Business context and reporting period
LKQ Corporation is a global distributor of alternative vehicle replacement parts, maintenance products and specialty accessories, with reportable segments in North America, Europe and Specialty. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods. Unless stated otherwise, amounts below are in U.S. dollars.
Key financial metrics
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Revenue | $3.248B | $3.031B | $6.348B | $5.752B |
| Gross margin | $1.247B; 38.4% | $1.162B; 38.3% | $2.455B; 38.7% | $2.216B; 38.5% |
| Operating income | $236.1M | $256.8M | $458.5M | $483.4M |
| Net income attributable to LKQ stockholders | $150.6M | $157.0M | $248.6M | $310.0M |
| Diluted EPS attributable to LKQ stockholders | $0.48 | $0.50 | $0.79 | $0.99 |
| Operating cash flow | — | $638.4M | $328.7M |
Q2 revenue rose 7.2% year over year, comprising 12.0% acquisition growth, offset by 2.4% lower organic revenue and 2.4% adverse foreign exchange. Q2 operating margin was 7.3% versus 8.5%; SG&A was 27.7% of revenue versus 27.3%. First-half operating margin was 7.2% versus 8.4%, while SG&A was 28.3% versus 27.7%. Reported revenue growth was substantially acquisition-driven, particularly in Europe.
Q2 segment EBITDA was $190.0M in North America (up 8.6%), $116.3M in Europe (up 4.9% reported; up 10.4% at constant currency), and $52.4M in Specialty (down 6.6%). Europe’s reported revenue growth reflected Stahlgruber; organic parts-and-services revenue declined 4.3% in Europe. North America parts-and-services revenue was approximately flat, and Specialty was approximately flat.
For the first half, operating cash flow increased to $638.4M, with inventory reduction contributing $144M of incremental cash flow and accounts payable contributing $122M. Investing cash outflow was $116.8M, versus $1.249B in 2018, when the Stahlgruber acquisition drove most spending. Capital expenditures were $101.3M. Financing cash outflow was $472.0M, including $190.8M of share repurchases and net repayments under credit facilities.
At June 30, 2019, cash and cash equivalents were $376.0M and gross debt was $4.086B, down from $4.348B at December 31, 2018. Credit-facility availability was $1.962B, giving reported total liquidity of $2.338B. The company was in compliance with debt covenants: net leverage was 2.8x against a 4.25x maximum, and interest coverage was 9.2x against a 3.0x minimum. The new lease standard added $1.3B of operating lease assets and liabilities at adoption; total lease liabilities were $1.384B at quarter-end.
Material changes versus prior comparable periods
- Despite higher reported revenue, Q2 and first-half operating income and LKQ-attributable earnings declined. A $33.5M Q2 and $48.5M first-half impairment of businesses classified as held for sale contributed to the decline.
- First-half equity in earnings of unconsolidated subsidiaries included a $39.6M impairment of LKQ’s Mekonomen investment; the reported equity-method loss was $38.0M for the half. The investment’s quoted fair value was $125M at June 30, versus a $110M carrying value after impairment.
- First-half revenue increased 10.4% as reported, but organic revenue declined 1.4% and foreign exchange reduced growth by 2.7%. Europe revenue growth was led by Stahlgruber; North America parts-and-services organic revenue declined 0.9% and Europe declined 1.8%.
- North America benefited from wholesale pricing initiatives, but lower scrap-metal prices and weaker other revenue affected results. Specialty EBITDA declined amid product-cost and mix pressures.
- LKQ repurchased 7.0M shares for $190.8M in the first half; $249M remained under the $500M authorization at June 30.
Outlook, commentary, risks and unusual items
The filing text provided does not give a clear quantified full-year revenue or earnings guidance. Management said current liquidity and expected operating cash generation should meet current operating and capital requirements, though future acquisitions could require additional financing. It expects $20M–$25M of further costs through 2020 for the 2019 cost-reduction program, plus approximately $15M of future acquisition-integration expenses.
The company began a cost-reduction program across all three segments in Q2, targeting underperforming assets and cost inefficiencies. It expects to sell certain North American and European businesses within 12 months; excluding the Czech business, those held-for-sale businesses had approximately $165M of annualized revenue. LKQ intends to divest the acquired Stahlgruber Czech Republic wholesale business, classified as discontinued operations, also within the next year. Fair-value estimates for these disposals use Level 3 inputs and could differ from actual sale outcomes.
Management cited softer European economic conditions, potential U.K. departure from the EU, fewer selling days, weather and lower North American collision claims as headwinds. Foreign exchange is material: non-U.S. operations generated 50.3% of first-half revenue, and a 10% currency movement was estimated to change consolidated revenue by 5.0% and operating income by 3.0%. Commodity-price changes create scrap-metal margin risk; average scrap prices fell 4% from Q1 to Q2. Approximately $527M of variable-rate debt was unhedged, with a 100-basis-point rate move estimated to change interest expense by $5M over the next 12 months. The company reported no material expected effect from outstanding litigation or ordinary-course contingencies.
Other notable items include an estimated $40M first-quarter Mekonomen impairment, held-for-sale impairment charges, and the termination and freeze of the primary U.S. defined-benefit plan effective June 30. The resulting settlement charge cannot yet be reasonably estimated; completion is expected in 2020. The filing also notes that reported interim results may not indicate full-year performance.
Important facts for investors to verify
- Whether organic revenue trends improve, particularly in Europe and North America, and how much future growth depends on acquisitions and currency movements.
- Whether held-for-sale valuations and planned divestitures produce proceeds consistent with management’s estimates, and whether further impairment charges arise.
- Whether the $638M first-half operating cash flow is sustainable given the effects of inventory reduction, payment timing and extended vendor terms.
- Progress and realized savings from restructuring and integration, against the expected additional costs disclosed.
- Debt, covenant headroom, interest-rate exposure, and the balance between share repurchases, debt repayment and acquisition spending.
- The final cost and timing of the U.S. pension-plan termination and the performance of the Mekonomen investment.