LKQ Corporation — Q3 2015 Form 10-Q
Business context and period. LKQ distributes alternative collision and mechanical vehicle parts, operates self-service recycling yards, and sells specialty vehicle aftermarket products. This unaudited report covers the quarter and nine months ended September 30, 2015; comparisons are with the corresponding 2014 periods. Results include acquisitions completed during 2015.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $1.832bn | $1.721bn | $5.444bn | $5.056bn |
| Gross margin | $712.8m; 38.9% | $664.4m; 38.6% | $2.136bn; 39.2% | $1.987bn; 39.3% |
| Operating income | $166.7m; 9.1% of revenue | $156.2m; 9.1% | $553.0m; 10.2% | $503.6m; 10.0% |
| Net income | $101.3m | $91.5m | $328.2m | $301.1m |
| Diluted EPS | $0.33 | $0.30 | $1.07 | $0.98 |
| Operating cash flow | Not separately stated for quarter | Not separately stated for quarter | $491.3m | $322.6m |
Q3 revenue rose 6.4%, operating income 6.8%, and net income 10.7%; diluted EPS increased 10.0%. For nine months, revenue rose 7.7%, operating income 9.8%, and net income 9.0%. Parts and services revenue grew 10.7% in Q3 and 11.1% year to date, while other revenue declined 30.8% and 23.2%, respectively, largely reflecting lower scrap and metals prices. Organic revenue growth was 2.6% in Q3 and 4.1% year to date; acquisitions contributed 7.6% and 7.3%, while foreign exchange reduced growth by 3.8% and 3.7%.
Q3 gross margin improved 0.3 percentage points year over year; the nine-month gross margin declined 0.1 point. Lower scrap revenue weakened operating leverage, partly offset by fuel savings and segment-level improvements. Q3 other expense fell to $11.8m from $16.4m, mainly on lower interest expense and higher other income. Nine-month interest expense was $44.3m, down from $48.1m. The nine-month effective tax rate was 34.8%.
Liquidity, debt and cash flow
- At September 30, cash was $137.1m, total debt $1.607bn, and net debt $1.470bn. Debt declined from $1.865bn at December 31, 2014.
- Available credit-facility capacity was $1.311bn; cash plus facility availability provided total liquidity of approximately $1.448bn. The company reported compliance with credit-agreement covenants.
- Nine-month operating cash flow was $491.3m. Investing used $253.8m, including $157.4m for acquisitions and $99.6m for property and equipment. Financing used $212.9m, principally reflecting net repayments under credit facilities. Cash increased by $22.5m to $137.1m.
- Reported current assets were $2.387bn and current liabilities $797.7m. Revolving credit facilities mature in May 2019; $600m of 4.75% senior notes mature in 2023; the receivables facility matures in October 2017.
Segments and material developments
- North America: Q3 revenue increased 1.2%, but Segment EBITDA fell 2.5% to $128.5m; margin decreased to 12.4% from 12.9%. Lower scrap and metals prices reduced Q3 Segment EBITDA by $7.2m and nine-month EBITDA by $22.0m, according to management.
- Europe: Q3 revenue increased 3.1% as reported and Segment EBITDA rose 26.4% to $52.7m. Nine-month revenue grew 9.2% and Segment EBITDA 18.9%. Currency translation reduced reported revenue growth materially; constant-currency EBITDA growth was stronger. Management cited U.K. growth, Netherlands distribution integration and improved gross margins.
- Specialty: Q3 revenue rose 41.4% and Segment EBITDA 45.0% to $26.1m; nine-month revenue rose 35.7% and EBITDA 42.9%. Growth included acquisitions and organic volume gains, with integration synergies partly offset by lower gross margins.
- LKQ completed 17 acquisitions in the first nine months, including Coast and Parts Channel and 11 Netherlands distributors. Acquired businesses contributed $83.4m revenue and $2.0m net income from acquisition dates through September 30. Acquisition cash spending was substantially below 2014, which included the Keystone Specialty purchase.
Outlook, risks and unusual items
- Management estimated 2015 net income of $428m–$442m and diluted EPS of $1.39–$1.44, excluding restructuring and acquisition-related expenses, acquisition/divestiture gains or losses (including contingent consideration fair-value changes), and debt-extinguishment losses. Expected capital expenditures were $135m–$150m; expected operating cash flow was $525m–$550m.
- Management expected additional integration costs through Q4 2015 and into 2016, with remaining costs to complete identified integration plans expected to be less than $9m.
- Scrap and other metals prices had fallen 39% since Q4 2014. Management expected depressed scrap steel prices to weigh on Self Service margins through 2016. An interim goodwill test found no impairment, but estimated fair value exceeded carrying value by only about 11%; lower cash flows, lower terminal growth or a higher discount rate could trigger impairment.
- Currency movements reduced nine-month diluted EPS by approximately $0.03 versus 2014. A 10% movement in relevant foreign currencies was estimated to change consolidated revenue and operating income by about 3%. A 100-basis-point interest-rate move was estimated to change interest expense by $7.2m over the next 12 months, excluding the expired swap noted in the filing.
- Other risks include variable-rate debt, exposure to foreign-currency and metals-price fluctuations, acquisition integration and execution, working-capital variability, and the availability and cost of future financing. The filing says ordinary-course litigation and environmental contingencies were not expected to materially affect results. No legal proceedings were reported in Part II.
- One-time or notable items included a $1.0m impairment charge on a U.K. equity-method investment during the first nine months, the August sale of a precious-metals processing business, and significant negative foreign-currency translation in other comprehensive income.
Investor verification priorities
- Verify the outlook’s exclusions and reconcile the adjusted guidance with reported GAAP results.
- Track scrap prices, North American Self Service margins, and progress against the goodwill valuation cushion.
- Assess whether organic growth and European/Specialty integration gains persist after acquisition effects and currency translation.
- Monitor acquisition spending, integration costs, operating cash conversion, and debt repayment against capital expenditures and future acquisitions.
- Review interest-rate and foreign-exchange exposure, swap maturities, and covenant headroom; the filing does not provide a clear quantified covenant cushion.