LKQ Corporation — Q1 2011 Form 10-Q
Business context and period: Unaudited results for the three months ended March 31, 2011, compared with Q1 2010. LKQ distributes aftermarket, recycled, refurbished and remanufactured vehicle replacement products, and operates in the U.S. and Canada, with additional operations in Central America and Mexico. Its three operating segments are reported together as one reportable segment.
Financial performance
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Revenue | $786.6 million | $603.5 million | +30.3% |
| Gross margin | $343.6 million; 43.7% | $283.3 million; 46.9% | Margin down 3.2 percentage points |
| Operating income | $107.4 million; 13.6% margin | $89.9 million; 14.9% margin | +19.4%; margin down 1.3 points |
| Income from continuing operations | $58.2 million | $52.0 million | +11.9% |
| Net income | $58.2 million | $53.9 million | +7.9% |
| Diluted EPS from continuing operations | $0.39 | $0.36 | Up $0.03 |
| Operating cash flow | $77.3 million | $88.1 million | Down $10.8 million |
| Capital expenditures | $18.1 million | $10.9 million | Up $7.2 million |
Revenue growth reflected acquisitions, higher product volumes and higher scrap and metal sales. Organic growth was 13.6% overall: 10.3% in parts and services and 36.7% in other revenue. Vehicle replacement products and services were about 84% of sales. Aftermarket, other new and refurbished products generated $381.1 million; recycled, remanufactured and related products and services generated $275.8 million; other revenue was $129.8 million.
Gross margin pressure reflected higher salvage-vehicle acquisition costs, aftermarket competitive pricing and a greater contribution from lower-margin scrap aluminum sales. Operating expense ratios improved with revenue scale, partially offsetting the gross-margin decline. Q1 2010 net income included $2.0 million from discontinued operations, including a sale gain; Q1 2011 had no discontinued-operations income.
Balance sheet, debt and liquidity
- Cash and equivalents were $64.5 million at March 31, down from $95.7 million at December 31, 2010. Current assets were $852.1 million and current liabilities $208.3 million.
- Total assets were $2.36 billion; stockholders’ equity was $1.49 billion.
- Long-term obligations were $559.3 million, including $14.8 million current maturities. Credit-facility borrowings were $547.5 million: $250.0 million term debt and $297.5 million revolver borrowings. Revolver availability, net of $25.7 million in letters of credit, was $426.8 million.
- On March 25, LKQ replaced its prior facility with a five-year $750 million revolving facility and $250 million term loan. The weighted-average rate on outstanding facility borrowings, after swaps, was 3.58%. The company reported compliance with its covenants, including a maximum net leverage ratio of 3.00x and minimum interest coverage ratio of 3.00x.
- Operating cash flow was lower mainly because of greater investment in primary working capital accounts. Investing used $61.5 million, including $43.5 million for acquisitions and $18.1 million for property and equipment. Financing used $47.0 million, including $7.7 million of new credit-facility issuance costs.
Material changes and unusual items
- LKQ acquired four businesses for total consideration of $48.8 million: an engine remanufacturer, an automotive heating and cooling distributor, a wholesale recycled-products business and a recycled heavy-duty truck business. Acquisitions contributed about $22.0 million of revenue and $1.2 million of operating income from their acquisition dates through quarter-end. Purchase-price allocations remained preliminary; $22.6 million of goodwill was recorded.
- A $5.3 million debt-extinguishment loss from writing off unamortized costs on the previous facility increased other expense. New facility fees of $7.7 million were capitalized.
- Q1 effective tax rate was 39.2%, versus 37.2% a year earlier. Q1 2011 included a $0.2 million discrete tax charge; the prior-year quarter included a $1.7 million discrete benefit.
- Goodwill was $1.06 billion. Management reported no Q1 impairment indicator, but identified greater estimation uncertainty for the heavy-duty truck reporting unit.
Outlook, commentary and risks
- For full-year 2011, management estimated income from continuing operations of $197–$211 million and diluted continuing-operations EPS of $1.33–$1.42, excluding restructuring expenses. Full-year organic growth in parts and services was projected at 6%–8%; management expected a lower rate in the second half than Q1.
- Management anticipated approximately $195 million of operating cash flow for 2011 and $67–$77 million of capital expenditures for the remainder of 2011, excluding acquisitions. It expected current cash, operating cash flow and credit availability to meet operating and capital needs.
- Cross Canada integration was expected to be completed in 2011, with approximately $1.6 million of charges beginning in Q2 for severance and facility closures.
- Key exposures include higher salvage-vehicle costs, competitive pricing, metal-price volatility and the lag between metal selling prices and inventory costs, rising fuel and freight costs, variable interest rates, foreign-exchange exposure and acquisition integration. A 100-basis-point interest-rate movement was estimated to change interest expense by $1.9 million over the next 12 months after the stated hedge expiration.
- Management said ordinary-course litigation and environmental contingencies were not expected to materially affect financial position, results or cash flows. Part II reported no legal proceedings. Results may fluctuate seasonally and are not necessarily indicative of full-year performance.
Important facts for investors to verify
- Whether projected 6%–8% full-year parts-and-services organic growth and the earnings guidance remain achievable as Q1 comparisons normalize.
- Whether gross-margin pressure from salvage acquisition costs, mix and pricing persists, and whether expense leverage can offset it.
- Final purchase-price allocations, acquired-business performance and integration costs, including the expected $1.6 million Cross Canada charge.
- Cash conversion and working-capital trends, planned capital spending, and the use of revolver capacity for acquisitions or expansion.
- Compliance with credit covenants and exposure to floating rates, foreign currencies, metal prices and potential goodwill impairment.