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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.
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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.
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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 | ) | ||||||
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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.
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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.
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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.
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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.
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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.
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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) |
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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, |
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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.
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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.
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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.