LKQ Corporation — FY2017 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2017; fourth-quarter figures are also noted below. LKQ distributes aftermarket, recycled, refurbished and remanufactured vehicle parts, along with specialty vehicle products. It reports three segments: North America, Europe and Specialty. Growth relies on its distribution network, organic expansion and acquisitions.
Financial performance
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Revenue | $9.737 billion | $8.584 billion | +13.4% |
| Gross profit / margin | $3.800 billion / 39.0% | $3.352 billion / 39.0% | Margin unchanged |
| Operating income / margin | $847 million / 8.7% | $763 million / 8.9% | Income +11.0%; margin down |
| Net income attributable to LKQ stockholders | $534 million | $464 million | +15.0% |
| Diluted EPS from continuing operations | $1.73 | $1.47 | +17.7% |
| Cash from operating activities | $519 million | $635 million | Down $116 million |
| Capital expenditures | $179 million | $207 million | Down $28 million |
| Gross debt | $3.428 billion | $3.366 billion | Up $63 million |
Year-end cash was $280 million; credit-facility availability was $1.395 billion, for total liquidity of approximately $1.675 billion. Working capital was $2.499 billion. Operating cash flow less capital expenditures was approximately $340 million, versus $428 million in 2016. The company reported $847 million of operating income and $101.6 million of interest expense.
Segment EBITDA and margin: North America, $655 million and 13.7% (13.3% in 2016); Europe, $319 million and 8.8% (9.7%); Specialty, $142 million and 10.9% (10.7%). Segment EBITDA is a non-GAAP measure.
For Q4 2017, revenue was $2.470 billion, compared with $2.150 billion in Q4 2016. Operating income was $168 million versus $162 million; continuing-operations income was $123 million versus $96 million. Diluted EPS from continuing operations was $0.39 versus $0.31.
Material changes versus prior year
- Revenue growth was supported by acquisitions (+8.7 percentage points) and organic growth (+4.9 points); foreign exchange reduced growth by 0.1 point. Europe revenue rose 24.5%, primarily due to acquisitions, while organic growth was 5.3%.
- North America revenue increased 8.0%; management cited salvage volume and improved parts-per-vehicle performance. Higher scrap-metal prices contributed $12 million to segment EBITDA.
- Operating margin declined despite flat gross margin, as facility, distribution, SG&A and depreciation/amortization costs increased as a share of sales. Europe segment margin was pressured by Andrew Page integration costs, inventory reserves and Tamworth distribution-center costs.
- Operating cash flow declined, with inventory-related cash outflow increasing by $133 million year over year. Acquisition cash spending fell to $513 million from $1.349 billion.
Outlook, commentary, risks and unusual items
- Pending Stahlgruber acquisition: Agreement signed in December 2017 for enterprise value of €1.5 billion; expected to close in the first half of 2018, subject to regulatory approvals. LKQ planned to fund it with debt and issuance of 8,055,569 shares. A €75 million break fee may apply if the deal does not close.
- Tax reform: The company recorded provisional 2017 tax expense of $51 million for the transition tax and a $73 million deferred-tax benefit from the U.S. tax-rate reduction. Management expected lower 2018 tax payments, while noting that the law’s final effects remained under review.
- Other transactions and costs: LKQ sold PGW’s glass-manufacturing business in March 2017 for $301 million and recorded a $6.5 million after-tax disposal loss. It acquired 26 businesses during 2017, including Warn Industries. Expected 2018 acquisition-integration expenses were less than $15 million.
- Key risks: Significant debt and variable-rate exposure; execution and financing risks for Stahlgruber and other acquisitions; competition and OEM pricing/IP claims; dependence on insurance-company acceptance of alternative parts; salvage-vehicle supply and scrap-metal price volatility; foreign-exchange and Brexit uncertainty; import tariffs and Asian sourcing; environmental, product-liability, cyber/privacy, labor and regulatory risks; and potential demand effects from accident-avoidance and electric-vehicle adoption.
- Year-end gross debt included $2.1 billion of secured debt and approximately $1.2 billion of unsecured senior notes. The company was compliant with credit-agreement covenants at year-end; 48% of variable-rate credit-facility debt was fixed through hedges. A 100-basis-point rate increase on unhedged variable debt was estimated to add $11 million of interest expense over 12 months.
- Management reported no material pending litigation expected to affect the company and no off-balance-sheet arrangements. The auditor issued an unqualified opinion on the financial statements and internal controls; controls over certain 2017 acquisitions were excluded from the company’s assessment.
Important facts for investors to verify
- Whether Stahlgruber closes on schedule, the final purchase financing and share dilution, and realization of expected synergies.
- Whether organic growth and segment margins improve, particularly in Europe, and how much recent growth reflects acquisitions versus existing operations.
- Inventory levels, working-capital conversion and sustainable operating cash flow after capital spending and acquisitions.
- Debt repayment capacity, covenant headroom, interest-rate sensitivity and liquidity after the planned acquisition.
- Final Tax Act accounting and actual 2018 cash taxes; the 2017 tax estimates were provisional.
- Exposure to scrap-metal pricing, currency movements, imported inventory and any new tariffs or Brexit-related disruption.