Business context and reporting period
LKQ Corporation is a global distributor of alternative vehicle replacement parts and specialty vehicle products. This Form 10-Q covers the quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods. Amounts below are in U.S. dollars unless stated otherwise.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $3,030.8m | $2,458.4m | $5,751.5m | $4,801.3m |
| Gross margin | $1,161.9m; 38.3% | $965.0m; 39.3% | $2,215.9m; 38.5% | $1,895.1m; 39.5% |
| Operating income | $256.8m; 8.5% of revenue | $244.6m; 9.9% | $483.4m; 8.4% | $480.3m; 10.0% |
| Net income attributable to LKQ stockholders | $157.0m | $150.9m | $310.0m | $287.2m |
| Diluted EPS from continuing operations | $0.50 | $0.49 | $0.99 | $0.94 |
Q2 SG&A was $826.0m (27.3% of revenue), restructuring and acquisition expenses were $15.9m, and net interest expense was $38.3m. For the first half, those amounts were $1,592.9m (27.7%), $19.9m, and $66.8m, respectively. The effective tax rate was 27.9% in Q2 and 26.3% for the first half, versus 33.6% and 33.8% in 2017; the lower rates primarily reflect the U.S. tax rate reduction.
First-half operating cash flow was $328.7m, compared with $362.1m a year earlier. Capital expenditures were $115.4m, versus $91.5m. Investing activities used $1,249.2m, principally reflecting $1,136.0m of acquisitions; financing activities provided $1,054.3m. Cash at June 30 was $345.2m.
Gross debt was $4,476.0m at June 30, 2018, up from $3,428.3m at December 31, 2017. Current maturities were $182.0m. Cash plus available credit facilities provided reported total liquidity of approximately $1.9bn, including $1.6bn of facility availability. The company reported compliance with credit-agreement covenants.
Material changes versus the prior comparable period
- Q2 revenue increased 23.3%; management attributed growth to organic growth (8.5%), acquisitions (12.1%) and foreign exchange (2.8%). First-half revenue rose 19.8%, comprising 6.6% organic growth, 9.2% acquisition growth and 3.9% foreign-exchange benefit.
- Despite higher sales and income, gross and operating margins declined in both comparisons. Management cited mix and input-cost pressures in North America, and U.K. distribution issues, customer incentives and competitive pricing in Europe.
- Europe supplied much of the acquisition-driven growth: LKQ acquired Stahlgruber on May 30 for consideration valued at approximately $1.4bn, including $1.1bn cash and $251m in LKQ shares. Stahlgruber contributed $168m of revenue and $6m of operating income from acquisition through quarter-end. Q2 Europe revenue also benefited from currency translation.
- Interest expense increased, primarily because of higher debt and interest rates. Gross debt increased following the Stahlgruber acquisition and related financing, including €1.0bn of Euro Notes issued in April.
- First-half 2017 included the discontinued glass-manufacturing business and a $301m disposal-related cash inflow; neither contributed to 2018 results.
Outlook, management commentary, risks and contingencies
The filing provides no numerical earnings guidance. Management said current liquidity and expected operating cash generation should meet current operating and capital requirements, but may not cover future acquisitions depending on their size. It expects additional 2018 acquisition-integration costs; remaining costs to complete the identified integration plans were expected to be less than $15m.
Management identified foreign exchange, interest rates and commodity prices as market exposures. A 10% currency movement was estimated to change first-half consolidated revenue by 4.5% and operating income by 2.6%; a 100-basis-point interest-rate change was estimated to affect interest expense by $9m over the next 12 months. Metals-price movements can affect both salvage inventory costs and scrap revenue, with timing differences creating margin volatility. Risks also include tariffs and trade restrictions, supplier and freight disruptions, salvage-vehicle availability and acquisition integration. LKQ noted that China’s ban on certain solid-waste imports could pressure prices for some metals.
LKQ received an EPA Notice of Violation alleging certain performance parts sold from 2015 to 2017 violated Clean Air Act requirements; negotiations were ongoing, and any likely penalty was not expected to be material. The company also disclosed a pending U.K. competition-related divestiture of certain Andrew Page locations and a related $2.4m impairment of held-for-sale net assets. It stated that ordinary-course litigation and environmental contingencies were not expected to materially affect its financial position, results or cash flows.
Other notable items: adoption of the new revenue standard had an immaterial expected ongoing net-income effect, though it changed balance-sheet and income-statement presentation. The company anticipated that the new lease standard would materially affect its balance sheet and disclosures. Stahlgruber purchase-price allocations remained preliminary, including valuations of acquired assets and liabilities.
Important facts for investors to verify
- How much reported revenue and profit growth reflects organic performance versus acquisitions and foreign-exchange movements, particularly in Europe.
- Whether the weaker gross and operating margins persist, and whether U.K. distribution challenges and integration efforts improve as expected.
- Post-acquisition debt, interest expense, covenant headroom and cash-flow capacity, including the costs and expected benefits of Stahlgruber.
- The outcome and financial effect, if any, of the EPA matter and the U.K. competition-related divestiture.
- Final purchase accounting for Stahlgruber, and the eventual balance-sheet effect of adopting the lease standard.