LKQ CORP, 10-Q filed on 4/29/2011
Quarterly Report
Document and Entity Information
3 Months Ended
Mar. 31, 2011
Apr. 22, 2011
Document and Entity Information
 
 
Document Type
10-Q 
 
Amendment Flag
FALSE 
 
Document Period End Date
2011-03-31 
 
Document Fiscal Year Focus
2011 
 
Document Fiscal Period Focus
Q1 
 
Entity Registrant Name
LKQ CORP 
 
Entity Central Index Key
0001065696 
 
Current Fiscal Year End Date
12/31 
 
Entity Filer Category
Large Accelerated Filer 
 
Entity Common Stock, Shares Outstanding
 
145,886,934 
Consolidated Condensed Balance Sheets (USD $)
In Thousands
3 Months Ended
Mar. 31, 2011
Year Ended
Dec. 31, 2010
Assets
 
 
Cash and equivalents
$ 64,517 
$ 95,689 
Receivables, net
222,581 
191,085 
Inventory
514,894 
492,688 
Deferred income taxes
34,135 
32,506 
Prepaid income taxes
 
10,923 
Prepaid expenses
15,990 
13,985 
Total Current Assets
852,117 
836,876 
Property and Equipment, net
342,181 
331,312 
Intangible Assets:
 
 
Goodwill
1,057,406 
1,032,973 
Other intangibles, net
67,872 
69,302 
Other Assets
35,803 
29,046 
Total Assets
2,355,379 
2,299,509 
Liabilities and Stockholders' Equity
 
 
Accounts payable
75,377 
76,437 
Accrued expenses:
 
 
Accrued payroll-related liabilities
35,723 
41,376 
Self-insurance reserves
16,806 
16,820 
Other accrued expenses
32,989 
25,832 
Income taxes payable
20,754 
 
Deferred revenue
9,245 
9,224 
Current portion of long-term obligations
14,817 
52,888 
Liabilities of discontinued operations
2,561 
2,744 
Total Current Liabilities
208,272 
225,321 
Long-Term Obligations, Excluding Current Portion
544,451 
548,066 
Deferred Income Tax Liabilities
67,582 
66,059 
Other Noncurrent Liabilities
49,704 
45,902 
Commitments and Contingencies
 
 
Stockholders' Equity:
 
 
Common stock, $0.01 par value, 500,000,000 shares authorized, 145,879,504 and 145,466,575 shares issued and outstanding at March 31, 2011 and December 31, 2010, respectively
1,459 
1,455 
Additional paid-in capital
878,206 
869,798 
Retained earnings
596,712 
538,530 
Accumulated other comprehensive income
8,993 
4,378 
Total Stockholders' Equity
1,485,370 
1,414,161 
Total Liabilities and Stockholders' Equity
$ 2,355,379 
$ 2,299,509 
Consolidated Condensed Balance Sheets (Parenthetical) (USD $)
Mar. 31, 2011
Dec. 31, 2010
Consolidated Condensed Balance Sheets
 
 
Common stock, par value
$ 0.01 
$ 0.01 
Common stock, shares authorized
500,000,000 
500,000,000 
Common stock, shares issued
145,879,504 
145,466,575 
Common stock, shares outstanding
145,879,504 
145,466,575 
Consolidated Condensed Statements of Income (USD $)
In Thousands, except Per Share data
3 Months Ended
Mar. 31,
2011
2010
Consolidated Condensed Statements of Income
 
 
Revenue
$ 786,648 
$ 603,516 
Cost of goods sold
443,002 
320,226 
Gross margin
343,646 
283,290 
Facility and warehouse expenses
69,818 
57,776 
Distribution expenses
65,811 
51,189 
Selling, general and administrative expenses
89,761 
75,087 
Restructuring expenses
46 
80 
Depreciation and amortization
10,839 
9,229 
Operating income
107,371 
89,929 
Other expense (income):
 
 
Interest expense, net
6,409 
7,276 
Loss on debt extinguishment
5,345 
 
Other income, net
(106)
(161)
Total other expense, net
11,648 
7,115 
Income from continuing operations before provision for income taxes
95,723 
82,814 
Provision for income taxes
37,541 
30,831 
Income from continuing operations
58,182 
51,983 
Discontinued operations:
 
 
Income from discontinued operations, net of taxes
 
224 
Gain on sale of discontinued operations, net of taxes
 
1,729 
Income from discontinued operations
 
1,953 
Net income
58,182 
53,936 
Basic earnings per share
 
 
Income from continuing operations
0.40 1
0.37 1
Income from discontinued operations
 
0.01 1
Total
0.40 1
0.38 1
Diluted earnings per share
 
 
Income from continuing operations
0.39 1
0.36 1
Income from discontinued operations
 
0.01 1
Total
$ 0.39 1
$ 0.37 1
Weighted average common shares outstanding:
 
 
Basic
145,611 
142,194 
Diluted
147,920 
145,124 
Consolidated Condensed Statements of Cash Flows (USD $)
In Thousands
3 Months Ended
Mar. 31,
2011
2010
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
Net income
$ 58,182 
$ 53,936 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Depreciation and amortization
11,926 
9,980 
Stock-based compensation expense
3,342 
2,524 
Deferred income taxes
562 
418 
Excess tax benefit from share-based payments
(2,460)
(3,500)
Gain on sale of discontinued operations
 
(2,744)
Loss on debt extinguishment
5,345 
 
Other
642 
785 
Changes in operating assets and liabilities, net of effects from acquisitions and divestitures:
 
 
Receivables
(19,039)
(3,306)
Inventory
2,678 
(4,173)
Prepaid income taxes/income taxes payable
33,769 
30,276 
Accounts payable
(9,658)
5,663 
Other operating assets and liabilities
(7,974)
(1,794)
Net cash provided by operating activities
77,315 
88,065 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
Purchases of property and equipment
(18,093)
(10,902)
Proceeds from sales of property and equipment
91 
92 
Proceeds from sale of businesses, net of cash sold
 
11,992 
Cash used in acquisitions, net of cash acquired
(43,517)
(3,746)
Net cash used in investing activities
(61,519)
(2,564)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
Proceeds from exercise of stock options
2,610 
3,185 
Excess tax benefit from share-based payments
2,460 
3,500 
Debt issuance costs
(7,741)
 
Borrowings under line of credit
341,753 
 
Repayments under line of credit
(44,328)
 
Borrowings under term loans
250,000 
 
Repayments under term loans
(591,089)
(7,476)
Repayments of other long-term debt
(652)
(351)
Net cash used in financing activities
(46,987)
(1,142)
Effect of exchange rate changes on cash and equivalents
19 
271 
Net (decrease) increase in cash and equivalents
(31,172)
84,630 
Cash and equivalents, beginning of period
95,689 
108,906 
Cash and equivalents, end of period
64,517 
193,536 
Supplemental disclosure of cash flow information:
 
 
Purchase price payable including notes issued in connection with business acquisitions
5,329 
2,150 
Cash paid for income taxes, net of refunds
3,313 
1,314 
Cash paid for interest
6,944 
7,142 
Property and equipment purchases not yet paid
$ 766 
$ 159 
Consolidated Condensed Statements of Stockholders' Equity and Other Comprehensive Income (USD $)
In Thousands
Common Stock [Member]
Additional Paid-In Capital [Member]
Retained Earnings [Member]
Accumulated Other Comprehensive Income [Member]
Total
BALANCE, value at Dec. 31, 2010
$ 1,455 
$ 869,798 
$ 538,530 
$ 4,378 
$ 1,414,161 
BALANCE, shares at Dec. 31, 2010
145,467 
 
 
 
 
Net income
 
 
58,182 
 
58,182 
Net reduction of unrealized loss/increase in unrealized gain on fair value of interest rate swap agreements, net of tax of $1,189
 
 
 
2,113 
2,113 
Foreign currency translation
 
 
 
2,502 
2,502 
Total comprehensive income
 
 
 
 
62,797 
Stock issued as director compensation, value
 
149 
 
 
149 
Stock issued as director compensation, shares
 
 
 
 
Stock-based compensation expense-options
 
3,193 
 
 
3,193 
Exercise of stock options, value
2,606 
 
 
2,610 
Exercise of stock options, shares
407 
 
 
 
 
Excess tax benefit from share-based payments
 
2,460 
 
 
2,460 
BALANCE, value at Mar. 31, 2011
$ 1,459 
$ 878,206 
$ 596,712 
$ 8,993 
$ 1,485,370 
BALANCE, shares at Mar. 31, 2011
145,880 
 
 
 
 
Consolidated Condensed Statements of Stockholders' Equity and Other Comprehensive Income (Parenthetical) (USD $)
In Thousands
3 Months Ended
Mar. 31, 2011
Consolidated Condensed Statements of Stockholders' Equity and Other Comprehensive Income
 
Tax paid on interest rate swap agreements
$ 1,189 
Interim Financial Statements
Interim Financial Statements

Note 1. Interim Financial Statements

The unaudited financial statements presented in this report represent the consolidation of LKQ Corporation, a Delaware corporation, and its subsidiaries. LKQ Corporation is a holding company and all operations are conducted by subsidiaries. When the terms "the Company," "we," "us," or "our" are used in this document, those terms refer to LKQ Corporation and its consolidated subsidiaries.

We have prepared the accompanying unaudited consolidated condensed financial statements pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") applicable to interim financial statements. Accordingly, certain information related to our significant accounting policies and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. These unaudited consolidated condensed financial statements reflect, in the opinion of management, all material adjustments (which include only normal recurring adjustments) necessary to fairly state, in all material respects, our financial position, results of operations and cash flows for the periods presented.

Operating results for interim periods are not necessarily indicative of the results that can be expected for any subsequent interim period or for a full year. These interim financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto included in our most recent Annual Report on Form 10-K for the year ended December 31, 2010 filed with the SEC on February 25, 2011.

As described in Note 3, "Discontinued Operations," during the fourth quarter of 2009, we agreed to sell two self service retail facilities in Dallas, Texas and we completed the sale in January 2010. These facilities qualified for treatment as discontinued operations. The financial results and assets and liabilities of these facilities are segregated from our continuing operations and presented as discontinued operations in the Unaudited Consolidated Condensed Balance Sheets and Unaudited Consolidated Condensed Statements of Income for all periods presented.

Financial Statement Information
Financial Statement Information

Note 2. Financial Statement Information

Revenue Recognition

The majority of our revenue is derived from the sale of aftermarket, recycled, refurbished and remanufactured automotive replacement products. Revenue is recognized when the products are shipped or picked up by customers and title has transferred, subject to an allowance for estimated returns, discounts and allowances that we estimate based upon historical information. We have recorded a reserve for estimated returns, discounts and allowances of approximately $20.1 million and $18.2 million at March 31, 2011 and December 31, 2010, respectively. We present taxes assessed by governmental authorities collected from customers on a net basis. Therefore, the taxes are excluded from revenue and are shown as a liability on our Unaudited Consolidated Condensed Balance Sheets until remitted. Revenue from the sale of separately-priced extended warranty contracts is reported as deferred revenue and recognized ratably over the term of the contracts or three years in the case of lifetime warranties.

Receivables

We have recorded a reserve for uncollectible accounts of approximately $6.7 million and $6.9 million at March 31, 2011 and December 31, 2010, respectively.

Inventory

Inventory consists of the following (in thousands):

 

     March 31,
2011
     December 31,
2010
 

Aftermarket and refurbished products

   $ 282,391       $ 274,728   

Salvage and remanufactured products

     225,682         209,514   

Core facilities inventory

     6,821         8,446   
                 
   $ 514,894       $ 492,688   
                 

 

Intangibles

Intangible assets consist primarily of goodwill (the cost of purchased businesses in excess of the fair value of the identifiable net assets acquired), and other specifically identifiable intangible assets, such as trade names, trademarks, covenants not to compete and customer relationships.

The change in the carrying amount of goodwill during the three months ended March 31, 2011 is as follows (in thousands):

 

Balance as of January 1, 2011

   $ 1,032,973   

Business acquisitions

     22,579   

Exchange rate effects

     1,854   
        

Balance as of March 31, 2011

   $ 1,057,406   
        

The components of other intangibles are as follows (in thousands):

 

     March 31, 2011      December 31, 2010  
     Gross
Carrying
Amount
     Accumulated
Amortization
    Net      Gross
Carrying
Amount
     Accumulated
Amortization
    Net  

Trade names and trademarks

   $ 75,688       $ (13,000   $ 62,688       $ 75,661       $ (12,020   $ 63,641   

Covenants not to compete

     1,705         (512     1,193         2,688         (1,382     1,306   

Customer relationships

     4,411         (420     3,991         4,355         —          4,355   
                                                   
   $ 81,804       $ (13,932   $ 67,872       $ 82,704       $ (13,402   $ 69,302   
                                                   

Trade names and trademarks are amortized over a useful life ranging from 10 to 20 years on a straight-line basis. Covenants not to compete are amortized over the lives of the respective agreements, which range from one to five years, on a straight-line basis. Customer relationships are amortized over the expected period to be benefitted (5 to 10 years) on either a straight-line or accelerated basis. Amortization expense for intangibles was approximately $1.5 million and $1.1 million during the three month periods ended March 31, 2011 and 2010, respectively. Estimated annual amortization expense for each of the years ending December 31, 2011 through 2015 is approximately $4.8 million.

Depreciation Expense

Included in cost of goods sold on the Unaudited Consolidated Condensed Statements of Income is depreciation expense associated with refurbishing, remanufacturing and smelting operations.

Warranty Reserve

Some of our salvage mechanical products are sold with a standard six-month warranty against defects. Additionally, some of our remanufactured engines are sold with a standard three-year warranty against defects. We record the estimated warranty costs at the time of sale using historical warranty claim information to project future warranty claims activity and related expenses. The changes in the warranty reserve during the three month period ended March 31, 2011 were as follows (in thousands):

 

Balance as of January 1, 2011

   $ 2,063   

Warranty expense

     4,833   

Warranty claims

     (4,641

Business acquisitions

     3,228   
        

Balance as of March 31, 2011

   $ 5,483   
        

For an additional fee, we also sell extended warranty contracts for certain mechanical products. The expense related to extended warranty claims is recognized when the claim is made.

 

Fair Value of Financial Instruments

Our debt is reflected on the balance sheet at cost. As discussed in Note 5, "Long-Term Obligations," we entered into a new senior secured credit agreement on March 25, 2011, the proceeds of which were used for full payment of amounts outstanding under our previous credit facility. Due to the brief period between the execution of the new credit agreement and the end of the quarter, the fair value of our outstanding debt reasonably approximated the carrying value of $548 million. We estimated the fair value of our credit facility borrowings by calculating the upfront cash payment a market participant would require to assume our obligations. The upfront cash payment, excluding any issuance costs, is the amount that a market participant would be able to lend at March 31, 2011 to an entity with a credit rating similar to ours and achieve sufficient cash inflows to cover the scheduled cash outflows under our credit facility.

The carrying amounts of our cash and equivalents, net trade receivables and accounts payable approximate fair value.

We apply the market and income approaches to value our financial assets and liabilities, which include the cash surrender value of life insurance, deferred compensation liabilities and interest rate swaps. Required fair value disclosures are included in Note 7, "Fair Value Measurements."

Segments

We are organized into three operating segments, composed of wholesale aftermarket and recycled products, self service retail products, and recycled heavy-duty truck products. These segments are aggregated into one reportable segment because they possess similar economic characteristics and have common products and services, customers and methods of distribution.

The following table sets forth revenue by type (in thousands):

 

     Three Months Ended
March 31,
 
     2011      2010  

Aftermarket, other new and refurbished products

   $ 381,116       $ 312,373   

Recycled, remanufactured and related products and services

     275,782         215,223   

Other

     129,750         75,920   
                 
   $ 786,648       $ 603,516   
                 

Revenue from other sources includes scrap sales, bulk sales to mechanical remanufacturers, and sales of aluminum ingots and sows from our smelting operations.

Recent Accounting Pronouncements

Effective January 1, 2011, we adopted Financial Accounting Standards Board Accounting Standards Update 2010-29, "Disclosure of Supplementary Pro Forma Information for Business Combinations," which clarifies the disclosure requirements for pro forma financial information related to a material business combination or a series of immaterial business combinations that are material in the aggregate. The guidance clarified that the pro forma disclosures are prepared assuming the business combination occurred at the start of the prior annual reporting period. Additionally, a narrative description of the nature and amount of material, non-recurring pro forma adjustments would be required. As this newly issued accounting standard only requires enhanced disclosure, the adoption of this standard did not impact our financial position or results of operations.

Discontinued Operations
Discontinued Operations

Note 3. Discontinued Operations

In the fourth quarter of 2009, we sold to Schnitzer Steel Industries, Inc. ("SSI") certain self service retail facilities and certain business assets related to additional self service facilities that were subsequently closed or converted to wholesale recycling operations. Related to this transaction, we agreed to sell to SSI two self service retail facilities in Dallas, Texas. These facilities were sold on January 15, 2010 for $12.0 million, resulting in a gain on the sale of approximately $1.7 million, net of tax, in our first quarter 2010 results. Goodwill totaling $6.7 million was included in the cost basis of net assets disposed when determining the gain on sale.

The self service facilities that we sold or closed are reported as discontinued operations for all periods presented. As of March 31, 2011 and December 31, 2010, we had accrued liabilities applicable to discontinued operations of $2.6 million and $2.7 million, respectively, included in the Unaudited Consolidated Condensed Balance Sheets.

 

Results of operations for the discontinued operations are as follows (in thousands):

 

     Three Months Ended
March 31,
 
     2011      2010  

Revenue

   $ —         $ 686   

Income before income tax provision

     —           355   

Income tax provision

     —           131   
                 

Income from discontinued operations, net of taxes, before gain on sale of discontinued operations

     —           224   

Gain on sale of discontinued operations, net of taxes of $1,015

     —           1,729   
                 

Income from discontinued operations, net of taxes

   $ —         $ 1,953   
                 

As of March 31, 2011, approximately $2.2 million of accrued restructuring expenses remained in liabilities of discontinued operations on our Unaudited Consolidated Condensed Balance Sheet for the excess lease payments (net of estimated sublease income) and facility closure costs related to two of the closed self service facilities. The excess facility costs are expected to be paid over the remaining term of the leases through 2018.

Equity Incentive Plans
Equity Incentive Plans

Note 4. Equity Incentive Plans

We have two stock-based compensation plans, the LKQ Corporation 1998 Equity Incentive Plan (the "Equity Incentive Plan") and the Stock Option and Compensation Plan for Non-Employee Directors (the "Director Plan"). Under the Equity Incentive Plan, both qualified and nonqualified stock options, stock appreciation rights, restricted stock, performance shares and performance units may be granted. On January 13, 2011, the Compensation Committee amended the Equity Incentive Plan to allow the grant of Restricted Stock Units ("RSUs"). Under the Director Plan, shares of LKQ common stock may be issued to directors in lieu of cash compensation. We expect to issue new shares of common stock to cover future equity grants under these plans.

We have granted stock options, restricted stock and RSUs under the Equity Incentive Plan. Stock options expire 10 years from the date they are granted. Most of the options granted under the Equity Incentive Plan vest over a period of five years. Restricted stock and RSU awards granted to date vest over a period of five years, subject to a continued service condition. Until the shares of restricted stock vest, they may not be sold, pledged or otherwise transferred and are subject to forfeiture. Each RSU converts into one share of LKQ common stock on the applicable vesting date.

A summary of transactions in our stock-based compensation plans for the three months ended March 31, 2011 is as follows:

 

     Shares
Available For
Grant
    Stock Options      Restricted Stock      RSUs  
     Number
Outstanding
    Weighted
Average
Exercise
Price
     Number
Outstanding
    Weighted
Average
Grant Date
Fair Value
     Number
Outstanding
     Weighted
Average
Grant Date
Fair Value
 

Balance, January 1, 2011

     2,140,090        8,073,965      $ 12.27         154,000      $ 19.00         —         $ —     

Granted

     (798,834     —          —           —          —           798,834         23.53   

Shares issued for director compensation

     (6,243     —          —           —          —           —           —     

Exercised

     —          (406,686     6.42         —          —           —           —     

Restricted stock or RSUs vested

     —          —          —           (38,000     19.14         —           —     

Cancelled

     50,475        (50,475     16.66         —          —           —           —     
                                                           

Balance, March 31, 2011

     1,385,488        7,616,804      $ 12.55         116,000      $ 18.95         798,834       $ 23.53   
                                                           

During the quarter ended March 31, 2011, our Board of Directors granted 798,834 RSUs to employees. The fair value of RSUs is based on the market price of LKQ stock on the date of issuance. When estimating forfeitures, we consider voluntary and involuntary termination behavior as well as analysis of historical forfeitures. For valuing RSU grants during the three month period ended March 31, 2011, forfeiture rates of 5% and 0% have been used for grants to employees and executive officers, respectively.

 

The total grant-date fair value of options that vested during the three months ended March 31, 2011 was approximately $4.6 million. There were 406,686 stock options exercised during the three months ended March 31, 2011 with an intrinsic value of $7.4 million. The fair value of restricted shares that vested during the three months ended March 31, 2011 was approximately $0.9 million.

The components of pre-tax stock-based compensation expense are as follows (in thousands):

 

     Three Months Ended
March 31,
 
     2011      2010  

Stock options

   $ 2,090       $ 2,226   

Restricted stock

     225         225   

RSUs

     878         —     

Stock issued to non-employee directors

     149         73   
                 

Total stock-based compensation expense

   $ 3,342       $ 2,524   
                 

The following table sets forth the total stock-based compensation expense included in the accompanying Unaudited Consolidated Condensed Statements of Income (in thousands):

 

     Three Months Ended
March 31,
 
     2011     2010  

Cost of goods sold

   $ 89      $ 70   

Facility and warehouse expenses

     611        527   

Selling, general and administrative expenses

     2,642        1,927   
                
     3,342        2,524   

Income tax benefit

     (1,303     (992
                

Total stock-based compensation expense, net of tax

   $ 2,039      $ 1,532   
                

We have not capitalized any stock-based compensation costs during either of the three month periods ended March 31, 2011 or 2010.

At March 31, 2011, a total of 7,557,912 options with a weighted average exercise price of $12.50 and a weighted average remaining contractual life of 6.2 years were expected to vest. As of March 31, 2011, 116,000 shares of restricted stock with a weighted average remaining contractual life of 2.4 years were expected to vest. As of March 31, 2011, 773,059 RSUs with a weighted average remaining contractual life of 4.8 years were expected to vest. Unrecognized compensation expense related to stock options, restricted stock and RSUs at March 31, 2011 is expected to be recognized as follows (in thousands):

 

     Stock
Options
     Restricted
Stock
     RSUs      Total  

Remainder of 2011

   $ 6,166       $ 688       $ 2,614       $ 9,468   

2012

     6,930         913         3,638         11,481   

2013

     4,743         208         3,638         8,589   

2014

     3,117         139         3,638         6,894   

2015

     78         —           3,638         3,716   

2016

     —           —           147         147   
                                   

Total unrecognized compensation expense

   $ 21,034       $ 1,948       $ 17,313       $ 40,295   
                                   

 

The following table summarizes information about outstanding and exercisable stock options at March 31, 2011:

 

Range of Exercise Prices

   Outstanding      Exercisable  
   Shares      Weighted
Average
Remaining
Contractual
Life (Yrs)
     Weighted
Average
Exercise
Price
     Shares      Weighted
Average
Remaining
Contractual
Life (Yrs)
     Weighted
Average
Exercise
Price
 

$0.75 - $5.00

     1,735,908         2.8       $ 3.67         1,735,908         2.8       $ 3.67   

$5.01 - $10.00

     660,385         4.7         9.34         658,985         4.7         9.34   

$10.01 - $15.00

     2,320,968         7.1         11.33         1,241,928         6.7         11.05   

$15.01 - $20.00

     2,872,043         7.9         19.56         1,042,873         7.4         19.35   

$20.01 +

     27,500         7.1         21.52         13,900         7.1         21.52   
                             
     7,616,804         6.2       $ 12.55         4,693,594         5.1       $ 9.95   
                             

The aggregate intrinsic value (market value of stock less option exercise price) of outstanding, expected to vest and exercisable stock options at March 31, 2011 was $88.0 million, $87.7 million and $66.4 million, respectively. The aggregate intrinsic value represents the total pre-tax intrinsic value, based on the Company's closing stock price of $24.10 on March 31, 2011. This amount changes based upon the fair market value of our common stock.

Long-Term Obligations
Long-Term Obligations

Note 5. Long-Term Obligations

Long-Term Obligations consist of the following (in thousands):

 

     March 31,
2011
    December 31,
2010
 

Senior secured debt:

    

Term loans payable

   $ 250,000      $ 590,099   

Revolving credit facility

     297,485        —     

Notes payable to individuals through August 2019, interest at 2.0% to 8.0%

     11,783        10,855   
                
     559,268        600,954   

Less current maturities

     (14,817     (52,888
                
   $ 544,451      $ 548,066   
                

We obtained a senior secured debt financing facility from Lehman Brothers Inc. and Deutsche Bank Securities, Inc. on October 12, 2007, which was amended on October 26, 2007, October 27, 2009 and November 19, 2010 (as amended, the "2007 Credit Agreement"). The 2007 Credit Agreement was scheduled to mature on October 12, 2013 and included a $610 million term loan, a $40 million Canadian currency term loan, an $85 million U.S. dollar revolving credit facility, and a $15 million dual currency revolving facility for drawings of either U.S. dollars or Canadian dollars. The 2007 Credit Agreement also provided for (i) the issuance of letters of credit of up to $35 million in U.S. dollars and up to $10 million in either U.S. or Canadian dollars, and (ii) the opportunity for us to add additional term loan facilities and/or increase the $100 million revolving credit facility's commitments, subject to certain requirements.

On March 25, 2011, we entered into a credit agreement (the "2011 Credit Agreement") with the several lenders from time to time party thereto, JPMorgan Chase Bank, N.A., as administrative agent, Bank of America N.A., as syndication agent, RBS Citizens, N.A. and Wells Fargo Bank, National Association, as co-documentation agents, and J.P. Morgan Securities LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, RBS Citizens, N.A. and Wells Fargo Securities, LLC, as joint lead arrangers and joint bookrunners, to borrow up to $1 billion, consisting of (1) a five-year $750 million revolving credit facility (the "Revolving Credit Facility"), and (2) a five-year $250 million term loan facility (the "Term Loan Facility"). Under the Revolving Credit Facility, we may borrow up to the U.S. dollar equivalent of $300 million in Canadian Dollars, Pounds Sterling, euros, and other agreed-upon currencies. The 2011 Credit Agreement also provides for (a) the issuance of up to $75 million of letters of credit under the Revolving Credit Facility in agreed-upon currencies, (b) the issuance of up to $25 million of swing line loans under the Revolving Credit Facility, and (c) the opportunity to increase the amount of the Revolving Credit Facility or obtain incremental term loans up to $400 million. Outstanding letters of credit and swing line loans will be taken into account when determining availability under the Revolving Credit Facility. We used the initial proceeds from the 2011 Credit Agreement to pay off outstanding amounts of $591.1 million under the 2007 Credit Agreement.

The obligations under the 2011 Credit Agreement are unconditionally guaranteed by our direct and indirect domestic subsidiaries and certain foreign subsidiaries. Obligations under the 2011 Credit Agreement, including the related guarantees, are collateralized by a security interest and lien on a majority of the existing and future personal property of, and a security interest in 100% of our equity interest in, each of our existing and future direct and indirect domestic and foreign subsidiaries, provided that if a pledge of 100% of a foreign subsidiary's voting equity interests gives rise to an adverse tax consequence, such pledge shall be limited to 65% of the voting equity interest of the first tier foreign subsidiary. In the event that we obtain and maintain certain ratings from S&P (BBB- or better, with stable or better outlook) or Moody's (Baa3 or better, with stable or better outlook), and upon our request, the security interests in and liens on the collateral described above shall be released. In April 2011, Moody's confirmed our credit rating at Ba2 with a stable outlook. In April 2010, S&P assigned a corporate credit rating of BB with a stable outlook.

 

Amounts under the Revolving Credit Facility will be due and payable upon maturity of the 2011 Credit Agreement in March 2016. Amounts under the Term Loan Facility will be due and payable in quarterly installments, with the annual payments equal to 5% of the original principal amount in the first and second years, 10% of the original principal amount in the third and fourth years, and 15% of the original principal amount in the fifth year. The remaining balance under the Term Loan Facility will be due and payable on the maturity date of the 2011 Credit Agreement. We are required to prepay the Term Loan Facility by amounts equal to proceeds from the sale or disposition of certain assets, if the proceeds are not reinvested within twelve months. We also have the option to prepay outstanding amounts under the 2011 Credit Agreement.

The 2011 Credit Agreement contains customary representations and warranties, and contains customary covenants that provide limitations and conditions on our ability to, among other things (i) incur indebtedness, (ii) incur liens, (iii) enter into any merger, consolidation, amalgamation, or otherwise liquidate or dissolve the Company, (iv) dispose of certain property, (v) make dividend payments, repurchase our stock, or enter into derivative contracts indexed to the value of our common stock, (vi) make certain investments, including the acquisition of assets constituting a business or the stock of a business designated as a non-guarantor, (vii) make optional prepayments of subordinated debt, (viii) enter into sale-leaseback transactions, (ix) issue preferred stock, redeemable stock, convertible stock or other similar equity instruments, and (x) enter into hedge agreements for speculative purposes or otherwise not in the ordinary course of business. The 2011 Credit Agreement also contains financial and affirmative covenants under which we: (i) may not exceed a maximum net leverage ratio of 3.00 to 1.00, except in connection with permitted acquisitions with aggregate consideration in excess of $200 million during any period of four consecutive fiscal quarters in which case the maximum net leverage ratio increases to 3.50 to 1.00 for the subsequent four fiscal quarters and (ii) are required to maintain a minimum interest coverage ratio of 3.00 to 1.00. We were in compliance with all restrictive covenants under the 2011 Credit Agreement and the 2007 Credit Agreement as of March 31, 2011 and December 31, 2010, respectively.

The 2011 Credit Agreement contains events of default that include (i) our failure to pay principal when due or interest, fees, or other amounts after grace periods, (ii) our material breach of any representation or warranty, (iii) covenant defaults, (iv) cross defaults to certain other indebtedness, (v) bankruptcy, (vi) certain ERISA events; (vii) material judgments; (viii) change of control, and (ix) failure of subordinated indebtedness to be validly and sufficiently subordinated.

Concurrently with the payment of amounts outstanding under the 2007 Credit Agreement, we incurred a loss on debt extinguishment related to the write-off of the unamortized balance of capitalized debt issuance costs of $5.3 million, which is included in Other Expense on our Unaudited Consolidated Condensed Statement of Income for the three months ended March 31, 2011. The amount of the write-off excludes debt issuance cost amortization, which is recorded as a component of interest expense. Fees incurred related to the execution of the 2011 Credit Agreement, totaling $7.7 million, were capitalized within Other Assets on our Unaudited Consolidated Condensed Balance Sheet and will be amortized over the term of the agreement.

Borrowings under the 2011 Credit Agreement bear interest at variable rates, which depend on the currency and duration of the borrowing elected, plus an applicable margin. The applicable margin is subject to change in increments of 0.25% depending on our total leverage ratio. Interest payments are due quarterly in arrears for the term loan and on the last day of the selected interest period on revolver borrowings. Including the effect of the interest rate swap agreements described in Note 6, "Derivative Instruments and Hedging Activities," the weighted average interest rate on borrowings outstanding against the 2011 Credit Agreement at March 31, 2011 was 3.58%. We will pay a commitment fee based on the average daily unused amount of the Revolving Credit Facility. The commitment fee is subject to change in increments of 0.05% depending on our total leverage ratio. We will also pay a participation commission on outstanding letters of credit at an applicable rate based on our total leverage ratio, as well as a fronting fee of 0.125% to the issuing bank, which are due quarterly in arrears. Borrowings under the 2011 Credit Agreement at March 31, 2011 totaled $547.5 million, of which $12.5 million was classified as current maturities. As of March 31, 2011, there were $25.7 million of outstanding letters of credit. The amounts available under the Revolving Credit Facility are reduced by the amounts outstanding under letters of credit, and thus availability on the Revolving Credit Facility at March 31, 2011 was $426.8 million.

Borrowings under the 2007 Credit Agreement accrued interest at variable rates, which depended on the currency and the duration of the borrowing elected, plus an applicable margin. Including the effect of the interest rate swap agreements, the weighted average interest rate on borrowings outstanding against 2007 Credit Agreement at December 31, 2010 was 3.97%. We also paid commitment fees on the unused portion of our revolving credit facilities, which ranged from 0.38% to 0.50% based on the currency of the borrowing elected. Borrowings under the 2007 Credit Agreement at December 31, 2010 totaled $590.1 million, of which $50.0 million was classified as current maturities.

Derivative Instruments and Hedging Activities
Derivative Instruments and Hedging Activities

Note 6. Derivative Instruments and Hedging Activities

We are exposed to market risks, including the effect of changes in interest rates, foreign currency exchange rates and commodity prices. Under our current policies, we use derivatives to manage our exposure to variable interest rates on our senior secured debt, but we do not attempt to hedge our foreign currency and commodity price risks. We do not hold or issue derivatives for trading purposes.

 

At March 31, 2011, we had interest rate swap agreements in place to hedge a portion of the variable interest rate risk on our variable rate debt, with the objective of minimizing the impact of interest rate fluctuations and stabilizing cash flows. Under the terms of the interest rate swap agreements, we pay the fixed interest rate and receive payment at a variable rate of interest based on the London InterBank Offered Rate ("LIBOR") on the notional amount. The interest rate swap agreements qualify as cash flow hedges, and we have elected to apply hedge accounting for these swap agreements. As a result, the effective portion of changes in the fair value of the interest rate swap agreements is recorded in Other Comprehensive Income and is reclassified to interest expense when the underlying interest payment has an impact on earnings. The ineffective portion of changes in the fair value of the interest rate swap agreements is reported in interest expense.

The following table summarizes the terms of our interest rate swap agreements as of March 31, 2011:

 

Notional Amount

 

Effective Date

 

Maturity Date

 

Fixed Interest Rate*

$200,000,000

  April 14, 2008   April 14, 2011   4.49%

$250,000,000

  October 14, 2010   October 14, 2015   3.31%

$100,000,000

  April 14, 2011   October 14, 2013   2.86%

* Includes applicable margin of 1.75% per annum on LIBOR-based debt currently in effect under the 2011 Credit Agreement

On March 25, 2011, Deutsche Bank AG, the counterparty on the Company's $100 million notional amount interest rate swap, assigned its obligation under the swap contract to Bank of America N.A because Deutsche Bank AG is not a secured lender under the 2011 Credit Agreement. We believe Bank of America N.A. is creditworthy to perform its obligation as the counterparty to the swap.

As of March 31, 2011 and December 31, 2010, the fair market value of the $200 million notional amount swap was a liability of $0.2 million and $1.4 million, respectively, included in Other Accrued Expenses on our Unaudited Consolidated Condensed Balance Sheets. The fair market value of the other swap contracts at March 31, 2011 and December 31, 2010 was an asset of $6.9 million and $4.8 million, respectively, included in Other Assets on our Unaudited Consolidated Condensed Balance Sheets.

The activity related to our interest rate swap agreements is as follows (in thousands):

 

     Three Months Ended
March 31,
 
     2011     2010  

Gain (loss) in Accumulated Other Comprehensive Income

   $ 5,573      $ (1,236

Loss reclassified to interest expense

     (2,046     (3,027

Hedge ineffectiveness

     (225     —     

In connection with the execution of our 2011 Credit Agreement on March 25, 2011 as discussed in Note 5, "Long-Term Obligations," we temporarily experienced differences in critical terms between the interest rate swaps and the underlying debt. As a result, we incurred $0.2 million of hedge ineffectiveness for the period. Beginning on April 14, 2011, we will hold, and expect to continue to hold through the maturity of the interest rate swap agreements, at least $350 million of LIBOR-based debt, such that future ineffectiveness will be immaterial and the swaps will continue to be highly effective in hedging our variable rate debt.

As of March 31, 2011, we estimate that $2.4 million of derivative losses (net of tax) included in Accumulated Other Comprehensive Income will be reclassified into interest expense within the next 12 months.

Fair Value Measurements
Fair Value Measurements

Note 7. Fair Value Measurements

We use the market and income approaches to value our financial assets and liabilities, and there were no changes in valuation techniques during the quarter ended March 31, 2011. The tables below present information about our assets and liabilities that are measured at fair value on a recurring basis and indicate the fair value hierarchy of the valuation techniques we utilized to determine such fair value. The tiers in the fair value hierarchy include: Level 1, defined as observable inputs such as quoted market prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

Our Level 2 assets and liabilities are valued using inputs from third parties and market observable data. We obtain valuation data for the cash surrender value of life insurance and deferred compensation liabilities from third party sources, which determine the net asset values for our accounts using quoted market prices, investment allocations and reportable trades. We value the interest rate swaps using a third party valuation model that performs a discounted cash flow analysis based on the terms of the contracts and market observable inputs such as LIBOR and forward interest rates.

 

The following tables present information about our financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010 (in thousands):

 

     Balance as
of March 31,
2011
     Fair Value Measurements as of March 31, 2011  
      Level 1      Level 2      Level 3  

Assets:

           

Cash surrender value of life insurance

   $ 12,680       $ —         $ 12,680       $ —     

Interest rate swaps

     6,894         —           6,894         —     
                                   

Total Assets

   $ 19,574       $ —         $ 19,574       $ —     
                                   

Liabilities:

           

Deferred compensation liabilities

   $ 13,094       $ —         $ 13,094       $ —     

Interest rate swaps

     193         —           193         —     
                                   

Total Liabilities

   $ 13,287       $ —         $ 13,287       $ —     
                                   
     Balance as
of December 31,
2010
     Fair Value Measurements as of December 31, 2010  
      Level 1      Level 2      Level 3  

Assets:

           

Cash surrender value of life insurance

   $ 10,517       $ —         $ 10,517       $ —     

Interest rate swaps

     4,815         —           4,815         —     
                                   

Total Assets

   $ 15,332       $ —         $ 15,332       $ —     
                                   

Liabilities:

           

Deferred compensation liabilities

   $ 11,245       $ —         $ 11,245       $ —     

Interest rate swaps

     1,416         —           1,416         —     
                                   

Total Liabilities

   $ 12,661       $ —         $ 12,661       $ —     
                                   

The cash surrender value of life insurance and deferred compensation liabilities are included in Other Assets and Other Noncurrent Liabilities, respectively, on our Unaudited Consolidated Condensed Balance Sheets.

Commitments and Contingencies
Commitments and Contingencies

Note 8. Commitments and Contingencies

Operating Leases

We are obligated under noncancelable operating leases for corporate office space, warehouse and distribution facilities, trucks and certain equipment.

The future minimum lease commitments under these leases at March 31, 2011 are as follows (in thousands):

 

Nine months ending December 31, 2011

   $ 49,717   

Years ending December 31:

  

2012

     59,127   

2013

     52,245   

2014

     41,584   

2015

     33,178   

2016

     25,136   

Thereafter

     73,444   
        

Future Minimum Lease Payments

   $ 334,431   
        

 

Litigation and Related Contingencies

We have certain contingencies resulting from litigation, claims and other commitments and are subject to a variety of environmental and pollution control laws and regulations incident to the ordinary course of business. We currently expect that the resolution of such contingencies will not materially affect our financial position, results of operations or cash flows.

Earnings Per Share
Earnings Per Share

Note 9. Earnings Per Share

The following chart sets forth the computation of earnings per share (in thousands, except per share amounts):

 

     Three Months Ended
March 31,
 
     2011      2010  

Income from continuing operations

   $ 58,182       $ 51,983   
                 

Denominator for basic earnings per share—Weighted-average shares outstanding

     145,611         142,194   

Effect of dilutive securities:

     

Stock options

     2,169         2,915   

Restricted stock

     24         15   

RSUs

     116         —     
                 

Denominator for diluted earnings per share—Adjusted weighted-average shares outstanding

     147,920         145,124   
                 

Basic earnings per share from continuing operations

   $ 0.40       $ 0.37   
                 

Diluted earnings per share from continuing operations

   $ 0.39       $ 0.36   
                 

The following table sets forth the number of employee stock-based compensation awards outstanding but not included in the computation of diluted earnings per share because their effect would have been antidilutive (in thousands):

 

     Three Months Ended
March 31,
 
     2011      2010  

Antidilutive securities:

     

Stock options

     1,608         3,080   
Business Combinations
Business Combinations

Note 10. Business Combinations

During the three months ended March 31, 2011, we acquired four businesses: an engine remanufacturer, an automotive heating and cooling component distributor, a wholesale recycled products business and a recycled heavy-duty truck business. The engine remanufacturer, heating and cooling component distributor and wholesale recycled products business are included in our wholesale operating segment. These acquisitions will enable us to expand our market presence and enter new markets. Additionally, with our purchase of the engine remanufacturer, we expanded our presence in the remanufacturing industry that we entered in 2010, while our acquisition of the heating and cooling component distributor supplements our expansion into the heating and cooling aftermarket products market.

Total consideration for the acquisitions during the quarter ended March 31, 2011 was $48.8 million, composed of $43.5 million of cash (net of cash acquired), $1.5 million of notes payable and $3.8 million of other purchase price obligations (non-interest bearing). We recorded goodwill of $22.6 million for these acquisitions, of which approximately $6.1 million is expected to be deductible for income tax purposes. In the period between the acquisition dates and March 31, 2011, these businesses generated approximately $22.0 million of revenue and $1.2 million of operating income.

During the year ended December 31, 2010, we made 20 acquisitions (16 in the wholesale products business, one in the recycled heavy-duty truck products business, two self service retail operations and one tire recycling business). Our acquisitions included the purchase of an engine remanufacturer, included in the wholesale operating segment, which allowed us to further vertically integrate our supply chain. We expanded our product offerings through the acquisition of an automotive heating and cooling component business, included in the wholesale operating segment, as well as a tire recycling business, which supports all of our operating segments. Our 2010 acquisitions have also enabled us to expand our geographic presence, most notably in Canada through our acquisition of Cross Canada, an aftermarket product supplier.

Total consideration for the 2010 acquisitions was $170.4 million, composed of $143.6 million of cash (net of cash acquired), $5.5 million of notes payable, $6.4 million of other purchase price obligations (non-interest bearing) and $14.9 million in stock issued (689,655 shares). The $14.9 million of common stock was issued in connection with our acquisition of Cross Canada on November 1, 2010. The fair value of common stock issued was based on the market price of LKQ stock on the date of issuance. We recorded goodwill of $91.8 million for the 2010 acquisitions, of which $74.9 million is expected to be deductible for income tax purposes.

The acquisitions are being accounted for under the purchase method of accounting and are included in our consolidated financial statements from the dates of acquisition. The purchase prices were allocated to the net assets acquired based upon estimated fair market values at the dates of acquisition. The purchase price allocations for the acquisitions made during the quarter ended March 31, 2011 and the last three quarters of 2010 are preliminary as we are in the process of determining the following: 1) valuation amounts for certain of the inventories acquired; 2) valuation amounts for certain intangible assets acquired; 3) the fair value of liabilities assumed; and 4) the final estimation of the tax basis of the entities acquired.

The purchase price allocations for the acquisitions completed during the quarter ended March 31, 2011 and the year ended December 31, 2010 are as follows (in thousands):

 

     March 31, 2011
(Preliminary)
    December 31,  2010
(Preliminary)
 

Receivables

   $ 12,590      $ 27,774   

Receivable reserves

     (630     (2,186

Inventory

     23,178        38,121   

Prepaid expenses

     99        1,480   

Property and equipment

     3,458        18,517   

Goodwill

     22,579        91,757   

Other intangibles

     —          6,163   

Other assets

     340        1,529   

Deferred income taxes

     1,881        2,922   

Current liabilities assumed

     (14,649     (15,665

Other purchase price obligations

     (3,804     (6,359

Notes issued

     (1,525     (5,530

Stock issued

     —          (14,945
                

Cash used in acquisitions, net of cash acquired

   $ 43,517      $ 143,578   
                

The primary reason for our acquisitions made during the quarter ended March 31, 2011 and the year ended December 31, 2010 was to increase our stockholder value by leveraging our strategy of becoming a one-stop provider for alternative vehicle replacement products. These acquisitions enabled us to expand our market presence, expand our product offerings and enter new markets. All or substantially all of the employees of these businesses became our employees following acquisition. These factors contributed to purchase prices that included, in many cases, a significant amount of goodwill.

 

The following pro forma summary presents the effect of the businesses acquired during 2011 and 2010 as though the businesses had been acquired as of January 1, 2010, and is based upon unaudited financial information of the acquired entities (in thousands, except per share data):

 

     Three Months Ended
March 31,
 
     2011      2010  

Revenue as reported

   $ 786,648       $ 603,516   

Revenue of purchased businesses for the period prior to acquisition

     479         96,281   
                 

Pro forma revenue

   $ 787,127       $ 699,797   
                 

Income from continuing operations, as reported

   $ 58,182       $ 51,983   

Net income of purchased businesses for the period prior to acquisition, including pro forma purchase accounting adjustments

     484         2,950   
                 

Pro forma income from continuing operations

   $ 58,666       $ 54,933   
                 

Basic earnings per share from continuing operations, as reported

   $ 0.40       $ 0.37   

Effect of purchased businesses for the period prior to acquisition

     0.00         0.02   
                 

Pro forma basic earnings per share from continuing operations (a)

   $ 0.40       $ 0.39   
                 

Diluted earnings per share from continuing operations, as reported

   $ 0.39       $ 0.36   

Effect of purchased businesses for the period prior to acquisition

     0.00         0.02   
                 

Pro forma diluted earnings per share from continuing operations (a)

   $ 0.40       $ 0.38   
                 

(a) The sum of the individual earnings per share amounts may not equal the total due to rounding.

Unaudited pro forma supplemental information is based upon accounting estimates and judgments that we believe are reasonable. The unaudited pro forma supplemental information includes the effect of purchase accounting adjustments, such as the adjustment of inventory acquired to net realizable value, adjustments to depreciation on acquired property and equipment, adjustments to interest expense, and the related tax effects. These pro forma results are not necessarily indicative either of what would have occurred if the acquisitions had been in effect for the period presented or of future results.

Restructuring and Integration Costs
Restructuring and Integration Costs

Note 11. Restructuring and Integration Costs

Cross Canada Integration

We have undertaken certain restructuring activities in connection with our acquisition of Cross Canada in the fourth quarter of 2010. The restructuring plan includes the integration of our existing Canadian aftermarket operations into the Cross Canada business, as well as the transition of certain corporate functions to our corporate headquarters and our field support center in Nashville. Based on our analysis of the overlapping facilities, we identified aftermarket warehouses and corporate locations that will be closed in order to eliminate duplicate facilities. Related to the facilities that will be closed, we will terminate certain personnel including drivers, other facility personnel and corporate employees. We are finalizing the integration plan, and we expect that these activities will be completed in 2011. We expect to incur approximately $1.6 million of charges beginning in the second quarter of 2011, including costs related to severance and benefits for terminated employees as well as related facility closure costs. We will record restructuring expense related to lease termination or excess facility costs if we are unable to recover the rent from a sublease tenant after we vacate the facilities. These restructuring expenses will be expensed as incurred, or in the case of excess facility costs, at the cease-use date for the facility.

Income Taxes
Income Taxes

Note 12. Income Taxes

At the end of each interim period, we estimate our annual effective tax rate and apply that rate to our interim earnings. We also record the tax impact of certain unusual or infrequently occurring items, including changes in judgment about valuation allowances and the effects of changes in tax laws or rates, in the interim period in which they occur.

The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment including, but not limited to, the expected operating income for the year, projections of the proportion of income earned and taxed in state and foreign jurisdictions, permanent and temporary differences between book and taxable income, and the likelihood of recovering deferred tax assets generated in the current year. The accounting estimates used to compute the provision for income taxes may change as new events occur, additional information is obtained or as the tax environment changes.

 

Our effective income tax rate for the three months ended March 31, 2011 was 39.2% compared with 37.2% for the comparable prior year period. The effective income tax rate for the three months ended March 31, 2011 included a discrete charge of $0.2 million primarily attributable to the revaluation of deferred taxes in connection with state tax rate changes, while the effective income tax rate for the comparable prior year period included a discrete benefit of $1.7 million resulting from the revaluation of deferred taxes in connection with a legal entity reorganization.