LKQ Corporation — Q2 2020 Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2020. Unaudited results; dollar amounts below are in U.S. dollars. LKQ distributes vehicle replacement parts and specialty products through its North America, Europe and Specialty reportable segments.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $2.626 billion | $3.248 billion | $5.627 billion | $6.348 billion |
| Gross margin | $1.011 billion; 38.5% | $1.247 billion; 38.4% | $2.225 billion; 39.5% | $2.455 billion; 38.7% |
| Operating income | $180 million; 6.9% of revenue | $236 million; 7.3% | $422 million; 7.5% | $459 million; 7.2% |
| Net income attributable to LKQ stockholders | $119 million | $151 million | $264 million | $249 million |
| Diluted EPS attributable to LKQ stockholders | $0.39 | $0.48 | $0.86 | $0.79 |
| Operating cash flow | Not separately stated in the filing text | Not separately stated in the filing text | $913 million | $638 million |
| Free cash flow | Not separately stated in the filing text | Not separately stated in the filing text | $836 million | $537 million |
Q2 revenue declined 19.1% year over year; organic parts and services revenue fell 16.8%. For the first half, revenue declined 11.4%, including a 10.3% organic decline in parts and services. Q2 diluted EPS was $0.39 versus $0.49 for continuing operations in the prior-year quarter. First-half net income increased despite lower revenue, in part because 2019 included a $40 million impairment of an equity-method investment.
Q2 gross margin was broadly stable, while operating margin declined. For the first half, gross margin improved but SG&A rose to 29.1% of revenue from 28.3%. Segment EBITDA, a non-GAAP measure, was $291 million in Q2 versus $359 million, and $613 million for the first half versus $679 million.
Segments and material changes
- North America: Q2 third-party revenue fell 23.5% and Segment EBITDA fell 21.3% year over year. Lower collision claims and reduced salvage throughput weighed on results; management cited share gains and strength in mechanical and self-service sales as partial offsets.
- Europe: Q2 third-party revenue fell 20.1%; Segment EBITDA fell 23.1% (20.1% on a constant-currency basis). Revenue recovered sequentially during the quarter, but management said the U.K. and Italy lagged Germany and the Netherlands.
- Specialty: Q2 third-party revenue declined 1.5%, and Segment EBITDA was nearly flat. Demand for recreational vehicle products and drop-ship fulfillment supported sales.
- COVID-19 restrictions reduced driving, collision claims and maintenance activity. Organic parts and services revenue per day declined 30.3% in April, 13.2% in May and 7.3% in June versus prior-year months. Management said the pace of recovery had flattened into July.
Cash, debt and liquidity
- Cash and cash equivalents were $476 million at June 30, 2020, down from $523 million at December 31, 2019. Total debt was $3.278 billion, versus $4.072 billion at year-end.
- Total liquidity was approximately $2.527 billion, comprising $476 million cash and approximately $2.051 billion available under credit facilities. The revolving facility had $1.9 billion available; the filing’s broader availability figure also includes the receivables facility.
- First-half operating cash flow rose to $913 million and free cash flow to $836 million. Working-capital movements contributed materially, including a $445 million inventory cash inflow. Cash generation also benefited from tax-payment deferrals; management expected these benefits to moderate in the second half as deferred taxes were paid and inventory was rebuilt.
- LKQ redeemed $600 million of 2023 U.S. notes in January and recorded a $13 million extinguishment loss. The June credit-agreement amendment temporarily raised the maximum net leverage covenant to 5.00:1.00; the reported ratio was 2.2, against a 3.00:1.00 minimum interest-coverage requirement and a reported 11.7 ratio.
- The company reported compliance with debt covenants. Approximately $1.976 billion of scheduled debt maturities falls in 2024. Variable-rate exposure, foreign exchange and scrap-metal price movements remain relevant financial risks.
Outlook, risks and unusual items
- Management expected second-half 2020 revenue to decline year over year, but at a lower rate than in the first half, assuming extensive March-April-style lockdowns did not recur. It expected positive second-half free cash flow, below first-half levels. The filing provides no specific full-year revenue or EPS guidance.
- Management cited uncertainty around the pandemic’s duration, renewed restrictions, customer and supplier liquidity, recovery pace and regional results. Cost actions included workforce reductions, reduced hours, route consolidation and facility actions; management said some savings would persist as volumes recovered.
- Foreign-government assistance of $33 million was recorded in Q2, primarily to offset personnel costs in Europe and Canada. Q2 other income included approximately $8 million of insurance settlement proceeds; a $2 million pension settlement loss partially offset this benefit.
- Approximately $175–$185 million of payments otherwise due in Q2 were deferred under government programs. Management estimated $125–$135 million would be paid in Q3, with the remainder in Q4 or later.
- COVID-19 drove higher expected credit losses: the allowance for lifetime credit losses was approximately $70 million at June 30, versus $53 million at year-end; first-half bad-debt expense was $24 million versus $6 million.
- Management found no impairment in its first-quarter goodwill test; the Europe reporting unit’s estimated fair value exceeded carrying value by at least 12%. A first-quarter test of the Warn trademark found fair value approximately 9% above carrying value. Future forecasts and market conditions could change impairment assessments.
- Restructuring expenses were $25 million in Q2. The company estimated $65–$75 million of total costs through 2022 for its 2020 global restructuring program. It also estimated $100–$125 million of 1 LKQ Europe program costs for 2020–2021, plus $80–$100 million for 2022–2024; certain projects restarted in July after a pandemic-related pause.
- The company was negotiating with the EPA over alleged stormwater-permit violations at certain Massachusetts facilities; any likely penalty was not expected to be material. Management said other outstanding claims were not expected to have a material effect.
Most important facts for investors to verify
- Whether the July revenue recovery continued, particularly given the reported flattening and risk of renewed COVID-19 restrictions.
- How much first-half operating cash flow and free cash flow depended on inventory reductions, tax deferrals and other working-capital timing, and the cash required to repay deferred taxes.
- Progress on debt reduction and covenant headroom as temporary leverage limits tighten after September 2021; note that share repurchases are restricted if net leverage exceeds 4.00:1.00.
- Whether segment margins and bad-debt expense improve as sales recover, and whether salvage-vehicle supply constraints pressure North America margins.
- Actual government assistance, insurance proceeds and restructuring/program costs compared with management’s estimates, and any future impairment charges.