LKQ Corporation — Q3 2018 Form 10-Q
Business context and period: LKQ distributes alternative vehicle replacement parts and specialty accessories through its North America, Europe and Specialty segments. This unaudited report covers the quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods unless noted. Results include Stahlgruber, acquired May 30, 2018.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $3.122B | $2.466B | $8.874B | $7.267B |
| Operating income | $234.7M | $199.1M | $718.1M | $679.4M |
| Net income | $134.5M | $122.4M | $445.1M | $409.6M |
| Diluted EPS from continuing operations | $0.42 | $0.39 | $1.41 | $1.33 |
| Operating cash flow | Not separately provided | Not separately provided | $521.2M | $449.2M |
- Revenue grew 26.6% in Q3 and 22.1% year to date. Management attributed much of the increase to acquisitions; Q3 growth comprised 5.1% organic growth, 22.1% acquisition growth and a 0.6% foreign-exchange headwind.
- Gross margin was 38.3% in Q3 versus 38.8%; operating margin was 7.5% versus 8.1%. For nine months, gross margin was 38.5% versus 39.2% and operating margin 8.1% versus 9.3%. Lower-margin European mix, segment costs and other factors weighed on margins.
- Segment EBITDA, a company-defined non-GAAP measure, was $326.3M in Q3 versus $267.0M and $963.5M for nine months versus $863.2M. Q3 North America EBITDA was nearly flat year over year; Europe and Specialty increased.
- Nine-month capital expenditures were $171.8M, making operating cash flow less capital expenditures approximately $349.4M. Investing cash outflow was $1.372B, including $1.206B net cash spent on acquisitions.
- At September 30, cash was $341.3M and total debt was $4.404B, up from $3.428B at December 31, 2017. Reported total liquidity was $1.843B, including $1.501B available under credit facilities. LKQ reported compliance with its debt covenants.
- Total assets were $11.585B and stockholders’ equity $4.897B. Current assets were $4.593B and current liabilities $1.736B.
Material changes and significant items
- Stahlgruber contributed $637M of revenue and $34M of operating income from acquisition through September 30. The transaction used cash, newly issued LKQ shares and debt; LKQ recorded approximately $929M of related goodwill. Czech Republic competition-authority review remained pending for an immaterial portion of the business.
- Interest expense rose to $40.9M in Q3 from $25.2M, primarily reflecting higher debt, including the Euro Notes issued to help fund Stahlgruber. The company issued €1.0B of senior notes due 2026 and 2028.
- LKQ recorded a $22.7M other-than-temporary impairment of its Mekonomen investment in the nine-month period; Q3 equity in losses of unconsolidated subsidiaries was $20.3M. Management also disclosed an expected $8M loss in Q4 from settling a Mekonomen-related derivative.
- The nine-month effective tax rate fell to 25.2% from 33.5%, primarily reflecting the U.S. federal tax-rate reduction; a favorable $10M adjustment to the Tax Act transition-tax estimate contributed to the 2018 period.
- Foreign-currency translation reduced nine-month other comprehensive income by $77.6M. LKQ said a 10% currency movement would have changed consolidated revenue by 4.7% and operating income by 2.9% for the period.
- ASC 606 adoption changed balance-sheet presentation, including a $106.7M refund liability at quarter-end; management said the standard’s ongoing net-income impact was expected to be immaterial.
Outlook, risks and contingencies
- The filing provides no specific consolidated revenue or earnings guidance. Management said current liquidity and expected operating cash flows should meet current operating and capital requirements, while noting that larger future acquisitions could require additional financing.
- Management expected less than $10M of additional integration costs to complete certain acquisition integration plans, with activities extending into 2019. Operating-lease commitments totaled $1.708B at September 30; the company anticipated that adoption of the new lease standard would materially affect its balance sheet and disclosures.
- Key exposures include foreign-exchange movements, variable interest rates and scrap-metal prices. A 100-basis-point interest-rate movement was estimated to change interest expense by $9M over the next 12 months; average scrap-metal prices fell 16% from Q2 to Q3 2018.
- Management said outstanding litigation and other contingencies were not expected to materially affect financial position, results or cash flows. On October 25, 2018, the board authorized repurchases of up to $500M of common stock through October 25, 2021; the program does not require purchases.
Important facts for investors to verify
- How much of reported growth and future profitability is attributable to Stahlgruber and other acquisitions versus organic performance, and whether European integration improves margins.
- Whether the lower gross and operating margins persist, including effects from segment mix, distribution costs, scrap prices and inventory write-downs.
- Debt reduction, interest costs and covenant headroom following the acquisition financing, alongside cash conversion and working-capital needs.
- The performance and carrying value of the Mekonomen investment, including the disclosed Q4 derivative settlement loss.
- Final resolution of the Czech Republic review, completion of Tax Act accounting estimates, and the balance-sheet effects of lease-standard adoption.
- Whether the authorized share-repurchase program is used and how any purchases would be balanced against debt, investment and acquisition priorities.