LKQ Corporation — Q3 2014 Form 10-Q
Business context and period. This unaudited quarterly report covers the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods. LKQ distributes alternative vehicle replacement parts and specialty aftermarket products through North America, Europe and Specialty segments. Results include Keystone Specialty from its January 3, 2014 acquisition; 2014 also included 19 other acquisitions in the first nine months.
Financial performance and liquidity
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $1,721.0 million | $1,298.1 million | $5,055.9 million | $3,745.8 million |
| Gross margin | $664.4 million; 38.6% | $517.9 million; 39.9% | $1,987.4 million; 39.3% | $1,529.7 million; 40.8% |
| Operating income | $156.2 million; 9.1% of revenue | $123.4 million; 9.5% | $503.6 million; 10.0% | $396.4 million; 10.6% |
| Net income | $91.5 million | $73.4 million | $301.1 million | $233.8 million |
| Diluted EPS | $0.30 | $0.24 | $0.98 | $0.77 |
| Operating cash flow | Not presented separately for the quarter | Not presented separately for the quarter | $322.6 million | $340.9 million |
- Revenue grew 32.6% in Q3 and 35.0% year to date. Management attributed 22.7% and 26.6%, respectively, to acquisition-related growth; organic growth was 8.5% in Q3 and 7.1% year to date. Foreign exchange contributed 1.3% in each comparison.
- Net income rose year over year, but gross, operating and net margins were lower. Acquisitions with lower gross margins, including Keystone’s three-step distribution model, were the primary reason gross margin declined. North American segment EBITDA margin improved, while Europe’s declined.
- Segment EBITDA was $191.6 million in Q3 (11.1% of revenue), versus $149.3 million (11.5%) a year earlier; nine-month segment EBITDA was $608.1 million (12.0%), versus $467.4 million (12.5%). This company-defined measure excludes several items, including restructuring, depreciation and amortization, interest and taxes.
- Year-to-date operating cash flow fell despite higher net income, reflecting greater working-capital cash use, including receivables and inventory growth. Investing cash outflow was $749.9 million, including $650.6 million for acquisitions and $100.2 million of capital expenditures. Financing provided $523.4 million.
- At September 30, cash was $244.6 million; total debt was $1,898.0 million and net debt $1,653.4 million. Total liquidity was $1,357.9 million, including $1,113.3 million available under credit facilities. The company reported compliance with credit-agreement covenants.
Material changes and management commentary
- Keystone Specialty contributed $200.4 million of Q3 revenue and $595.2 million for the nine months since acquisition. It expanded the company into specialty aftermarket products and established a new reportable segment.
- European revenue grew substantially, supported by acquisitions, UK branch openings and favorable currency. European segment EBITDA margin decreased to 8.4% in Q3 from 10.9%, and to 9.3% year to date from 11.8%. Management cited acquisition mix, branch expansion costs, higher operating expenses and weakness in parts of continental Europe.
- North American segment EBITDA margin increased to 12.9% in Q3 from 11.7%, and to 13.5% year to date from 12.7%, helped by lower inventory purchase costs, improved operating leverage and lower vehicle acquisition costs in self-service operations.
- The March 2014 credit-agreement amendment extended maturity to May 2019, increased total availability to $2.3 billion and reduced borrowing margins and commitment fees. The receivables facility was amended to extend maturity to October 2017 and raise its maximum capacity to $97 million; $80 million was outstanding at quarter-end. Senior notes total $600 million, bear 4.75% interest and mature in 2023.
- After quarter-end, LKQ acquired two Specialty businesses for approximately $112 million, net of cash acquired. Management said this reduced available liquidity by approximately that amount.
Guidance, risks and unusual items
- Management estimated 2014 net income of $405–$417 million and diluted EPS of $1.32–$1.36, excluding restructuring and acquisition-related expenses, acquisition or divestiture gains and losses (including contingent-consideration fair-value changes), and debt-extinguishment loss. It also expected 2014 operating cash flow of approximately $375 million and capital expenditures, excluding acquisitions, of $110–$140 million.
- Management expected current liquidity and future operating cash flow to cover current operating and capital needs, but noted that larger future acquisitions could require additional funding. Additional financing may not be available on attractive terms or at all.
- Q3 included $1.6 million of severance costs for a European restructuring. Nine-month restructuring and acquisition-related expenses were $12.8 million. Further integration costs were expected in Q4 2014 and 2015, though management did not expect material costs to complete the stated plans. The filing also reports substantial acquisition spending and preliminary purchase-price allocations; goodwill was $2.26 billion at quarter-end.
- Key exposures include variable interest rates, foreign currency movements, scrap and metals prices, economic conditions affecting miles driven and repairs, OEM intellectual-property claims, supplier and salvage-auction concentration, inventory availability, and labor and environmental matters. A 100-basis-point rate move was estimated to change interest expense by $6.9 million over 12 months on unhedged variable-rate debt. Management said existing litigation and other contingencies were not expected to materially affect results.
- The filing gives no assurance that forward-looking expectations will be achieved. Management stated disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- How much reported growth and earnings contribution are recurring and organic versus acquired, particularly for Keystone and European acquisitions.
- Whether gross-margin pressure and Europe’s lower segment EBITDA margin improve as acquired inventory turns and distribution integration progresses.
- Whether operating cash flow recovers as inventory and receivables expand, and how acquisition spending affects net debt and liquidity.
- Progress against the 2014 adjusted earnings, cash-flow and capital-expenditure outlook, including the effect of the October acquisitions and excluded items.
- Acquisition purchase-price allocations, goodwill and expected synergies, alongside risks from currency, interest rates, metals prices, suppliers and OEM patent claims.