chunk. Could you tell us how many basis points you picked up on metals just so we can get a normal margin run rate?

[Varun Laroyia]

Yes. Bret, it’s Varun here. Great question. Essentially, within our overall salvage operations, we do not break out precious metals on a car by car or an automotive -- on a unit-by-unit basis. What we do know is precious metals alone had close to a $50 million uptick in revenue on a year-over-year basis. As you think about it from that perspective, you can kind of do the math in terms of how much of that can actually flow through. There is a cost associated with getting to the precious metals that are found within the salvage vehicles. But again, as I said previously also, in the last quarter earnings numbers, our operating teams have just done a phenomenal job in positioning themselves to be able to extract and take advantage of what’s happening in the precious market -- in the precious metals market. So again, happy with the way they’ve performed in kind of essentially making their own destiny from that perspective.

[Nick Zarcone, President and Chief Executive Officer]

Yes. And at some point in time, the cost of the vehicle goes up or falls, based on the value of those metals. And what we’ve seen, as Varun indicated in his prepared comments, is those values have come back down. Not all the way back to where they were at the beginning of the year, but they have come back in.

[Bret Jordan, Jefferies]

Okay. Thank you.

[Operator]

Your next question is from the line of Michael Hoffman with Stifel.

[Michael Hoffman, Stifel]

Thank you. Good morning. I hope everybody in your family, friends, and colleagues are safe and healthy. Trying to take all of this great data, and the first pass quickly trying to adjust the model on the fly, you’ll still be profitable in 1Q and 2Q, but it’s going to be paper thin. Is that the right way to think about it?

[Varun Laroyia]

Yes. Michael, it’s Varun here. It all depends in terms of how the trend continues. As I – as Nick mentioned in his comments also, the first half of April was a continuation of March, which was down almost like 40% to 45%. In the last 10 to 12 days, we’ve seen a nice little uptick, but having said that, it is still down on a year-over-year basis. It all depends in terms of what the outlook is for the month of May and June. We also do know that in the month of April, here in the United States for example, with the folks that we’ve put on furlough, we essentially have allowed our folks to be able to run down their PTO balances. Essentially, we are paying them, which we believe will get exhausted by the end of April. In addition, we have continued health benefits for a certain period.

This is not the time to be pulling the rug from people’s – from under people’s feet given what’s happening out in the broader macroeconomic situation in any case. So April, we know from a profitability perspective, we’ll be challenged, but it all depends in terms of how May and June comes through. What we have said is that we have suspended guidance. And again, as and when numbers begin to come through for April month end and again, as we go through the quarter, we will update the markets. We do have a series of virtual NDRs and investor calls setup for later in the quarter. But again, at this point of time, we are not in the position to say, as to where Q2 will be coming through. It all depends in terms of how the next 60 days play out.

[Michael Hoffman, Stifel]

Okay. All right, I’ll cycle back and ask the next question. Thanks.

[Operator]

[Operator Instructions] Our next question comes from Craig Kennison with Baird.

[Craig Kennison, Baird]

Good morning. Thanks for taking my questions and the thorough slides and review. You had mentioned competitive disruption. I guess to the extent your competitors are struggling and you are able to take share. Can you serve that opportunity through your existing operations or would you need to expand branches or acquire businesses in some geographies to cover that potential opportunity?

[Nick Zarcone, President and Chief Executive Officer]

Craig, great question. No, we’re convinced that we have the footprint we need in most every market in which we operate to service more customers and with more volume. And actually, I think both Varun and I put in our formal remarks, we’re actually going to be consolidating some of the branch that work across the globe to gain further efficiencies. As these volumes have come in, we will – there is opportunity to get to even a more efficient footprint and we believe even though some of that is going to be on a permanent basis, that we will still be able to fulfill and even heightened the demand that will ultimately come out of this.

[Varun Laroyia]

And Craig, I’ll just going to add one more to what a data point to what Nick mentioned. In terms of the hypothesis that this will end up potentially being a gain share for LKQ, I understand it’s still early days, but across each of our three operating segments, we are seeing customers that we haven’t seen in quite some time. And I’m talking of a few years. So both in North America and in Europe, and then also in our specialty unit, we are seeing activity from customers that we haven’t seen for some time. And again, data is hard to come by in certain markets, but even where markets are down, what we are picking up from a market intel is that, we are outperforming our competitors in those specific markets. So back to your hypothesis, it is playing out now. And then to the additional point whether we need to expand our footprint, no, we believe our footprint is adequate. And in fact, we actually have an opportunity to essentially fine tune our geographic footprint through this period.

[Craig Kennison, Baird]

That’s helpful. Thank you.

[Operator]

Your next question comes from Gary Prestopino with Barrington Research.

[Gary Prestopino, Barrington Research]

Good morning. Just a quick question here, in terms of your customer base on the repair side, I mean, is it more or less the 80%-20% rule that, you’re doing 80% of the business with the 20% largest percent across both North America and Europe?

[Nick Zarcone, President and Chief Executive Officer]

No, it’s not quite that way Gary. The customer base is incredibly fragmented. I mean, there is – in the United States, for example, somewhere between 35,000 and 40,000 collision repair shops, in Europe, there’s literally hundreds of thousands of mechanical service and repair shops. So there are bigger entities there. We got the MSOs on the collision repair site in North America. You got some large chains over in Europe. But no, it’s not 80%-20%. So this is an industry, our customer base is an industry that’s represented by an incredibly fragmented group of competitors.

[Gary Prestopino, Barrington Research]

So is there any worries on a short term basis at least, with some of these smaller players coming – falling out of bed here, just closing shop, like you were talking about some of the competitive situation of other suppliers in Europe that are declaring bankruptcies?

[Nick Zarcone, President and Chief Executive Officer]

Absolutely. Whenever you have a severe economic contraction, small enterprises, this mom-and-pop enterprises, oftentimes, just don’t have the capital to endure. We actually have sponsored and promoted some educational sessions for our North American customer base to get some tapped into how to best utilize the government programs that are in place to fund small and medium-sized businesses, and so we ran and sponsored seminars that our body shop customers could dial into to understand how to navigate the loan program, for an example, because we want them see profitable segment business.

[Gary Prestopino, Barrington Research]

Okay. Thanks a lot.

[Operator]

We have a follow-up from Bret Jordan with Jefferies.

[Bret Jordan, Jefferies]

Good morning, again guys. You talked about, I guess Service King having shot a number of their branches. I think they also delayed a bond payment recently as well. Do you have any exposure either to them or any other major collision chains which you have to worry about as far as getting paid back at accounts receivable?

[Varun Laroyia]

Hey Bret, it’s Varun here. So let me take that question. Listen, as we closed out the first quarter of 2020, I will share with you, and again, this is the appropriate time to share it with everyone is the company has never been in a better position in terms of managing our past due receivables. Again, these things don’t happen by accident. We started the program, probably, in the better part of almost two years ago, because there was a massive opportunity in terms of the way our customer receivables were being managed. So again, as we closed out, we were in a very fortunate position, thanks to the phenomenal work of all our field operators, both in North America, but also in Europe.

To your specific question about one of our larger customers, we enjoy a great relationship with them. And yes, we also heard about the news, but I’m happy to report that as of the end of the first quarter, we were current with them across their receivables balance.

And then with regards to, call it other customers and stuff, listen, this is an evolving situation as of now. Nick mentioned the fact that we have a fairly fragmented customer base. The good news is several of our smaller customers do have the ability to drop on the payment protection – the paycheck protection plan. And we, certainly, are encouraging them to apply through the SBA side of things, in any case. But other than that, happy in terms of how we remain close to our customers. And again, we are confident on their ability to, again, gain share through this period. But again, no specific issues with receivable hits as such.

[Bret Jordan, Jefferies]

Okay. Thank you.

[Operator]

Your next question is going to be a follow-up from Michael Hoffman with Stifel.

[Michael Hoffman, Stifel]

Hi. So circling back, I think to get the point of clarity, if I could, on an early question. You shared $15 million of incremental sales in the quarter for metals, did I hear that correctly? So they gave you 100% credit for that? Because it is all price. Forget that you had cost. I pulled that out of the 2011 on the EBITDA. You still are 15% margins. Is that – am I doing something wrong? Just want to understand.

[Varun Laroyia]

No, Michael. The math is appropriate except for the fact that precious metals was close to $50 million up on a year-over-year basis.

[Michael Hoffman, Stifel]

$50 million, okay.

[Varun Laroyia]

Yes, absolutely. So I think that’s the piece to kind of think about. The second point is what we are currently seeing in April trading of precious metals, they have come off their record highs that we experienced earlier in the first quarter. So again, we do not anticipate that set of gains to be on an ongoing basis. The other piece to think about is, as we always talked about on the salvage side, scrap metal prices, while they were down on a year-over-year basis, it’s more kind of the sequential pricing, which matters to us. And sequentially, scrap metal was up about 23%. So that also helped the overall North America margin. So that’s how you should think about this. But again, precious metal was by far the biggest piece. But as I said, we don’t anticipate that upside to continue at least not in the near-term.

[Nick Zarcone, President and Chief Executive Officer]

But directionally, it’s correct Michael. Even without the impact of the metals, our margins would have been up.

[Michael Hoffman, Stifel]

Right. Okay. That’s – I was trying to get at that. And then back to the $80 million to $90 million. Is there a way to think about how that plays out between the two major regions as far as where it comes – where you can get savings? And then how much – if you learn to be leaner, how much of it do you get to keep permanently? I mean I get you can’t keep a whole $1 billion, but how much do you think you might keep?

[Nick Zarcone, President and Chief Executive Officer]

Well, half – as Varun indicated about half of the $80 million to 90 million is with people-related. And those adjustments have been made in each of the three segments: North America, Specialty and Europe. We have more people in Europe to start with. So you should assume that the majority of the 17,000 person adjustment came out of Europe, North America next and Specialty, obviously, being the smallest. All of our operating heads are working under the orders and the assumption that when we get back to 100% of revenue volume, whenever that is, that we should be able to service that without adding back all 17,000 people. That there has to be some embedded productivity gains coming out of that process.

We don’t have at this point in time, the magic answer is to whether that’s adding back 99% of our people or 95% of the people or 90% of the people. But we do anticipate that we will gain productivity from a human capital perspective. And the same with some of the other operating costs. Again, there are things we’re going to have to add back, but importantly as Varun indicated, we kind of do it kind of in arrears, is we’re going to make sure that revenue is there and sustainable and then add some back, and it will be gradual process as we walk back up with the hope that when we get to the – when we get back to 100%, we will not have added back 100% of the operating expense.

[Varun Laroyia]

And Michael to your specific question of how much of it is between the two geographies. It’s roughly half and half, so the $80 million to 90 million, roughly half in Europe and the other half here in North America. And then with regards to the key categories, just to reiterate, personnel costs is by far the single largest line item in our overall OpEx. And so that clearly is the bulk of it. But in addition to that, we do know that there are certain variable expenses such as the spend that we have on routes and deliveries and fuel. And we certainly are picking up that variability also as revenues have come in. So just to kind of give you that additional color for the sake of comprehensiveness.

[Michael Hoffman, Stifel]

Okay. And since we’re repeating or turning the thing, could I ask one more, just if I could, for the benefit of everybody. The world recovers. We get – we start to [indiscernible] again whenever it is, but it recovers. Do we get back to old revenue number in the U.S. from a collision standpoint? I get why we would in Europe on maintenance, if you’re driving your car, you got to do the maintenance. How do I get back to the old revenue number? I felt like I’m going to have a whole bunch more above average accidents.

[Nick Zarcone, President and Chief Executive Officer]

Ultimately, once the miles driven gets back to kind of pre-COVID levels and people are kind of back into their normal routines, the accident rates will – from a frequency perspective will move back, we believe to where they were, pre-virus, right? Once the roads and the highways are full of cars and other vehicles and that’s really what’s the key, Michael, is the number of accidents because that’s what drives repair volumes and ultimately what drives the demand for the repair parts that we supplied to the body shops.

Yes. So we’re comfortable that in time, assuming miles driven gets back that the frequency will be return, and that will be a strong driver of our revenue. The $64 question is when does that all occur, right? There’s anecdotal data out there now it’s from China, so it’s a very different economy. But what the Chinese have reported is that about 2.5 to three months after them hitting peak from a virus infection perspective, miles driven in individual vehicles was at 80% of pre-crisis levels. Contrast that to their public transportation volumes, which were only back to 40% of pre-crisis levels. So folks, at least in China, we clearly view their personal vehicle as being a safer mode of transportation than jumping on public transport. And that’s a good sign, right. What I suggest is that the same could happen here in the U.S. But just because – either on a federal basis or on a state basis, some of the restrictions get lifted, nobody should assume that miles driven is going to snap back to pre-virus levels.

I mean, I sit here in the state of Texas and our Governor on Tuesday, indicated that he was going to open up – start to open up the Texas economy this coming Friday. And that’s great because there’s all sorts of businesses that have been shut down. On the same day, one of the local news stations did a survey of 3,500 residents of Austin and 86% of them said, it was too much, too soon. So even though some of the restrictions may be lifted, it remains to be seen as to whether residents around the world are going to have the courage to actually venture out immediately and get back into their normal routines. We think it’s going to be a much more of a gradual return.

[Operator]

Our next question is from the line of Daniel Imbro with Stephens, Inc.

[Varun Laroyia]

Hey, good morning, Daniel.

[Daniel Imbro, Stephens, Inc.]

Thanks for squeezing me in. I think I dropped off for a second. So sorry if you touched on this, but Varun wanted to touch back on Europe in the 1Q. Something that stood out is just the gross margin leverage, just like pretty soft sales there. We talked a lot about North America and the metals pricing, but can you shed some more light on what drove that gross margin improvement in Europe? And then how you think about the sustainability of those drivers, obviously as near-term demand trends are pressured.

[Varun Laroyia]

Yes. I think Daniel, it’s far out here, just for the sake of everyone understanding, I think your question was there was a 40 basis point improvement in gross margin across our European segment and the sustainability of that. So yes, very happy with the way that has come through. The level of discipline that our teams have been putting out in Europe in the pursuit of profitable revenue growth and accretive margins that has continued to kind of come through. In the past where we may have been kind of chasing the last time down the rabbit hole. That discipline that the team has picked up has been tremendous.

And in these circumstances, chasing, chasing any and all revenue could become a fool’s errand and so essentially the teams have been focusing on only pursuing profitable revenue. In addition to that, as you know, we’ve been doing well from a centralized procurement perspective and those benefits have also accrued. But just think about the fact that, we’ve just been very disciplined from a pricing perspective. And that was something that was much needed over in Europe in addition to everything that the team has been doing from a centralized procurement perspective.

[Daniel Imbro, Stephens, Inc.]

Got it. That’s really helpful.

[Nick Zarcone, President and Chief Executive Officer]

We’re going to need to bring the call to a close. So just one last question and then we’ll wrap up. We’re a bit over. Did you have one last question, Daniel?

[Varun Laroyia]

Nick, I think we’re all done. We’re not showing anyone on the screen. So I think we’re all good to close off. So back to you.

[Nick Zarcone, President and Chief Executive Officer]

Okay, great. We greatly appreciate your time and attention here this morning. We’ve obviously shared a fair amount of information that normally we would not provide. But we thought it was important to provide additional clarity and transparency in this great time of uncertainty. So now we do appreciate you participating in our call. And we’ll be back together again in about 90 days with our second quarter results. Thanks everyone.

[Operator]

Ladies and gentlemen, thank you for participating. You may disconnect at this time.