LKQ CORP quarterly report, Q2 FY2020

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

MetricQ2 2020Q2 2019Six months 2020Six 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 flowNot separately stated in the filing textNot separately stated in the filing text$913 million$638 million
Free cash flowNot separately stated in the filing textNot 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.