LKQ Corporation — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011. LKQ distributes aftermarket, recycled, refurbished and remanufactured vehicle products, alongside self-service retail and heavy-duty truck products. Unless otherwise noted, figures are in millions of dollars.
Financial performance
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Revenue | $759.7 | $584.7 | $1,546.3 | $1,188.2 |
| Gross margin | $322.2; 42.4% | $261.3; 44.7% | $665.9; 43.1% | $544.6; 45.8% |
| Operating income | $78.5; 10.3% | $69.6; 11.9% | $185.9; 12.0% | $159.5; 13.4% |
| Income from continuing operations | $46.7 | $37.9 | $104.9 | $89.9 |
| Net income | $46.7 | $37.9 | $104.9 | $91.8 |
| Diluted EPS from continuing operations | $0.32 | $0.26 | $0.71 | $0.62 |
| Operating cash flow | Not separately reported for Q2 | $101.1 | $101.2 |
- Q2 revenue increased 29.9% year over year; first-half revenue increased 30.1%. Management attributed growth to acquisitions, higher product volumes, and higher scrap and metals revenue. Organic growth was 12.2% in Q2 and 12.9% for the first half.
- Profit increased, but margins contracted. Management cited lower-margin acquired product lines and scrap aluminum, higher salvage vehicle costs, competitive pricing and higher aftermarket input costs. Higher fuel and freight costs also pressured distribution expense.
- Q2 other expense fell to $2.7 million from $7.0 million, helped by lower interest expense and a $1.6 million gain from adjusting an acquisition-related contingent payment. First-half other expense was $14.3 million and included a $5.3 million debt-extinguishment loss.
- First-half 2010 net income included $2.0 million from discontinued operations, principally the after-tax gain on sale of two facilities; there was no discontinued-operations income in 2011.
Financial position, debt and liquidity
- At June 30, 2011, cash was $42.3 million, total assets $2.418 billion, and stockholders’ equity $1.536 billion. Inventory was $556.5 million.
- Long-term obligations were $586.4 million, including $246.9 million of term loans and $327.7 million drawn on the revolver; $11.8 million consisted of other notes. Credit-facility borrowings were $574.6 million. Revolver availability, net of $33.7 million of letters of credit, was $388.6 million.
- LKQ replaced its prior facility in March with a five-year, $750 million revolver and $250 million term loan. The effective weighted-average rate, including swaps, was 2.77%. The company reported compliance with credit covenants at quarter-end.
- First-half cash flow from operations was $101.1 million; investing used $138.0 million, including $95.6 million for acquisitions and $42.5 million for property and equipment. Financing used $16.5 million. Cash declined $53.4 million from year-end 2010.
- Operating cash flow was approximately flat year over year despite higher operating income, reflecting greater working-capital investment and tax payments. Future minimum operating lease payments were $345.8 million.
Outlook, developments and risks
- 2011 guidance: continuing-operations income of $201–$211 million and diluted EPS of $1.36–$1.42, excluding restructuring costs and acquisition or divestiture gains or losses.
- Management projected full-year organic parts-and-services revenue growth of 6%–8%, and approximately $195 million of operating cash flow. It expected first-half growth comparisons to ease in the second half. For acquisitions completed by June 30, estimated acquisition revenue growth was approximately $100 million in Q3 and $50 million in Q4.
- Capital expenditures for the remainder of 2011 were forecast at $42–$52 million, excluding acquisitions and acquisition-related capital spending.
- Seven acquisitions closed in the first half for $100.0 million of total consideration; they contributed approximately $53.4 million of revenue and $1.9 million of operating income from acquisition dates through June 30. Four additional acquisitions closed in July. Purchase-price allocations remained preliminary.
- The Akzo Nobel distribution agreement includes a potential payment of up to $21 million if specified purchase thresholds are not met through May 2014; the acquisition-date fair value had not yet been determined. Integration and restructuring charges were expected to continue, including approximately $0.8 million of additional Akzo-related charges and $1.2 million for Cross Canada integration in 2011.
- LKQ renewed its Ford aftermarket-parts arrangement in July, effective October 1, 2011 through March 2015, on substantially similar terms and subject to an additional upfront fee; the filing text does not provide a clear amount.
- Key exposures include salvage vehicle acquisition costs, fuel and freight, metal prices, variable interest rates and foreign currency. A 100-basis-point rate move was estimated to change interest expense by $2.2 million over the next 12 months. Unhedged variable-rate debt was $224.6 million.
- Management identified accident frequency and severity as a business risk, as accidents affect both repair demand and supply of recycled products. Goodwill was $1.064 billion; management noted greater forecasting uncertainty in the heavy-duty truck reporting unit. Ordinary-course litigation and environmental contingencies were not expected to materially affect results; the filing reports no legal proceedings under Item 1.
Important facts for investors to verify
- Whether revenue growth can continue as the prior-year comparisons become less favorable, and whether the company can stabilize gross and operating margins.
- Whether salvage acquisition costs, aftermarket pricing pressure, fuel and freight costs, and metal-price movements affect margins as management expects.
- Progress against EPS, organic growth, operating cash flow and capital expenditure guidance, including the effect of acquisitions and restructuring costs.
- Final purchase accounting and contingent-consideration values for acquisitions, including the Akzo Nobel purchase-threshold obligation.
- Debt covenant headroom, revolver availability, variable-rate exposure, and the cash and working-capital impact of continued acquisitions and investment.
- Integration outcomes and goodwill assumptions, particularly for the heavy-duty truck business; also verify the terms and upfront fee for the renewed Ford arrangement.