LKQ-2014.09.30 10-Q

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________________ 
FORM 10-Q
________________________ 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2014
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from              to
Commission File Number: 000-50404
________________________ 
LKQ CORPORATION
(Exact name of registrant as specified in its charter)
________________________ 
DELAWARE
 
36-4215970
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
500 WEST MADISON STREET,
SUITE 2800, CHICAGO, IL
 
60661
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (312) 621-1950
________________________ 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
At October 24, 2014, the registrant had issued and outstanding an aggregate of 303,035,573 shares of Common Stock.
 




PART I
FINANCIAL INFORMATION

Item 1.
Financial Statements.

LKQ CORPORATION AND SUBSIDIARIES
Unaudited Condensed Consolidated Balance Sheets
(In thousands, except share and per share data)
 
September 30,
 
December 31,
 
2014
 
2013
Assets
 
 
 
Current Assets:
 
 
 
Cash and equivalents
$
244,646

 
$
150,488

Receivables, net
609,434

 
458,094

Inventory
1,341,325

 
1,076,952

Deferred income taxes
73,997

 
63,938

Prepaid expenses and other current assets
76,136

 
50,345

Total Current Assets
2,345,538

 
1,799,817

Property and Equipment, net
612,292

 
546,651

Intangible Assets:
 
 
 
Goodwill
2,257,153

 
1,937,444

Other intangibles, net
221,049

 
153,739

Other Assets
98,546

 
81,123

Total Assets
$
5,534,578

 
$
4,518,774

Liabilities and Stockholders’ Equity
 
 
 
Current Liabilities:
 
 
 
Accounts payable
$
403,587

 
$
349,069

Accrued expenses:
 
 
 
Accrued payroll-related liabilities
88,082

 
58,695

Sales taxes payable
45,098

 
30,701

Other accrued expenses
127,838

 
109,373

Contingent consideration liabilities
2,288

 
52,465

Other current liabilities
31,587

 
36,115

Current portion of long-term obligations
72,908

 
41,535

Total Current Liabilities
771,388

 
677,953

Long-Term Obligations, Excluding Current Portion
1,825,133

 
1,264,246

Deferred Income Taxes
159,270

 
133,822

Other Noncurrent Liabilities
111,093

 
92,008

Commitments and Contingencies
 
 
 
Stockholders’ Equity:
 
 
 
Common stock, $0.01 par value,1,000,000,000 shares authorized, 303,031,358 and 300,805,276 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively
3,030

 
3,008

Additional paid-in capital
1,044,004

 
1,006,084

Retained earnings
1,622,692

 
1,321,642

Accumulated other comprehensive (loss) income
(2,032
)
 
20,011

Total Stockholders’ Equity
2,667,694

 
2,350,745

Total Liabilities and Stockholders’ Equity
$
5,534,578

 
$
4,518,774


See notes to unaudited condensed consolidated financial statements.
2







LKQ CORPORATION AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Income
(In thousands, except per share data)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Revenue
$
1,721,024

 
$
1,298,094

 
$
5,055,933

 
$
3,745,839

Cost of goods sold
1,056,613

 
780,187

 
3,068,579

 
2,216,110

Gross margin
664,411

 
517,907

 
1,987,354

 
1,529,729

Facility and warehouse expenses
133,330

 
108,349

 
387,995

 
311,480

Distribution expenses
148,572

 
109,593

 
432,445

 
320,033

Selling, general and administrative expenses
192,229

 
153,546

 
563,344

 
436,614

Restructuring and acquisition related expenses
3,594

 
2,206

 
12,816

 
7,391

Depreciation and amortization
30,498

 
20,818

 
87,136

 
57,850

Operating income
156,188

 
123,395

 
503,618

 
396,361

Other expense (income):
 
 
 
 
 
 
 
Interest expense, net
16,394

 
15,200

 
48,140

 
36,287

Loss on debt extinguishment

 

 
324

 
2,795

Change in fair value of contingent consideration liabilities
12

 
712

 
(2,000
)
 
1,765

Other income, net
(18
)
 
(1,562
)
 
(1,021
)
 
(1,737
)
Total other expense, net
16,388

 
14,350

 
45,443

 
39,110

Income before provision for income taxes
139,800

 
109,045

 
458,175

 
357,251

Provision for income taxes
47,564

 
35,600

 
155,926

 
123,492

Equity in earnings of unconsolidated subsidiaries
(721
)
 

 
(1,199
)
 

Net income
$
91,515

 
$
73,445

 
$
301,050

 
$
233,759

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.30

 
$
0.24

 
$
1.00

 
$
0.78

Diluted
$
0.30

 
$
0.24

 
$
0.98

 
$
0.77


Unaudited Condensed Consolidated Statements of Comprehensive Income
(In thousands)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Net income
$
91,515

 
$
73,445

 
$
301,050

 
$
233,759

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation
(39,329
)
 
28,514

 
(24,013
)
 
6,330

Net change in unrecognized gains/losses on derivative instruments, net of tax
817

 
625

 
2,067

 
3,986

Change in unrealized gain on pension plan, net of tax
(30
)
 

 
(97
)
 

Total other comprehensive (loss) income
(38,542
)
 
29,139

 
(22,043
)
 
10,316

Total comprehensive income
$
52,973

 
$
102,584

 
$
279,007

 
$
244,075


See notes to unaudited condensed consolidated financial statements.
3







LKQ CORPORATION AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Cash Flows
(In thousands)
 
Nine Months Ended
 
September 30,
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
301,050

 
$
233,759

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
90,647

 
61,868

Stock-based compensation expense
16,967

 
16,292

Excess tax benefit from stock-based payments
(14,455
)
 
(15,998
)
Other
3,440

 
7,424

Changes in operating assets and liabilities, net of effects from acquisitions:
 
 
 
Receivables
(69,680
)
 
(35,287
)
Inventory
(55,266
)
 
(18,207
)
Prepaid income taxes/income taxes payable
20,858

 
40,551

Accounts payable
1,433

 
1,641

Other operating assets and liabilities
27,648

 
48,886

Net cash provided by operating activities
322,642

 
340,929

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of property and equipment
(100,191
)
 
(61,126
)
Proceeds from sales of property and equipment
3,174

 
1,459

Investments in unconsolidated subsidiaries
(2,240
)
 
(9,136
)
Acquisitions, net of cash acquired
(650,614
)
 
(395,974
)
Net cash used in investing activities
(749,871
)
 
(464,777
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from exercise of stock options
6,520

 
13,647

Excess tax benefit from stock-based payments
14,455

 
15,998

Proceeds from issuance of senior notes

 
600,000

Borrowings under revolving credit facility
1,299,821

 
399,758

Repayments under revolving credit facility
(808,039
)
 
(745,313
)
Borrowings under term loans
11,250

 
35,000

Repayments under term loans
(11,250
)
 
(11,250
)
Borrowings under receivables securitization facility
80,000

 
41,500

Repayments under receivables securitization facility

 
(111,500
)
Repayments of other long-term debt
(20,532
)
 
(19,518
)
Payments of other obligations
(41,934
)
 
(32,091
)
Other financing activities, net
(6,881
)
 
(16,912
)
Net cash provided by financing activities
523,410

 
169,319

Effect of exchange rate changes on cash and equivalents
(2,023
)
 
2,096

Net increase in cash and equivalents
94,158

 
47,567

Cash and equivalents, beginning of period
150,488

 
59,770

Cash and equivalents, end of period
$
244,646

 
$
107,337

Supplemental disclosure of cash paid for:
 
 
 
Income taxes, net of refunds
$
135,447

 
$
82,536

Interest
38,399

 
22,853

Supplemental disclosure of noncash investing and financing activities:
 
 
 
Notes payable and other obligations, including notes issued and debt assumed in connection with business acquisitions
$
87,731

 
$
10,728

Contingent consideration liabilities
5,854

 
3,854

Non-cash property and equipment additions
4,852

 
2,657


See notes to unaudited condensed consolidated financial statements.
4




LKQ CORPORATION AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Stockholders’ Equity
(In thousands)
 
Common Stock
 
Additional Paid-In Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Stockholders’
Equity
 
Shares
Issued
 
Amount
 
BALANCE, January 1, 2014
300,805

 
$
3,008

 
$
1,006,084

 
$
1,321,642

 
$
20,011

 
$
2,350,745

Net income

 

 

 
301,050

 

 
301,050

Other comprehensive loss

 

 

 

 
(22,043
)
 
(22,043
)
Restricted stock units vested
975

 
10

 
(10
)
 

 

 

Stock-based compensation expense

 

 
16,967

 

 

 
16,967

Exercise of stock options
1,251

 
12

 
6,508

 

 

 
6,520

Excess tax benefit from stock-based payments

 

 
14,455

 

 

 
14,455

BALANCE, September 30, 2014
303,031

 
$
3,030

 
$
1,044,004

 
$
1,622,692

 
$
(2,032
)
 
$
2,667,694




See notes to unaudited condensed consolidated financial statements.
5




LKQ CORPORATION AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated 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 "LKQ," "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 condensed consolidated 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 of America have been condensed or omitted. These unaudited condensed consolidated financial statements reflect, in the opinion of management, all material adjustments (which include only normally 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, 2013 filed with the SEC on March 3, 2014.
As described in Note 8, "Business Combinations," on January 3, 2014, we completed our acquisition of Keystone Automotive Holdings, Inc. ("Keystone Specialty"), a distributor and marketer of specialty aftermarket equipment and accessories in North America. With our acquisition of Keystone Specialty, we present an additional reportable segment, Specialty. Our unaudited condensed consolidated financial statements reflect the impact of Keystone Specialty from the date of acquisition through September 30, 2014.

Note 2.
Financial Statement Information
Revenue Recognition
The majority of our revenue is derived from the sale of vehicle parts. Revenue is recognized when the products are shipped to, delivered to 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 recorded a reserve for estimated returns, discounts and allowances of approximately $30.0 million and $26.6 million at September 30, 2014 and December 31, 2013, respectively. We present taxes assessed by governmental authorities collected from customers on a net basis. Therefore, the taxes are excluded from revenue on our Unaudited Condensed Consolidated Statements of Income and are shown as a current liability on our Unaudited Condensed Consolidated Balance Sheets until remitted. We recognize revenue from the sale of scrap, cores and other metals when title has transferred, which typically occurs upon delivery to the customer.
Allowance for Doubtful Accounts
We recorded a reserve for uncollectible accounts of approximately $19.1 million and $14.4 million at September 30, 2014 and December 31, 2013, respectively.
Inventory
Inventory consists of the following (in thousands):
 
September 30,
 
December 31,
 
2014
 
2013
Aftermarket and refurbished products
$
944,451

 
$
706,600

Salvage and remanufactured products
396,874

 
370,352

 
$
1,341,325

 
$
1,076,952


Our acquisitions completed during the first nine months of 2014 and adjustments to preliminary valuations of inventory for certain of our 2013 acquisitions contributed $217.3 million of the increase in our aftermarket and refurbished products inventory and $13.0 million of the increase in our salvage and remanufactured products inventory during the nine months ended September 30, 2014. See Note 8, "Business Combinations," for further information on our acquisitions.

6





Intangible Assets
Intangible assets consist primarily of goodwill (the cost of purchased businesses in excess of the fair value of the identifiable net assets acquired) and other specifically identifiable intangible assets, such as trade names, trademarks, customer relationships, software and other technology related assets and covenants not to compete.
The changes in the carrying amount of goodwill by reportable segment during the nine months ended September 30, 2014 are as follows (in thousands):
 
North America
 
Europe
 
Specialty
 
Total
Balance as of January 1, 2014
$
1,358,937

 
$
578,507

 
$

 
$
1,937,444

Business acquisitions and adjustments to previously recorded goodwill
44,981

 
73,959

 
233,998

 
352,938

Exchange rate effects
(6,332
)
 
(26,898
)
 
1

 
(33,229
)
Balance as of September 30, 2014
$
1,397,586

 
$
625,568

 
$
233,999

 
$
2,257,153

The components of other intangibles are as follows (in thousands):
 
September 30, 2014
 
December 31, 2013
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Trade names and trademarks
$
165,262

 
$
(33,643
)
 
$
131,619

 
$
143,577

 
$
(27,950
)
 
$
115,627

Customer relationships
71,345

 
(21,906
)
 
49,439

 
29,583

 
(10,770
)
 
18,813

Software and other technology related assets
45,513

 
(8,657
)
 
36,856

 
20,384

 
(2,718
)
 
17,666

Covenants not to compete
6,199

 
(3,064
)
 
3,135

 
3,979

 
(2,346
)
 
1,633

 
$
288,319

 
$
(67,270
)
 
$
221,049

 
$
197,523

 
$
(43,784
)
 
$
153,739

During the nine months ended September 30, 2014, we recorded preliminary intangible asset valuations resulting from our 2014 acquisitions and adjustments to certain preliminary intangible asset valuations from our 2013 acquisitions, which included $24.7 million of trade names, $42.8 million of customer relationships, $26.8 million of software and other technology related assets and $2.4 million of covenants not to compete. The trade names, customer relationships, and software and technology related assets recorded in the nine months ended September 30, 2014 included $20.9 million, $23.1 million and $26.8 million, respectively, related to our acquisition of Keystone Specialty, as discussed in Note 8, "Business Combinations."
Trade names and trademarks are amortized over a useful life ranging from 10 to 30 years on a straight-line basis. Customer relationships are amortized over the expected period to be benefited (5 to 15 years) on an accelerated basis. Software and other technology related assets are amortized on a straight-line basis over the expected period to be benefited (five to six years). Covenants not to compete are amortized over the lives of the respective agreements, which range from one to five years, on a straight-line basis. Amortization expense for intangibles was $24.4 million and $9.0 million during the nine month periods ended September 30, 2014 and 2013, respectively. Estimated amortization expense for each of the five years in the period ending December 31, 2018 is $32.4 million, $29.4 million, $26.1 million, $23.7 million and $18.7 million, respectively.
Warranty Reserve
Some of our salvage mechanical products are sold with a standard six month warranty against defects. Additionally, some of our remanufactured engines are sold with a standard three year warranty against defects. We also provide a limited lifetime warranty for certain of our aftermarket products that is supported by certain of the suppliers of those products. We record the estimated warranty costs at the time of sale using historical warranty claim information to project future warranty claims activity. The changes in the warranty reserve during the nine month period ended September 30, 2014 were as follows (in thousands):
Balance as of January 1, 2014
$
12,447

Warranty expense
22,890

Warranty claims
(20,514
)
Balance as of September 30, 2014
$
14,823


7





Investments in Unconsolidated Subsidiaries
As of September 30, 2014, the carrying value of our investments in unconsolidated subsidiaries was $9.5 million; of this amount, $7.6 million relates to our investment in ACM Parts Pty Ltd ("ACM Parts"). In August 2013, we entered into an agreement with Suncorp Group, a leading general insurance group in Australia and New Zealand, to develop ACM Parts, an alternative vehicle replacement parts business in those countries. We hold a 49% equity interest in the entity and will contribute our experience to help establish automotive parts recycling operations and to facilitate the procurement of aftermarket parts; Suncorp Group holds a 51% equity interest and will supply salvage vehicles to the venture as well as assist in establishing relationships with repair shops as customers. We are accounting for our interest in this subsidiary using the equity method of accounting, as our investment gives us the ability to exercise significant influence, but not control, over the investee. The total of our investment in ACM Parts and other unconsolidated subsidiaries is included within Other Assets on our Unaudited Condensed Consolidated Balance Sheets. Our equity in the net earnings of the investees for the three and nine months ended September 30, 2014 was not material.
Depreciation Expense
Included in Cost of Goods Sold on the Unaudited Condensed Consolidated Statements of Income is depreciation expense associated with our refurbishing, remanufacturing, and furnace operations as well as our distribution centers.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update 2014-09, "Revenue from Contracts with Customers" ("ASU 2014-09"). This update outlines a new comprehensive revenue recognition model which supersedes most current revenue recognition guidance, and requires companies to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Entities adopting the standard have the option of using either a full retrospective or modified retrospective approach in the application of this guidance. ASU 2014-09 will be effective for the Company during the first quarter of our fiscal year 2017. Early adoption is not permitted. We are still evaluating the impact that ASU 2014-09 will have on our consolidated financial statements and related disclosures.
In June 2014, the FASB issued Accounting Standards Update 2014-12, "Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period" ("ASU 2014-12"). This update requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition, and requires the recognition of compensation cost in the period in which it becomes probable that the performance target will be achieved. ASU 2014-12 will be effective for the Company during the first quarter of our fiscal year 2016. Early adoption is permitted. The new standard can be applied either prospectively to all awards granted or modified after the effective date or retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements as an adjustment to opening retained earnings. We do not anticipate the adoption of this guidance will have a material impact on our financial position, results of operations, cash flows, or disclosures.

Note 3.
Equity Incentive Plans
In order to attract and retain employees, non-employee directors, consultants, and other persons associated with us, we may grant qualified and nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units (“RSUs”), performance shares and performance units under the LKQ Corporation 1998 Equity Incentive Plan (the “Equity Incentive Plan”). We have granted RSUs, stock options, and restricted stock under the Equity Incentive Plan. We expect to issue new shares of common stock to cover past and future equity grants.
RSUs
RSUs vest over periods of up to five years. RSUs may contain either a time-based vesting condition or a combination of a performance-based vesting condition and a time-based vesting condition, in which case both conditions must be met before any RSUs vest. For RSUs containing a performance-based vesting condition, the Company must report positive diluted earnings per share, subject to certain adjustments, during any fiscal year period within five years following the grant date. Each RSU converts into one share of LKQ common stock on the applicable vesting date. The grant date fair value of RSUs is based on the market price of LKQ stock on the grant date.
During the nine months ended September 30, 2014, we granted 664,897 RSUs to employees. The fair value of RSUs that vested during the nine months ended September 30, 2014 was approximately $27.7 million.
Stock Options

8





Stock options vest over periods of up to five years, subject to a continued service condition. Stock options expire either 6 or 10 years from the date they are granted. During the nine months ended September 30, 2014, we granted 126,755 stock options to employees. The grant date fair value of these options was immaterial to the financial statements.
Restricted Stock
Restricted stock vests over a five year period, subject to a continued service condition. Shares of restricted stock may not be sold, pledged or otherwise transferred until they vest.
A summary of transactions in our stock-based compensation plans is as follows:
 
Shares
Available For
Grant
 
RSUs
 
Stock Options
 
Restricted Stock
Number
Outstanding
 
Weighted
Average
Grant Date
Fair Value
 
Number
Outstanding
 
Weighted
Average
Exercise
Price
 
Number
Outstanding
 
Weighted
Average
Grant Date
Fair Value
Balance, January 1, 2014
13,965,440

 
2,558,213

 
$
16.63

 
6,832,331

 
$
7.04

 
20,000

 
$
9.30

Granted
(791,652
)
 
664,897

 
31.82

 
126,755

 
32.31

 

 

Exercised

 

 

 
(1,250,620
)
 
5.21

 

 

Vested

 
(975,462
)
 
17.01

 

 

 
(10,000
)
 
9.30

Canceled
142,887

 
(89,138
)
 
20.49

 
(53,749
)
 
13.42

 

 

Balance, September 30, 2014
13,316,675

 
2,158,510

 
$
20.98

 
5,654,717

 
$
7.95


10,000

 
$
9.30

For the RSU grants that contain both a performance-based vesting condition and a time-based vesting condition, we recognize compensation expense under the accelerated attribution method, pursuant to which expense is recognized over the requisite service period for each separate vesting tranche of the award. During the three and nine months ended September 30, 2014, we recognized $1.8 million and $6.5 million of stock based compensation expense, respectively, related to the RSUs containing a performance-based vesting condition. During the three and nine months ended September 30, 2013 we recognized $2.3 million and $6.0 million of stock based compensation expense, respectively, related to the RSUs containing a performance-based vesting condition. For all other awards, which are subject to only a time-based vesting condition, we recognize compensation expense on a straight-line basis over the requisite service period of the entire award.
In all cases, compensation expense is adjusted to reflect estimated forfeitures. When estimating forfeitures, we consider voluntary and involuntary termination behavior as well as analysis of historical forfeitures.
The components of pre-tax stock-based compensation expense are as follows (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
RSUs
$
4,434

 
$
4,559

 
$
14,625

 
$
12,674

Stock options
703

 
1,124

 
2,203

 
3,457

Restricted stock
47

 
47

 
139

 
161

Total stock-based compensation expense
$
5,184

 
$
5,730

 
$
16,967

 
$
16,292

The following table sets forth the classification of total stock-based compensation expense included in our Unaudited Condensed Consolidated Statements of Income (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Cost of goods sold
$
105

 
$
98

 
$
308

 
$
294

Facility and warehouse expenses
527

 
687

 
1,672

 
2,058

Selling, general and administrative expenses
4,552

 
4,945

 
14,987

 
13,940

 
5,184

 
5,730

 
16,967

 
16,292

Income tax benefit
(1,996
)
 
(2,235
)
 
(6,532
)
 
(6,354
)
Total stock-based compensation expense, net of tax
$
3,188

 
$
3,495

 
$
10,435

 
$
9,938


9





We have not capitalized any stock-based compensation costs during either of the nine month periods ended September 30, 2014 or 2013.
As of September 30, 2014, unrecognized compensation expense related to unvested RSUs and stock options is expected to be recognized as follows (in thousands):
 
RSUs
 
Stock
Options
 
Total
Remainder of 2014
$
4,292

 
$
724

 
$
5,016

2015
13,459

 
396

 
13,855

2016
8,433

 
331

 
8,764

2017
5,049

 
9

 
5,058

2018
2,553

 

 
2,553

2019
110

 

 
110

Total unrecognized compensation expense
$
33,896

 
$
1,460

 
$
35,356


Note 4.
Long-Term Obligations
Long-Term Obligations consist of the following (in thousands):
 
September 30,
 
December 31,
 
2014
 
2013
Senior secured credit agreement:
 
 
 
Term loans payable
$
438,750

 
$
438,750

Revolving credit facility
693,299

 
233,804

Senior notes
600,000

 
600,000

Receivables securitization facility
80,000

 

Notes payable through October 2018 at weighted average interest rates of 1.1%
53,994

 
15,730

Other long-term debt at weighted average interest rates of 2.9% and 3.5%, respectively
31,998

 
17,497

 
1,898,041

 
1,305,781

Less current maturities
(72,908
)
 
(41,535
)
 
$
1,825,133

 
$
1,264,246

Senior Secured Credit Agreement
    
On March 27, 2014, LKQ Corporation, LKQ Delaware LLP, and certain other subsidiaries (collectively, the "Borrowers") entered into a third amended and restated credit agreement (the "Credit Agreement") with the several lenders from time to time party thereto, Wells Fargo Bank, National Association, as administrative agent; Bank of America, N.A., as syndication agent; The Bank of Tokyo-Mitsubishi UFJ, LTD. ("BTMU") and RBS Citizens, N.A., as co-documentation agents; and Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, BTMU, and RBS Citizens, N.A., as joint bookrunners and joint lead arrangers. The Credit Agreement retains many of the terms of the Company’s second amended and restated credit agreement dated May 3, 2013 while also modifying certain terms to (1) extend the maturity date by one year to May 3, 2019; (2) increase the total availability under the Credit Agreement from $1.8 billion to $2.3 billion (composed of $1.69 billion in the revolving credit facility's multicurrency component, $165 million in the revolving credit facility's U.S. dollar only component, and $450 million of term loans); (3) reduce the applicable margin on outstanding borrowings under the Credit Agreement; (4) reduce the commitment fee percentage we pay on average daily unused amounts under the revolving credit facility; (5) allow for additional unsecured foreign borrowings; (6) adjust certain limitations on our ability to make restricted payments; and (7) make other immaterial or clarifying modifications and amendments to the terms of the Company's second amended and restated credit agreement. The Credit Agreement allows the Company to increase the amount of the revolving credit facility or obtain incremental term loans up to the greater of $400 million or the amount that may be borrowed while maintaining a senior secured leverage ratio of less than or equal to 2.50 to 1.00, subject to the agreement of the lenders. The proceeds of the Credit Agreement were used to repay outstanding revolver borrowings and to pay fees related to the amendment and restatement.
Amounts under the revolving credit facility are due and payable upon maturity of the Credit Agreement on May 3, 2019. Term loan borrowings are due and payable in quarterly installments equal to 1.25% of the original principal amount

10





beginning on June 30, 2014 with the remaining balance due and payable on the maturity date of the Credit Agreement. We are required to prepay the term loan by amounts equal to proceeds from the sale or disposition of certain assets if the proceeds are not reinvested within twelve months. We also have the option to prepay outstanding amounts under the Credit Agreement without penalty.
The Credit Agreement contains customary representations and warranties, and contains customary covenants that provide limitations and conditions on our ability to enter into certain transactions. The Credit Agreement also contains financial and affirmative covenants under which we (i) may not exceed a maximum net leverage ratio of 3.50 to 1.00 except in connection with permitted acquisitions with aggregate consideration in excess of $200 million during any period of four consecutive fiscal quarters in which case the maximum net leverage ratio may increase to 4.00 to 1.00 for the subsequent four fiscal quarters and (ii) are required to maintain a minimum interest coverage ratio of 3.00 to 1.00.
Borrowings under the Credit Agreement bear interest at variable rates, which depend on the currency and duration of the borrowing elected, plus an applicable margin. The applicable margin is subject to change in increments of 0.25% depending on our net leverage ratio. Interest payments are due on the last day of the selected interest period or quarterly in arrears depending on the type of borrowing. Including the effect of the interest rate swap agreements described in Note 5, "Derivative Instruments and Hedging Activities," the weighted average interest rates on borrowings outstanding under the Credit Agreement at September 30, 2014 and December 31, 2013 were 2.35% and 3.05%, respectively. We also pay a commitment fee based on the average daily unused amount of the revolving credit facility. The commitment fee is subject to change in increments of 0.05% depending on our net leverage ratio. In addition, we pay a participation commission on outstanding letters of credit at an applicable rate based on our net leverage ratio, as well as a fronting fee of 0.125% to the issuing bank, which are due quarterly in arrears. Borrowings under the Credit Agreement totaled $1.1 billion and $672.6 million at September 30, 2014 and December 31, 2013, respectively, of which $22.5 million was classified as current maturities at both September 30, 2014 and December 31, 2013. As of September 30, 2014, there were letters of credit outstanding in the aggregate amount of $60.4 million. The amounts available under the revolving credit facility are reduced by the amounts outstanding under letters of credit, and thus availability under the revolving credit facility at September 30, 2014 was $1.1 billion.
Related to the execution of the Credit Agreement in March 2014, we incurred $3.7 million of fees, of which $3.4 million were capitalized within Other Assets on our Unaudited Condensed Consolidated Balance Sheet and are amortized over the term of the agreement. The remaining $0.3 million of fees were expensed during the nine months ended September 30, 2014 as a loss on debt extinguishment. Related to the execution of the second amended and restated credit agreement in May 2013, we incurred $7.2 million of fees, of which $6.1 million were capitalized within Other Assets on our Unaudited Condensed Consolidated Balance Sheet. The remaining $1.1 million of fees, together with $1.7 million of capitalized debt issuance costs related to the original credit agreement, were expensed during the nine months ended September 30, 2013 as a loss on debt extinguishment.
Senior Notes
On May 9, 2013, LKQ Corporation completed an offering of $600 million aggregate principal amount of senior notes due May 15, 2023 (the "Original Notes") in a private placement conducted pursuant to Rule 144A and Regulation S under the Securities Act of 1933. In April 2014, LKQ Corporation completed an offer to exchange $600 million aggregate principal amount of registered 4.75% Senior Notes due 2023 (the "Notes") for the Original Notes. The Notes are governed by the Indenture dated as of May 9, 2013 among LKQ Corporation, certain of our subsidiaries (the "Guarantors") and U.S. Bank National Association, as trustee. The Notes are substantially identical to the Original Notes, except the Notes are registered under the Securities Act of 1933, and the transfer restrictions, registration rights, and related additional interest provisions applicable to the Original Notes do not apply to the Notes.
The Notes bear interest at a rate of 4.75% per year from the date of the original issuance or from the most recent payment date on which interest has been paid or provided for. Interest on the Notes is payable in arrears on May 15 and November 15 of each year. The first interest payment was made on November 15, 2013. The Notes are fully and unconditionally guaranteed, jointly and severally, by the Guarantors.
The Notes and the guarantees are, respectively, LKQ Corporation's and each Guarantor's senior unsecured obligations and are subordinated to all of the Guarantors' existing and future secured debt to the extent of the assets securing that secured debt. In addition, the Notes are effectively subordinated to all of the liabilities of our subsidiaries that are not guaranteeing the Notes to the extent of the assets of those subsidiaries.
Receivables Securitization Facility
On September 28, 2012, we entered into a three year receivables securitization facility with BTMU as Administrative Agent. Under the facility, LKQ sells an ownership interest in certain receivables, related collections and security interests to BTMU for the benefit of conduit investors and/or financial institutions for up to $80 million in cash proceeds. Upon payment of

11





the receivables by customers, rather than remitting to BTMU the amounts collected, LKQ retains such collections as proceeds for the sale of new receivables generated by certain of the ongoing operations of the Company. On September 29, 2014, the parties amended the terms of the facility to: (i) extend the term of the facility to October 2, 2017; (ii) increase the maximum amount available to $97 million; and (iii) make other clarifying and updating changes.
The sale of the ownership interest in the receivables is accounted for as a secured borrowing in our Unaudited Condensed Consolidated Balance Sheets, under which the receivables included in the program collateralize the amounts invested by BTMU, the conduit investors and/or financial institutions (the "Purchasers"). The receivables are held by LKQ Receivables Finance Company, LLC ("LRFC"), a wholly owned bankruptcy-remote special purpose subsidiary of LKQ, and therefore, the receivables are available first to satisfy the creditors of LRFC, including the investors. As of September 30, 2014, $123.4 million of net receivables were collateral for the investment under the receivables facility. There were no borrowings outstanding under the receivables facility as of December 31, 2013.
Under the receivables facility, we pay variable interest rates plus a margin on the outstanding amounts invested by the Purchasers. The variable rates are based on (i) commercial paper rates, (ii) the London InterBank Offered Rate ("LIBOR"), or (iii) base rates, and are payable monthly in arrears. Commercial paper rates will be the applicable variable rate unless conduit investors are not available to invest in the receivables at commercial paper rates. In such case, financial institutions will invest at the LIBOR rate or at base rates. We also pay a commitment fee on the excess of the investment maximum over the average daily outstanding investment, payable monthly in arrears. As of September 30, 2014, the interest rate under the receivables facility was based on commercial paper rates and was 0.92%. The outstanding balance of $80 million as of September 30, 2014 was classified as long-term on the Unaudited Condensed Consolidated Balance Sheets because we have the ability and intent to refinance these borrowings on a long-term basis.

Note 5.
Derivative Instruments and Hedging Activities
We are exposed to market risks, including the effect of changes in interest rates, foreign currency exchange rates and commodity prices. Under our current policies, we use derivatives to manage our exposure to variable interest rates on our senior secured debt, changing foreign exchange rates for certain foreign currency denominated transactions and changes in metals prices. We do not hold or issue derivatives for trading purposes.
Cash Flow Hedges
At September 30, 2014, we had interest rate swap agreements in place to hedge a portion of the variable interest rate risk on our variable rate borrowings under our Credit Agreement, with the objective of minimizing the impact of interest rate fluctuations and stabilizing cash flows. Under the terms of the interest rate swap agreements, we pay the fixed interest rate and receive payment at a variable rate of interest based on LIBOR or the Canadian Dealer Offered Rate (“CDOR”) for the respective currency of each interest rate swap agreement’s notional amount. The effective portion of changes in the fair value of the interest rate swap agreements is recorded in Accumulated Other Comprehensive Income (Loss) and is reclassified to interest expense when the underlying interest payment has an impact on earnings. The ineffective portion of changes in the fair value of the interest rate swap agreements is reported in interest expense. Our interest rate swap contracts have maturity dates ranging from 2015 through 2016.
From time to time, we may hold foreign currency forward contracts related to certain foreign currency denominated intercompany transactions, with the objective of minimizing the impact of changing exchange rates on these future cash flows, as well as minimizing the impact of fluctuating exchange rates on our results of operations through the respective dates of settlement. Under the terms of the foreign currency forward contracts, we will sell the foreign currency in exchange for U.S. dollars at a fixed rate on the maturity dates of the contracts. The effective portion of the changes in fair value of the foreign currency forward contracts is recorded in Accumulated Other Comprehensive Income (Loss) and reclassified to other income (expense) when the underlying transaction has an impact on earnings. In the nine months ended September 30, 2014, we settled these foreign currency forward contracts through payments to the counterparties totaling $20.0 million. At that time, we also settled the underlying intercompany debt transactions.

12





The following table summarizes the notional amounts and fair values of our designated cash flow hedges as of September 30, 2014 and December 31, 2013 (in thousands):
 
 
Notional Amount
 
Fair Value at September 30, 2014 (USD)
 
Fair Value at December 31, 2013 (USD)
 
 
September 30, 2014
 
December 31, 2013
 
Other Noncurrent Liabilities
 
Other Accrued Expenses
 
Other Noncurrent Liabilities
Interest rate swap agreements
 
 
 
 
 
 
USD denominated
 
$
420,000

 
$
420,000

 
$
5,128

 
$

 
$
8,099

GBP denominated
 
£
50,000

 
£
50,000

 
396

 

 
345

CAD denominated
 
C$
25,000

 
C$
25,000

 
32

 

 
26

Foreign currency forward contracts
 
 
 
 
 
 
EUR denominated
 

 
149,976

 

 
11,632

 

GBP denominated
 
£

 
£
70,000

 

 
10,186

 

Total cash flow hedges
 
$
5,556

 
$
21,818

 
$
8,470

 
While our derivative instruments executed with the same counterparty are subject to master netting arrangements, we present our cash flow hedge derivative instruments on a gross basis in our Unaudited Condensed Consolidated Balance Sheets. The impact of netting the fair values of these contracts would not have a material effect on our Unaudited Condensed Consolidated Balance Sheets at September 30, 2014 or December 31, 2013.
The activity related to our cash flow hedges is included in Note 12, "Accumulated Other Comprehensive Income (Loss)." Ineffectiveness related to our cash flow hedges was immaterial to our results of operations during the three and nine months ended September 30, 2014 and September 30, 2013. We do not expect future ineffectiveness related to our cash flow hedges to have a material impact on our results of operations.
As of September 30, 2014, we estimate that $3.6 million of derivative losses (net of tax) included in Accumulated Other Comprehensive Income will be reclassified into our consolidated statements of income within the next 12 months.
Other Derivative Instruments
We hold other short-term derivative instruments, including foreign currency forward contracts to manage our exposure to variability related to inventory purchases and intercompany financing transactions denominated in a non-functional currency, as well as commodity forward contracts to manage our exposure to fluctuations in metals prices. We have elected not to apply hedge accounting for these transactions, and therefore the contracts are adjusted to fair value through our results of operations as of each balance sheet date, which could result in volatility in our earnings. The notional amount and fair value of these contracts at September 30, 2014 and December 31, 2013, along with the effect on our results of operations during each of the nine month periods ended September 30, 2014 and September 30, 2013, were immaterial.

Note 6.
Fair Value Measurements
Financial Assets and Liabilities Measured at Fair Value
We use the market and income approaches to value our financial assets and liabilities, and during the nine months ended September 30, 2014, there were no significant changes in valuation techniques or inputs related to the financial assets or liabilities that we have historically recorded at 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.

13





The following tables present information about our financial assets and liabilities measured at fair value on a recurring basis and indicate the fair value hierarchy of the valuation inputs we utilized to determine such fair value as of September 30, 2014 and December 31, 2013 (in thousands):
 
Balance as of September 30, 2014
 
Fair Value Measurements as of September 30, 2014
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
Cash surrender value of life insurance policies
$
26,438

 
$

 
$
26,438

 
$

Total Assets
$
26,438

 
$

 
$
26,438

 
$

Liabilities:
 
 
 
 
 
 
 
Contingent consideration liabilities
$
7,301

 
$

 
$

 
$
7,301

Deferred compensation liabilities
25,834

 

 
25,834

 

Interest rate swaps
5,556

 

 
5,556

 

Total Liabilities
$
38,691

 
$

 
$
31,390

 
$
7,301

 
Balance as of December 31, 2013
 
Fair Value Measurements as of December 31, 2013
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
Cash surrender value of life insurance policies
$
25,745

 
$

 
$
25,745

 
$

Total Assets
$
25,745

 
$

 
$
25,745

 
$

Liabilities:
 
 
 
 
 
 
 
Contingent consideration liabilities
$
55,653

 
$

 
$

 
$
55,653

Deferred compensation liabilities
25,232

 

 
25,232

 

Foreign currency forward contracts
21,818

 

 
21,818

 

Interest rate swaps
8,470

 

 
8,470

 

Total Liabilities
$
111,173

 
$

 
$
55,520

 
$
55,653


The cash surrender value of life insurance policies and deferred compensation liabilities are included in Other Assets and Other Noncurrent Liabilities, respectively, on our Unaudited Condensed Consolidated Balance Sheets. The contingent consideration liabilities are classified as a separate line item in current liabilities and within Other Noncurrent Liabilities on our Unaudited Condensed Consolidated Balance Sheets based on the expected timing of the related payments. The balance sheet classification of the interest rate swaps and foreign currency forward contracts is presented in Note 5, "Derivative Instruments and Hedging Activities."
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 our derivative instruments 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 current and forward interest rates and current and forward foreign exchange rates.
Our contingent consideration liabilities are related to our business acquisitions as further described in Note 8, "Business Combinations." Under the terms of the contingent consideration agreements, payments may be made at specified future dates depending on the performance of the acquired business subsequent to the acquisition. The liabilities for these payments are classified as Level 3 liabilities because the related fair value measurement, which is determined using an income approach, includes significant inputs not observable in the market. These unobservable inputs include internally-developed assumptions of the probabilities of achieving specified targets, which are used to determine the resulting cash flows, and the applicable discount rate. Our Level 3 fair value measurements are established and updated quarterly by our corporate accounting department using current information about these key assumptions, with the input and oversight of our operational and executive management teams. We evaluate the performance of the business during the period compared to our previous expectations, along with any changes to our future projections, and update the estimated cash flows accordingly. In addition, we consider changes to our cost of capital and changes to the probability of achieving the earnout payment targets when updating our discount rate on a quarterly basis.

14





The significant unobservable inputs used in the fair value measurements of our Level 3 contingent consideration liabilities were as follows:
 
September 30,
 
December 31,
 
2014
 
2013
Unobservable Input
(Weighted Average)
Probability of achieving payout targets
78.7
%
 
70.6
%
Discount rate
7.5
%
 
6.5
%
A decrease in the assessed probabilities of achieving the targets or an increase in the discount rate, in isolation, would result in a lower fair value measurement. Changes in the values of the liabilities are recorded in Change in Fair Value of Contingent Consideration Liabilities within Other Expense (Income) on our Unaudited Condensed Consolidated Statements of Income.
Changes in the fair value of our contingent consideration obligations are as follows (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Beginning Balance
$
8,762

 
$
49,473

 
$
55,653

 
$
90,009

Contingent consideration liabilities recorded for business acquisitions
(1,203
)
 
1,204

 
5,854

 
3,854

Payments

 

 
(52,305
)
 
(38,349
)
Increase (decrease) in fair value included in earnings
12

 
712

 
(2,000
)
 
1,765

Exchange rate effects
(270
)
 
3,096

 
99

 
(2,794
)
Ending Balance
$
7,301

 
$
54,485

 
$
7,301

 
$
54,485

The purchase price for our 2011 acquisition of Euro Car Parts Holdings Limited included contingent payments depending on the achievement of certain annual performance targets in 2012 and 2013. The performance target for each of the measurement periods was exceeded, and therefore, we settled the liabilities related to the 2012 and 2013 performance periods for the maximum amounts of £25 million and £30 million, respectively. During April 2014, we settled the liability for the 2013 performance period through a cash payment of $44.8 million (£26.9 million) and the issuance of notes for $5.1 million (£3.1 million). The liability for the 2012 performance period was settled during the three months ended March 31, 2013 through a cash payment of $33.9 million (£22.4 million) and the issuance of notes for $3.9 million (£2.6 million). During the three months ended September 30, 2014, we finalized our acquisition-date estimates of the likelihood of payment for certain of our contingent payment arrangements, which resulted in a reduction to our contingent consideration liabilities of $1.2 million, with the offset recorded as a reduction of goodwill.
Of the amounts included in earnings for the nine months ended September 30, 2014, $0.2 million of gains were related to contingent consideration obligations outstanding as of September 30, 2014; all of the amounts included in earnings for the three months ended September 30, 2014 related to contingent consideration obligations outstanding as of September 30, 2014. Substantially all of the gains included in earnings during the three and nine months ended September 30, 2013 related to contingent consideration obligations that were settled by September 30, 2014. The changes in the fair value of contingent consideration obligations included in earnings during the respective periods in 2014 and 2013 reflect the quarterly reassessment of each obligation's fair value, including an analysis of the significant inputs used in the valuation, as well as the accretion of the present value discount.
Financial Assets and Liabilities Not Measured at Fair Value
Our debt is reflected on the Unaudited Condensed Consolidated Balance Sheets at cost. Based on market conditions as of September 30, 2014 and December 31, 2013, the fair value of our credit agreement borrowings reasonably approximated the carrying value of $1.1 billion and $673 million, respectively. In addition, based on market conditions, the fair value of the outstanding borrowings under the receivables facility reasonably approximated the carrying value of $80 million at September 30, 2014; we did not have any borrowings outstanding under the receivables facility as of December 31, 2013. As of September 30, 2014, the fair value of our senior notes was approximately $581 million compared to a carrying value of $600 million.
The fair value measurements of the borrowings under our credit agreement and receivables facility are classified as Level 2 within the fair value hierarchy since they are determined based upon significant inputs observable in the market,

15





including interest rates on recent financing transactions with similar terms and maturities. We estimated the fair values by calculating the upfront cash payment a market participant would require to assume these obligations. The fair value of our senior notes is classified as Level 1 within the fair value hierarchy since it is determined based upon observable market inputs including quoted market prices in an active market.

Note 7.
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, 2014 are as follows (in thousands):
Three months ending December 31, 2014
$
35,353

Years ending December 31:
 
2015
134,572

2016
114,205

2017
95,568

2018
78,838

2019
63,638

Thereafter
251,142

Future Minimum Lease Payments
$
773,316

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.

Note 8.
Business Combinations
On January 3, 2014, we completed our acquisition of Keystone Specialty, which is a leading distributor and marketer of specialty aftermarket equipment and accessories in North America serving the following six product segments: truck and off-road; speed and performance; recreational vehicle; towing; wheels, tires and performance handling; and miscellaneous accessories. Total acquisition date fair value of the consideration for our Keystone Specialty acquisition was $471.1 million, composed of $427.1 million of cash (net of cash acquired), $31.5 million of notes payable and $12.6 million of other purchase price obligations (non-interest bearing). We recorded $234.0 million of goodwill related to our acquisition of Keystone Specialty, which we do not expect to be deductible for income tax purposes. In the period between January 3, 2014 and September 30, 2014, Keystone Specialty generated approximately $595.2 million of revenue and $24.4 million of net income.
In addition to our acquisition of Keystone Specialty, we made 19 acquisitions during the nine months ended September 30, 2014, including 9 wholesale businesses in North America, 8 wholesale businesses in Europe, and 2 self service retail operations. Our European acquisitions included seven aftermarket parts distribution businesses in the Netherlands, five of which were customers of and distributors for our Netherlands subsidiary, Sator Beheer B.V. ("Sator"). Our European acquisitions were completed with the objective of expanding our distribution network in the Netherlands; our other acquisitions completed during the nine months ended September 30, 2014 enabled us to expand into new product lines and enter new markets. Total acquisition date fair value of the consideration for these additional acquisitions was $233.6 million, composed of $210.7 million of cash (net of cash acquired), $11.8 million of notes payable, $0.3 million of other purchase price obligations (non-interest bearing), $5.9 million for the estimated value of contingent payments to former owners (with maximum potential payments totaling $8.3 million), and $4.9 million of pre-existing balances between us and the acquired entities considered to be effectively settled as a result of the acquisitions. During the nine months ended September 30, 2014, we recorded $118.9 million of goodwill related to these acquisitions and immaterial adjustments to preliminary purchase price allocations related to certain of our 2013 acquisitions. We expect $32.2 million of the $118.9 million of goodwill recorded to be deductible for income tax purposes. In the period between the acquisition dates and September 30, 2014, these acquisitions generated revenue of $142.7 million and a net loss of $1.5 million.

16





In October 2014, we completed the acquisition of two businesses in our Specialty segment: a supplier of replacement parts, supplies and accessories for recreational vehicles, and a specialty aftermarket vehicle equipment and accessories distributor. These acquisitions allowed us to expand our market share in these product categories. The preliminary aggregate purchase price for these acquisitions was approximately $112 million, net of cash acquired. We are in the process of completing the purchase accounting for our October 2014 acquisitions, and as a result, we are unable to disclose the amounts recognized for each major class of assets acquired and liabilities assumed, or the pro forma effect of the acquisitions on our results of operations.
On May 1, 2013, we acquired the shares of Sator, a vehicle mechanical aftermarket parts distribution company based in the Netherlands, with operations in the Netherlands, Belgium and Northern France. With the acquisition of Sator, we expanded our geographic presence in the European vehicle mechanical aftermarket products market into continental Europe to complement our existing U.K. operations. Total acquisition date fair value of the consideration for the acquisition of Sator was €209.8 million ($272.8 million) of cash, net of cash acquired. We recorded $142.7 million of goodwill related to our acquisition of Sator, which we do not expect will be deductible for income tax purposes.
In addition to our acquisition of Sator, we made 19 acquisitions during 2013, including 10 wholesale businesses in North America, 7 wholesale businesses in Europe and 2 self service retail operations. Our European acquisitions included five automotive paint distribution businesses in the U.K., which enabled us to expand our collision product offerings. Our other acquisitions completed during 2013 enabled us to expand into new product lines and enter new markets. Total acquisition date fair value of the consideration for these additional 2013 acquisitions was $146.1 million, composed of $134.6 million of cash (net of cash acquired), $7.5 million of notes payable, $0.2 million of other purchase price obligations (non-interest bearing) and $3.9 million for the estimated value of contingent payments to former owners (with maximum potential payments totaling $5.0 million). During the year ended December 31, 2013, we recorded $92.7 million of goodwill related to these acquisitions and immaterial adjustments to preliminary purchase price allocations related to certain of our 2012 acquisitions. We expect $18.3 million of the $92.7 million of goodwill recorded to be deductible for income tax purposes.
Our acquisitions are accounted for under the purchase method of accounting and are included in our unaudited condensed consolidated financial statements from the dates of acquisition. The purchase prices were allocated to the net assets acquired based upon estimated fair market values at the dates of acquisition. The purchase price allocations for the acquisitions made during the nine months ended September 30, 2014 and the last three months of 2013 are preliminary as we are in the process of determining the following: 1) valuation amounts for certain receivables, inventories and fixed assets acquired; 2) valuation amounts for certain intangible assets acquired; 3) the acquisition date fair value of certain liabilities assumed; and 4) the final estimation of the tax basis of the entities acquired. We have recorded preliminary estimates for certain of the items noted above and will record adjustments, if any, to the preliminary amounts upon finalization of the valuations.

17





The preliminary purchase price allocations for the acquisitions completed during the nine months ended September 30, 2014 and the year ended December 31, 2013 are as follows (in thousands):
 
 
Nine Months Ended
 
Year Ended
 
September 30, 2014
 
December 31, 2013
 
Keystone Specialty
 
Other Acquisitions
 
Total
 
Sator
 
Other Acquisitions
 
Total
Receivables
$
48,473

 
$
57,191

 
$
105,664

 
$
61,639

 
$
38,685

 
$
100,324

Receivable reserves
(4,403
)
 
(2,817
)
 
(7,220
)
 
(8,563
)
 
(3,246
)
 
(11,809
)
Inventory
151,013

 
79,260

 
230,273

 
71,784

 
26,455

 
98,239

Income taxes receivable
13,972

 

 
13,972

 

 

 

Prepaid expenses and other current assets
8,339

 
3,266

 
11,605

 
7,184

 
1,933

 
9,117

Property and equipment
38,080

 
16,389

 
54,469

 
19,484

 
14,015

 
33,499

Goodwill
233,998

 
118,940

 
352,938

 
142,721

 
92,726

 
235,447

Other intangibles
70,830

 
25,897

 
96,727

 
45,293

 
12,353

 
57,646

Other assets
7,805

 
5,623

 
13,428

 
2,049

 
1,251

 
3,300

Deferred income taxes
(17,418
)
 
429

 
(16,989
)
 
(14,100
)
 
(564
)
 
(14,664
)
Current liabilities assumed
(65,439
)
 
(34,880
)
 
(100,319
)
 
(49,593
)
 
(36,799
)
 
(86,392
)
Debt assumed

 
(26,425
)
 
(26,425
)
 

 
(664
)
 
(664
)
Other noncurrent liabilities assumed
(14,147
)
 
(9,282
)
 
(23,429
)
 
(5,074
)
 

 
(5,074
)
Contingent consideration liabilities

 
(5,854
)
 
(5,854
)
 

 
(3,854
)
 
(3,854
)
Other purchase price obligations
(12,553
)
 
(313
)
 
(12,866
)
 

 
(214
)
 
(214
)
Notes issued
(31,500
)
 
(11,842
)
 
(43,342
)
 

 
(7,482
)
 
(7,482
)
Settlement of pre-existing balances

 
(4,922
)
 
(4,922
)
 

 

 

Cash used in acquisitions, net of cash acquired
$
427,050

 
$
210,660

 
$
637,710

 
$
272,824

 
$
134,595

 
$
407,419

The primary reason for our acquisitions made during the nine months ended September 30, 2014 and the year ended December 31, 2013 was to create economic value for our stockholders by enhancing our position as a leading source for alternative collision and mechanical repair products and expanding into other product lines and businesses that may benefit from our operating strengths. Our acquisition of Keystone Specialty allows us to enter into new product lines and increase the size of our addressable market. In addition, we believe that the acquisition creates potential cross-selling opportunities and logistics and administrative cost synergies, which contributed to the goodwill recorded on the Keystone Specialty acquisition. Our other acquisitions enabled us to further expand our market presence, including continental Europe through the Sator acquisition, as well as to widen our product offerings such as paint and related equipment in the U.K. We believe that our Sator acquisition will allow for synergies within our European operations, most notably in procurement, warehousing and product management. These projected synergies contributed to the goodwill recorded on the Sator acquisition.
When we identify potential acquisitions, we attempt to target companies with a leading market share, an experienced management team and a workforce that provide a fit with our existing operations and strong cash flows. For certain of our acquisitions, we have identified cost savings and synergies as a result of integrating the company with our existing business that provide additional value to the combined entity. In many cases, acquiring companies with these characteristics can result in purchase prices that include a significant amount of goodwill.


18







The following pro forma summary presents the effect of the businesses acquired during the nine months ended September 30, 2014 as though they had been acquired as of January 1, 2013 and the businesses acquired during the year ended December 31, 2013 as though they had been acquired as of January 1, 2012. The pro forma adjustments are based upon unaudited financial information of the acquired entities (in thousands, except per share data):

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Revenue, as reported
$
1,721,024

 
$
1,298,094

 
$
5,055,933

 
$
3,745,839

Revenue of purchased businesses for the period prior to acquisition:
 
 
 
 
 
 
 
Keystone Specialty

 
177,324

 
3,443

 
540,826

Sator

 

 

 
126,309

Other acquisitions
4,815

 
101,971

 
116,326

 
371,312

Pro forma revenue
$
1,725,839

 
$
1,577,389

 
$
5,175,702

 
$
4,784,286

 
 
 
 
 
 
 
 
Net income, as reported
$
91,515

 
$
73,445

 
$
301,050

 
$
233,759

Net income of purchased businesses for the period prior to acquisition, including pro forma purchase accounting adjustments:
 
 
 
 
 
 
 
Keystone Specialty
180

 
7,142

 
514

 
24,769

Sator

 

 

 
5,712

Other acquisitions
3,623

 
5,059

 
8,053

 
11,505

Pro forma net income
$
95,318

 
$
85,646

 
$
309,617

 
$
275,745

 
 
 
 
 
 
 
 
Earnings per share-basic, as reported
$
0.30

 
$
0.24

 
$
1.00

 
$
0.78

Effect of purchased businesses for the period prior to acquisition:
 
 
 
 
 
 
 
Keystone Specialty
0.00

 
0.02

 
0.00

 
0.08

Sator

 

 

 
0.02

Other acquisitions
0.01

 
0.02

 
0.03

 
0.04

Pro forma earnings per share-basic (a) 
$
0.31

 
$
0.29

 
$
1.03

 
$
0.92

 
 
 
 
 
 
 
 
Earnings per share-diluted, as reported
$
0.30

 
$
0.24

 
$
0.98

 
$
0.77

Effect of purchased businesses for the period prior to acquisition:
 
 
 
 
 
 
 
Keystone Specialty
0.00

 
0.02

 
0.00

 
0.08

Sator

 

 

 
0.02

Other acquisitions
0.01

 
0.02

 
0.03

 
0.04

Pro forma earnings per share-diluted (a) 
$
0.31

 
$
0.28

 
$
1.01

 
$
0.91


(a) The sum of the individual earnings per share amounts may not equal the total due to rounding.
Unaudited pro forma supplemental information is based upon accounting estimates and judgments that we believe are reasonable. The unaudited pro forma supplemental information includes the effect of purchase accounting adjustments, such as the adjustment of inventory acquired to net realizable value, adjustments to depreciation on acquired property and equipment, adjustments to rent expense for above or below market leases, adjustments to amortization on acquired intangible assets, adjustments to interest expense, and the related tax effects. The pro forma impact of our other acquisitions includes an adjustment for intercompany sales between Sator and the five Netherlands distributors that would have been reflected as intercompany transactions if the acquisitions had occurred on January 1, 2013. Our cost of sales in the initial months after the acquisitions reflects the increased valuation of acquired inventory, which has the impact of temporarily reducing our gross margin. Moving this negative gross margin impact to the nine months ended September 30, 2013 for our pro forma disclosure

19





has the effect of increasing our pro forma net income during the three and nine months ended September 30, 2014. Additionally, the pro forma impact of our acquisitions reflects the elimination of acquisition related expenses totaling $0.5 million and $2.3 million for the three and nine months ended September 30, 2014, respectively, primarily related to our May 2014 acquisitions of five aftermarket parts distribution businesses in the Netherlands. The pro forma impact of our acquisition related expenses for the three and nine months ended September 30, 2013 totaled $2.0 million and $6.0 million, respectively, primarily related to our May 2013 acquisition of Sator and our August 2013 acquisition of five U.K.-based paint distribution businesses. Refer to Note 9, "Restructuring and Acquisition Related Expenses," for further information on our acquisition related expenses. These pro forma results are not necessarily indicative of what would have occurred if the acquisitions had been in effect for the periods presented or of future results.

Note 9.
Restructuring and Acquisition Related Expenses
Acquisition Related Expenses
Acquisition related expenses, which include external costs such as legal, accounting and advisory fees, totaled $1.3 million and $3.2 million for the three and nine months ended September 30, 2014, respectively. These expenses were primarily related to our 2014 acquisitions of seven aftermarket parts distribution businesses in the Netherlands, as well as other potential acquisitions. Expenses incurred during the three and nine months ended September 30, 2013 totaled $2.0 million and $6.0 million, respectively. Of these amounts, we incurred $1.4 million in the three and nine months ended September 30, 2013 related to our August 2013 acquisitions of five U.K.-based paint distribution businesses. Expenses for the nine months ended September 30, 2013 also included $3.6 million related to our May 2013 acquisition of Sator. These costs are expensed as incurred.
Acquisition Integration Plans
During the three and nine months ended September 30, 2014, we incurred $0.4 million and $5.8 million, respectively, of restructuring expenses as a result of the integration of our acquisition of Keystone Specialty into our existing business. These integration activities included the closure of duplicate facilities, termination of employees in connection with the consolidation of overlapping facilities with our existing business, and moving expenses. Future expenses to complete our integration plan are not expected to be material.
We incurred other restructuring costs related to our acquisitions during the three and nine months ended September 30, 2014 totaling $0.3 million and $2.2 million, respectively. Restructuring costs incurred during the three and nine months ended September 30, 2013 totaled $0.2 million and $1.4 million, respectively. These costs are a result of activities to integrate our acquisitions into our existing business, including the closure of duplicate facilities, termination of employees in connection with the consolidation of overlapping facilities with our existing business, moving expenses, and other third party services directly related to our acquisitions.
We expect to incur additional integration expenses related to the integration of certain of our acquisitions into our existing operations in the fourth quarter of 2014 and 2015. These integration activities are expected to include the closure of duplicate facilities, termination of employees in connection with the consolidation of overlapping facilities with our existing business, and moving expenses. Future expenses to complete these integration plans are not expected to be material.
European Restructuring Plan
In the third quarter of 2014, we initiated restructuring activities to eliminate overlapping positions within certain of our European operations. As a result of these restructuring activities, we incurred $1.6 million of expenses during the three months ended September 30, 2014, primarily for severance costs to terminated employees. While we do not expect material incremental expenses for this portion of the integration plan, we may incur additional expenses in the future as we continue to rationalize our European operations.


20





Note 10.
Earnings Per Share
The following chart sets forth the computation of earnings per share (in thousands, except per share amounts):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Net Income
$
91,515

 
$
73,445

 
$
301,050

 
$
233,759

Denominator for basic earnings per share—Weighted-average shares outstanding
302,724

 
300,223

 
302,058

 
299,213

Effect of dilutive securities:
 
 
 
 
 
 
 
RSUs
658

 
883

 
804

 
775

Stock options
2,817

 
3,564

 
2,988

 
3,765

Restricted stock
7

 
15

 
7

 
18

Denominator for diluted earnings per share—Adjusted weighted-average shares outstanding
306,206

 
304,685

 
305,857

 
303,771

Earnings per share, basic
$
0.30

 
$
0.24

 
$
1.00

 
$
0.78

Earnings per share, diluted
$
0.30

 
$
0.24

 
$
0.98

 
$
0.77

The following table sets forth the number of employee stock-based compensation awards outstanding but not included in the computation of diluted earnings per share because their effect would have been antidilutive for the three and nine months ended September 30, 2014 and 2013 (in thousands).
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Antidilutive securities:
 
 
 
 
 
 
 
RSUs
389

 

 
265

 

Stock Options
115

 

 
120

 


Note 11.
Income Taxes
At the end of each interim period, we estimate our annual effective tax rate and apply that rate to our interim earnings. We also record the tax impact of certain unusual or infrequently occurring items, including changes in judgment about valuation allowances and the effects of changes in tax laws or rates, in the interim period in which they occur.
The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment including, but not limited to, the expected operating income for the year, projections of the proportion of income earned and taxed in state and foreign jurisdictions, permanent and temporary differences between book and taxable income, and the likelihood of recovering deferred tax assets generated in the current year. The accounting estimates used to compute the provision for income taxes may change as new events occur, additional information is obtained or as the tax environment changes.
Our effective income tax rate for the nine months ended September 30, 2014 was 34.0% compared with 34.6% for the comparable prior year period. In 2014, we expect a larger proportion of our annual pretax income to be generated in lower tax rate jurisdictions as a result of our expanding international operations. The effective income tax rate during the nine months ended September 30, 2013 reflects favorable discrete tax adjustments of $2.6 million. These favorable discrete tax adjustments included $1.6 million related to the revaluation of our net U.K. deferred tax liabilities as a result of reductions in the U.K. corporate income tax rate. In addition, we recorded a $0.9 million favorable deferred tax adjustment during the nine months ended September 30, 2013 resulting from changes in state tax legislation.
    

21





Note 12.
Accumulated Other Comprehensive Income (Loss)
The components of Accumulated Other Comprehensive Income (Loss) are as follows (in thousands):

 
 
Three Months Ended
 
Three Months Ended
 
 
 
September 30, 2014
 
September 30, 2013
 
 
 
Foreign
Currency
Translation
 
Unrealized Gain (Loss)
on Cash Flow Hedges
 
Change in Unrealized Gain on Pension Plan
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Foreign
Currency
Translation
 
Unrealized Gain (Loss)
on Cash Flow Hedges
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Beginning balance
 
$
40,222

 
$
(4,346
)
 
$
634

 
$
36,510

 
$
(11,334
)
 
$
(6,730
)
 
$
(18,064
)
 
Pretax income (loss)
 
(39,329
)
 
(186
)
 

 
(39,515
)
 
28,514

 
(15,315
)
 
13,199

 
Income tax effect
 

 
(7
)
 

 
(7
)
 

 
5,647

 
5,647

 
Reclassification of unrealized loss (gain)
 

 
1,554

 
(39
)
 
1,515

 

 
15,956

 
15,956

 
Reclassification of deferred income taxes
 

 
(544
)
 
9

 
(535
)
 

 
(5,849
)
 
(5,849
)
 
Hedge ineffectiveness
 

 

 

 

 

 
293

 
293

 
Income tax effect
 

 

 

 

 

 
(107
)
 
(107
)
 
Ending balance
 
$
893

 
$
(3,529
)
 
$
604

 
$
(2,032
)
 
$
17,180

 
$
(6,105
)
 
$
11,075

 

 
 
Nine Months Ended
 
Nine Months Ended
 
 
 
September 30, 2014
 
September 30, 2013
 
 
 
Foreign
Currency
Translation
 
Unrealized Gain (Loss)
on Cash Flow Hedges
 
Change in Unrealized Gain on Pension Plan
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Foreign
Currency
Translation
 
Unrealized Gain (Loss)
on Cash Flow Hedges
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Beginning balance
 
$
24,906

 
$
(5,596
)
 
$
701

 
$
20,011

 
$
10,850

 
$
(10,091
)
 
$
759

 
Pretax income (loss)
 
(24,013
)
 
(362
)
 

 
(24,375
)
 
6,330

 
(14,170
)
 
(7,840
)
 
Income tax effect
 

 
39

 

 
39

 

 
5,305

 
5,305

 
Reclassification of unrealized loss (gain)
 

 
3,647

 
(129
)
 
3,518

 

 
19,771

 
19,771

 
Reclassification of deferred income taxes
 

 
(1,257
)
 
32

 
(1,225
)
 

 
(7,211
)
 
(7,211
)
 
Hedge ineffectiveness
 

 

 

 

 

 
460

 
460

 
Income tax effect
 

 

 

 

 

 
(169
)
 
(169
)
 
Ending balance
 
$
893

 
$
(3,529
)
 
$
604

 
$
(2,032
)
 
$
17,180

 
$
(6,105
)
 
$
11,075

 

Unrealized losses on our interest rate swap contracts totaling $1.6 million and $4.6 million were reclassified to interest expense in our Unaudited Condensed Consolidated Statements of Income during the three and nine months ended September 30, 2014, respectively. During the three and nine months ended September 30, 2013, unrealized losses of $1.5 million and $4.7 million, respectively, related to our interest rate swaps were reclassified to interest expense. The remaining reclassification of unrealized gains and losses during these periods related to our foreign currency forward contracts and were recorded to other income in our Unaudited Condensed Consolidated Statements of Income. These gains offset the remeasurement of certain of our intercompany balances as discussed in Note 5, "Derivative Instruments and Hedging Activities." The deferred income taxes related to our cash flow hedges were reclassified from Accumulated Other Comprehensive Income to income tax expense.

Note 13.
Segment and Geographic Information
We have four operating segments: Wholesale – North America; Wholesale – Europe; Self Service; and Specialty. Our Specialty operating segment was formed with our January 3, 2014 acquisition of Keystone Specialty, as discussed in Note 8, "Business Combinations." Our Wholesale – North America and Self Service operating segments are aggregated into one

22





reportable segment, North America, because they possess similar economic characteristics and have common products and services, customers, and methods of distribution. Therefore, we present three reportable segments: North America, Europe and Specialty.
The following tables present our financial performance by reportable segment for the periods indicated (in thousands):
 
North America
 
Europe
 
Specialty
 
Eliminations
 
Consolidated
Three Months Ended September 30, 2014
 
 
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
 
 
Third Party
$
1,024,835

 
$
495,776

 
$
200,413

 
$

 
$
1,721,024

Intersegment
132

 

 
594

 
(726
)
 

Total segment revenue
$
1,024,967

 
$
495,776

 
$
201,007

 
$
(726
)
 
$
1,721,024

Segment EBITDA
$
131,851

 
$
41,726

 
$
17,977

 
$

 
$
191,554

Depreciation and amortization
18,029

 
9,411

 
4,314

 

 
31,754

Three Months Ended September 30, 2013
 
 
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
 
 
Third Party
$
928,307

 
$
369,787

 
$

 
$

 
$