LKQ Corporation — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; unaudited. LKQ distributes vehicle replacement parts and services, recycled and remanufactured products, and specialty automotive products through North America, Europe, and Specialty segments. Results began to reflect the COVID-19 downturn, particularly in March.
Financial results and liquidity
| Metric | Q1 2020 | Q1 2019 / comparison |
|---|---|---|
| Revenue | $3.001 billion | $3.100 billion; down 3.2% reported and 2.2% organic |
| Gross margin | $1.214 billion; 40.4% of revenue | $1.208 billion; 39.0% |
| Operating income | $241.8 million; 8.1% margin | $222.4 million; 7.2% margin |
| Net income attributable to LKQ stockholders | $145.1 million; diluted EPS $0.47 | $98.0 million; diluted EPS $0.31 |
| Operating cash flow | $194.6 million | $177.2 million |
| Capital expenditures / free cash flow | $44.5 million / $150.0 million | $53.0 million / $124.2 million |
| Total debt | $3.789 billion | $4.072 billion at December 31, 2019 |
| Cash and credit availability | $332.8 million cash; $1.528 billion facility availability; $1.861 billion total liquidity | Total liquidity $2.446 billion at December 31, 2019 |
The reported earnings increase included a $39.5 million improvement in equity-method results: Q1 2019 included a $40 million impairment of the Mekonomen investment. Q1 2020 also included a $12.8 million loss on early debt extinguishment. Cash declined during the quarter, in part because LKQ redeemed $600 million of U.S. notes and repurchased $88 million of stock. The company reported $91 million of current debt maturities and was in compliance with credit covenants at quarter-end.
Material changes and segment performance
- Parts and services revenue declined 4.6% overall: North America down 4.2%, Europe down 5.8%, and Specialty down 1.5%. Organic parts and services revenue fell 3.5%, including a benefit from one additional selling day.
- Management attributed the sharp March revenue declines to COVID-19 restrictions, reduced driving, and fewer collisions. Before the pandemic, parts and services revenue through February was slightly below the prior year in North America and slightly above it in Europe and Specialty.
- North America Segment EBITDA rose to $211.4 million from $176.6 million, with margin increasing to 16.4% from 13.6%. Higher precious-metals and scrap-related revenue and margin initiatives contributed.
- Europe Segment EBITDA fell to $78.3 million from $105.3 million; margin declined to 5.7% from 7.3%. Lower revenue, COVID-related bad-debt expense, and operating-cost deleverage weighed on results.
- Specialty Segment EBITDA decreased to $32.2 million from $38.0 million; margin declined to 9.2% from 10.7%, reflecting lower demand, product and channel mix, and higher inventory reserves.
- SG&A rose to 30.0% of revenue from 28.9%, partially offsetting improved gross margin. Foreign-currency translation reduced reported revenue growth by 1.2 percentage points.
Outlook, risks, and unusual items
- LKQ provided no specific full-year earnings or revenue guidance in the filing. It expected full-year 2020 results to be adversely affected by COVID-19, a significant profitability decline in Q2, and a gradual recovery in the second half, subject to substantial uncertainty. Management expected positive 2020 free cash flow, but below 2019.
- The company reported significant percentage declines in revenue across segments in the second half of March and into April. Cost actions included furloughs and workforce reductions, reduced hours and compensation, route consolidation, temporary branch closures, lower inventory orders, deferred projects, and a halt to share buybacks.
- Management’s impairment forecasts assumed Q2 revenue could be as much as 50% below its prior forecast, followed by gradual recovery. No goodwill impairment was recorded; the Europe reporting unit’s estimated fair value exceeded carrying value by at least 12%. The Warn trademark’s estimated fair value exceeded carrying value by about 9%. Further deterioration could lead to impairment charges.
- The Mekonomen investment had a $116 million carrying value versus a $67 million quoted fair value at March 31. LKQ concluded the decline was not other-than-temporary, but said a prolonged impairment could result in a future charge.
- LKQ was discussing a credit-facility amendment with lenders in case pandemic-related declines threatened its net-leverage covenant. It believed an agreement would be reached; the maximum leverage limit tightens in Q2. Failure to meet covenants could restrict borrowing or cause default.
- Planned restructuring costs included an estimated $50–$60 million for the 2020 global program. The multi-year 1 LKQ Europe program was delayed in part; estimated program costs were $100–$125 million for 2020–2021 and an additional $80–$100 million through expected completion in 2024.
- Other notable items: the Czech Republic business sale resulted in a $1 million discontinued-operations loss; foreign currency translation and other items drove a $113.0 million comprehensive loss component; and the new expected-credit-loss standard contributed to an increase in receivables reserves, which reached about $60 million.
Important facts for investors to verify
- Subsequent-quarter revenue, customer collections, inventory conversion, and the pace of recovery from COVID-19 restrictions.
- Liquidity, covenant headroom, lender-amendment status, and the effect of the $600 million note redemption and Q2 note-interest payments.
- Whether Europe’s profitability and customer credit quality stabilize, and whether any goodwill, trademark, or Mekonomen impairment becomes necessary.
- Actual restructuring and 1 LKQ Europe costs, timing, and savings, as well as any government assistance received.
- Changes in precious-metals and scrap prices, foreign-exchange rates, variable-rate debt exposure, and the impact on margins and interest expense.