LKQ Corporation — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. LKQ distributes vehicle replacement parts and specialty aftermarket products through North America, Europe and Specialty segments. Results include Keystone Specialty from its January 3, 2014 acquisition.
Financial performance
- Second quarter: Revenue was $1.709 billion, up 36.5% year over year; net income was $104.9 million, versus $75.7 million; diluted EPS was $0.34, versus $0.25.
- First half: Revenue was $3.335 billion, up 36.2%; net income was $209.5 million, versus $160.3 million; diluted EPS was $0.69, versus $0.53.
- Margins: Q2 gross margin was 39.3% versus 40.7% and operating margin was 10.2% versus 10.5%; net margin was 6.1% versus 6.0%. First-half gross margin was 39.7% versus 41.3%, and operating margin was 10.4% versus 11.2%.
- Cash flow and investment: First-half operating cash flow was $152.2 million, down from $209.5 million. Investing cash outflow was $702.3 million, including $635.3 million for acquisitions and $67.3 million of capital expenditures. Cash declined to $109.6 million from $150.5 million at year-end.
- Debt and liquidity: Total debt was $1.951 billion and net debt $1.842 billion at June 30, compared with $1.306 billion and $1.155 billion, respectively, at December 31, 2013. Cash plus available credit facilities provided $1.168 billion of reported total liquidity. Revolver availability was approximately $1.1 billion; the company reported compliance with its debt covenants.
- Segment EBITDA: Q2 North America was $137.2 million (13.4% of segment revenue), Europe $45.9 million (9.9%), and Specialty $28.4 million (13.0%). Management defines Segment EBITDA as excluding, among other items, restructuring and acquisition costs, depreciation and amortization, interest and taxes.
Material changes versus prior periods
- Acquisitions contributed 28.3 percentage points of Q2 revenue growth; organic growth was 6.6% and favorable foreign exchange added 1.7%. First-half growth included 28.7% acquisition-related growth, 6.3% organic growth and 1.2% favorable currency effects.
- LKQ acquired Keystone Specialty for consideration valued at $471.8 million and completed 15 additional acquisitions in the first half. Keystone contributed $394.8 million of revenue and $17.4 million of net income from acquisition through June 30.
- Acquired businesses with lower gross margins, including Keystone’s three-step distribution model, pressured consolidated gross margin. Existing North American operations improved margins, while European Segment EBITDA margin declined year over year, reflecting acquisition mix, higher operating costs and weaker-than-expected continental European sales.
- First-half operating cash flow fell despite higher earnings, principally as cash outflows for receivables, inventory and payables increased to $133.1 million from $42.2 million. Acquisition spending and borrowing also increased substantially.
Outlook, commentary and risks
- Management estimated full-year 2014 net income of $405–$430 million and diluted EPS of $1.32–$1.40, excluding restructuring and acquisition-related expenses, specified acquisition or divestiture gains and losses (including contingent consideration fair-value changes), and debt-extinguishment losses. It projected operating cash flow of approximately $375 million and capital expenditures of $110–$140 million, excluding acquisitions.
- Management cited expected acquisition synergies and cross-selling opportunities, but noted that European distribution costs may rise as it transitions toward direct delivery to repair shops. The company expected less than $1 million of additional Keystone integration costs in the second half of 2014 and said future costs for other integration plans were not expected to be material.
- Interest-rate exposure increased with debt: 45% of variable-rate credit-facility debt was fixed through swaps at June 30, versus 78% at year-end. Management estimated a 100-basis-point rate move would change interest expense by $7.3 million over the next 12 months. Foreign exchange, metals prices, salvage-vehicle costs, weather, and economic conditions may also affect results.
- LKQ disclosed an intellectual-property dispute with Chrysler settled in June 2014 under an arrangement expiring in June 2019; a separate Ford settlement expires in March 2015. The filing warns that successful OEM claims could restrict aftermarket product sales and entail significant defense costs. Management said resolution of ordinary litigation and environmental contingencies was not expected to materially affect results.
- The filing lists $748.9 million of future minimum operating lease payments. The receivables securitization facility, with $80 million outstanding, matures in September 2015; management expected to seek an extension but gave no assurance it could do so on acceptable terms.
Most important facts for investors to verify
- Whether the full-year earnings and cash-flow outlook is achieved, including the stated exclusions and assumptions.
- Whether acquired businesses deliver expected synergies and whether lower-margin acquisition mix or European operating costs continue to weigh on margins.
- Debt, interest-rate exposure, covenant headroom, and refinancing or extension plans for the receivables facility.
- Working-capital needs and cash conversion as inventory, receivables and the business expand.
- Developments in OEM intellectual-property matters, especially the Ford settlement’s March 2015 expiration and any effect on product availability.