LKQ CORP, 10-Q filed on 10/29/2010
Quarterly Report
Document and Entity Information
9 Months Ended
Sep. 30, 2010
Oct. 22, 2010
Document and Entity Information
 
 
Document Type
10-Q 
 
Amendment Flag
FALSE 
 
Document Period End Date
2010-09-30 
 
Document Fiscal Year Focus
2010 
 
Document Fiscal Period Focus
Q3 
 
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
 
144,422,886 
Consolidated Condensed Balance Sheets (USD $)
In Thousands
9 Months Ended
Sep. 30, 2010
Year Ended
Dec. 31, 2009
Assets
 
 
Cash and equivalents
$ 168,678 
$ 108,906 
Receivables, net
167,181 
152,443 
Inventory
444,617 
385,686 
Deferred income taxes
29,924 
31,847 
Prepaid income taxes
 
4,663 
Prepaid expenses
11,100 
9,603 
Assets of discontinued operations
 
9,720 
Total Current Assets
821,500 
702,868 
Property and Equipment, net
306,820 
289,902 
Intangible Assets:
 
 
Goodwill
990,589 
938,783 
Other intangibles, net
64,708 
67,239 
Other Assets
21,832 
21,329 
Total Assets
2,205,449 
2,020,121 
Liabilities and Stockholders' Equity
 
 
Accounts payable
70,413 
51,300 
Accrued expenses:
 
 
Accrued payroll-related liabilities
42,252 
37,314 
Self-insurance reserves
32,513 
30,368 
Other accrued expenses
25,992 
26,345 
Income taxes payable
1,713 
 
Deferred revenue
9,672 
9,259 
Current portion of long-term obligations
39,880 
10,063 
Liabilities of discontinued operations
2,857 
3,832 
Total Current Liabilities
225,292 
168,481 
Long-Term Obligations, Excluding Current Portion
557,589 
592,982 
Deferred Income Tax Liabilities
53,179 
52,209 
Other Noncurrent Liabilities
32,478 
27,015 
Commitments and Contingencies
 
 
Stockholders' Equity:
 
 
Common stock, $0.01 par value, 500,000,000 shares authorized, 143,788,606 and 142,004,797 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively
1,438 
1,420 
Additional paid-in capital
841,747 
815,952 
Retained earnings
497,202 
369,459 
Accumulated other comprehensive loss
(3,476)
(7,397)
Total Stockholders' Equity
1,336,911 
1,179,434 
Total Liabilities and Stockholders' Equity
$ 2,205,449 
$ 2,020,121 
Consolidated Condensed Balance Sheets (Parenthetical) (USD $)
Sep. 30, 2010
Dec. 31, 2009
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
143,788,606 
142,004,797 
Common stock, shares outstanding
143,788,606 
142,004,797 
Consolidated Condensed Statements of Income (USD $)
In Thousands, except Per Share data
3 Months Ended
Sep. 30,
9 Months Ended
Sep. 30,
2010
2009
2010
2009
Consolidated Condensed Statements of Income
 
 
 
 
Revenue
$ 607,621 
$ 494,812 
$ 1,795,818 
$ 1,492,037 
Cost of goods sold
346,197 
269,708 
989,838 
817,114 
Gross margin
261,424 
225,104 
805,980 
674,923 
Facility and warehouse expenses
56,991 
48,337 
170,125 
145,101 
Distribution expenses
51,783 
45,604 
154,140 
132,608 
Selling, general and administrative expenses
77,671 
65,893 
228,437 
198,688 
Restructuring expenses
223 
852 
593 
1,910 
Depreciation and amortization
9,549 
8,373 
27,940 
24,893 
Operating income
65,207 
56,045 
224,745 
171,723 
Other expense (income):
 
 
 
 
Interest expense, net
7,186 
7,780 
21,617 
23,082 
Other income, net
(274)
(23)
(573)
(170)
Total other expense, net
6,912 
7,757 
21,044 
22,912 
Income from continuing operations before provision for income taxes
58,295 
48,288 
203,701 
148,811 
Provision for income taxes
22,394 
18,147 
77,911 
58,197 
Income from continuing operations
35,901 
30,141 
125,790 
90,614 
Discontinued Operations
 
 
 
 
(Loss) income from discontinued operations, net of taxes
 
(986)
224 
(298)
Gain on sale of discontinued operations, net of taxes
 
 
1,729 
 
(Loss) income from discontinued operations
 
(986)
1,953 
(298)
Net income
35,901 
29,155 
127,743 
90,316 
Basic earnings per share
 
 
 
 
Income from continuing operations
0.25 1
0.21 1
0.88 1
0.65 1
(Loss) income from discontinued operations
 
(0.01)1
0.01 1
1
Total
0.25 1
0.21 1
0.89 1
0.64 1
Diluted earnings per share
 
 
 
 
Income from continuing operations
0.25 1
0.21 1
0.86 1
0.63 1
(Loss) income from discontinued operations
 
(0.01)1
0.01 1
1
Total
$ 0.25 1
$ 0.2 1
$ 0.88 1
$ 0.63 1
Weighted average common shares outstanding:
 
 
 
 
Basic
143,258 
140,746 
142,769 
140,257 
Diluted
145,798 
144,047 
145,470 
143,669 
Consolidated Condensed Statements of Cash Flows (USD $)
In Thousands
9 Months Ended
Sep. 30,
2010
2009
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
Net income
$ 127,743 
$ 90,316 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Depreciation and amortization
30,389 
27,931 
Stock-based compensation expense
7,713 
5,457 
Deferred income taxes
(788)
2,663 
Excess tax benefit from share-based payments
(9,375)
(5,744)
Gain on sale of discontinued operations
(2,744)
 
Other
791 
3,873 
Changes in operating assets and liabilities, net of effects from acquisitions and divestitures:
 
 
Receivables
(1,433)
18,671 
Inventory
(43,818)
(24,302)
Prepaid income taxes/income taxes payable
14,566 
19,887 
Accounts payable
11,307 
(12,722)
Other operating assets and liabilities
10,212 
9,434 
Net cash provided by operating activities
144,563 
135,464 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
Purchases of property and equipment
(36,982)
(28,993)
Proceeds from sales of property and equipment
977 
952 
Proceeds from sale of businesses, net of cash sold
11,992 
 
Cash used in acquisitions, net of cash acquired
(70,281)
(18,580)
Net cash used in investing activities
(94,294)
(46,621)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
Proceeds from exercise of stock options
8,725 
4,986 
Excess tax benefit from share-based payments
9,375 
5,744 
Repayments of long-term debt
(8,824)
(16,212)
Borrowings under line of credit
 
2,310 
Net cash provided by (used in) financing activities
9,276 
(3,172)
Effect of exchange rate changes on cash and equivalents
227 
1,267 
Net increase in cash and equivalents
59,772 
86,938 
Cash and equivalents, beginning of period
108,906 
79,067 
Cash and equivalents, end of period
168,678 
166,005 
Supplemental disclosure of cash flow information:
 
 
Notes issued in connection with business acquisitions
2,432 
1,129 
Cash paid for income taxes, net of refunds
65,709 
34,450 
Cash paid for interest
20,927 
22,235 
Property and equipment purchases not yet paid
$ 611 
$ 598 
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 Loss [Member]
Total
BALANCE, value at Dec. 31, 2009
$ 1,420 
$ 815,952 
$ 369,459 
$ (7,397)
$ 1,179,434 
BALANCE, shares at Dec. 31, 2009
142,005 
 
 
 
 
Net income
 
 
127,743 
 
127,743 
Net reduction of unrealized loss on fair value of interest rate swap agreements, net of tax of $1,655
 
 
 
2,943 
2,943 
Foreign currency translation
 
 
 
978 
978 
Total comprehensive income
 
 
 
 
131,664 
Stock issued as director compensation, value
 
218 
 
 
218 
Stock issued as director compensation, shares
11 
 
 
 
 
Stock-based compensation expense
 
7,495 
 
 
7,495 
Exercise of stock options, value
18 
8,707 
 
 
8,725 
Exercise of stock options, shares
1,773 
 
 
 
 
Excess tax benefit from share-based payments
 
9,375 
 
 
9,375 
BALANCE, value at Sep. 30, 2010
$ 1,438 
$ 841,747 
$ 497,202 
$ (3,476)
$ 1,336,911 
BALANCE, shares at Sep. 30, 2010
143,789 
 
 
 
 
Consolidated Condensed Statements of Stockholders' Equity and Other Comprehensive Income (Parenthetical) (USD $)
In Thousands
9 Months Ended
Sep. 30, 2010
Consolidated Condensed Statements of Stockholders' Equity and Other Comprehensive Income
 
Tax paid on interest rate swap agreements
$ 1,655 
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, 2009 filed with the SEC on February 26, 2010.

As described in Note 3, "Discontinued Operations," during the fourth quarter of 2009, we sold, agreed to sell or closed certain of our self service facilities. 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 recycled and aftermarket 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 $15.3 million and $15.8 million at September 30, 2010 and December 31, 2009, 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 $6.9 million and $6.5 million at September 30, 2010 and December 31, 2009, respectively.

Inventory

Inventory consists of the following (in thousands):

 

     September 30,
2010
     December 31,
2009
 

Salvage products

   $ 197,438       $ 152,438   

Aftermarket and refurbished products

     240,186         226,299   

Core facilities inventory

     6,993         6,949   
                 
   $ 444,617       $ 385,686   
                 

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, including the Keystone trade name, covenants not to compete and trademarks.

The change in the carrying amount of goodwill during the nine months ended September 30, 2010 is as follows (in thousands):

 

Balance as of December 31, 2009

   $ 938,783   

Business acquisitions

     50,759   

Exchange rate effects

     1,047   
        

Balance as of September 30, 2010

   $ 990,589   
        

Other intangible assets totaled approximately $64.7 million and $67.2 million, net of accumulated amortization of $12.3 million and $9.2 million, at September 30, 2010 and December 31, 2009, respectively. Amortization expense was approximately $3.1 million for each of the nine month periods ended September 30, 2010 and 2009. Estimated annual amortization expense is approximately $4.0 million for each of the years 2010 through 2014.

Depreciation Expense

Included in cost of goods sold on the unaudited consolidated condensed statements of income is depreciation expense associated with refurbishing and smelting operations.

Warranty Reserve

Some of our mechanical products are sold with a standard six-month 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 nine months ended September 30, 2010 were as follows (in thousands):

 

Balance as of December 31, 2009

   $ 604   

Warranty expense

     6,085   

Warranty claims

     (5,767
        

Balance as of September 30, 2010

   $ 922   
        

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.

Stock-Based Compensation

The fair value of stock options has been estimated using the Black-Scholes option-pricing model. The following table summarizes the assumptions used to compute the weighted average fair value of options granted during the respective periods:

 

     Nine Months Ended
September 30,
 
   2010     2009  

Expected life (in years)

     6.4        6.3   

Risk-free interest rate

     3.17     1.84

Volatility

     43.9     44.6

Dividend yield

     0     0

Weighted average fair value of options granted

   $ 9.54      $ 5.50   

Estimated forfeitures – When estimating forfeitures, we consider voluntary and involuntary termination behavior as well as analysis of historical forfeitures. For options granted in 2010, a forfeiture rate of 8.0% has been used in calculating the stock-based compensation expense for employee option grants, while a forfeiture rate of 0% has been used in calculating the stock-based compensation expense for executive officer option grants.

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

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010      2009  

Stock options

   $ 2,298       $ 1,624       $ 6,812       $ 4,696   

Restricted stock

     230         183         683         544   

Stock issued to non-employee directors

     73         72         218         217   
                                   

Total stock-based compensation expense

   $ 2,601       $ 1,879       $ 7,713       $ 5,457   
                                   

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
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Cost of goods sold

   $ 73      $ 13      $ 216      $ 36   

Facility and warehouse expenses

     541        688        1,608        1,992   

Selling, general and administrative expenses

     1,987        1,178        5,889        3,429   
                                
     2,601        1,879        7,713        5,457   

Income tax benefit

     (1,023     (738     (3,032     (2,145
                                

Total stock-based compensation expense, net of tax

   $ 1,578      $ 1,141      $ 4,681      $ 3,312   
                                

We have not capitalized any stock-based compensation costs during either of the nine month periods ended September 30, 2010 or 2009. As of September 30, 2010, unrecognized compensation expense related to unvested stock options and restricted stock is expected to be recognized as follows (in thousands):

 

 

     Stock
Options
     Restricted
Stock
     Total  

Remainder of 2010

   $ 2,300       $ 230       $ 2,530   

2011

     8,376         913         9,289   

2012

     7,048         913         7,961   

2013

     4,789         208         4,997   

2014

     3,146         139         3,285   

2015

     79         —           79   
                          

Total unrecognized compensation expense

   $ 25,738       $ 2,403       $ 28,141   
                          

Fair Value of Financial Instruments

We are required to disclose the fair value for any financial instruments carried at cost on the balance sheet.

Our debt is reflected on the balance sheet at cost. Based on current market conditions, our interest rate margins are below the rate available in the market, which causes the fair value of our debt to fall below the carrying value. The fair value of our term loans (see Note 5, "Long-Term Obligations") is approximately $576 million at September 30, 2010, as compared to the carrying value of $589 million. We estimated the fair value of our term loans 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 September 30, 2010 to an entity with a credit rating similar to ours and achieve sufficient cash inflows to cover the scheduled cash outflows under our term loans. 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 recycled and aftermarket 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 our revenue by product category within our reportable segment (in thousands):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010      2009  

Recycled and related products and services

   $ 228,797       $ 180,482       $ 658,179       $ 548,040   

Aftermarket, other new and refurbished products

     291,607         257,670         894,251         799,953   

Other

     87,217         56,660         243,388         144,044   
                                   
   $ 607,621       $ 494,812       $ 1,795,818       $ 1,492,037   
                                   

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

Discontinued Operations
Discontinued Operations

Note 3. Discontinued Operations

On October 1, 2009, we sold to Schnitzer Steel Industries, Inc. ("SSI") four self service retail facilities in Oregon and Washington and certain business assets related to two self service facilities in Northern California and a self service facility in Portland, Oregon for $17.5 million, net of cash sold. We recognized a gain on the sale of approximately $2.5 million, net of tax, in our fourth quarter 2009 results. Goodwill totaling $9.9 million was included in the cost basis of net assets disposed when determining the gain on sale. In the fourth quarter of 2009, we closed the two self service facilities in Northern California and converted the self service operation in Portland to a wholesale recycling business.

On January 15, 2010, we also sold to SSI two self service retail facilities in Dallas, Texas for $12.0 million. We recognized 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. We reported these facilities in discontinued operations because the cash flows derived from the facilities were eliminated as a result of the sales or closures and we will not have continuing involvement in these facilities. A summary of the assets and liabilities applicable to discontinued operations included in the unaudited consolidated condensed balance sheets as of September 30, 2010 and December 31, 2009 is as follows (in thousands):

 

     September 30,
2010
     December 31,
2009
 

Inventory

   $ —         $ 1,152   

Other current assets

     —           307   

Property and equipment, net

     —           1,553   

Goodwill

     —           6,708   
                 

Total assets

   $ —         $ 9,720   
                 

Accounts payable and accrued liabilities

   $ 2,857       $ 3,832   
                 

Total liabilities

   $ 2,857       $ 3,832   
                 

As of September 30, 2010, approximately $2.9 million of accrued restructuring expenses remained in liabilities of discontinued operations on our unaudited consolidated condensed balance sheets for the excess lease payments (net of estimated sublease income), and facility closure costs related to the two closed self service facilities in Northern California. The excess lease payments are expected to be paid over the remaining term of the leases through 2018.

Results of operations for the discontinued operations for the three and nine months ended September 30, 2010 and 2009 are as follows (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010      2009     2010      2009  

Revenue

   $ —         $ 7,335      $ 686       $ 20,853   

(Loss) income before income tax (benefit) provision

     —           (1,565     355         (473

Income tax (benefit) provision

     —           (579     131         (175
                                  

(Loss) income from discontinued operations, net of taxes, before gain on sale of discontinued operations

     —           (986     224         (298

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

     —           —          1,729         —     
                                  

(Loss) income from discontinued operations, net of taxes

   $ —         $ (986   $ 1,953       $ (298
                                  

 

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.

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. Options granted under the Director Plan vest six months after the date of grant. We expect to issue new shares of common stock to cover future stock option exercises.

A summary of transactions in our stock-based compensation plans for the nine months ended September 30, 2010 is as follows:

 

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

Balance, December 31, 2009

     3,642,803        202,000      $ 19.00         9,329,407      $ 8.81   

Granted

     (1,711,533     —          —           1,711,533        19.95   

Exercised

     —          —          —           (1,773,005     4.92   

Restricted shares vested

     —          (43,000     19.07         —          —     

Cancelled

     116,275        —          —           (116,275     16.00   
                                         

Balance, September 30, 2010

     2,047,545        159,000      $ 18.98         9,151,660      $ 11.56   
                                         

The following table summarizes information about outstanding and exercisable stock options at September 30, 2010:

 

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

     2,808,535         3.4       $ 3.71         2,808,535         3.4       $ 3.71   

  5.01 – 10.00

     745,160         5.2         9.39         661,700         5.2         9.34   

10.01 – 15.00

     2,564,290         7.5         11.30         1,123,570         7.0         10.91   

15.01 – 20.00

     3,003,675         8.4         19.56         807,948         7.7         19.27   

20.01 +

     30,000         7.6         21.61         12,150         7.6         21.60   
                             
     9,151,660         6.4       $ 11.56         5,413,903         5.0       $ 8.26   
                             

At September 30, 2010, a total of 9,030,657 options with an average exercise price of $11.47 and a weighted average remaining contractual life of 6.3 years were exercisable or expected to vest.

The aggregate intrinsic value (market value of stock less option exercise price) of outstanding, expected to vest and exercisable stock options at September 30, 2010 was $84.6 million, $84.2 million and $67.9 million, respectively. The aggregate intrinsic value represents the total pre-tax intrinsic value, based on our closing stock price of $20.80 on September 30, 2010. This amount changes based upon the fair market value of our common stock. There were 1,773,005 stock options exercised during the nine months ended September 30, 2010 with an intrinsic value of $27.0 million. There were 1,240,471 stock options exercised during the nine months ended September 30, 2009 with an intrinsic value of $15.9 million.

The total grant-date fair value of options that vested during the nine months ended September 30, 2010 was approximately $7.6 million. The fair value of restricted shares that vested during the nine months ended September 30, 2010 was approximately $0.9 million.

Long-Term Obligations
Long-Term Obligations

Note 5. Long-Term Obligations

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

 

     September 30,
2010
    December 31,
2009
 

Senior secured debt financing facility:

    

Term loans payable

   $ 588,995      $ 595,716   

Revolving credit facility

     —          —     

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

     8,474        7,329   
                
     597,469        603,045   

Less current maturities

     (39,880     (10,063
                
   $ 557,589      $ 592,982   
                

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 and was further amended on October 27, 2009 (as further amended, the "Credit Agreement"). The Credit Agreement matures on October 12, 2013 and includes 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 Credit Agreement also provides 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, provided that such additions or increases do not exceed $150 million in the aggregate and provided further that no existing lender is required to make its pro rata share of any such additions or increases without its consent. Amounts under each term loan facility are due and payable in quarterly installments of increasing amounts that began in the first quarter of 2008, with the balance payable in full on October 12, 2013. Amounts due under each revolving credit facility will be due and payable on October 12, 2013. We are also required to prepay the term loan facilities with certain amounts generated by the sale of assets under certain circumstances, the incurrence of certain debt, and the receipt of certain insurance and condemnation proceeds, in each case, to the extent of the proceeds of such event, and with up to 50% of our excess cash flow, with the amount of such excess cash flow determined based upon our total leverage ratio.

As of September 30, 2010, there were no borrowings against our revolving credit facility of $100 million. Availability on the revolving credit facility is reduced by outstanding letters of credit. At September 30, 2010, there were $20.1 million of outstanding letters of credit and thus availability on the revolving credit facility totaled approximately $79.9 million.

The Credit Agreement contains customary representations and warranties, and contains customary covenants that restrict our ability to, among other things (i) incur liens, (ii) incur any indebtedness (including guarantees or other contingent obligations), and (iii) engage in mergers and consolidations. The Credit Agreement also requires us to meet certain financial covenants, the most restrictive of which is the required senior secured debt ratio. We were in compliance with all restrictive covenants as of September 30, 2010 and December 31, 2009.

Borrowings under the Credit Agreement accrue interest at variable rates, which depend on the type (U.S. dollar or Canadian dollar) and duration of the borrowing, plus an applicable margin rate. The weighted-average interest rates, including the effect of interest rate swap agreements and excluding the amortization of debt issuance costs, on borrowings outstanding against our senior secured credit facility at September 30, 2010 and December 31, 2009 were 4.40% and 4.53%, respectively. Borrowings against the senior secured credit facility totaled $589.0 million and $595.7 million at September 30, 2010 and December 31, 2009, respectively, of which $37.4 million and $7.5 million are classified as current maturities, respectively.

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 Credit Agreement, 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 September 30, 2010, we had interest rate swap agreements in place to hedge a portion of the variable interest rate risk on our variable rate term loans, with the objective of minimizing the impact of interest rate fluctuations and stabilizing cash flows. Beginning on the effective dates of the interest rate swap agreements, on a monthly basis through the maturity date, we have paid and will pay the fixed interest rate and have received and will 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 earnings 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 September 30, 2010:

 

Notional Amount     Effective Date   Maturity Date   Fixed Interest Rate*  
  $200,000,000      April 14, 2008   April 14, 2011     4.99
  $250,000,000      September 15, 2008   October 14, 2010     4.88
  $250,000,000      October 14, 2010   October 14, 2015     3.81
  $100,000,000      April 14, 2011   October 14, 2013     3.34

* Includes applicable margin of 2.25% per annum currently in effect under the Credit Agreement

As of September 30, 2010, the fair market value of these contracts was a liability of $5.6 million and was included in Other Accrued Expenses ($3.3 million) and Other Noncurrent Liabilities ($2.3 million) on our unaudited consolidated condensed balance sheet. As of December 31, 2009, the fair market value of the interest rate swap contracts was a liability of $10.2 million and was included in Other Accrued Expenses ($5.0 million) and Other Noncurrent Liabilities ($5.2 million) on our unaudited consolidated condensed balance sheet.

During the nine months ended September 30, 2010 and 2009, we recognized a $2.5 million loss (net of tax) and $4.4 million loss (net of tax), respectively, on derivatives in Other Comprehensive Income. Approximately $5.4 million of losses (net of tax) were reclassified to interest expense from Accumulated Other Comprehensive Loss during each of the nine month periods ended September 30, 2010 and 2009. As of September 30, 2010, we estimate that $2.4 million of net derivative losses (net of tax) included in Accumulated Other Comprehensive Loss will be reclassified into interest expense within the next 12 months. There was no hedge ineffectiveness for the nine months ended September 30, 2010 and 2009.

Fair Value Measurements
Fair Value Measurements

Note 7. Fair Value Measurements

Effective January 1, 2010, we adopted a newly issued accounting standard which clarifies existing disclosure requirements related to the level of disaggregation of fair value measurements for each class of assets and liabilities and requires additional disclosures about inputs and valuation techniques used to measure fair value for both recurring and nonrecurring Level 2 and Level 3 measurements. 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.

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.

We use the market and income approaches to value our financial assets and liabilities, and there were no changes in valuation techniques during the nine months ended September 30, 2010. 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 September 30, 2010 and December 31, 2009 (in thousands):

 

     Balance as
of September 30,
2010
     Fair Value Measurements as of September 30, 2010  
      Level 1      Level 2      Level 3  

Assets:

           

Cash surrender value of life insurance

   $ 9,539       $ –         $ 9,539       $ –     
                                   

Total Assets

   $ 9,539       $ –         $ 9,539       $ –     
                                   

Liabilities:

           

Deferred compensation liabilities

   $ 9,690       $ –         $ 9,690       $ –     

Interest rate swaps

     5,615         –           5,615         –     
                                   

Total Liabilities

   $ 15,305       $ –         $ 15,305       $ –     
                                   
     Balance as
of December 31,
2009
     Fair Value Measurements as of December 31, 2009  
        Level 1      Level 2      Level 3  

Assets:

           

Cash surrender value of life insurance

   $ 7,323       $ –         $ 7,323       $ –     
                                   

Total Assets

   $ 7,323       $ –         $ 7,323       $ –     
                                   

Liabilities:

           

Deferred compensation liabilities

   $ 7,902       $ –         $ 7,902       $ –     

Interest rate swaps

     10,213         –           10,213         –     
                                   

Total Liabilities

   $ 18,115       $ –         $ 18,115       $ –     
                                   

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 September 30, 2010 are as follows (in thousands):

 

Three months ending December 31, 2010

   $ 15,416   

Years ending December 31:

  

2011

     53,729   

2012

     44,943   

2013

     38,682   

2014

     28,630   

2015

     20,043   

Thereafter

     56,488   
        

Future Minimum Lease Payments

   $ 257,931   
        

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
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010      2009  

Income from continuing operations

   $ 35,901       $ 30,141       $ 125,790       $ 90,614   
                                   

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

     143,258         140,746         142,769         140,257   

Effect of dilutive securities:

           

Stock options

     2,510         3,286         2,680         3,410   

Restricted stock

     30         15         21         2   
                                   

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

     145,798         144,047         145,470         143,669   
                                   

Basic earnings per share from continuing operations

   $ 0.25       $ 0.21       $ 0.88       $ 0.65   
                                   

Diluted earnings per share from continuing operations

   $ 0.25       $ 0.21       $ 0.86       $ 0.63   
                                   

The following chart 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
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010      2009  

Antidilutive securities:

           

Stock options

     3,027         1,361         3,034         1,368   

Restricted stock

     –           –           –           152   
Business Combinations
Business Combinations

Note 10. Business Combinations

During the nine months ended September 30, 2010, we made 12 acquisitions (ten in the wholesale parts business, one in the recycled heavy-duty truck parts business and one tire recycling business). The acquisitions enabled us to expand our geographic presence in the wholesale parts business and our network of recycled heavy-duty truck parts facilities as well as expand our product offerings. The tire recycling business will support all of our operating segments.

In October 2010, we completed four acquisitions, including three in the wholesale recycled and aftermarket products operating segment and one self service retail operation. We are in the process of completing the purchase accounting for these acquisitions, and as a result, we are unable to disclose the amounts recognized for each major class of assets acquired and liabilities assumed.

On October 1, 2009, we acquired Greenleaf Auto Recyclers, LLC ("Greenleaf") from SSI for $38.8 million, net of cash acquired. Greenleaf is the entity through which SSI operated its wholesale recycling business. We recorded a gain on bargain purchase for the Greenleaf acquisition totaling $4.3 million in our results of operations for 2009. During the quarter ended September 30, 2010, we finalized the valuation of acquired inventory, accrued liabilities, and deferred taxes. As a result, we identified certain immaterial adjustments to the opening balance sheet, which were recorded through the results of operations for the three and nine months ended September 30, 2010.

Also in 2009, we acquired a 100% interest in each of seven businesses (four in the wholesale parts business and three in the recycled heavy-duty truck parts business). The aggregate consideration for these seven businesses totaled approximately $29.5 million in cash, net of cash acquired, and $1.2 million of debt issued.

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. In connection with the acquisitions during the nine months ended September 30, 2010, the purchase price allocations are preliminary as we are in the process of determining the valuation amounts for certain of the inventories and the fair value of liabilities assumed. We do not anticipate material adjustments to these purchase price allocations will be required. The purchase price allocations for the acquisitions completed during the nine months ended September 30, 2010 are as follows (in thousands):

 

     September 30,
2010
(Preliminary)
 

Receivables

   $ 13,492   

Receivable reserves

     (511

Inventory

     14,194   

Prepaid expenses

     151   

Property and equipment

     6,757   

Goodwill

     50,759   

Other intangibles

     607   

Deferred income taxes

     203   

Current liabilities assumed

     (6,788

Other purchase price obligations

     (6,151

Notes issued

     (2,432
        

Cash used in acquisitions, net of cash acquired

   $ 70,281   
        

Total consideration for the acquisitions for the nine months ended September 30, 2010 was $78.9 million, composed of $70.3 million of cash (net of cash acquired), $2.4 million of notes payable, and $6.2 million of other purchase price obligations (non-interest bearing). We recorded goodwill of $50.8 million for the 2010 acquisitions, of which $46.8 million is expected to be deductible for income tax purposes. In the period between the acquisition dates and September 30, 2010, the businesses acquired in 2010 generated approximately $25.2 million of revenue and $0.8 million of operating income.

The primary reason for our acquisitions made in 2010 and 2009 was to increase our stockholder value by levering our strategy of becoming a one-stop provider for alternative vehicle replacement parts. 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 2010 and 2009 as though the businesses had been acquired as of January 1, 2009, and is based upon unaudited financial information of the acquired entities (in thousands, except per share data):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010      2009  

Revenue as reported

   $ 607,621      $ 494,812      $ 1,795,818       $ 1,492,037   

Revenue of purchased businesses for the period prior to acquisition

     12,899        64,560        82,599         187,660   
                                 

Pro forma revenue

   $ 620,520      $ 559,372      $ 1,878,417       $ 1,679,697   
                                 

Income from continuing operations, as reported

   $ 35,901      $ 30,141      $ 125,790       $ 90,614   

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

     (207     (126     2,526         (3,186
                                 

Pro forma income from continuing operations

   $ 35,694      $ 30,015      $ 128,316       $ 87,428   
                                 

Basic earnings per share from continuing operations, as reported

   $ 0.25      $ 0.21      $ 0.88       $ 0.65   

Effect of purchased businesses for the period prior to acquisition

     (0.00     (0.00     0.02         (0.02
                                 

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

   $ 0.25      $ 0.21      $ 0.90       $ 0.62   
                                 

Diluted earnings per share from continuing operations, as reported

   $ 0.25      $ 0.21      $ 0.86       $ 0.63   

Effect of purchased businesses for the period prior to acquisition

     (0.00     (0.00     0.02         (0.02
                                 

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

   $ 0.24      $ 0.21      $ 0.88       $ 0.61   
                                 

(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 also includes purchase accounting adjustments, 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

Greenleaf Integration

In the fourth quarter of 2009, we began our restructuring and integration efforts in connection with the acquisition of Greenleaf on October 1, 2009. The restructuring plan includes the integration of the acquired Greenleaf operations into our existing salvage business. We are in the process of identifying those facilities and delivery routes that will be combined or closed to eliminate the duplication with existing LKQ facilities. Drivers and some facility personnel have been or will be terminated as part of the consolidation of these overlapping facilities and delivery routes.

We expect that our ongoing integration activities will not be completed until 2011. We expect to incur approximately $0.8 million of additional charges as we execute the integration plan. These charges are expected to include costs related to the closure of duplicate facilities, the movement of inventory between locations, and severance and related benefits for terminated employees. In addition, we will incur restructuring expense related to excess facility and lease termination costs if we are unable to convert the duplicate facilities to alternate uses or recover the rent from a sublease tenant after we have vacated the facility. These restructuring charges will be expensed as incurred or in the case of excess facility costs when we cease using the facility.

Restructuring and integration expenses associated with the Greenleaf acquisition totaled approximately $0.6 million for the nine months ended September 30, 2010, and are included in restructuring expenses on the accompanying unaudited consolidated condensed statements of income. These charges reflected costs related to the closure of facilities and severance and related benefits for terminated personnel.

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 judgments 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, 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 nine months ended September 30, 2010 was 38.2% compared with 39.1% for the comparable prior year period. The effective income tax rate for the nine months ended September 30, 2010 included a discrete benefit of $1.7 million resulting from the revaluation of deferred taxes in connection with a legal entity reorganization.