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 June 30, 2008

 

 

 

OR

 

 

 

o

 

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

 

(I.R.S. Employer

incorporation or organization)

 

Identification Number)

 

 

 

120 NORTH LASALLE STREET, SUITE 3300, CHICAGO, IL

 

60602

(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  o

 

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 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 o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a 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  o No  x

 

At July 31, 2008, the registrant had issued and outstanding an aggregate of 135,590,217 shares of Common Stock.

 

 

 



 

PART I

 

FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

LKQ CORPORATION AND SUBSIDIARIES

Unaudited Consolidated Condensed Balance Sheets

(In thousands, except share and per share data)

 

 

 

June 30,

 

December 31,

 

 

 

2008

 

2007

 

Assets

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash and equivalents

 

$

104,062

 

$

74,241

 

Receivables, net

 

137,564

 

125,572

 

Inventory

 

333,476

 

320,238

 

Deferred income taxes

 

21,364

 

18,809

 

Prepaid income taxes

 

 

6,344

 

Prepaid expenses

 

8,586

 

8,088

 

Total Current Assets

 

605,052

 

553,292

 

 

 

 

 

 

 

Property and Equipment, net

 

230,363

 

217,059

 

Intangibles

 

 

 

 

 

Goodwill

 

843,865

 

825,881

 

Other intangibles, net

 

73,237

 

74,951

 

Other Assets

 

27,093

 

21,472

 

Total Assets

 

$

1,779,610

 

$

1,692,655

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Accounts payable

 

$

59,535

 

$

68,871

 

Accrued expenses

 

74,267

 

73,172

 

Income taxes payable

 

11,879

 

 

Deferred revenue

 

6,106

 

4,844

 

Current portion of long-term obligations

 

18,055

 

16,936

 

Total Current Liabilities

 

169,842

 

163,823

 

 

 

 

 

 

 

Long-Term Obligations, Excluding Current Portion

 

629,367

 

641,526

 

Deferred Income Tax Liability

 

31,291

 

25,607

 

Other Noncurrent Liabilities

 

9,982

 

11,922

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

Common stock, $0.01 par value, 500,000,000 shares authorized, 135,513,917 and 134,149,066 shares issued and outstanding at June 30, 2008 and December 31, 2007, respectively

 

1,355

 

1,341

 

Additional paid-in capital

 

729,850

 

705,778

 

Retained earnings

 

203,906

 

142,039

 

Accumulated other comprehensive income

 

4,017

 

619

 

Total Stockholders’ Equity

 

939,128

 

849,777

 

Total Liabilities and Stockholders’ Equity

 

$

1,779,610

 

$

1,692,655

 

 

See notes to unaudited consolidated condensed financial statements.

 

2



 

LKQ CORPORATION AND SUBSIDIARIES

Unaudited Consolidated Condensed Statements of Income

(In thousands, except per share data)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

484,392

 

$

233,278

 

$

976,300

 

$

468,596

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

264,684

 

128,195

 

533,278

 

256,417

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

219,708

 

105,083

 

443,022

 

212,179

 

 

 

 

 

 

 

 

 

 

 

Facility and warehouse expenses

 

43,802

 

24,634

 

88,304

 

50,244

 

 

 

 

 

 

 

 

 

 

 

Distribution expenses

 

45,326

 

22,213

 

90,095

 

44,388

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

61,759

 

28,130

 

125,862

 

56,862

 

 

 

 

 

 

 

 

 

 

 

Restructuring expenses

 

3,149

 

 

4,323

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

7,258

 

3,464

 

14,516

 

6,781

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

58,414

 

26,642

 

119,922

 

53,904

 

 

 

 

 

 

 

 

 

 

 

Other (income) expense:

 

 

 

 

 

 

 

 

 

Interest expense, net

 

8,411

 

2,093

 

18,712

 

3,826

 

Other income, net

 

(451

)

(27

)

(720

)

(675

)

 

 

 

 

 

 

 

 

 

 

Total other expense

 

7,960

 

2,066

 

17,992

 

3,151

 

 

 

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

50,454

 

24,576

 

101,930

 

50,753

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

19,465

 

10,560

 

40,063

 

20,943

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

30,989

 

$

14,016

 

$

61,867

 

$

29,810

 

 

 

 

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.23

 

$

0.13

 

$

0.46

 

$

0.28

 

 

 

 

 

 

 

 

 

 

 

Diluted

 

$

0.22

 

$

0.12

 

$

0.44

 

$

0.27

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

135,287

 

107,046

 

134,922

 

106,841

 

 

 

 

 

 

 

 

 

 

 

Diluted

 

140,301

 

112,494

 

140,035

 

112,247

 

 

See notes to unaudited consolidated condensed financial statements.

 

3



 

LKQ CORPORATION AND SUBSIDIARIES

Unaudited Consolidated Condensed Statements of Cash Flows

(In thousands)

 

 

 

Six Months Ended June 30,

 

 

 

2008

 

2007

 

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

61,867

 

$

29,810

 

Adjustments to reconcile net income to net cash

 

 

 

 

 

provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

15,802

 

7,056

 

Stock-based compensation expense

 

2,715

 

1,760

 

Deferred income taxes

 

1,239

 

1,985

 

Excess tax benefit from exercise of stock options

 

(1,958

)

(2,171

)

Other adjustments

 

1,177

 

(48

)

Changes in operating assets and liabilities, net of effects from purchase transactions:

 

 

 

 

 

Receivables

 

(11,919

)

(4,173

)

Inventory

 

(10,975

)

(27,350

)

Prepaid income taxes/income taxes payable

 

20,166

 

4,917

 

Accounts payable

 

(8,800

)

    (419

)

Other operating assets and liabilities

 

(1,941

)

2,072

 

 

 

 

 

 

 

Net cash provided by operating activities

 

67,373

 

13,439

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Purchases of property and equipment

 

(26,404

)

(18,385

)

Proceeds from disposal of assets

 

217

 

279

 

Cash used in acquisitions

 

(4,418

)

(24,239

)

Purchases of investment securities

 

 

(5,885

)

 

 

 

 

 

 

Net cash used in investing activities

 

(30,605

)

(48,230

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from exercise of stock options

 

1,408

 

1,988

 

Repurchase and retirement of redeemable common stock

 

 

(1,125

)

Excess tax benefit from exercise of stock options

 

1,958

 

2,171

 

Debt issuance costs

 

(219

)

(193

)

Repayments of long-term debt

 

(10,026

)

(3,420

)

Net borrowings under line of credit

 

 

40,193

 

 

 

 

 

 

 

Net cash (used in) provided by financing activities

 

(6,879

)

39,614

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and equivalents

 

(68

)

 

 

 

 

 

 

 

Net increase in cash and equivalents

 

29,821

 

4,823

 

 

 

 

 

 

 

Cash and equivalents, beginning of period

 

74,241

 

4,031

 

 

 

 

 

 

 

Cash and equivalents, end of period

 

$

104,062

 

$

8,854

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Notes issued in connection with business acquisitions

 

$

25

 

$

1,449

 

Stock issued in connection with business acquisitions

 

18,006

 

 

Cash paid for income taxes, net of refunds

 

18,607

 

14,041

 

Cash paid for interest

 

19,799

 

3,651

 

 

See notes to unaudited consolidated condensed financial statements.

 

4



 

LKQ CORPORATION AND SUBSIDIARIES

Unaudited Consolidated Condensed Statements of Stockholders’ Equity and Other Comprehensive Income

(In thousands)

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

Common Stock

 

 

 

 

 

Other

 

Total

 

 

 

Shares

 

 

 

Additional

 

Retained

 

Comprehensive

 

Stockholders’

 

 

 

Issued

 

Amount

 

Paid-In Capital

 

Earnings

 

Income

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE, December 31, 2007

 

134,149

 

$

1,341

 

$

705,778

 

$

142,039

 

$

619

 

$

849,777

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

61,867

 

 

61,867

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on change in fair value of interest rate swap agreements, net of tax of $2,418

 

 

 

 

 

3,688

 

3,688

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation

 

 

 

 

 

(290

)

(290

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total comprehensive income

 

 

 

 

 

 

65,265

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock issued in business acquisition

 

838

 

8

 

17,998

 

 

 

18,006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock issued as director compensation

 

3

 

1

 

60

 

 

 

61

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation expense

 

 

 

2,314

 

 

 

2,314

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Activity related to restricted stock awards

 

190

 

2

 

338

 

 

 

340

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercise of stock options, including related tax benefits of $1,958

 

334

 

3

 

3,362

 

 

 

3,365

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE, June 30, 2008

 

135,514

 

$

1,355

 

$

729,850

 

$

203,906

 

$

4,017

 

$

939,128

 

 

See notes to unaudited consolidated condensed financial statements.

 

5



 

LKQ CORPORATION AND SUBSIDIARIES

Notes to Unaudited Consolidated Condensed Financial Statements

 

Note 1.  Interim Financial Statements

 

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

 

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 report on Form 10-K for the year ended December 31, 2007 filed with the SEC.

 

Note 2.  Financial Statement Information

 

Revenue Recognition

 

Revenue is recognized when products are shipped 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 $8.3 million and $7.5 million at June 30, 2008 and December 31, 2007, respectively.

 

Receivables

 

We have recorded a reserve for uncollectible accounts of approximately $5.0 million and $4.3 million at June 30, 2008 and December 31, 2007, respectively.

 

Inventory

 

Inventory consists of the following (in thousands):

 

 

 

June 30,

 

December 31,

 

 

 

2008

 

2007

 

 

 

 

 

 

 

Salvage products

 

$

130,235

 

$

111,775

 

Aftermarket and refurbished products

 

195,969

 

201,408

 

Core facilities inventory

 

7,272

 

7,055

 

 

 

 

 

 

 

 

 

$

333,476

 

$

320,238

 

 

6



 

Intangibles

 

Intangible assets consist primarily of goodwill (the cost of purchased businesses in excess of the fair value of the net assets acquired), and other specifically identifiable intangible assets such as the tradename acquired in connection with our acquisition of Keystone Automotive Industries, Inc. (“Keystone”) during the fourth quarter of 2007, covenants not to compete and trademarks.

 

The change in the carrying amount of goodwill during the six months ended June 30, 2008 is as follows (in thousands):

 

Balance as of December 31, 2007

 

$

825,881

 

Adjustment of previously recorded goodwill

 

1,572

 

Exchange rate effects

 

(611

)

Business acquisitions

 

17,023

 

 

 

 

 

Balance as of June 30, 2008

 

$

843,865

 

 

We adjusted previously recorded goodwill primarily due to Keystone inventory valuation adjustments of approximately $1.0 million, other purchase price adjustments related to the Keystone acquisition of $0.8 million and final inventory valuation adjustments of approximately ($0.2) million for our Canadian businesses acquired during 2007.

 

Other intangible assets totaled approximately $73.2 million and $75.0 million, net of accumulated amortization of $3.0 million and $1.0 million, at June 30, 2008 and December 31, 2007, respectively.  Amortization expense was approximately $2.1 million during the six months ended June 30, 2008. The amount for the corresponding 2007 period was immaterial. Estimated annual amortization expense is approximately $4.0 million for each of the years 2008 through 2012.

 

Depreciation Expense

 

Included in Cost of Goods Sold 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. Our warranty activity during the first six months of 2008 was as follows (in thousands):

 

Balance as of January 1, 2008

 

$

580

 

Warranty expense

 

1,839

 

Warranty claims

 

(1,869

)

Balance as of June 30, 2008

 

$

550

 

 

We also sell separately priced extended warranty contracts for certain mechanical products. The expense related to extended warranty claims is recognized when the claim is made.

 

7



 

Stock-Based Compensation

 

We account for stock-based compensation in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”).

 

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 stock option grants:

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2008

 

2007

 

 

 

 

 

 

 

Expected life (in years)

 

6.4

 

6.4

 

Risk-free interest rate

 

3.27

%

4.40

%

Volatility

 

39.3

%

40.0

%

Dividend yield

 

0

%

0

%

Weighted average fair value of options granted

 

$

8.54

 

$

4.77

 

 

Estimated forfeitures – When estimating forfeitures, we consider voluntary and involuntary termination behavior as well as analysis of historical forfeitures.  For options granted in 2008, a forfeiture rate of 8.0% has been used for valuing employee option grants, while a forfeiture rate of 0% has been used for valuing executive officer option grants.

 

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

 

 

 

Three Months ended June 30,

 

Six Months ended June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

Stock options

 

$

1,200

 

$

563

 

$

2,314

 

$

1,712

 

Restricted stock

 

181

 

 

340

 

 

Stock issued in lieu of quarterly cash compensation for non-employee directors

 

30

 

30

 

61

 

48

 

 

 

 

 

 

 

 

 

 

 

Total stock-based compensation expense

 

$

1,411

 

$

593

 

$

2,715

 

$

1,760

 

 

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
June 30,

 

Six months ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

$

4

 

$

3

 

$

7

 

$

6

 

Facility and warehouse expenses

 

514

 

230

 

987

 

468

 

Selling, general and administrative expenses

 

893

 

360

 

1,721

 

1,286

 

 

 

 

 

 

 

 

 

 

 

 

 

1,411

 

593

 

2,715

 

1,760

 

Income tax benefit

 

(545

)

(231

)

(1,067

)

(686

)

Total stock based compensation expense, net of tax

 

$

866

 

$

362

 

$

1,648

 

$

1,074

 

 

We have not capitalized any stock-based compensation cost during the six months ended June 30, 2008 and 2007.  As of June 30, 2008, unrecognized compensation expense related to unvested stock options and restricted stock is expected to be recognized as follows (in millions):

 

8



 

 

 

Stock
Options

 

Restricted
Stock

 

Total

 

 

 

 

 

 

 

 

 

Remainder of 2008

 

$

2.3

 

$

0.4

 

$

2.7

 

2009

 

4.6

 

0.7

 

5.3

 

2010

 

4.2

 

0.7

 

4.9

 

2011

 

3.4

 

0.7

 

4.1

 

2012

 

2.5

 

0.8

 

3.3

 

 

 

 

 

 

 

 

 

Total unrecognized compensation expense

 

$

17.0

 

$

3.3

 

$

20.3

 

 

Segments

 

The following table sets forth our revenue by product category (in thousands):

 

 

 

Three Months ended
June 30,

 

Six Months ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

Recycled and related products and services

 

$

159,425

 

$

129,133

 

$

314,287

 

$

258,225

 

Aftermarket, other new and refurbished products

 

241,211

 

59,161

 

516,290

 

122,066

 

Other

 

83,756

 

44,984

 

145,723

 

88,305

 

 

 

 

 

 

 

 

 

 

 

 

 

$

484,392

 

$

233,278

 

$

976,300

 

$

468,596

 

 

Recent Accounting Pronouncements

 

Effective January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements” (“SFAS 157”) as it pertains to financial assets and liabilities. In accordance with the provisions of FASB Staff Position 157-2, we elected to defer the adoption of SFAS 157 relating to the fair value of non-financial assets and liabilities. We are currently evaluating the impact, if any, of applying SFAS 157 to our non-financial assets and liabilities. SFAS 157 established a framework for reporting fair value and expands disclosures required for fair value measurements. Although the adoption of SFAS 157 did not have a significant impact on our consolidated financial position, results of operations or cash flows, we are now required to provide additional disclosures as part of our financial statements. These additional disclosures are provided in Note 10.

 

Effective January 1, 2008, we adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). The adoption of SFAS 159 did not have a significant impact on our consolidated financial position, results of operations or cash flows.

 

In December 2007, the SEC issued SAB 110 to amend the SEC’s views discussed in SAB 107 regarding the use of the simplified method in developing an estimate of expected life of share options in accordance with SFAS No. 123R. We will continue to use the simplified method until we have the historical data necessary to provide a reasonable estimate of expected life in accordance with SAB 107, as amended by SAB 110.

 

In December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”). Under SFAS 141R, companies will be required to, among other things,  recognize the assets acquired, liabilities assumed, including contractual contingencies, and contingent consideration at fair value on the date of acquisition. SFAS 141R also requires that acquisition-related expenses be expensed as incurred, restructuring costs be expensed in periods subsequent to the acquisition date, and changes in accounting for deferred income tax asset valuation allowances and acquired income tax

 

9



 

uncertainties after the measurement period be included in income tax expense. SFAS 141R will be effective on January 1, 2009 and will change our accounting for business combinations upon adoption. We are currently assessing the impact that the adoption of SFAS 141R will have on our consolidated financial position, results of operations and cash flows.

 

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of SFAS No. 133” (“SFAS 161”). SFAS 161 requires enhanced disclosures about derivative and hedging activities and is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. As SFAS 161 specifically relates to disclosures regarding derivative and hedging activities, it will not impact our consolidated financial position, results of operations or cash flows.

 

Note 3.  Capital Structure

 

On September 25, 2007, we completed the sale of 23,600,000 shares of our common stock pursuant to a registration statement filed with the SEC. Pursuant to the same registration statement, the selling stockholders named in the registration statement sold 4,000,000 shares of our common stock. We received $349.5 million, net of the underwriting discount and net of offering related expenses of approximately $0.7 million, for the common stock we issued and sold. We did not receive any proceeds from the sale of shares by the selling stockholders. We also received approximately $2.8 million in proceeds from the exercise of 1,000,000 stock options by certain members of management in connection with the offering.

 

On November 5, 2007, our Board of Directors approved a two-for-one split of our common stock payable as a stock dividend. Each stockholder of record at the close of business on November 16, 2007 received an additional share of common stock for every outstanding share held. The payment date was December 3, 2007, and the common stock began trading on a split-adjusted basis on December 4, 2007. All share and per share amounts for all periods presented have been adjusted to reflect the stock split.

 

On March 4, 2008, in connection with a business acquisition, we issued 838,073 shares of our common stock.

 

Note 4.  Stock-Based Compensation 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.

 

On January 11, 2008, we issued 190,000 shares of restricted stock to key employees. The grant-date fair value of the awards was approximately $3.6 million, or $19.14 per share. Vesting of the awards is subject to a continued service condition, with 20% of the awards vesting each year on the anniversary of the grant date. The fair value of each share of restricted stock awarded was equal to the market value of a share of our common stock on the grant date.

 

A summary of transactions in our stock-based compensation plans for the six months ended June 30, 2008 is as follows:

 

 

 

Restricted

 

 

 

Stock Options

 

 

 

Shares and

 

 

 

 

 

Weighted

 

 

 

Options

 

Restricted

 

 

 

Average

 

 

 

Available

 

Shares

 

Number

 

Exercise

 

 

 

For Grant

 

Outstanding

 

Outstanding

 

Price

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2007

 

6,852,680

 

 

11,032,102

 

$

5.06

 

 

 

 

 

 

 

 

 

 

 

Granted

 

(1,608,250

)

190,000

 

1,418,250

 

19.18

 

Exercised

 

 

 

(333,710

)

4.22

 

Cancelled

 

63,015

 

 

(63,015

)

15.61

 

 

 

 

 

 

 

 

 

 

 

Balance, June 30, 2008

 

5,307,445

 

190,000

 

12,053,627

 

$

6.69

 

 

10



 

The following table summarizes information about outstanding and exercisable stock options at June 30, 2008:

 

 

 

Outstanding

 

Exercisable

 

 

 

 

 

Weighted

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

Average

 

Weighted

 

 

 

Average

 

Weighted

 

 

 

 

 

Remaining

 

Average

 

 

 

Remaining

 

Average

 

Range of

 

 

 

Contractual

 

Exercise

 

 

 

Contractual

 

Exercise

 

Exercise Prices

 

Shares

 

Life (Yrs)

 

Price

 

Shares

 

Life (Yrs)

 

Price

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$0.75

 

278,000

 

2.6

 

$

0.75

 

278,000

 

2.6

 

$

0.75

 

2.00 -2.50

 

1,406,070

 

4.1

 

2.09

 

1,405,870

 

4.1

 

2.09

 

3.13 -3.99

 

2,266,400

 

3.1

 

3.51

 

2,154,800

 

3.0

 

3.52

 

4.16 -4.72

 

4,409,502

 

6.2

 

4.44

 

4,067,682

 

6.2

 

4.44

 

7.56 -8.64

 

246,000

 

7.2

 

7.59

 

243,000

 

7.2

 

7.59

 

9.33 - 12.42

 

1,970,780

 

8.1

 

10.04

 

708,180

 

8.0

 

10.18

 

18.87 - 22.58

 

1,476,875

 

9.5

 

19.16

 

10,000

 

9.3

 

18.87

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

12,053,627

 

6.0

 

$

6.69

 

8,867,532

 

5.1

 

$

4.29

 

 

At June 30, 2008, a total of 11,972,694 options with an average exercise price of $6.63 and a weighted average remaining contractual life of 6.0 years were exercisable or expected to vest. The total grant-date fair value of options that vested during the six months ended June 30, 2008 was approximately $1.2 million.

 

The aggregate intrinsic value (market value of stock less option exercise price) of outstanding, expected to vest and exercisable stock options at June 30, 2008 is $137.2 million, $137.0 million and $122.2 million, respectively. The aggregate intrinsic value represents the total pre-tax intrinsic value, based on the Company’s closing stock price of $18.07 on June 30, 2008, which would have been received by the option holders had all option holders exercised their options as of that date. This amount changes based upon the fair market value of our common stock. The total intrinsic value of stock options exercised was $5.5 million during the six months ended June 30, 2008. There were 659,564 stock options exercised during the six months ended June 30, 2007 with an intrinsic value of $5.8 million.

 

Note 5.  Long-Term Obligations

 

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

 

 

 

June 30,

 

December 31,

 

 

 

2008

 

2007

 

 

 

 

 

 

 

Senior secured debt financing facility:

 

 

 

 

 

Term loans payable

 

$

644,231

 

$

650,252

 

Revolving credit facility

 

 

 

Notes payable to individuals in monthly installments through November 2010, interest at 3.5% to 10.0%

 

3,191

 

8,210

 

 

 

647,422

 

658,462

 

Less current maturities

 

(18,055

)

(16,936

)

 

 

 

 

 

 

 

 

$

629,367

 

$

641,526

 

 

We obtained a senior secured debt financing facility (“Credit Agreement”) from Lehman Brothers Inc. (“Lehman”) and Deutsche Bank Securities, Inc. (“Deutsche Bank”) on October 12, 2007, which was amended on October 26, 2007. The Credit Agreement has a six year term and includes a $610 million term loan, a $40 million Canadian currency term loan, a $100 million U.S. dollar revolving credit facility, and a $15 million dual currency 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, (ii) for a swing line credit facility of $25 million under the $100 million revolving credit facility, and (iii) 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. 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

 

11



 

October 12, 2013. Amounts due under each revolving credit facility will be due and payable October 12, 2013.  We are also required to prepay the term loan facilities upon the sale of certain assets, upon the incurrence of certain debt, upon receipt of certain insurance and condemnation proceeds, 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.

 

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, including compliance with the required senior secured debt ratio.  We were in compliance with all restrictive covenants as of June 30, 2008.

 

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 on borrowings outstanding against the Company’s senior secured credit facility at June 30, 2008 and December 31, 2007 were 4.85% and 7.53%, respectively. Borrowings against the senior secured credit facility totaled $644.2 million and $650.3 million at June 30, 2008 and December 31, 2007, respectively, of which $15.0 million and $10.0 million are classified as current maturities, respectively.

 

The weighted average interest rate at June 30, 2008 includes the effect of the following interest rate swap agreements, which we entered into in March 2008 in order to hedge a portion of the variable interest rate risk on our variable rate term loans:

 

Notional Amount

 

Effective Date

 

Maturity Date

 

Fixed Interest Rate

 

 

 

 

 

 

 

 

 

$ 200,000,000

 

April 14, 2008

 

April 14, 2011

 

2.74

%

$ 50,000,000

 

April 14, 2008

 

April 14, 2010

 

2.43

%

 

Beginning on the effective dates of the interest rate swap agreements, we will, on a monthly basis through the maturity date, pay the fixed interest rate and receive 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, as defined by SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended (“SFAS 133”).  As of June 30, 2008, the fair market value of these market contracts was approximately $6.1 million. The fair market value of the interest rate swaps is subject to changes in value due to changes in interest rates. Hedge ineffectiveness for the six months ended June 30, 2008 was immaterial.

 

Note 6. Commitments and Contingencies

 

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 June 30, 2008 are as follows (in thousands):

 

Six months ended December 31, 2008

 

$

21,428

 

Years ended December 31:

 

 

 

2009

 

35,767

 

2010

 

28,462

 

2011

 

21,183

 

2012

 

15,348

 

2013

 

11,880

 

Thereafter

 

26,817

 

 

 

 

 

 

 

$

160,885

 

 

12



 

Litigation and Related Contingencies

 

On December 2, 2005, Ford Global Technologies, LLC (“Ford”) filed a complaint under Section 337 of the Tariff Act of 1930 with the United States International Trade Commission (“USITC”) against Keystone and five other named Respondents, including four Taiwan-based manufacturers. On December 12, 2005, Ford filed an Amended Complaint. Both the Complaint and the Amended Complaint contended that Keystone and the other Respondents infringed 14 design patents that Ford alleges cover eight parts on the 2004-2005 Ford F-150 truck (the “Ford Design Patents”). Ford asked the USITC to issue a permanent general exclusion order excluding from entry into the United States all automotive parts that infringe the Ford Design Patents and that are imported into the United States, sold for importation in the United States, or sold within the United States after importation. Ford also sought a permanent order directing Keystone and the other Respondents to cease and desist from, among other things, selling, marketing, advertising, distributing and offering for sale imported automotive parts that infringe the Ford Design Patents. On December 28, 2005, the USITC issued a Notice of Investigation based on Ford’s Amended Complaint. The USITC’s Notice of Investigation was published in the Federal Register on January 4, 2006.

 

On January 23, 2006, Keystone filed its Response to the Complaint and Notice of Investigation. In the Response, Keystone denied, among other things, that any of the Ford Design Patents is valid and/or enforceable and, accordingly, denied each and every allegation of infringement. Keystone further asserted several affirmative defenses. In interlocutory rulings, the Administrative Law Judge (“ALJ”) struck Keystone’s affirmative defenses of patent exhaustion, permissible repair, license and patent misuse and Keystone’s affirmative defense that each of the patents is invalid for failure to comply with the ornamentality requirement of 35 U.S.C.§171. Additionally, the ALJ granted Ford’s request to drop four patents from the investigation. A hearing before the ALJ took place the last week of August 2006.

 

On December 4, 2006, the ALJ issued an Initial Determination upholding seven of Ford’s design patents and declaring the remaining three design patents to be invalid. Both Ford and the Company petitioned the USITC to review and set aside portions of the ALJ’s Initial Determination. Keystone’s petition also sought review of the ALJ’s interlocutory rulings concerning certain of its affirmative defenses. On March 20, 2007, the USITC decided not to review the ALJ’s Initial Determination.

 

On June 6, 2007, the USITC issued its Notice of Final Determination. The Notice of Final Determination denied Respondents’ petition for reconsideration and their motion for leave to supplement their petition. In addition, the USITC issued a general exclusion order prohibiting the importation of certain automotive parts found to infringe the seven Ford design patents found valid. The USITC’s decision became final on August 6, 2007 upon the expiration without action of the 60-day Presidential review period.  On May 18, 2007, Ford filed a Notice of Appeal with the United States Federal Circuit Court of Appeals with regard to the three patents declared invalid in the ALJ’s Initial Determination. On August 23, 2007, the Respondents filed a Notice of Appeal with the United States Federal Court of Appeals. The appeals were consolidated, and the parties have submitted their respective briefs to the appellate court.

 

On May 2, 2008, Ford filed with the USITC another complaint under section 337 of the Tariff Act of 1930. The complaint alleges that LKQ Corporation, Keystone Automotive Industries, Inc., and six other entities (collectively, the “Respondents”) import and sell certain automotive parts relating to the 2005 Ford Mustang that infringe eight Ford design patents. On May 29, 2008, the USITC issued a Notice of Investigation based on Ford’s complaint. The USITC’s Notice of Investigation was published in the Federal Register on June 5, 2008. On June 23, 2008, the Respondents filed their Response to the Complaint and Notice of Investigation. In the Response, the Respondents denied, among other things, that any of the Ford design patents is valid and/or enforceable and, accordingly, denied each and every allegation of infringement. The Respondents further asserted several affirmative defenses. The parties are conducting discovery. The USITC has set September 7, 2009 as the target date for completion of the investigation.

 

We will continue to vigorously defend the December 2005 action and the May 2008 action. At the time the exclusion order was issued in the December 2005 action, the parts that are subject to the order comprised only a minimal amount of our sales. Similarly, the parts that relate to the May 2008 action comprise only a minimal amount of our sales. However, as such parts become incorporated into more vehicles over time, it is likely that the amount of our sales of such parts will increase or would have increased substantially. If the design patents in question are ultimately upheld as valid and infringed, it is not anticipated that the loss of sales of these parts over time will be materially adverse to our financial condition, cash flows or results of operations. However, depending upon the nature and extent of any adverse ruling, auto manufacturers may attempt to assert similar allegations based upon design patents on a significant number of parts for several of their models, which over time could have a material adverse impact on the entire aftermarket parts industry.

 

We also have certain other contingent liabilities 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 believe that the probable resolution of such contingencies will not materially affect our financial position, results of operations or cash flows.

 

13



 

Note 7Earnings Per Share

 

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

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

30,989

 

$

14,016

 

$

61,867

 

$

29,810

 

 

 

 

 

 

 

 

 

 

 

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

 

135,287

 

107,046

 

134,922

 

106,841

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options

 

4,989

 

5,448

 

5,013

 

5,406

 

Restricted stock

 

25

 

 

100

 

 

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

 

140,301

 

112,494

 

140,035

 

112,247

 

 

 

 

 

 

 

 

 

 

 

Earnings per share, basic

 

$

0.23

 

$

0.13

 

$

0.46

 

$

0.28

 

 

 

 

 

 

 

 

 

 

 

Earnings per share, diluted

 

$

0.22

 

$

0.12

 

$

0.44

 

$

0.27

 

 

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

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Antidilutive securities:

 

 

 

 

 

 

 

 

 

Stock options

 

1,484

 

1,890

 

133

 

2,130

 

 

Note 8.  Business Combinations

 

During the six month period ended June 30, 2008, we acquired a 100% equity interest in each of three businesses (two in the recycled OEM parts business and one wheel polishing business) including on March 4, 2008, Texas Best Diesel, L.P., a recycled OEM heavy truck parts business.  The aggregate consideration for these businesses totaled approximately $4.4 million in cash and $18.0 million in stock issued. The acquisitions enabled us to expand our presence in an existing market and become a provider of recycled OEM heavy truck parts.

 

During the six month period ended June 30, 2007, we acquired a 100% equity interest in each of seven businesses (four in the recycled OEM products business, two in the aftermarket products business and one that refurbishes and distributes head lamps and tail lamps) for an aggregate of $22.3 million in cash and $1.4 million in notes issued. The acquisitions enabled us to serve new market areas and become a provider of refurbished head lamps and tail lamps.

 

On October 12, 2007, we completed our acquisition of 100% of the outstanding common stock of Keystone. The acquisition of Keystone enabled us to become the largest nationwide provider of aftermarket collision replacement products and refurbished bumper covers and wheels.

 

The acquisitions are being accounted for under the purchase method of accounting and are included in our 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 acquisitions made subsequent to June 30, 2007, the purchase price allocations are preliminary as we are in the process of determining the following: 1) whether any operations acquired will be closed or combined with existing operations; 2) valuation amounts for certain of the inventories and fixed assets acquired and the fair value of liabilities assumed; and 3) the final estimation of the tax basis of the entities acquired. During the six months ended June 30, 2008, we made

 

14



 

adjustments to the preliminary purchase allocations to finalize the inventory valuations and the estimated tax basis for certain of the businesses acquired in 2007. These adjustments increased goodwill related to these 2007 acquisitions by approximately $1.6 million.

 

The purchase price allocations for acquisitions completed and adjustments made to preliminary purchase price allocations during the six months ended June 30, 2008 and 2007 are as follows (in thousands):

 

 

 

2008

 

2007

 

 

 

 

 

 

 

Receivables, net

 

$

304

 

$

716

 

Inventory

 

2,534

 

4,666

 

Prepaid expenses and other assets

 

9

 

44

 

Property and equipment

 

1,627

 

2,365

 

Goodwill

 

18,595

 

17,282

 

Current liabilities assumed

 

(1,153

)

(1,113

)

Deferred taxes

 

533

 

 

Purchase price payable in subsequent period

 

 

(190

)

Notes issued

 

(25

)

(1,449

)

Stock issued (See Note 3)

 

(18,006

)

 

Long-term obligations assumed

 

 

(38

)

Payment of prior year purchase price payable

 

 

1,956

 

 

 

 

 

 

 

Cash used in acquisitions, net of cash acquired

 

$

4,418

 

$

24,239

 

 

We recorded goodwill of $18.6 million during the six month period ended June 30, 2008, an immaterial amount of which is expected to be deductible for income tax purposes. Of the $17.3 million of goodwill recorded during the six month period ended June 30, 2007, $12.8 million is expected to be deductible for income tax purposes.

 

15



 

The following pro forma summary presents the effect of the businesses acquired during 2008 and 2007 as though the businesses had been acquired as of January 1, 2007 and is based upon unaudited financial information of the acquired entities (in thousands, except per share data):

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Revenue as reported

 

$

484,392

 

$

233,278

 

$

976,300

 

$

468,596

 

Revenue of purchased businesses for the period prior to acquisition:

 

 

 

 

 

 

 

 

 

Keystone, net of eliminations

 

 

179,773

 

 

379,059

 

Other acquisitions

 

 

18,159

 

2,054

 

34,600

 

Pro forma revenue

 

$

484,392

 

$

431,210

 

$

978,354

 

$

882,255

 

 

 

 

 

 

 

 

 

 

 

Net income as reported

 

$

30,989

 

$

14,016

 

$

61,867

 

$

29,810

 

Net income of purchased businesses for the period prior to acquisition, including adjustments for interest and amortization:

 

 

 

 

 

 

 

 

 

Keystone

 

 

(120

)

659

 

2,751

 

Other acquisitions

 

 

828

 

360

 

1,643

 

Pro forma net income

 

$

30,989

 

$

14,724

 

$

62,886

 

$

34,204

 

 

 

 

 

 

 

 

 

 

 

Earnings per share-basic, as reported

 

$

0.23

 

$

0.13

 

$

0.46

 

$

0.28

 

Effect of purchased businesses for the period prior to acquisition:

 

 

 

 

 

 

 

 

 

Keystone

 

0.00

 

0.00

 

0.01

 

0.03

 

Other acquisitions

 

0.00

 

0.01

 

0.00

 

0.01

 

Pro forma earnings per share-basic

 

$

0.23

 

$

0.14

 

$

0.47

 

$

0.32

 

 

 

 

 

 

 

 

 

 

 

Earnings per share-diluted, as reported

 

$

0.22

 

$

0.12

 

$

0.44

 

$

0.27

 

Effect of purchased businesses for the period prior to acquisition:

 

 

 

 

 

 

 

 

 

Keystone

 

0.00

 

0.00

 

0.01

 

0.02

 

Other acquisitions

 

0.00

 

0.01

 

0.00

 

0.01

 

Pro forma earnings per share-diluted

 

$

0.22

 

$

0.13

 

$

0.45

 

$

0.30

 

 

Unaudited pro forma supplemental information is based upon accounting estimates and judgments that we believe are reasonable. Revenue between LKQ and Keystone has been eliminated. The unaudited pro forma supplemental information also includes purchase accounting adjustments (including a $0.7 million and a $2.9 million increase in Keystone’s reported cost of goods sold during the three and six months ended June 30, 2007, respectively, resulting from a write-up of Keystone inventory to fair value and adjustments to depreciation on acquired property and equipment), amortization expense associated with the Keystone tradename, 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.

 

Note 9. Restructuring and Integration Costs

 

We have undertaken certain restructuring activities in connection with our acquisition of Keystone, which was completed during the fourth quarter of 2007. The restructuring activities primarily include reductions in staffing levels resulting from the elimination of duplicative functions and staffing and the closure of excess facilities resulting from overlap with existing LKQ facilities. To the extent these restructuring activities are associated with Keystone operations, they are being accounted for in accordance with EITF Issue No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination.” Restructuring activities associated with our existing operations are being accounted for in accordance with SFAS No. 146, “Accounting for Costs Associated With Exit or Disposal Activities.”

 

16



 

In connection with the Keystone restructuring activities, as part of the cost of the acquisition, we established reserves as detailed below. In accordance with EITF Issue No. 95-3, we intend to finalize our restructuring plans no later than one year from the date of our acquisition of Keystone. Upon finalization of restructuring plans or settlement of obligations for less than the expected amount, any excess reserves will be reversed with a corresponding decrease in goodwill.  Accrued acquisition expenses are included in accrued expenses in the accompanying Consolidated Condensed Balance Sheets.

 

The changes in accrued acquisition expenses directly related to the Keystone acquisition during 2007 and the six months ended June 30, 2008 are as follows (in thousands):

 

 

 

Severance
Related
Costs

 

Excess
Facility
Costs

 

Other

 

Total

 

 

 

 

 

 

 

 

 

 

 

Reserves established

 

$

11,233

 

$

2,823

 

$

488

 

$

14,544

 

Payments

 

(1,727

)

(85

)

(488

)

(2,300

)

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2007

 

9,506

 

2,738

 

 

12,244

 

 

 

 

 

 

 

 

 

 

 

Reserves adjusted

 

 

 

(34

)

 

(34

)

Payments

 

(6,731

)

(119

)

 

(6,850

)

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2008

 

$

2,775

 

$

2,585

 

$

 

$

5,360

 

 

All of the severance related costs are expected to be paid in 2008. The excess facility costs are expected to be paid over the remaining terms of the leases through 2013.

 

Restructuring and integration costs associated with our operations of $3.1 million and $4.3 million are included in Restructuring expenses on the accompanying Consolidated Condensed Statements of Income for the three and six months ended June 30, 2008, respectively. These charges include costs to move inventory between facilities, migrate systems, and standardize processes and procedures totaling $2.1 million and $2.9 million for the three and six months ended June 30, 2008, respectively. We also recognized costs associated with the closure of existing facilities due to overlap with acquired Keystone locations of $1.0 million and $1.4 million for the three and six months ended June 30, 2008, respectively. 

 

We have established a reserve for the costs related to the closure of existing facilities.  The other restructuring charges are generally expensed and paid in the same reporting period.  The changes in accrued restructuring expenses for the six months ended June 30, 2008 are as follows (in thousands):

 

 

 

Excess Facility Costs

 

 

 

 

 

Balance at December 31, 2007

 

$

 

 

 

 

 

Reserves established

 

1,447

 

Payments

 

(158

)

 

 

 

 

Balance at June 30, 2008

 

$

1,289

 

 

The excess facility costs are expected to be paid over the remaining terms of the leases through 2016.

 

17



 

Note 10. Fair Value Measurements

 

SFAS 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers 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 approach to value our financial assets and liabilities, and there were no changes in valuation techniques during the six months ended June 30, 2008.  The following table presents information about our financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2008 (in thousands):

 

 

 

Balance as
of June 30,

 

Fair Value Measurements as of June 30, 2008

 

 

 

2008

 

Level 1

 

Level 2

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

Cash equivalents

 

$

77,821

 

$

77,821

 

$

 

$

 

Interest rate swap

 

6,106

 

 

6,106

 

$

 

Cash surrender value of life insurance

 

5,113

 

 

5,113

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets

 

$

89,040

 

$

77,821

 

$

11,219

 

$

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Deferred compensation liabilities

 

$

4,518

 

$

 

$

4,518

 

$

 

 

 

 

 

 

 

 

 

 

 

Total Liabilities

 

$

4,518

 

$

 

$

4,518

 

$

 

 

Note 11. Income Taxes

 

We calculate our interim income tax provision in accordance with Accounting Principles Board Opinion No. 28, “Interim Financial Reporting” and FASB Interpretation No. 18, “Accounting for Income Taxes in Interim Periods.” 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, 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 tax rate for the six months ended June 30, 2008 was 39.3% compared with 41.3% for the comparable prior year period.

 

18



 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Overview

 

We provide replacement systems, components, and parts needed to repair vehicles (cars and trucks). Buyers of vehicle replacement products have the option to purchase from primarily four sources: new products produced by original equipment manufacturers (“OEMs”), which are commonly known as OEM products; new products produced by companies other than the OEMs, which are sometimes referred to as “aftermarket” products; recycled products originally produced by OEMs, which we refer to as recycled OEM products; and OEM products that have been refurbished. We participate in the market for recycled OEM products as well as the market for collision repair aftermarket products. We obtain aftermarket products and salvage vehicles from a variety of sources, and we dismantle the salvage vehicles to obtain a comprehensive range of vehicle products that we distribute into the vehicle repair market. We also refurbish bumpers, wheels, head lamps and tail lamps.

 

We are the largest nationwide provider of recycled OEM products and related services, with sales, processing, and distribution facilities that reach most major markets in the U.S. In October 2007, we acquired Keystone Automotive Industries, Inc., the nation’s leading distributor of aftermarket collision parts. As a result, we are the largest nationwide provider of aftermarket collision replacement products, and refurbished bumper covers and wheels. We believe there are opportunities for growth in both product lines through acquisitions and internal development.

 

Our revenue, cost of goods sold, and operating results have fluctuated on a quarterly and annual basis in the past and can be expected to continue to fluctuate in the future as a result of a number of factors, some of which are beyond our control. Please refer to the risk factors enumerated in Item 1A in our 2007 Annual Report on Form 10-K filed with the SEC on February 29, 2008, and the update to Item 1A included in Part II of this Quarterly Report on Form 10-Q.  Due to these risk factors, our operating results in future periods can be expected to fluctuate. Accordingly, our historical results of operations may not be indicative of future performance.

 

Acquisitions

 

Since our inception in 1998 we have pursued a growth strategy of both organic growth and acquisitions. We have pursued acquisitions that we believe will help drive profitability, cash flow and stockholder value. Our principal focus for acquisitions is companies that will expand our geographic presence and our ability to provide a wider choice of alternative vehicle replacement products and services to our customers.

 

In the first six months of 2008, we acquired two businesses in the recycled OEM parts business and one in the wheel polishing business. These business acquisitions enabled us to expand our presence in an existing market and become a provider of recycled OEM heavy truck parts.

 

Sources of Revenue

 

Since 2005, our revenue from the sale of vehicle replacement products and related services, and since February 2008, heavy truck parts, has ranged between 81% and 89% of our total revenue, of which between 5% and 11% of our total revenue has come from our self-service facilities. We sell the majority of our vehicle replacement products to collision repair shops and mechanical repair shops. Our vehicle replacement products include engines, transmissions, front-ends, doors, trunk lids, bumpers, hoods, fenders, grilles, valances, wheels, head lamps, and tail lamps. We sell extended warranty contracts for certain mechanical products. These contracts cover the cost of parts and labor and are sold for periods of six months, one year, or two years. We defer the revenue from such contracts and recognize it ratably over the term of the contracts. We also sell damaged vehicles to vehicle repairers. The demand for our products and services is influenced by several factors, including the number of vehicles in operation, the number of miles being driven, the frequency and severity of vehicle accidents, availability and pricing of new parts, seasonal weather patterns, and local weather conditions. Additionally, automobile insurers exert significant influence over collision repair shops as to how an insured vehicle is repaired and the cost level of the products used in the repair process. Accordingly, we consider automobile insurers to be key demand drivers of our products. While they are not our direct customers, we do provide insurance companies services in an effort to promote the increased usage of alternative replacement products in the repair process. Such services include the review of vehicle repair order estimates, as well as direct quotation services to their adjusters. There is no standard price for recycled OEM products, but rather a pricing structure that varies from day to day based upon such factors as product availability, quality, demand, new OEM replacement product prices, the age of the vehicle being repaired, and competitor pricing. The pricing for aftermarket and refurbished products is determined based on a number of factors, including availability, quality, demand, new OEM replacement product prices, and competitor pricing.

 

19



 

Since 2005, approximately 11% to 19% of our revenue has been obtained from other sources. These include bulk sales to mechanical remanufacturers, scrap sales, and sales of aluminum ingots and sows. We derive scrap metal from several sources, including OEM’s and other companies that contract with us to dismantle and scrap certain vehicles (which we refer to as “crush only” vehicles) and from vehicles that have been used in both our wholesale and self service recycling operations. Our revenue from other sources has increased since 2004 primarily due to our obtaining an aluminum smelter through a business acquisition in 2006, higher scrap sales from our recycle and wheel operations, and higher bulk sales of certain products.

 

When we obtain mechanical products from dismantled vehicles and determine they are damaged, or when we have a surplus of a certain mechanical product type, we sell them in bulk to mechanical remanufacturers. The majority of these products are sorted by product type and model type. Examples of such products are engine blocks and heads, transmissions, starters, alternators, and air conditioner compressors. After we have recovered all the products we intend to resell, the remaining materials are crushed and sold to scrap processors.

 

Cost of Goods Sold

 

Our cost of goods sold for recycled OEM products includes the price we pay for the salvage vehicle and, where applicable, auction, storage, and towing fees. We are facing increasing competition in the purchase of salvage vehicles from shredders and scrap recyclers, internet-based buyers, and others. Our cost of goods sold also includes labor and other costs we incur to acquire and dismantle such vehicles. The acquisition and dismantling of salvage vehicles is a manual process and, as a result, energy costs are not material.

 

Our cost of goods sold for aftermarket products includes the price we pay for the parts, freight, and other inventoried costs such as import fees and duties, where applicable. Our aftermarket products are acquired from a number of vendors. Our cost of goods sold for refurbished wheels, bumpers and lights includes the price we pay for inventory, freight, and costs to refurbish the parts, including direct and indirect labor, rent, depreciation and other overhead costs related to refurbishing operations.

 

In the event we do not have a recycled OEM product or suitable aftermarket product in our inventory to fill a customer order, we attempt to purchase the part from a competitor. We refer to these parts as brokered products. Since 2005, the revenue from brokered products that we sell to our customers has ranged from 2% to 8% of our total revenue. The gross margin on brokered product sales as a percentage of revenue is generally less than half of what we achieve from sales of our own inventory because we must pay higher prices for these products.

 

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.   We also sell separately priced extended warranty contracts for certain mechanical products. The expense related to extended warranty claims is recognized when the claim is made.

 

Expenses

 

Our facility and warehouse expenses primarily include our costs to operate our distribution, self-service, and warehouse facilities. These costs include labor for both plant management and facility and warehouse personnel, stock-based compensation, facility rent, property and liability insurance, utilities, and other occupancy costs.

 

Our distribution expenses primarily include our costs to deliver our products to our customers. Included in our distribution expense category are labor costs for drivers, local delivery and transfer truck rentals and subcontractor costs, vehicle repairs and maintenance, insurance, and fuel.

 

Our selling and marketing expenses primarily include our advertising, promotion, and marketing costs; salary and commission expenses for sales personnel; sales training; telephone and other communication expenses; and bad debt expense. Since 2005, personnel costs have accounted for approximately 77% to 80% of our selling and marketing expenses. Most of our recycled OEM product sales personnel are paid on a commission basis. The number and quality of our sales force is critical to our ability to respond to our customers’ needs and increase our sales volume. Our objective is to continually evaluate our sales force, develop and implement training programs, and utilize appropriate measurements to assess our selling effectiveness.

 

Our general and administrative expenses include primarily the costs of our corporate and regional offices that provide corporate and field management, treasury, accounting, legal, payroll, business development, human resources, and information systems functions. These costs include wages and benefits for corporate, regional and administrative personnel, stock-based compensation, long term incentive compensation, accounting, legal and other professional fees, office supplies, telephone and other communication costs, insurance and rent.

 

20



 

Seasonality

 

Our operating results are subject to quarterly variations based on a variety of factors, influenced primarily by seasonal changes in weather patterns. During the winter months we tend to have higher demand for our products because there are more weather related accidents. In addition, the cost of salvage vehicles tends to be lower as more weather related accidents occur generating a larger supply of total loss vehicles.

 

Critical Accounting Policies and Estimates

 

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”). The preparation of these financial statements requires us to make estimates, assumptions, and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, assumptions, and judgments, including those related to revenue recognition, inventory valuation, allowance for doubtful accounts, goodwill impairments, self-insurance programs, contingencies, stock-based compensation, and accounting for income taxes. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. The results of these estimates form the basis for our judgments about the carrying values of assets and liabilities and our recognition of revenue. Actual results may differ from these estimates.

 

Revenue Recognition

 

We recognize and report revenue from the sale of vehicle replacement products when they are shipped and title has transferred, subject to a reserve for returns, discounts, and allowances that management estimates based upon historical information. A replacement product would ordinarily be returned within a few days of shipment. Our customers may earn discounts based upon sales volumes or sales volumes coupled with prompt payment. Allowances are normally given within a few days following product shipment. We analyze historical returns and allowances activity by comparing the items to the original invoice amounts and dates. We use this information to project future returns and allowances on products sold.

 

We also sell separately priced extended warranty contracts for certain mechanical products. Revenue from these contracts is deferred and recognized ratably over the term of the contracts.

 

Inventory Accounting

 

Salvage Inventory.  Salvage inventory is recorded at the lower of cost or market. Our salvage inventory cost is established based upon the price we pay for a vehicle, and includes buying; dismantling; and, where applicable, auction, storage, and towing fees. Inventory carrying value is determined using the average cost to sales percentage at each of our facilities and applying that percentage to the facility’s inventory at expected selling prices. The average cost to sales percentage is derived from each facility’s historical vehicle profitability for salvage vehicles purchased at auction or from contracted rates for salvage vehicles acquired under direct procurement arrangements.

 

Aftermarket and Refurbished Product Inventory.  Aftermarket and refurbished product inventory is recorded at the lower of cost or market. Our aftermarket inventory cost is based on the average price we pay for parts, and includes expenses incurred for freight and buying, where applicable. For items purchased from foreign sources, import fees and duties and transportation insurance are also included. Our refurbished product inventory cost is based on the average price we pay for wheel and bumper cores, and includes expenses incurred for freight, buying, and refurbishing overhead.

 

For all inventory, our carrying value is reduced regularly to reflect the age and current anticipated demand for our products. If actual demand differs from our estimates, additional reductions to our inventory carrying value would be necessary in the period such determination is made.

 

Allowance for Doubtful Accounts

 

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. The allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts, the aging of the accounts receivable, and our historical experience. Our allowance for doubtful accounts at June 30, 2008 was approximately $5.0 million, which represents 3.5% of gross receivables. If actual defaults are higher than our historical experience, our allowance for doubtful accounts may be insufficient to cover the uncollectible receivables, which would have an adverse impact on our operating results in the period of occurrence. A 10% change in the 2007 annual write-off rate would result in a change in the estimated allowance for doubtful accounts of approximately $0.2 million. For our vehicle replacement parts operations, our exposure

 

21



 

to uncollectible accounts receivable is limited because the majority of our sales are to a large number of small customers that are generally geographically dispersed. We also have certain customers in our vehicle replacement parts operations that pay for products at the time of delivery. The aluminum smelter and our mechanical core operation sell in larger quantities to a small number of distributors, foundry customers and remanufacturers. As a result, our exposure to uncollectible accounts receivable is greater in these operations. We control credit risk through credit approvals, credit limits, and monitoring policies.

 

Goodwill Impairment

 

We record goodwill as a result of our acquisitions. SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), requires us to analyze our goodwill for impairment at least annually. The determination of the value of goodwill requires us to make estimates and assumptions that affect our consolidated financial statements. In assessing the recoverability of our goodwill, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets. We perform goodwill impairment tests annually in the fourth quarter and between annual tests whenever events may indicate that an impairment exists. In response to changes in industry and market conditions, we may be required to strategically realign our resources and consider restructuring, disposing of, or otherwise exiting businesses, which could result in an impairment of goodwill.

 

Our goodwill would be considered impaired if the net book value of a reporting unit exceeded its estimated fair value. The fair value estimates are primarily established using a discounted cash flow methodology, supported by comparative market multiples where appropriate. As of June 30, 2008, we had $843.9 million in goodwill subject to future impairment tests. If we were required to recognize goodwill impairments in future periods, we would report those impairment losses as part of our operating results. We determined that no adjustments were necessary when we performed our annual impairment testing in the fourth quarter of 2007. A 10% decrease in the fair value estimates used in the fourth quarter of 2007 impairment test would not have changed this determination.

 

Self-Insurance Programs

 

We self-insure a portion of employee medical benefits under the terms of our employee health insurance program. We also self-insure a portion of automobile, general liability, and workers’ compensation claims. We have purchased both aggregate (in some cases) and specific (in all cases) stop-loss insurance coverage from third party insurers in order to limit our total liability exposure. The cost of the stop-loss insurance is expensed over the contract periods.

 

We record an accrual for the claims expense related to our employee medical benefits, automobile, general liability, and workers’ compensation claims based upon the expected amount of all such claims. If actual claims are higher than what we anticipated, our accrual might be insufficient to cover our claims costs, which would have an adverse impact on our operating results in that period.

 

Contingencies

 

We are subject to the possibility of various loss contingencies arising in the ordinary course of business resulting from litigation, claims and other commitments, and from a variety of environmental and pollution control laws and regulations. We consider the likelihood of loss or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in determining loss contingencies. We accrue an estimated loss contingency when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. We determine the amount of reserves, if any, with the assistance of our outside legal counsel. We regularly evaluate current information available to us to determine whether the accruals should be adjusted. If the amount of an actual loss were greater than the amount we have accrued, the excess loss would have an adverse impact on our operating results in the period that the loss occurred. If the loss contingency is subsequently determined to no longer be probable, the amount of loss contingency previously accrued would be included in our operating results in the period such determination was made.

 

Accounting for Income Taxes

 

All income tax amounts reflect the use of the liability method. Under this method, deferred tax assets and liabilities are determined based upon the expected future tax consequences of temporary differences between the carrying amounts of assets and liabilities for financial and income tax reporting purposes. We operate in multiple tax jurisdictions with different tax rates, and we determine the allocation of income to each of these jurisdictions based upon various estimates and assumptions.

 

We record a provision for taxes based upon our effective income tax rate. We record a valuation allowance to reduce our deferred tax assets to the amount that we expect is more likely than not to be realized. We consider historical taxable income, expectations, and risks associated with our estimates of future taxable income and ongoing tax planning strategies in assessing the need for a valuation allowance. We had a valuation allowance of $0.5 million and $0.7 million at June 30, 2008 and December 31,

 

22



 

2007, respectively, against our deferred tax assets. Should we determine that it is more likely than not that we would be able to realize all of our deferred tax assets in the future, an adjustment to the net deferred tax asset would increase income in the period such determination was made. Conversely, should we determine that it is more likely than not that we would not be able to realize all of our deferred tax assets in the future, an adjustment to the net deferred tax assets would decrease income in the period such determination was made.

 

We account for uncertain tax positions in accordance with FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 establishes a threshold for the financial statement recognition and measurement of tax positions taken or expected to be taken in tax returns. Only those positions that meet the more-likely-than-not recognition threshold may be recognized in the financial statements. We recognize interest accrued relating to unrecognized tax benefits in our income tax expense. In the normal course of business we will undergo tax audits by various tax jurisdictions. Such audits often require an extended period of time to complete and may result in income tax adjustments if changes to the allocation are required between jurisdictions with different tax rates. Under existing GAAP, changes in accruals for uncertainties arising from the resolution of pre-acquisition contingencies of acquired businesses are charged or credited to goodwill. Adjustments to other tax accruals we make are generally recognized in the period they are determined. Under proposed Statement of Financial Accounting Standards No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”), changes in accruals for uncertainties arising from the resolution of pre-acquisition contingencies of acquired businesses will be recorded in earnings in the period the changes are determined after the effective date of SFAS 141R. See “Recently Issued Accounting Pronouncements” for further discussion of SFAS 141R.

 

Stock-Based Compensation

 

We measure compensation cost for all share-based payments (including employee stock options) at fair value and recognize compensation expense for all awards on a straight-line basis over the requisite service period of the award in accordance with SFAS No. 123R, “Share-Based Payment” (“SFAS 123R”).

 

Several key factors and assumptions affect the valuation models currently utilized for valuing our stock option awards under SFAS 123R. We have been in existence since early 1998 and have been a public company since October 2003. As a result, we do not have the historical data necessary to consider using a lattice valuation model at this time. We have therefore elected to use the Black-Scholes valuation model. In December 2007, the SEC issued Staff Accounting Bulletin No. 110 (“SAB 110”) to amend the SEC’s views discussed in SAB 107 regarding the use of the simplified method in developing an estimate of expected life of share options in accordance with SFAS No. 123R. We will continue to use the simplified method until we have the historical data necessary to provide a reasonable estimate of expected life in accordance with SAB 107, as amended by SAB 110. Key assumptions used in determining the fair value of stock options granted in 2008 were: expected term of 6.4 years; risk-free interest rate of 3.27%; dividend yield of 0%; forfeiture rate of 6.7%; and volatility of 39.3%.

 

Recently Issued Accounting Pronouncements

 

In December 2007, the SEC issued SAB 110 to amend the SEC’s views discussed in SAB 107 regarding the use of the simplified method in developing an estimate of expected life of share options in accordance with SFAS No. 123R. We will continue to use the simplified method until we have the historical data necessary to provide a reasonable estimate of expected life in accordance with SAB 107, as amended by SAB 110.

 

In December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”). Under SFAS 141R, companies will be required to, among other things,  recognize the assets acquired, liabilities assumed, including contractual contingencies, and contingent consideration at fair value on the date of acquisition. SFAS 141R also requires that acquisition-related expenses be expensed as incurred, restructuring costs be expensed in periods subsequent to the acquisition date, and changes in accounting for deferred income tax asset valuation allowances and acquired income tax uncertainties after the measurement period be included in income tax expense. SFAS 141R will be effective on January 1, 2009 and will change our accounting for business combinations upon adoption. We are currently assessing the impact that the adoption of SFAS 141R will have on our consolidated financial position, results of operations and cash flows.

 

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of SFAS No. 133” (“SFAS 161”). SFAS 161 requires enhanced disclosures about derivative and hedging activities and is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. As SFAS 161 specifically relates to disclosures regarding derivative and hedging activities, it will not impact our consolidated financial position, results of operations or cash flows.

 

23



 

Segment Reporting

 

Over 95% of our operations are conducted in the U.S. During 2004, we acquired a recycled OEM products business with locations in Guatemala and Costa Rica. In May and July 2007, we acquired two recycled OEM products businesses located in Canada. Keystone has bumper refurbishing operations in Mexico and two aftermarket products businesses in Canada. Revenue generated and properties located outside of the U.S. are not material. We manage our operations geographically. Our vehicle replacement products operations are organized into ten operating segments, eight for recycled OEM products, one for aftermarket products and one for refurbished 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. Our vehicle replacement products operations account for over 94% of our revenue, earnings, and assets.

 

Results of Operations

 

The following table sets forth statement of income data as a percentage of total revenue for the periods indicated:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Statement of Income Data:

 

 

 

 

 

 

 

 

 

Revenue

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of goods sold

 

54.6

%

55.0

%

54.6

%

54.7

%

Gross margin

 

45.4

%

45.0

%

45.4

%

45.3

%

Facility and warehouse expenses

 

9.0

%

10.6

%

9.0

%

10.7

%

Distribution expenses

 

9.4

%

9.5

%

9.2

%

9.5

%

Selling, general and administrative expenses

 

12.7

%

12.1

%

12.9

%

12.1

%

Restructuring Expenses

 

0.7

%

 

0.4

%

 

Depreciation and amortization

 

1.5

%

1.5

%

1.5

%

1.4

%

Operating income

 

12.1

%

11.4

%

12.3

%

11.5

%

Other expense, net

 

1.6

%

0.9

%

1.8

%

0.7

%

Income before provision for income taxes

 

10.4

%

10.5

%

10.4

%

10.8

%

Net income

 

6.4

%

6.0

%

6.3

%

6.4

%

 

Three Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2007

 

Revenue. Our revenue increased 107.6% to $484.4 million for the three month period ended June 30, 2008, from $233.3 million for the comparable period of 2007. The increase in revenue was primarily due to business acquisitions, in particular Keystone.  In addition, we had a higher volume of products we sold and higher volumes of vehicle processing that resulted in higher revenue from processing fees and the sale of scrap and other commodities derived from our dismantling process.  Since the October 2007 acquisition of Keystone, we have been integrating the sale and distribution of our pre-existing aftermarket, wheel and reconditioned light product offerings with Keystone and with our recycled parts in more locations in order to provide a wider selection of products to our customers. Organic revenue growth was approximately 13.2% in the three month period ended June 30, 2008, and was calculated assuming we had owned Keystone in the three month period ended June 30, 2007. The integration of our pre-existing aftermarket and wheel operations with Keystone prevents us from measuring revenue growth between Keystone and our pre-existing businesses since the acquisition.

 

Cost of Goods Sold. Our cost of goods sold increased 106.5% to $264.7 million in the three month period ended June 30, 2008, from $128.2 million in the comparable period of 2007. The increase in cost of goods sold was primarily due to increased volume of products sold. Our acquisition of Keystone accounted for a majority of the increases.  As a percentage of revenue, cost of goods sold decreased from 55.0% to 54.6%. This decrease as a percentage of revenue was primarily due to higher sales volumes in lower priced cars and crush only vehicles that generate higher gross margin percentages.

 

Gross Margin. Our gross margin increased 109.1% to $219.7 million in the three month period ended June 30, 2008, from $105.1 million in the comparable period of 2007. Our gross margin increased primarily due to increased volume. As a percentage of revenue, gross margin increased from 45.0% to 45.4%. Our gross margin as a percentage of revenue increased due primarily to the factors noted above in Cost of Goods Sold.

 

Facility and Warehouse Expenses. Facility and warehouse expenses increased 77.8% to $43.8 million in the three month period ended June 30, 2008, from $24.6 million in the comparable period of 2007. Our facility and warehouse expenses increased primarily due to $9.7 million in higher wages and fringe benefits resulting from increased headcount and stock option expenses for field personnel and $8.1 million related to higher facility and equipment rent, property taxes, repairs and maintenance, utilities and

 

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supplies. Our acquisition of Keystone accounted for a majority of the increases. As a percentage of revenue, facility and warehouse expenses decreased from 10.6% to 9.0%, as we achieved greater leverage from combining Keystone with our existing LKQ operations.

 

Distribution Expenses. Distribution expenses increased 104.1% to $45.3 million in the three month period ended June 30, 2008, from $22.2 million in the comparable period of 2007. Our distribution expenses increased primarily due to $10.4 million of higher wage and benefit costs from an increase in the number of employees, higher fuel costs of $5.8 million, higher truck rentals and repairs of $3.0 million, and higher third party freight of $2.6 million. Our acquisition of Keystone accounted for the majority of the increases. As a percentage of revenue, our distribution expenses decreased from 9.5% to 9.4%.

 

Selling, General, and Administrative Expenses. Selling, general, and administrative expenses increased 119.5% to $61.8 million in the three month period ended June 30, 2008, from $28.1 million in the comparable period of 2007. As a percentage of revenue our selling, general, and administrative expenses increased from 12.1% to 12.7%. The majority of the expense increase was a result of an increase in labor and labor-related expenses of $23.5 million due primarily to higher sales commission expenses and increased headcount. Our selling expenses tend to rise as revenue increases due to our commissioned sales forces. Our remaining selling, general and administrative expenses increased due primarily to higher professional fees of $2.2 million, higher telephone expense of $1.6 million, higher bad debt expense of $1.4 million, and higher advertising and promotion of $1.1 million. Our acquisition of Keystone accounted for a majority of the increases.

 

Restructuring Expenses.  Restructuring expenses totaled $3.1 million in the three month period ended June 30, 2008. We had no restructuring expenses in the comparable period of 2007. The restructuring expenses are the result of our integration of Keystone and pre-existing LKQ operations, and include $0.4 million of severance and relocation costs for LKQ employees, LKQ facility closure costs and moving expenses of $2.7 million for pre-existing LKQ facilities, and professional fees of $0.1 million.

 

Depreciation and Amortization. Depreciation and amortization (including that reported in cost of goods sold above) increased 120.0% to $7.9 million in the three month period ended June 30, 2008, from $3.6 million in the comparable period of 2007. Our acquisition of Keystone accounted for the majority of the increase in depreciation and amortization expense, including $0.9 million of amortization of the Keystone trade name.

 

Operating Income. Operating income increased 119.3% to $58.4 million in the three month period ended June 30, 2008 from $26.6 million in the comparable period of 2007. As a percentage of revenue, operating income increased from 11.4% to 12.1%.

 

Other (Income) Expense.  Total other expense, net increased 285.3% to $8.0 million for the three month period ended June 30, 2008, from $2.1 million for the comparable period of 2007.  Net interest expense increased 301.9% to $8.4 million for the three month period ended June 30, 2008, from $2.1 million for the comparable period of 2007.  Our average bank borrowings were approximately $528.4 million higher at June 30, 2008 as compared to June 30, 2007, due primarily to the Keystone acquisition.  Other income increased $0.4 million, to $0.5 million in the three month period ended June 30, 2008, from $0.1 million for the comparable period of 2007.

 

Provision for Income Taxes. The provision for income taxes increased 84.3% to $19.5 million in the three month period ended June 30, 2008, from $10.6 million in the comparable period of 2007, due primarily to improved operating results. Our effective tax rate was 38.6% in 2008 and 43.0% in 2007. The decrease in our effective income tax rate in 2008 was due primarily to lower taxes on our Canadian operations as well as from the benefit of a state net operating loss that is now expected to be realizable. Additionally, our 2007 effective rate was impacted by the enactment of a new income tax law in April 2007 (retroactive to January 1, 2007) in a state in which we operate. We reduced certain deferred tax assets and increased our income tax provision by approximately $0.6 million in the second quarter of 2007 as a result of this new law.

 

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Six Months Ended June 30, 2008 Compared to Six Months Ended June 30, 2007

 

Revenue. Our revenue increased 108.3% to $976.3 million for the six month period ended June 30, 2008, from $468.6 million for the comparable period of 2007. The increase in revenue was primarily due to business acquisitions, in particular Keystone.  In addition, we had a higher volume of products we sold and higher volumes of vehicle processing that resulted in higher revenue from processing fees and the sale of scrap and other commodities derived from our dismantling process. Organic revenue growth was approximately 11.2% in the six month period ended June 30, 2008, and was calculated assuming we had owned Keystone since January 1, 2007. The integration of our pre-existing aftermarket and wheel operations with Keystone prevents us from measuring revenue growth between Keystone and our pre-existing businesses since the acquisition.

 

Cost of Goods Sold. Our cost of goods sold increased 108.0% to $533.3 million in the six month period ended June 30, 2008, from $256.4 million in the comparable period of 2007. The increase in cost of goods sold was primarily due to increased volume of products sold. Our acquisition of Keystone accounted for a majority of the increases.  As a percentage of revenue, cost of goods sold decreased from 54.7% to 54.6%.

 

Gross Margin. Our gross margin increased 108.8% to $443.0 million in the six month period ended June 30, 2008, from $212.2 million in the comparable period of 2007. Our gross margin increased primarily due to increased volume. As a percentage of revenue, gross margin increased from 45.3% to 45.4%.

 

Facility and Warehouse Expenses. Facility and warehouse expenses increased 75.8% to $88.3 million in the six month period ended June 30, 2008, from $50.2 million in the comparable period of 2007. Our facility and warehouse expenses increased primarily due to $19.1 million in higher wages and fringe benefits resulting from increased headcount and stock-based compensation expenses for field personnel, along with $16.5 million related to higher facility and equipment rent, property taxes, repairs and maintenance, utilities and supplies. Our acquisition of Keystone accounted for a majority of the increases. As a percentage of revenue, facility and warehouse expenses decreased from 10.7% to 9.0%, as we achieved greater leverage from combining Keystone with our existing LKQ operations.

 

Distribution Expenses. Distribution expenses increased 103.0% to $90.1 million in the six month period ended June 30, 2008, from $44.4 million in the comparable period of 2007.  Our distribution expenses increased due to higher wages and fringe benefits of $21.5 million primarily from an increase in the number of employees, and higher fuel costs of $10.9 million, higher truck rentals and repairs of $6.0 million, and higher third party freight of $4.8 million. Our acquisition of Keystone accounted for a majority of the increases. As a percentage of revenue, our distribution expenses decreased from 9.5% to 9.2%.

 

 Selling, General, and Administrative Expenses. Selling, general, and administrative expenses increased 121.3% to $125.9 million in the six month period ended June 30, 2008, from $56.9 million in the comparable period of 2007. As a percentage of revenue our selling, general, and administrative expenses increased from 12.1% to 12.9%. The majority of the expense increase was a result of an increase in labor and labor-related expenses of $49.2 million due primarily to higher sales commission expenses and increased headcount. Our selling expenses tend to rise as revenue increases due to our commissioned sales forces. Our remaining selling, general and administrative expenses increased due primarily to higher professional fees of $4.6 million, higher telephone expense of $3.1 million, higher bad debt expense of $2.1 million, and higher advertising and promotion of $2.3 million. Our acquisition of Keystone accounted for a majority of the increases.

 

Restructuring Expenses.  Restructuring expenses totaled $4.3 million in the six month period ended June 30, 2008. We had no restructuring expenses in the comparable period of 2007. The restructuring expenses are the result of our integration of Keystone into pre-existing LKQ operations, and include $0.5 million of severance and relocation costs for LKQ employees, facility closure costs and moving expenses of $3.5 million for pre-existing LKQ facilities, and professional fees of $0.4 million.

 

Depreciation and Amortization. Depreciation and amortization (including that reported in cost of goods sold above) increased 123.9% to $15.8 million in the six month period ended June 30, 2008, from $7.1 million in the comparable period of 2007. Our acquisition of Keystone accounted for the majority of the increase in depreciation and amortization expense, including $1.9 million of amortization of the Keystone trade name.

 

Operating Income. Operating income increased 122.5% to $119.9 million in the six month period ended June 30, 2008 from $53.9 million in the comparable period of 2007. As a percentage of revenue, operating income increased from 11.5% to 12.3%.

 

Other (Income) Expense. Total other expense, net increased 471.0% to $18.0 million for the six month period ended June 30, 2008, from $3.2 million for the comparable period of 2007.  Net interest expense increased 389.1% to $18.7 million for the six month period ended June 30, 2008, from $3.8 million for the comparable period of 2007.  Our average bank borrowings were approximately

 

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$540.8 million higher for the six month period ended June 30, 2008 as compared to the six month period ended June 30, 2007, due primarily to acquisitions.  Other income was $0.7 million in each of the six month periods ended June 30, 2008 and 2007, respectively.