LKQ (LKQ) - 2023 Q1 - Quarterly Report

PART I FINANCIAL INFORMATION This section provides LKQ Corporation's unaudited condensed consolidated financial statements and detailed notes for the three months ended March 31, 2023 and 2022 Item 1. Financial Statements This section details LKQ Corporation's unaudited condensed consolidated financial statements and accompanying notes for the specified interim periods Unaudited Condensed Consolidated Statements of Income | Metric | Three Months Ended March 31, 2023 (Millions) | Three Months Ended March 31, 2022 (Millions) | | :------------------------------------- | :------------------------------------------- | :------------------------------------------- | | Revenue | $3,349 | $3,348 | | Cost of goods sold | $1,977 | $1,991 | | Gross margin | $1,372 | $1,357 | | Operating income | $365 | $371 | | Income from continuing operations | $270 | $269 | | Net income | $270 | $273 | | Basic earnings per share | $1.01 | $0.96 | | Diluted earnings per share | $1.01 | $0.95 | Unaudited Condensed Consolidated Statements of Comprehensive Income | Metric | Three Months Ended March 31, 2023 (Millions) | Three Months Ended March 31, 2022 (Millions) | | :------------------------------------------ | :------------------------------------------- | :------------------------------------------- | | Net income | $270 | $273 | | Foreign currency translation, net of tax | $57 | $(54) | | Net change in unrealized gains/losses on cash flow hedges, net of tax | $(17) | — | | Other comprehensive income (loss) | $43 | $(53) | | Comprehensive income | $313 | $220 | Unaudited Condensed Consolidated Balance Sheets | Metric | March 31, 2023 (Millions) | December 31, 2022 (Millions) | | :-------------------------------- | :------------------------ | :--------------------------- | | Total current assets | $4,623 | $4,258 | | Property, plant and equipment, net | $1,265 | $1,236 | | Goodwill | $4,366 | $4,319 | | Total assets | $12,508 | $12,038 | | Total current liabilities | $2,412 | $2,271 | | Long-term obligations, excluding current portion | $2,684 | $2,622 | | Total liabilities and stockholders' equity | $12,508 | $12,038 | | Total Company stockholders' equity | $5,691 | $5,453 | | Total stockholders' equity | $5,705 | $5,467 | Unaudited Condensed Consolidated Statements of Cash Flows | Metric | Three Months Ended March 31, 2023 (Millions) | Three Months Ended March 31, 2022 (Millions) | | :------------------------------------------ | :------------------------------------------- | :------------------------------------------- | | Net cash provided by operating activities | $223 | $409 | | Net cash used in investing activities | $(97) | $(63) | | Net cash used in financing activities | $(66) | $(278) | | Net increase in cash and cash equivalents | $64 | $53 | | Cash and cash equivalents, end of period | $342 | $327 | Unaudited Condensed Consolidated Statements of Stockholders' Equity | Metric | Balance as of January 1, 2023 (Millions) | Balance as of March 31, 2023 (Millions) | | :------------------------------------------ | :--------------------------------------- | :-------------------------------------- | | Total Stockholders' Equity | $5,467 | $5,705 | | Net income | — | $270 | | Other comprehensive income | — | $43 | | Purchase of treasury stock | — | $(5) | | Dividends declared to LKQ stockholders | — | $(74) | Notes to Unaudited Condensed Consolidated Financial Statements Note 1. Interim Financial Statements - The company adopted Accounting Standards Update No. 2022-04 (ASU 2022-04) on a retrospective basis in Q1 2023, requiring disclosure of supplier finance program obligations, with no material impact on financial statements[23] Note 2. Discontinued Operations and Divestitures - For the three months ended March 31, 2022, the company recorded a $4 million benefit to discontinued operations, primarily from reassessing a deferred tax asset related to its glass manufacturing business sold in 2017[24] - In April 2022, the company completed the sale of PGW Auto Glass, its aftermarket glass business, for $361 million[25] Note 3. Uni-Select Acquisition - On February 26, 2023, LKQ Corporation agreed to acquire Uni-Select Inc. for CAD 48.00 per share in cash, totaling approximately CAD 2.8 billion ($2.1 billion)[26] - The acquisition is expected to close in the second half of 2023, subject to regulatory approvals, with LKQ intending to divest the GSF Car Parts segment[26][28] - The company entered into foreign exchange contracts to reduce CAD foreign exchange rate risk, resulting in a $23 million gain reported in Q1 2023[29] - Financing arrangements include a $2.1 billion senior unsecured bridge loan facility (reduced to $1.6 billion) and a new CAD 700 million unsecured term loan credit agreement[30][31] Note 4. Inventories | Inventory Category | March 31, 2023 (Millions) | December 31, 2022 (Millions) | | :------------------------- | :------------------------ | :--------------------------- | | Aftermarket and refurbished products | $2,219 | $2,279 | | Salvage and remanufactured products | $464 | $427 | | Manufactured products | $50 | $46 | | Total inventories | $2,733 | $2,752 | Note 5. Allowance for Credit Losses | Metric | March 31, 2023 (Millions) | December 31, 2022 (Millions) | | :-------------------------- | :------------------------ | :--------------------------- | | Allowance for credit losses | $58 | $54 | - The provision for credit losses was $5 million for the three months ended March 31, 2023, compared to $8 million for the same period in 2022[37] Note 6. Noncontrolling Interest - The company reported a $24 million redeemable noncontrolling interest as of March 31, 2023, related to redeemable shares from a previous acquisition[38] - The redeemable shares include a put option for the minority shareholder at a fixed price of $24 million, exercisable in Q4 2023[38] Note 7. Intangible Assets - Goodwill and indefinite-lived intangible assets are tested for impairment at least annually; the last annual test in Q4 2022 found no impairment, and no indicators for an interim test were identified in Q1 2023[39] Note 8. Equity Method Investments | Investment | Segment | Ownership (Mar 31, 2023) | March 31, 2023 (Millions) | December 31, 2022 (Millions) | | :--------- | :------ | :----------------------- | :------------------------ | :--------------------------- | | MEKO AB | Europe | 26.6% | $143 | $129 | | Other | | | $13 | $12 | | Total | | | $156 | $141 | - The Level 1 fair value of the investment in MEKO AB was $178 million as of March 31, 2023[40] Note 9. Warranty Reserve | Metric | Amount (Millions) | | :-------------------------- | :---------------- | | Balance as of December 31, 2022 | $32 | | Warranty expense | $19 | | Warranty claims | $(19) | | Balance as of March 31, 2023 | $32 | Note 10. Revenue Recognition | Revenue Category | Three Months Ended March 31, 2023 (Millions) | Three Months Ended March 31, 2022 (Millions) | | :----------------- | :------------------------------------------- | :------------------------------------------- | | Parts and services | $3,152 | $3,104 | | Other | $197 | $244 | | Total revenue | $3,349 | $3,348 | | Geographic Area | Three Months Ended March 31, 2023 (Millions) | Three Months Ended March 31, 2022 (Millions) | | :---------------- | :------------------------------------------- | :------------------------------------------- | | United States | $1,681 | $1,750 | | United Kingdom | $415 | $425 | | Germany | $416 | $386 | | Other countries | $837 | $787 | | Total revenue | $3,349 | $3,348 | Note 11. Restructuring and Transaction Related Expenses | Expense Type | Three Months Ended March 31, 2023 (Millions) | Three Months Ended March 31, 2022 (Millions) | | :-------------------------------- | :------------------------------------------- | :------------------------------------------- | | Total restructuring expenses | $8 | — | | Transaction related expenses | $10 | $3 | | Restructuring and transaction related expenses | $18 | $3 | - Restructuring expenses in Q1 2023 primarily included $5 million for global restructuring plans, $2 million for acquisition integration, and $1 million for the 1 LKQ Europe plan[123] - Transaction related expenses in Q1 2023 and Q1 2022 were mainly external legal, accounting, and advisory fees for completed and potential acquisitions, including Uni-Select costs in 2023[123] Note 12. Stock-Based Compensation | Metric | Three Months Ended March 31, 2023 (Millions) | Three Months Ended March 31, 2022 (Millions) | | :-------------------------------- | :------------------------------------------- | :------------------------------------------- | | Pre-tax stock-based compensation expense | $10 | $13 | - As of March 31, 2023, unrecognized compensation expense related to unvested RSUs and PSUs was $71 million[58] Note 13. Earnings Per Share | Metric | Three Months Ended March 31, 2023 | Three Months Ended March 31, 2022 | | :------------------------------------------ | :-------------------------------- | :-------------------------------- | | Income from continuing operations | $270 | $269 | | Weighted-average shares outstanding (basic) | 267.4 | 285.7 | | Basic earnings per share from continuing operations | $1.01 | $0.94 | | Diluted earnings per share from continuing operations | $1.01 | $0.94 | Note 14. Accumulated Other Comprehensive Loss | Component | Balance as of January 1, 2023 (Millions) | Balance as of March 31, 2023 (Millions) | | :-------------------------------- | :--------------------------------------- | :-------------------------------------- | | Foreign Currency Translation | $(333) | $(276) | | Unrealized Gain (Loss) on Cash Flow Hedges | — | $(17) | | Unrealized Gain on Pension Plans | $11 | $11 | | Other Comprehensive Income (Loss) from Unconsolidated Subsidiaries | $(1) | $2 | | Accumulated Other Comprehensive Loss | $(323) | $(280) | Note 15. Supply Chain Financing - As of March 31, 2023, the company had $240 million of Accounts payable outstanding under its voluntary supply chain finance programs, down from $248 million at December 31, 2022[62] Note 16. Long-Term Obligations | Debt Type | March 31, 2023 (Millions) | December 31, 2022 (Millions) | | :-------------------------------- | :------------------------ | :--------------------------- | | Term loans payable | $500 | — | | Revolving credit facilities | $1,335 | $1,786 | | Euro Notes (2024) | $542 | $535 | | Euro Notes (2028) | $271 | $268 | | Total debt | $2,740 | $2,662 | - On January 5, 2023, the company entered into a new Senior Unsecured Credit Agreement, establishing a $2.0 billion unsecured revolving credit facility and a $500 million unsecured term loan facility, replacing the prior Senior Secured Credit Agreement[64][66] - The weighted average interest rate on total borrowings was 4.7% at March 31, 2023[167] Note 17. Derivative Instruments and Hedging Activities - In February 2023, the company entered into interest rate swap agreements with a total notional amount of $700 million to mitigate variable interest rate risk on borrowings under its Senior Unsecured Credit Agreement[70] - In March 2023, forward-starting interest rate swaps with a total notional amount of $1.2 billion were entered into to hedge interest rate risk related to forecasted debt issuance for the Uni-Select Acquisition[71] - Foreign exchange contracts related to the Uni-Select Acquisition purchase price resulted in a $23 million gain in Q1 2023[74] Note 18. Fair Value Measurements | Financial Instrument | Fair Value - Asset (Millions) (Mar 31, 2023) | Fair Value - Liability (Millions) (Mar 31, 2023) | | :------------------------- | :------------------------------------------- | :----------------------------------------------- | | Foreign currency forward contracts (Level 2) | $23 | — | | Contingent consideration liabilities (Level 3) | — | $7 | | Interest rate swaps (Level 2) | — | $22 | - The fair value of Senior Unsecured Credit Agreement borrowings approximated its carrying value of $1,835 million as of March 31, 2023[81] Note 19. Employee Benefit Plans - The aggregate funded status of defined benefit plans was a $72 million liability as of both March 31, 2023, and December 31, 2022[85] Note 20. Income Taxes | Metric | Three Months Ended March 31, 2023 | Three Months Ended March 31, 2022 | | :-------------------- | :-------------------------------- | :-------------------------------- | | Effective income tax rate | 26.1% | 25.0% | - The increase in the effective tax rate is primarily due to the geographic distribution of income and higher non-deductible transaction costs related to the Uni-Select Acquisition[89] - The company does not expect the corporate minimum tax provisions of the Inflation Reduction Act of 2022 to have a material impact on its financial results[90] Note 21. Segment and Geographic Information - The company operates in four reportable segments: Wholesale - North America, Europe, Specialty, and Self Service[91] | Segment | Segment EBITDA (Millions) (Q1 2023) | Segment EBITDA (Millions) (Q1 2022) | | :------------------------ | :---------------------------------- | :---------------------------------- | | Wholesale - North America | $252 | $218 | | Europe | $151 | $131 | | Specialty | $31 | $58 | | Self Service | $22 | $40 | | Consolidated | $456 | $447 | | Geographic Area | Long-lived assets (Millions) (Mar 31, 2023) | Long-lived assets (Millions) (Dec 31, 2022) | | :---------------- | :------------------------------------------ | :------------------------------------------ | | United States | $1,386 | $1,371 | | Germany | $302 | $290 | | United Kingdom | $263 | $256 | | Other countries | $563 | $546 | | Total | $2,514 | $2,463 | Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses LKQ Corporation's financial condition, operational results, liquidity, capital resources, and key business factors Overview - LKQ Corporation is a global distributor of vehicle replacement parts and specialty vehicle aftermarket products, focusing on alternative parts for collision and mechanical repair shops[103][104] - The company is organized into four operating segments: Wholesale - North America, Europe, Specialty, and Self Service[105] Acquisitions and Investments - The company has shifted its acquisition strategy from consolidation to targeting high synergies and critical capabilities, with the pending Uni-Select Acquisition being a key example[108] Sources of Revenue - Revenue is reported in two categories: 'parts and services' (vehicle products, warranties, diagnostic/repair services) and 'other' (scrap, precious metals, bulk sales)[109] - Revenue from 'other' sources fluctuates based on commodity prices and the volume of materials sold[109] Critical Accounting Estimates - There have been no material changes to the company's critical accounting estimates during the three months ended March 31, 2023[110] Financial Information by Geographic Area - Detailed information regarding revenue and long-lived assets by geographic region is provided in Note 10 and Note 21 of the financial statements[111] 1 LKQ Europe Program - The multi-year '1 LKQ Europe' program aims to centralize and standardize key functions in the Europe segment, involving restructuring expenses, transformation expenses, and transformation capital expenditures[112] - Costs for the program from 2023 through its projected completion in 2025 are estimated to range between $50 million and $80 million, expected to be entirely funded by trade working capital initiatives[114] Ukraine/Russia Conflict - The conflict has restricted sales in Russia and Belarus and impacted operations in Ukraine, but the company does not expect a material impact on its ongoing results of operations or cash flows, as Ukraine operations represented less than 1% of total annual revenue and operating profit for fiscal year 2022[115] Key Performance Indicators - The company identifies organic revenue growth, Segment EBITDA, and free cash flow as key performance indicators used for incentive compensation, aiming to motivate a balanced approach to growth, profitability, and cash flow generation[116][117] Results of Operations—Consolidated | Metric | Three Months Ended March 31, 2023 | Three Months Ended March 31, 2022 | | :------------------------------------------ | :-------------------------------- | :-------------------------------- | | Revenue | $3,349M | $3,348M | | Gross margin | 41.0% | 40.5% | | Operating income | $365M | $371M | | Net income | $270M | $273M | | Interest expense | $36M | $16M | - Consolidated revenue remained flat year-over-year at $3,349 million, with parts and services revenue increasing 1.5% and other revenue decreasing 19.2%[119][120] - Interest expense increased by $20 million, primarily due to higher interest rates and amortization of pre-acquisition bridge loan financing costs related to the Uni-Select Acquisition[125] - The effective income tax rate increased to 26.1% from 25.0%, mainly due to the geographic distribution of income and higher non-deductible transaction costs from the Uni-Select Acquisition[126] Results of Operations—Segment Reporting | Segment | Segment EBITDA (Millions) (Q1 2023) | Segment EBITDA (Millions) (Q1 2022) | % Change | | :------------------------ | :---------------------------------- | :---------------------------------- | :------- | | Wholesale - North America | $252 | $218 | +15.6% | | Europe | $151 | $131 | +14.8% | | Specialty | $31 | $58 | -46.3% | | Self Service | $22 | $40 | -43.5% | Wholesale - North America | Metric | Q1 2023 (Millions) | Q1 2022 (Millions) | Total Change (%) | | :------------------------ | :----------------- | :----------------- | :--------------- | | Total third party revenue | $1,229 | $1,201 | +2.3% | | Parts & services organic revenue growth | +14.4% | | | | Other revenue change | -14.7% | | | - Parts and services organic revenue increased 14.4% due to pricing initiatives, net volume increase, and the continued rollout of State Farm's aftermarket parts program[136] - Segment EBITDA increased 15.6% to $252 million, despite a $16 million negative impact from the PGW business divestiture, driven by higher parts prices, improved aftermarket volumes, and lower freight costs[137] Europe | Metric | Q1 2023 (Millions) | Q1 2022 (Millions) | Total Change (%) | | :------------------------ | :----------------- | :----------------- | :--------------- | | Total third party revenue | $1,555 | $1,488 | +4.5% | | Parts & services organic revenue growth | +9.7% | | | | Foreign exchange impact on revenue | -5.9% | | | - Segment EBITDA increased 14.8% to $151 million, or 21.3% on a constant currency basis, driven by organic revenue growth and margin expansion from favorable leverage effects and productivity initiatives[144] Specialty | Metric | Q1 2023 (Millions) | Q1 2022 (Millions) | Total Change (%) | | :------------------------ | :----------------- | :----------------- | :--------------- | | Total third party revenue | $396 | $460 | -14.0% | | Parts & services organic revenue change | -13.5% | | | - The organic revenue decline of 13.5% was primarily due to demand softness in the recreational vehicle (RV) product line[148] - Segment EBITDA decreased 46.3% to $31 million, primarily due to the organic revenue decline and negative leverage effect on overhead expenses[148] Self Service | Metric | Q1 2023 (Millions) | Q1 2022 (Millions) | Total Change (%) | | :------------------------ | :----------------- | :----------------- | :--------------- | | Total third party revenue | $169 | $199 | -14.8% | | Parts & services organic revenue growth | +4.9% | | | | Other organic revenue change | -14.5% | | | - Other organic revenue decreased by $20 million, primarily due to lower prices for precious metals and scrap steel[154] - Segment EBITDA decreased 43.5% to $22 million, driven by unfavorable movements in commodity prices and gross margin compression from higher vehicle procurement costs[152] Liquidity and Capital Resources | Metric | March 31, 2023 (Millions) | December 31, 2022 (Adjusted Millions) | | :------------------------------------------ | :------------------------ | :------------------------------------ | | Cash and cash equivalents | $342 | $278 | | Availability under credit facilities | $591 | $1,295 | | Total liquidity | $933 | $1,573 | | Metric | Three Months Ended March 31, 2023 (Millions) | Three Months Ended March 31, 2022 (Millions) | | :------------------------------------------ | :------------------------------------------- | :------------------------------------------- | | Net cash provided by operating activities | $223 | $409 | | Purchases of property, plant and equipment | $70 | $59 | | Free cash flow | $153 | $350 | - The decrease in net cash provided by operating activities was primarily due to lower cash inflows from accounts payable ($287 million decrease) and higher interest payments[174] - The company was in compliance with all applicable covenants under its Senior Unsecured Credit Agreement as of March 31, 2023, with a total leverage ratio of 1.6 (covenant 4.00:1.00) and an interest coverage ratio of 19.9 (covenant 3.00:1.00)[164] - Financing for the Uni-Select Acquisition includes a $1.6 billion bridge loan facility and a CAD 700 million delayed draw term loan[162] - A quarterly cash dividend of $0.275 per share was declared on February 21, 2023, payable on March 30, 2023[159] - The company repurchased 0.1 million shares of common stock in January 2023 at an average price of $54.20 per share, with $1,106 million remaining under the current authorization[197] Item 3. Quantitative and Qualitative Disclosures About Market Risk This section details LKQ Corporation's exposure to market risks, including foreign exchange, interest rates, commodity prices, and inflation, and outlines risk management strategies Foreign Exchange Rates - The company is exposed to foreign currency fluctuations, with operations outside the U.S. representing 49.8% of Q1 2023 revenue[179] - A 10% increase or decrease in the U.S. dollar's strength against other currencies would result in a 5.0% change in consolidated revenue and a 3.6% change in operating income for Q1 2023[179] - Derivatives, including foreign currency forward contracts, are used to hedge some foreign currency exposures, such as for a portion of inventory purchases and the Uni-Select Acquisition[180][181] Interest Rates - The company is exposed to changes in interest rates primarily on its variable-rate debt under credit facilities, which are tied to rates like SOFR[183] - Interest rate swap contracts are used to manage this exposure by converting a portion of variable-rate debt to fixed rates[183] - As of March 31, 2023, approximately $1,135 million of variable rate debt was unhedged; a 100 basis point movement in interest rates would change interest expense by $11 million over the next twelve months[186] Commodity Prices - The company is exposed to market risk from price fluctuations in scrap metal and precious metals (platinum, palladium, rhodium), which affect both inventory costs and revenue[187] - While there is a natural hedge, lags and rapid price movements can lead to positive or negative gross margin effects[187] - For Q1 2023 compared to Q1 2022, average prices of rhodium, palladium, and platinum decreased by 44%, 37%, and 4% respectively; scrap metal prices increased by 33% over Q4 2022[187] Inflation - The company is exposed to inflation in product, labor, shipping, freight, and general overhead costs, which increased in 2022 and continued into 2023[188] - Mitigation efforts include price adjustments and productivity initiatives, but sustained or increased inflationary pressures could adversely affect gross margins and SG&A expenses if not fully offset[188] Item 4. Controls and Procedures This section assesses the effectiveness of LKQ Corporation's disclosure controls and procedures and reports on internal control changes Evaluation of Disclosure Controls and Procedures - Management, including the CEO and CFO, concluded that the company's disclosure controls and procedures were effective as of March 31, 2023, providing reasonable assurance for timely and accurate reporting[190] Changes in Internal Control over Financial Reporting - There were no changes in internal control over financial reporting during the quarter ended March 31, 2023, that materially affected, or are reasonably likely to materially affect, the company's internal control over financial reporting[191] PART II OTHER INFORMATION This section provides additional information including legal proceedings, risk factors, equity security sales, and required exhibits Item 1. Legal Proceedings This section provides an update on legal proceedings, including a recent settlement with the U.S. Environmental Protection Agency - The company reached a settlement with Region 4 of the U.S. Environmental Protection Agency (EPA) to pay a penalty of $465,000 for alleged violations of federal stormwater regulations, which was paid on February 28, 2023[194] Item 1A. Risk Factors This section refers readers to the company's Annual Report on Form 10-K for a comprehensive discussion of risks and uncertainties - Readers are directed to the company's 2022 Form 10-K for information concerning risks and uncertainties that could negatively impact the business[195] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds This section details the company's stock repurchase program and the activity during the quarter - The Board of Directors authorized a stock repurchase program extending through October 25, 2025[196] | Period | Total Number of Shares Purchased (Millions) | Average Price Paid per Share | | :-------------------------- | :---------------------------------------- | :--------------------------- | | January 1, 2023 - January 31, 2023 | 0.1 | $54.20 | | February 1, 2023 - February 28, 2023 | — | — | | March 1, 2023 - March 31, 2023 | — | — | | Total | 0.1 | | - As of March 31, 2023, approximately $1,106 million remained available under the stock repurchase program authorization[197] Item 6. Exhibits This section lists all exhibits filed as part of the Quarterly Report on Form 10-Q, including various agreements and certifications - Exhibits include the Arrangement Agreement for the Uni-Select acquisition, Credit Agreement, Term Loan Credit Agreement, and certifications from the CEO and CFO[198] SIGNATURES This section contains the official signatures of the authorized officers of LKQ Corporation, certifying the filing of the report - The report was signed on April 27, 2023, by Rick Galloway, Senior Vice President and Chief Financial Officer, and Michael S. Clark, Vice President - Finance and Controller[201][202]