LKQ Corporation — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. LKQ distributes vehicle replacement parts and related products across North America, Europe, Specialty and Glass. Results include Rhiag from March 18 and Pittsburgh Glass Works (PGW) from April 21, 2016; acquisitions materially affect comparisons.
Key financial results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $2,386.8m | $1,831.7m | $6,759.0m | $5,443.7m |
| Gross margin | $883.4m; 37.0% | $712.8m; 38.9% | $2,565.8m; 38.0% | $2,136.2m; 39.2% |
| Operating income | $203.0m; 8.5% of revenue | $166.7m; 9.1% | $631.9m; 9.3% | $553.0m; 10.2% |
| Net income | $122.7m | $101.3m | $377.6m | $328.2m |
| Diluted EPS | $0.40 | $0.33 | $1.22 | $1.07 |
| Operating cash flow | Not separately provided | Not separately provided | $524.2m | $505.0m |
Q3 revenue increased 30.3% year over year, including 30.5% acquisition-related growth and 2.8% organic growth, partly offset by a 3.0% foreign-exchange impact. Nine-month revenue rose 24.2%, driven by 22.6% acquisition-related growth and 3.5% organic growth, offset by a 2.0% currency impact. Net income rose about 21% in Q3 and 15% year to date. Segment EBITDA, a non-GAAP measure, was $273.8m in Q3 versus $207.3m and $829.4m year to date versus $661.7m.
Gross and operating margins contracted despite higher revenue. Management attributed much of the gross-margin pressure to the lower margins of acquired Rhiag and PGW; year-to-date results also include PGW inventory fair-value step-up expense. Lower distribution costs as a share of revenue, including acquisition mix and fuel savings, partly offset pressure.
Liquidity, debt and investment
- At September 30, cash was $271.9m, total debt $3,289.9m and net debt $3,018.1m. Debt was $1,599.7m at December 31, 2015.
- Reported total liquidity was $1,448.9m, comprising cash and $1,177.1m available under credit facilities. Revolver capacity was reduced by outstanding borrowings and letters of credit.
- Operating cash flow was $524.2m; capital expenditures were $152.7m. Acquisition spending, net of acquired cash, was $1,301.1m, and net cash used in investing activities was $1,424.7m.
- Debt includes $748.9m of term loans, $1,202.0m of revolver borrowings, $600.0m of 4.75% senior notes due 2023, $561.8m of 3.875% Euro Notes due 2024 and $97.0m under the receivables facility. Overall weighted-average borrowing cost was 2.9%; the company reported compliance with credit-agreement covenants.
- Working-capital requirements and cash interest increased; management said operating cash flow and current liquidity should meet current operating and capital needs, but may not fund future acquisitions depending on size.
Material developments, outlook and risks
- Rhiag expanded LKQ’s European operations; PGW added automotive glass distribution and manufacturing. Combined net cash acquisition consideration was approximately $1.30bn. Management expects potential procurement and distribution synergies, but realization is not assured.
- In October, LKQ acquired substantially all business assets of U.K. distributor Andrew Page for a preliminary cash price of about £16.5m, subject to customary U.K. regulatory approval.
- Restructuring and acquisition-related expenses were $32.3m for nine months, versus $12.7m. Management expected less than $5m of further integration costs for certain acquisitions into 2017; this excludes possible future Rhiag and PGW integration costs.
- Year-to-date results included a $26.7m debt-extinguishment loss, an $18.3m gain on acquisition-related foreign-exchange contracts, and a $9.8m PGW inventory step-up charge. Early adoption of a share-based-payment accounting standard generated an $11.5m tax benefit, increasing year-to-date EPS by $0.04; this is not necessarily recurring.
- Foreign-currency translation and transactions reduced diluted EPS by approximately $0.01 in Q3 and $0.025 year to date versus prior-year periods. A 100-basis-point interest-rate move was estimated to change interest expense by $13.4m over the next 12 months on unhedged variable-rate exposure. Metal-price changes can affect salvage margins; management reported scrap-metal prices had risen 43% since Q4 2015.
- Future minimum operating lease payments totaled $1,198.9m. The company said litigation and environmental contingencies were not expected to materially affect its financial position, results or cash flows. Its forward-looking statements remain subject to execution, acquisition, currency, interest-rate, demand and other risks.
Important facts for investors to verify
- How much reported growth and earnings improvement is organic versus attributable to Rhiag, PGW and other acquisitions, and how results compare on a pro forma basis.
- Whether acquired businesses deliver the anticipated synergies and whether integration costs, margin dilution and purchase-accounting effects persist.
- Debt reduction, interest costs, covenant headroom and liquidity after the acquisition-related increase in borrowing.
- Underlying cash conversion after working-capital needs and capital expenditures, excluding acquisition financing and one-time items.
- The recurring earnings effect of the $11.5m share-based-payment tax benefit and the continued impact of currency, interest rates and salvage-metal prices.