LKQ Corporation — Q2 2015 Form 10-Q
Business context and reporting period. LKQ distributes alternative vehicle replacement and maintenance parts, recycled and remanufactured products, and specialty vehicle aftermarket products. This unaudited report covers the quarter and six months ended June 30, 2015, compared with the same 2014 periods. Reportable segments are North America, Europe, and Specialty.
Financial performance
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Revenue | $1,838.1m | $1,709.1m | $3,612.0m | $3,334.9m |
| Gross margin | $723.9m; 39.4% | $671.1m; 39.3% | $1,423.4m; 39.4% | $1,322.9m; 39.7% |
| Operating income | $200.3m | $173.6m | $386.2m | $347.4m |
| Net income | $119.7m | $104.9m | $226.8m | $209.5m |
| Diluted EPS | $0.39 | $0.34 | $0.74 | $0.69 |
- Q2 revenue increased 7.5%; reported growth reflected 4.7% organic growth and 6.7% acquisition contribution, partly offset by 3.9% foreign-exchange impact. First-half revenue increased 8.3%.
- Q2 operating income grew 15.4% and net income grew 14.1% year over year. First-half operating income increased 11.2% and net income increased 8.3%.
- Q2 operating margin was 10.9%, versus 10.2% a year earlier; first-half operating margin was 10.7%, versus 10.4%. First-half gross margin declined to 39.4% from 39.7%, mainly due to mix from Specialty growth.
- Q2 Segment EBITDA was $233.0m, or 12.7% of segment revenue, versus $211.5m, or 12.4%. First-half Segment EBITDA was $454.3m, versus $416.5m.
- Interest expense was $14.6m in Q2 and $29.5m for the first half, down from $15.6m and $31.7m, respectively, in 2014.
Cash flow, balance sheet and liquidity
- First-half operating cash flow was $282.7m, versus $152.2m. Capital expenditures were $66.8m, implying operating cash flow less capital expenditures of approximately $215.9m; the comparable 2014 amount was approximately $84.9m.
- Investing cash outflow was $109.2m, including $37.2m net cash for acquisitions; financing cash outflow was $144.9m, reflecting net debt repayments. Cash increased to $143.4m from $114.6m at year-end 2014.
- Total debt was $1,691.4m, down from $1,864.6m at year-end; net debt was $1,548.0m. Current maturities were $39.4m. Stockholders’ equity was $2,954.1m.
- Available credit-facility capacity was approximately $1,238.8m; cash plus availability totaled $1,382.2m. The company reported compliance with credit-agreement covenants at June 30.
- Credit-agreement borrowings had a weighted average rate of 2.11% after swaps; the overall borrowing rate, including notes and receivables financing, was 3.00%. About 54% of variable-rate credit-agreement debt was fixed through swaps.
Material changes and management commentary
- North America revenue grew 1.8% in Q2; segment EBITDA rose 1.3% to $138.9m. Lower scrap and metal prices materially pressured results: management estimated a $5.7m Q2 and $14.8m first-half adverse effect on North American Segment EBITDA.
- Europe revenue rose 9.6% in Q2, including acquisition growth but with an 11.7% adverse currency effect. European Segment EBITDA increased 17.4% reported and 29% at constant currency.
- Specialty revenue rose 30.0% in Q2, substantially reflecting acquisitions; Segment EBITDA increased 41.8% to $40.2m. Acquired Specialty operations contributed growth but weighed on gross-margin mix.
- During the first half, LKQ completed ten acquisitions for total acquisition-date consideration of $40.2m. July acquisitions, including Parts Channel, had preliminary aggregate cash consideration of approximately $75m.
- Management attributed first-half cash-flow improvement partly to stronger earnings and lower working-capital cash use than in 2014. The filing cautions that working-capital timing can be volatile.
Outlook, risks and unusual items
- For full-year 2015, management estimated net income of $425m–$445m and diluted EPS of $1.38–$1.45, excluding restructuring and acquisition-related expenses, specified acquisition or divestiture gains or losses (including contingent-consideration fair-value changes), and debt-extinguishment losses. The company also expected approximately $450m of operating cash flow and $150m–$180m of capital expenditures.
- Management expected foreign-exchange movements to continue to weigh on revenue growth for the remainder of 2015. Currency translation and transaction effects reduced first-half diluted EPS by approximately $0.03 versus the prior year.
- Scrap prices had fallen 25% since Q4 2014, although they stabilized in Q2. Management warned that further or rapid metal-price declines could pressure margins because revenue and vehicle acquisition costs adjust at different times.
- Interest-rate sensitivity: a 100-basis-point move in rates on the $540m of unhedged variable-rate debt was estimated to change interest expense by $5.4m over the next 12 months. Foreign-currency, commodity-price, competition, integration, and distribution-system risks remain relevant.
- First-half results included a $1.0m impairment charge on a U.K. equity-method investment; total equity-method investee losses were $3.1m. The effective tax rate rose to 35.2% from 34.0%, primarily reflecting expected geographic income mix. Litigation and other contingencies were not expected by management to materially affect financial position, results, or cash flows.
- Integration and acquisition-related charges totaled $8.2m for the first half. Management expected less than $5.0m of additional integration costs to complete specified plans, with some integration activity expected through 2015 and into the first half of 2016.
Important facts for investors to verify
- How much reported growth is sustainable organic growth versus acquisition contribution, and how foreign exchange affects reported results.
- Whether metal and scrap prices stabilize, and whether LKQ can protect North American margins if prices weaken further.
- Whether European and Specialty growth, integration synergies, and acquired-business margins meet management’s expectations.
- Whether the 2015 adjusted earnings, operating-cash-flow, and capital-expenditure outlook is achieved, and how exclusions reconcile to GAAP results.
- Debt, covenant headroom, variable-rate exposure, and the company’s capacity to fund further acquisitions while maintaining liquidity.
- The final purchase accounting and financial contribution of the July 2015 acquisitions; the filing states these details were not yet available.