LKQ Corporation — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. LKQ distributes alternative and aftermarket vehicle parts across North America, Europe and Specialty markets. Results are unaudited and compared with the corresponding 2016 periods.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $2,458.4m | $2,304.8m | $4,801.3m | $4,226.3m |
| Gross margin | $965.0m; 39.3% | $905.8m; 39.3% | $1,895.1m; 39.5% | $1,666.3m; 39.4% |
| Operating income | $244.6m; 9.9% of revenue | $232.4m; 10.1% | $480.3m; 10.0% | $418.1m; 9.9% |
| Continuing-operations income | $150.9m | $137.8m | $291.7m | $250.0m |
| Net income | $150.9m | $142.8m | $287.2m | $255.0m |
| Diluted EPS from continuing operations | $0.49 | $0.45 | $0.94 | $0.81 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $362.1m | $361.9m |
Revenue increased 6.7% in Q2 and 13.6% in the first half. Organic growth contributed 4.2% and 4.9%, respectively; acquisitions contributed 4.9% and 11.3%, while foreign exchange reduced growth by 2.4% and 2.5%. Q2 operating income grew about 5.2%; first-half operating income grew about 14.9%. Continuing-operations income rose about 9.5% in Q2 and 16.7% in the first half.
First-half net income includes a $4.5m loss from discontinued operations, including an $8.6m pretax loss on the sale of glass manufacturing operations, net of tax benefits. The prior-year first half included $5.0m of discontinued-operations income. Thus, total net income comparisons are affected by the disposal; continuing-operations results are more comparable.
Liquidity, debt and cash flow
- Cash was $303.5m at June 30, 2017, up from $227.4m at December 31, 2016. Cash flow from operations was $362.1m; capital expenditures were $91.5m.
- Investing activities provided $113.7m, including $301.3m of proceeds from the glass manufacturing sale and $100.7m spent on acquisitions. Financing activities used $423.1m, principally reflecting net repayments of credit facilities.
- Gross debt was $3.010bn, down from $3.366bn at year-end; cash-adjusted net debt was approximately $2.706bn. Current maturities were $99.3m. The filing reports $1.432bn of credit-facility availability and total liquidity of $1.735bn, including cash.
- Weighted average interest rate on total borrowings was 3.0%; the credit-agreement rate, after hedging, was 2.1%. The company reported compliance with its debt covenants. A 100-basis-point interest-rate change on unhedged variable-rate debt was estimated to change interest expense by $7.6m over 12 months.
- Current assets were $3.501bn and current liabilities $1.222bn. Inventory totaled $2.063bn, up from $1.935bn at year-end.
Material changes and operating trends
- North America Q2 revenue grew 6.1%; segment EBITDA increased 4.6% to $173.7m, while its margin eased to 14.4% from 14.6%. Higher parts volumes and salvage performance helped; scrap-metal price timing added $3.9m to Q2 segment EBITDA.
- Europe Q2 revenue grew 8.0%, but segment EBITDA fell 7.1% to $83.5m and margin declined to 9.4% from 10.9%. Currency translation reduced segment EBITDA by $5.4m; excluding that effect, EBITDA declined 1.1%. In the first half, Europe EBITDA rose 10.0% reported and 17.8% at constant currency, while margin fell to 9.5% from 10.8%.
- Specialty Q2 revenue grew 5.5% and segment EBITDA rose 11.6% to $48.6m; margin improved to 13.4% from 12.6%, reflecting operating-expense savings that more than offset weaker gross margin.
- In the first half, LKQ completed ten acquisitions for total consideration of $107.8m. On July 3, 2017, it acquired four Belgian distributors for approximately $136.5m, after the reporting date.
- LKQ completed the sale of PGW’s glass manufacturing business on March 1, 2017, for $301.3m of proceeds. The aftermarket glass distribution business remained in continuing operations. Q2 total comprehensive income included a substantial favorable foreign-currency translation impact; this is distinct from net income.
Outlook, commentary and risks
- The filing gives no specific consolidated revenue, earnings or EPS guidance. Management said current liquidity and expected operating cash flows should meet current operating and capital requirements, though future acquisitions could require additional financing.
- Management expected the annual effective tax rate to remain near 35%, absent significant changes in geographic earnings mix or tax laws. The six-month effective rate was 33.8%.
- Management expected less than $5m of additional integration expenses to complete certain plans; integration work includes facility closures, consolidation and personnel rationalization.
- The CMA’s review of the Andrew Page U.K. acquisition remained ongoing; LKQ said it could not integrate Andrew Page with existing U.K. operations until approval was received. Purchase-price allocations for recent acquisitions remained preliminary, and the Andrew Page bargain-purchase gain could be adjusted.
- Principal exposures include foreign-currency movements, variable interest rates, and scrap-metal prices. The filing notes that rapid metal-price changes can affect margins because revenue and inventory costs respond with a lag. LKQ also cited operating-result variability, acquisition execution and financing availability as risks.
- Litigation, environmental and other contingencies were not expected by management to materially affect financial position, results or cash flows. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- How much reported growth reflects organic demand versus acquisitions, and whether Europe’s margin pressure improves.
- The ongoing CMA review and any eventual integration plans or purchase-accounting adjustments for Andrew Page.
- The sustainability of cash conversion given inventory growth and working-capital cash outflows, and the use of glass-sale proceeds to reduce debt.
- Exposure to currency, commodity and interest-rate movements, including the sensitivity of margins and earnings to scrap prices and unhedged debt.
- Whether future acquisitions, integration costs and lease commitments affect liquidity, leverage or returns; the filing lists $1.339bn of future minimum operating lease payments.