LKQ Corporation — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2016. Unaudited results; comparisons are with the corresponding 2015 periods. Amounts are in U.S. dollars unless stated otherwise.
Business context
LKQ distributes alternative replacement parts, specialty vehicle products and automotive glass. During the period it acquired Rhiag, a European aftermarket-parts distributor, and Pittsburgh Glass Works (PGW), adding a Glass reportable segment. The reported growth therefore includes substantial contributions from acquisitions; the filing also reports organic growth.
Financial results and liquidity
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $2,450.7m | $1,838.1m | $4,372.2m | $3,612.0m |
| Gross margin | $921.9m; 37.6% | $723.9m; 39.4% | $1,682.4m; 38.5% | $1,423.4m; 39.4% |
| Operating income | $243.2m; 9.9% of revenue | $200.3m; 10.9% | $428.9m; 9.8% | $386.2m; 10.7% |
| Net income | $140.7m | $119.7m | $248.5m | $226.8m |
| Diluted EPS | $0.46 | $0.39 | $0.81 | $0.74 |
| Operating cash flow | — | $355.2m | $282.7m |
Q2 revenue rose 33.3% and net income rose 17.5%; first-half revenue rose 21.0% and net income rose 9.6%. Organic revenue growth was 3.8% in Q2 and 3.9% for the first half, with acquisitions accounting for much of the reported increase. Gross margin and operating margin declined year over year, reflecting acquired businesses’ lower margins and, in Q2, a $10.2m PGW inventory step-up charge. Q2 diluted EPS also benefited from a $0.02-per-share favorable scrap-price effect, according to management.
Segment EBITDA, a non-GAAP measure, was $318.9m in Q2 (13.0% of segment revenue), versus $233.0m (12.7%) a year earlier; first-half Segment EBITDA was $555.5m (12.7%), versus $454.3m (12.6%).
At June 30, cash was $273.2m, total debt was $3.362bn and net debt was $3.088bn. Total liquidity, including available credit, was $1.362bn, with $1.089bn of credit availability. Operating cash flow increased, while investing cash outflow reached $1.342bn, mainly from $1.269bn of net acquisition spending and $102.3m of capital expenditures. Financing provided $1.178bn. Cash and equivalents increased from $87.4m at year-end 2015.
Material changes and financing
- Rhiag was acquired in March for consideration of approximately $602m, net of cash acquired; PGW was acquired in April for approximately $662m. Acquired debt and related liabilities were also repaid. The acquisitions added $774.2m of preliminary goodwill and expanded assets, debt and amortization.
- Debt increased from $1.600bn at December 31, 2015 to $3.362bn at June 30, 2016. LKQ amended its credit agreement, increasing total availability to $3.2bn and extending maturity to January 2021, and issued €500m of 3.875% senior notes due 2024. Existing $600m senior notes bear 4.75% and mature in 2023.
- First-half other expense included a $26.7m loss on debt extinguishment and an $18.3m gain on acquisition-related foreign exchange contracts. Acquisition-related and restructuring expenses totaled $23.9m, versus $8.2m a year earlier.
- Foreign currency translation contributed a $73.1m first-half other comprehensive loss. The filing attributes an approximately $0.015 negative diluted-EPS effect to currency translation and currency losses versus the prior-year period.
Outlook, risks and contingencies
The filing provides no formal earnings or revenue guidance. Management expected approximately $6m of additional integration expenses for certain prior acquisitions, excluding potential future restructuring costs for Rhiag and PGW, and expected to continue investing in facilities and pursuing selected acquisitions. Management said current liquidity and expected operating cash generation should meet current operating and capital requirements, but may not fund future acquisitions depending on their size. The company reported compliance with credit-agreement covenants at June 30.
Key sensitivities include acquisition integration and realization of anticipated synergies; variable-rate debt (a 100-basis-point rate move was estimated to change interest expense by $14.3m over the next 12 months); currency movements and the uncertain effects of the U.K.’s vote to leave the European Union; vehicle-repair demand, weather and economic conditions; and volatile scrap-metal prices. Management noted scrap-metal prices had risen 68% since Q4 2015 and that rapid price changes can affect margins because vehicle costs and scrap proceeds adjust at different times.
Operating lease commitments totaled $1.041bn. The company reported no material expected effect from ordinary-course litigation, claims or environmental contingencies and stated there were no off-balance-sheet arrangements. It continued to monitor its Self Service reporting unit; the 2015 impairment test showed fair value approximately 11% above carrying value, and forecasts used in that test remained unchanged through Q2 2016.
Important facts for investors to verify
- How much future revenue and profit growth is organic versus acquisition-driven, and whether Rhiag and PGW achieve expected purchasing and distribution synergies.
- Whether lower consolidated gross and operating margins persist, including the effects of acquired-business mix, PGW inventory step-up and commodity-price movements.
- Debt reduction, interest costs, covenant headroom and refinancing capacity following the increase in borrowings; also assess the exposure to unhedged variable rates.
- Cash conversion and working-capital needs as acquired operations are integrated, alongside capital expenditure and any further acquisition spending.
- Final purchase-price allocations and goodwill, particularly the preliminary Rhiag and PGW valuations, and developments affecting the Self Service goodwill impairment assessment.
- Exchange-rate, Brexit, seasonal-demand and scrap-metal impacts, plus the timing and cost of remaining integration and restructuring work.