LKQ-2014.06.30 10-Q

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________________ 
FORM 10-Q
________________________ 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2014
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from              to
Commission File Number: 000-50404
________________________ 
LKQ CORPORATION
(Exact name of registrant as specified in its charter)
________________________ 
DELAWARE
 
36-4215970
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
500 WEST MADISON STREET,
SUITE 2800, CHICAGO, IL
 
60661
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (312) 621-1950
________________________ 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
At July 25, 2014, the registrant had issued and outstanding an aggregate of 302,661,457 shares of Common Stock.
 




PART I
FINANCIAL INFORMATION

Item 1.
Financial Statements.

LKQ CORPORATION AND SUBSIDIARIES
Unaudited Condensed Consolidated Balance Sheets
(In thousands, except share and per share data)
 
June 30,
 
December 31,
 
2014
 
2013
Assets
 
 
 
Current Assets:
 
 
 
Cash and equivalents
$
109,564

 
$
150,488

Receivables, net
624,300

 
458,094

Inventory
1,346,723

 
1,076,952

Deferred income taxes
74,092

 
63,938

Prepaid expenses and other current assets
86,047

 
50,345

Total Current Assets
2,240,726

 
1,799,817

Property and Equipment, net
621,600

 
546,651

Intangible Assets:
 
 
 
Goodwill
2,308,943

 
1,937,444

Other intangibles, net
230,429

 
153,739

Other Assets
97,147

 
81,123

Total Assets
$
5,498,845

 
$
4,518,774

Liabilities and Stockholders’ Equity
 
 
 
Current Liabilities:
 
 
 
Accounts payable
$
392,659

 
$
349,069

Accrued expenses:
 
 
 
Accrued payroll-related liabilities
70,515

 
58,695

Sales taxes payable
50,998

 
30,701

Other accrued expenses
127,119

 
109,373

Contingent consideration liabilities
2,304

 
52,465

Other current liabilities
35,126

 
36,115

Current portion of long-term obligations
71,487

 
41,535

Total Current Liabilities
750,208

 
677,953

Long-Term Obligations, Excluding Current Portion
1,879,837

 
1,264,246

Deferred Income Taxes
160,452

 
133,822

Other Noncurrent Liabilities
105,832

 
92,008

Commitments and Contingencies
 
 
 
Stockholders’ Equity:
 
 
 
Common stock, $0.01 par value,1,000,000,000 shares authorized, 302,189,513 and 300,805,276 shares issued and outstanding at June 30, 2014 and December 31, 2013, respectively
3,022

 
3,008

Additional paid-in capital
1,031,807

 
1,006,084

Retained earnings
1,531,177

 
1,321,642

Accumulated other comprehensive income
36,510

 
20,011

Total Stockholders’ Equity
2,602,516

 
2,350,745

Total Liabilities and Stockholders’ Equity
$
5,498,845

 
$
4,518,774


See notes to unaudited condensed consolidated financial statements.
2







LKQ CORPORATION AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Income
(In thousands, except per share data)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Revenue
$
1,709,132

 
$
1,251,748

 
$
3,334,909

 
$
2,447,745

Cost of goods sold
1,038,073

 
741,875

 
2,011,966

 
1,435,923

Gross margin
671,059

 
509,873

 
1,322,943

 
1,011,822

Facility and warehouse expenses
128,506

 
102,885

 
254,665

 
203,131

Distribution expenses
146,544

 
106,583

 
283,873

 
210,440

Selling, general and administrative expenses
186,585

 
146,012

 
371,115

 
283,068

Restructuring and acquisition related expenses
5,901

 
3,680

 
9,222

 
5,185

Depreciation and amortization
29,927

 
19,335

 
56,638

 
37,032

Operating income
173,596

 
131,378

 
347,430

 
272,966

Other expense (income):
 
 
 
 
 
 
 
Interest expense, net
15,628

 
12,492

 
31,746

 
21,087

Loss on debt extinguishment

 
2,795

 
324

 
2,795

Change in fair value of contingent consideration liabilities
(790
)
 
230

 
(2,012
)
 
1,053

Other income, net
(907
)
 
(577
)
 
(1,003
)
 
(175
)
Total other expense, net
13,931

 
14,940

 
29,055

 
24,760

Income before provision for income taxes
159,665

 
116,438

 
318,375

 
248,206

Provision for income taxes
54,341

 
40,716

 
108,362

 
87,892

Equity in earnings of unconsolidated subsidiaries
(442
)
 

 
(478
)
 

Net income
$
104,882

 
$
75,722

 
$
209,535

 
$
160,314

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.35

 
$
0.25

 
$
0.69

 
$
0.54

Diluted
$
0.34

 
$
0.25

 
$
0.69

 
$
0.53


Unaudited Condensed Consolidated Statements of Comprehensive Income
(In thousands)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Net income
$
104,882

 
$
75,722

 
$
209,535

 
$
160,314

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation
15,879

 
(3,204
)
 
15,316

 
(22,184
)
Net change in unrecognized gains/losses on derivative instruments, net of tax
457

 
2,629

 
1,250

 
3,361

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

 
(67
)
 

Total other comprehensive income (loss)
16,306

 
(575
)
 
16,499

 
(18,823
)
Total comprehensive income
$
121,188

 
$
75,147

 
$
226,034

 
$
141,491


See notes to unaudited condensed consolidated financial statements.
3




LKQ CORPORATION AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Cash Flows
(In thousands)
 
Six Months Ended
 
June 30,
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
209,535

 
$
160,314

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
58,893

 
39,711

Stock-based compensation expense
11,783

 
10,562

Excess tax benefit from stock-based payments
(9,747
)
 
(10,902
)
Other
1,645

 
6,126

Changes in operating assets and liabilities, net of effects from acquisitions:
 
 
 
Receivables
(71,779
)
 
(50,320
)
Inventory
(40,773
)
 
(6,227
)
Prepaid income taxes/income taxes payable
9,653

 
34,521

Accounts payable
(20,549
)
 
14,361

Other operating assets and liabilities
3,543

 
11,344

Net cash provided by operating activities
152,204

 
209,490

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of property and equipment
(67,331
)
 
(40,151
)
Proceeds from sales of property and equipment
2,581

 
1,251

Investments in unconsolidated subsidiaries
(2,240
)
 

Acquisitions, net of cash acquired
(635,332
)
 
(308,579
)
Net cash used in investing activities
(702,322
)
 
(347,479
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from exercise of stock options
4,207

 
10,604

Excess tax benefit from stock-based payments
9,747

 
10,902

Debt issuance costs
(3,715
)
 
(16,521
)
Proceeds from issuance of senior notes

 
600,000

Borrowings under revolving credit facility
1,160,461

 
353,408

Repayments under revolving credit facility
(674,432
)
 
(708,060
)
Borrowings under term loans
11,250

 
35,000

Repayments under term loans
(5,625
)
 
(5,625
)
Borrowings under receivables securitization facility
80,000

 
1,500

Repayments under receivables securitization facility

 
(1,500
)
Repayments of other long-term debt
(13,529
)
 
(6,465
)
Settlements of foreign currency forward contracts
(19,959
)
 

Payments of other obligations
(41,934
)
 
(32,091
)
Net cash provided by financing activities
506,471

 
241,152

Effect of exchange rate changes on cash and equivalents
2,723

 
(1,343
)
Net (decrease) increase in cash and equivalents
(40,924
)
 
101,820

Cash and equivalents, beginning of period
150,488

 
59,770

Cash and equivalents, end of period
$
109,564

 
$
161,590

Supplemental disclosure of cash paid for:
 
 
 
Income taxes, net of refunds
$
98,938

 
$
53,459

Interest
29,182

 
15,286

Supplemental disclosure of noncash investing and financing activities:
 
 
 
Notes payable and other obligations, including notes issued and debt assumed in connection with business acquisitions
$
87,983

 
$
7,260

Contingent consideration liabilities
7,057

 
2,650

Non-cash property and equipment additions
4,177

 
3,407


See notes to unaudited condensed consolidated financial statements.
4




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

 
$
3,008

 
$
1,006,084

 
$
1,321,642

 
$
20,011

 
$
2,350,745

Net income

 

 

 
209,535

 

 
209,535

Other comprehensive income

 

 

 

 
16,499

 
16,499

Restricted stock units vested
562

 
6

 
(6
)
 

 

 

Stock-based compensation expense

 

 
11,783

 

 

 
11,783

Exercise of stock options
823

 
8

 
4,199

 

 

 
4,207

Excess tax benefit from stock-based payments

 

 
9,747

 

 

 
9,747

BALANCE, June 30, 2014
302,190

 
$
3,022

 
$
1,031,807

 
$
1,531,177

 
$
36,510

 
$
2,602,516




See notes to unaudited condensed consolidated financial statements.
5




LKQ CORPORATION AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements

Note 1.
Interim Financial Statements
The unaudited financial statements presented in this report represent the consolidation of LKQ Corporation, a Delaware corporation, and its subsidiaries. LKQ Corporation is a holding company and all operations are conducted by subsidiaries. When the terms "LKQ," "the Company," "we," "us," or "our" are used in this document, those terms refer to LKQ Corporation and its consolidated subsidiaries.
We have prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") applicable to interim financial statements. Accordingly, certain information related to our significant accounting policies and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These unaudited condensed consolidated financial statements reflect, in the opinion of management, all material adjustments (which include only normally recurring adjustments) necessary to fairly state, in all material respects, our financial position, results of operations and cash flows for the periods presented.
Operating results for interim periods are not necessarily indicative of the results that can be expected for any subsequent interim period or for a full year. These interim financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto included in our most recent Annual Report on Form 10-K for the year ended December 31, 2013 filed with the SEC on March 3, 2014.
As described in Note 8, "Business Combinations," on January 3, 2014, we completed our acquisition of Keystone Automotive Holdings, Inc. ("Keystone Specialty"), a distributor and marketer of specialty aftermarket equipment and accessories in North America. With our acquisition of Keystone Specialty, we present an additional reportable segment, Specialty. Our unaudited condensed consolidated financial statements reflect the impact of Keystone Specialty from the date of acquisition through June 30, 2014.

Note 2.
Financial Statement Information
Revenue Recognition
The majority of our revenue is derived from the sale of vehicle parts. Revenue is recognized when the products are shipped, delivered to or picked up by customers and title has transferred, subject to an allowance for estimated returns, discounts and allowances that we estimate based upon historical information. We recorded a reserve for estimated returns, discounts and allowances of approximately $30.6 million and $26.6 million at June 30, 2014 and December 31, 2013, respectively. We present taxes assessed by governmental authorities collected from customers on a net basis. Therefore, the taxes are excluded from revenue on our Unaudited Condensed Consolidated Statements of Income and are shown as a current liability on our Unaudited Condensed Consolidated Balance Sheets until remitted. We recognize revenue from the sale of scrap, cores and other metals when title has transferred, which typically occurs upon delivery to the customer.
Allowance for Doubtful Accounts
We recorded a reserve for uncollectible accounts of approximately $18.6 million and $14.4 million at June 30, 2014 and December 31, 2013, respectively.
Inventory
Inventory consists of the following (in thousands):
 
June 30,
 
December 31,
 
2014
 
2013
Aftermarket and refurbished products
$
955,428

 
$
706,600

Salvage and remanufactured products
391,295

 
370,352

 
$
1,346,723

 
$
1,076,952


Our acquisitions completed during the first half of 2014 and adjustments to preliminary valuations of inventory for certain of our 2013 acquisitions contributed $211.6 million of the increase in our aftermarket and refurbished products inventory and $10.7 million of the increase in our salvage and remanufactured products inventory during the six months ended June 30, 2014. See Note 8, "Business Combinations," for further information on our acquisitions.

6





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

 
$
578,507

 
$

 
$
1,937,444

Business acquisitions and adjustments to previously recorded goodwill
49,451

 
74,313

 
234,381

 
358,145

Exchange rate effects
(317
)
 
13,675

 
(4
)
 
13,354

Balance as of June 30, 2014
$
1,408,071

 
$
666,495

 
$
234,377

 
$
2,308,943

The components of other intangibles are as follows (in thousands):
 
June 30, 2014
 
December 31, 2013
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Trade names and trademarks
$
168,537

 
$
(31,982
)
 
$
136,555

 
$
143,577

 
$
(27,950
)
 
$
115,627

Customer relationships
69,575

 
(18,191
)
 
51,384

 
29,583

 
(10,770
)
 
18,813

Software and other technology related assets
47,087

 
(6,971
)
 
40,116

 
20,384

 
(2,718
)
 
17,666

Covenants not to compete
5,173

 
(2,799
)
 
2,374

 
3,979

 
(2,346
)
 
1,633

 
$
290,372

 
$
(59,943
)
 
$
230,429

 
$
197,523

 
$
(43,784
)
 
$
153,739

During the six months ended June 30, 2014, we recorded preliminary intangible asset valuations resulting from our 2014 acquisitions and adjustments to certain preliminary intangible asset valuations from our 2013 acquisitions, which included $23.6 million of trade names, $39.4 million of customer relationships, $26.8 million of software and other technology related assets and $1.2 million of covenants not to compete. The trade names, customer relationships, and software and technology related assets recorded in the six months ended June 30, 2014 included $20.9 million, $23.1 million and $26.8 million, respectively, related to our acquisition of Keystone Specialty, as discussed in Note 8, "Business Combinations."
Trade names and trademarks are amortized over a useful life ranging from 10 to 30 years on a straight-line basis. Customer relationships are amortized over the expected period to be benefited (5 to 15 years) on either a straight-line or accelerated basis. Software and other technology related assets are amortized on a straight-line basis over the expected period to be benefited (five to six years). Covenants not to compete are amortized over the lives of the respective agreements, which range from one to five years, on a straight-line basis. Amortization expense for intangibles was $15.8 million and $5.3 million during the six month periods ended June 30, 2014 and 2013, respectively. Estimated amortization expense for each of the five years in the period ending December 31, 2018 is $31.8 million, $29.1 million, $26.0 million, $23.7 million and $18.6 million, respectively.
Warranty Reserve
Some of our salvage mechanical products are sold with a standard six month warranty against defects. Additionally, some of our remanufactured engines are sold with a standard three year warranty against defects. We also provide a limited lifetime warranty for certain of our aftermarket products that is supported by certain of the suppliers of those products. We record the estimated warranty costs at the time of sale using historical warranty claim information to project future warranty claims activity. The changes in the warranty reserve during the six month period ended June 30, 2014 were as follows (in thousands):
Balance as of January 1, 2014
$
12,447

Warranty expense
15,375

Warranty claims
(13,623
)
Balance as of June 30, 2014
$
14,199


7





Investments in Unconsolidated Subsidiaries
As of June 30, 2014, the carrying value of our investments in unconsolidated subsidiaries was $11.0 million; of this amount, $8.9 million relates to our investment in ACM Parts Pty Ltd ("ACM Parts"). In August 2013, we entered into an agreement with Suncorp Group, a leading general insurance group in Australia and New Zealand, to develop ACM Parts, an alternative vehicle replacement parts business in those countries. We hold a 49% equity interest in the entity and will contribute our experience to help establish automotive parts recycling operations and to facilitate the procurement of aftermarket parts; Suncorp Group holds a 51% equity interest and will supply salvage vehicles to the venture as well as assist in establishing relationships with repair shops as customers. We are accounting for our interest in this subsidiary using the equity method of accounting, as our investment gives us the ability to exercise significant influence, but not control, over the investee. The total of our investment in ACM Parts and other unconsolidated subsidiaries is included within Other Assets on our Unaudited Condensed Consolidated Balance Sheets. Our equity in the net earnings of the investees for the three and six months ended June 30, 2014 was not material.
Depreciation Expense
Included in Cost of Goods Sold on the Unaudited Condensed Consolidated Statements of Income is depreciation expense associated with our refurbishing, remanufacturing, and furnace operations as well as our distribution centers.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update 2014-09, "Revenue from Contracts with Customers" ("ASU 2014-09"). This update outlines a new comprehensive revenue recognition model which supersedes most current revenue recognition guidance, and requires companies to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Entities adopting the standard have the option of using either a full retrospective or modified retrospective approach in the application of this guidance. ASU 2014-09 will be effective for the Company during the first quarter of our fiscal year 2017. Early adoption is not permitted. We are still evaluating the impact that ASU 2014-09 will have on our consolidated financial statements and related disclosures.
In June 2014, the FASB issued Accounting Standards Update 2014-12, "Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period" ("ASU 2014-12"). This update requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition, and requires the recognition of compensation cost in the period in which it becomes probable that the performance target will be achieved. ASU 2014-12 will be effective for the Company during the first quarter of our fiscal year 2016. Early adoption is permitted. The new standard can be applied either prospectively to all awards granted or modified after the effective date or retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements as an adjustment to opening retained earnings. We do not anticipate the adoption of this guidance will have a material impact on our financial position, results of operations, cash flows, or disclosures.

Note 3.
Equity Incentive Plans
In order to attract and retain employees, non-employee directors, consultants, and other persons associated with us, we may grant qualified and nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units (“RSUs”), performance shares and performance units under the LKQ Corporation 1998 Equity Incentive Plan (the “Equity Incentive Plan”). We have granted RSUs, stock options, and restricted stock under the Equity Incentive Plan. We expect to issue new shares of common stock to cover past and future equity grants.
RSUs
RSUs vest over periods of up to five years. RSUs may contain either a time-based vesting condition or a combination of a performance-based vesting condition and a time-based vesting condition, in which case, both conditions must be met before any RSUs vest. For RSUs containing a performance-based vesting condition, the Company must report positive diluted earnings per share, subject to certain adjustments, during any fiscal year period within five years following the grant date. Each RSU converts into one share of LKQ common stock on the applicable vesting date. The grant date fair value of RSUs is based on the market price of LKQ stock on the grant date.
During the six months ended June 30, 2014, our Board of Directors granted 663,397 RSUs to employees. The fair value of RSUs that vested during the six months ended June 30, 2014 was approximately $16.7 million.
Stock Options

8





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

 
2,558,213

 
$
16.63

 
6,832,331

 
$
7.04

 
20,000

 
$
9.30

Granted
(790,152
)
 
663,397

 
31.83

 
126,755

 
32.31

 

 

Exercised

 

 

 
(822,039
)
 
5.12

 

 

Vested

 
(562,198
)
 
16.56

 

 

 
(10,000
)
 
9.30

Canceled
102,703

 
(56,830
)
 
20.11

 
(45,873
)
 
13.01

 

 

Balance, June 30, 2014
13,277,991

 
2,602,582

 
$
20.44

 
6,091,174

 
$
7.78


10,000

 
$
9.30

For the RSU grants that contain both a performance-based vesting condition and a time-based vesting condition, we recognize compensation expense under the accelerated attribution method, pursuant to which expense is recognized over the requisite service period for each separate vesting tranche of the award. During the three and six months ended June 30, 2014, we recognized $2.1 million and $4.7 million of stock based compensation expense, respectively, related to the RSUs containing a performance-based vesting condition. During the three and six months ended June 30, 2013 we recognized $2.3 million and $3.7 million of stock based compensation expense, respectively, related to the RSUs containing a performance-based vesting condition. For all other awards, which are subject to only a time-based vesting condition, we recognize compensation expense on a straight-line basis over the requisite service period of the entire award.
In all cases, compensation expense is adjusted to reflect estimated forfeitures. When estimating forfeitures, we consider voluntary and involuntary termination behavior as well as analysis of historical forfeitures.
The components of pre-tax stock-based compensation expense are as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
RSUs
$
4,795

 
$
4,443

 
$
10,191

 
$
8,115

Stock options
696

 
1,124

 
1,500

 
2,333

Restricted stock
46

 
46

 
92

 
114

Total stock-based compensation expense
$
5,537

 
$
5,613

 
$
11,783

 
$
10,562

The following table sets forth the classification of total stock-based compensation expense included in our Unaudited Condensed Consolidated Statements of Income (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Cost of goods sold
$
100

 
$
98

 
$
203

 
$
196

Facility and warehouse expenses
566

 
687

 
1,145

 
1,371

Selling, general and administrative expenses
4,871

 
4,828

 
10,435

 
8,995

 
5,537

 
5,613

 
11,783

 
10,562

Income tax benefit
(2,131
)
 
(2,189
)
 
(4,536
)
 
(4,119
)
Total stock-based compensation expense, net of tax
$
3,406

 
$
3,424

 
$
7,247

 
$
6,443


9





We have not capitalized any stock-based compensation costs during either of the six month periods ended June 30, 2014 or 2013.
As of June 30, 2014, unrecognized compensation expense related to unvested RSUs, stock options and restricted stock is expected to be recognized as follows (in thousands):
 
RSUs
 
Stock
Options
 
Restricted
Stock
 
Total
Remainder of 2014
$
8,805

 
$
1,455

 
$
47

 
$
10,307

2015
13,608

 
398

 

 
14,006

2016
8,498

 
331

 

 
8,829

2017
5,034

 
9

 

 
5,043

2018
2,546

 

 

 
2,546

2019
108

 

 

 
108

Total unrecognized compensation expense
$
38,599

 
$
2,193

 
$
47

 
$
40,839


Note 4.
Long-Term Obligations
Long-Term Obligations consist of the following (in thousands):
 
June 30,
 
December 31,
 
2014
 
2013
Senior secured credit agreement:
 
 
 
Term loans payable
$
444,375

 
$
438,750

Revolving credit facility
731,201

 
233,804

Senior notes
600,000

 
600,000

Receivables securitization facility
80,000

 

Notes payable through October 2018 at weighted average interest rates of 1.1%
55,908

 
15,730

Other long-term debt at weighted average interest rates of 3.1% and 3.5%, respectively
39,840

 
17,497

 
1,951,324

 
1,305,781

Less current maturities
(71,487
)
 
(41,535
)
 
$
1,879,837

 
$
1,264,246

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

10





beginning on June 30, 2014 with the remaining balance due and payable on the maturity date of the Credit Agreement. We are required to prepay the term loan by amounts equal to proceeds from the sale or disposition of certain assets if the proceeds are not reinvested within twelve months. We also have the option to prepay outstanding amounts under the Credit Agreement without penalty.
The Credit Agreement contains customary representations and warranties, and contains customary covenants that provide limitations and conditions on our ability to enter into certain transactions. The Credit Agreement also contains financial and affirmative covenants under which we (i) may not exceed a maximum net leverage ratio of 3.50 to 1.00 except in connection with permitted acquisitions with aggregate consideration in excess of $200 million during any period of four consecutive fiscal quarters in which case the maximum net leverage ratio may increase to 4.00 to 1.00 for the subsequent four fiscal quarters and (ii) are required to maintain a minimum interest coverage ratio of 3.00 to 1.00.
Borrowings under the Credit Agreement bear interest at variable rates, which depend on the currency and duration of the borrowing elected, plus an applicable margin. The applicable margin is subject to change in increments of 0.25% depending on our net leverage ratio. Interest payments are due on the last day of the selected interest period or quarterly in arrears depending on the type of borrowing. Including the effect of the interest rate swap agreements described in Note 5, "Derivative Instruments and Hedging Activities," the weighted average interest rates on borrowings outstanding under the Credit Agreement at June 30, 2014 and December 31, 2013 were 2.37% and 3.05%, respectively. We also pay a commitment fee based on the average daily unused amount of the revolving credit facility. The commitment fee is subject to change in increments of 0.05% depending on our net leverage ratio. In addition, we pay a participation commission on outstanding letters of credit at an applicable rate based on our net leverage ratio, as well as a fronting fee of 0.125% to the issuing bank, which are due quarterly in arrears. Borrowings under the Credit Agreement totaled $1.2 billion and $672.6 million at June 30, 2014 and December 31, 2013, respectively, of which $22.5 million was classified as current maturities at both June 30, 2014 and December 31, 2013. As of June 30, 2014, there were letters of credit outstanding in the aggregate amount of $60.5 million. The amounts available under the revolving credit facility are reduced by the amounts outstanding under letters of credit, and thus availability under the revolving credit facility at June 30, 2014 was $1.1 billion.
Related to the execution of the Credit Agreement in March 2014, we incurred $3.7 million of fees, of which $3.4 million were capitalized within Other Assets on our Unaudited Condensed Consolidated Balance Sheet and are amortized over the term of the agreement. The remaining $0.3 million of fees were expensed during the six months ended June 30, 2014 as a loss on debt extinguishment. Related to the execution of the second amended and restated credit agreement in May 2013, we incurred $7.1 million of fees, of which $6.0 million were capitalized within Other Assets on our Unaudited Condensed Consolidated Balance Sheet. The remaining $1.1 million of fees, together with $1.7 million of capitalized debt issuance costs related to the original credit agreement, were expensed during the three and six months ended June 30, 2013 as a loss on debt extinguishment.
Senior Notes
On May 9, 2013, we completed an offering of $600 million aggregate principal amount of senior notes due May 15, 2023 (the "Original Notes") in a private placement conducted pursuant to Rule 144A and Regulation S under the Securities Act of 1933. In April 2014, we completed an offer to exchange $600 million aggregate principal amount of registered 4.75% Senior Notes due 2023 (the "Notes") for the Original Notes. The Notes are governed by the Indenture dated as of May 9, 2013 among LKQ Corporation, certain of our subsidiaries (the "Guarantors") and U.S. Bank National Association, as trustee. The Notes are substantially identical to the Original Notes, except the Notes are registered under the Securities Act of 1933, and the transfer restrictions, registration rights, and related additional interest provisions applicable to the Original Notes do not apply to the Notes.
The Notes bear interest at a rate of 4.75% per year from the date of the original issuance or from the most recent payment date on which interest has been paid or provided for. Interest on the Notes is payable in arrears on May 15 and November 15 of each year. The first interest payment was made on November 15, 2013. The Notes are fully and unconditionally guaranteed, jointly and severally, by the Guarantors.
The Notes and the guarantees are, respectively, our and each Guarantor's senior unsecured obligations and are subordinated to all of the Guarantors' existing and future secured debt to the extent of the assets securing that secured debt. In addition, the Notes are effectively subordinated to all of the liabilities of our subsidiaries that are not guaranteeing the Notes to the extent of the assets of those subsidiaries.
Receivables Securitization Facility
On September 28, 2012, we entered into a three year receivables securitization facility with BTMU as Administrative Agent. Under the facility, LKQ sells an ownership interest in certain receivables, related collections and security interests to BTMU for the benefit of conduit investors and/or financial institutions for up to $80 million in cash proceeds. Upon payment of

11





the receivables by customers, rather than remitting to BTMU the amounts collected, LKQ retains such collections as proceeds for the sale of new receivables generated by certain of the ongoing operations of the Company.
The sale of the ownership interest in the receivables is accounted for as a secured borrowing in our Unaudited Condensed Consolidated Balance Sheets, under which the receivables included in the program collateralize the amounts invested by BTMU, the conduit investors and/or financial institutions (the "Purchasers"). The receivables are held by LKQ Receivables Finance Company, LLC ("LRFC"), a wholly owned bankruptcy-remote special purpose subsidiary of LKQ, and therefore, the receivables are available first to satisfy the creditors of LRFC, including the investors. As of June 30, 2014, $123.2 million of net receivables were collateral for the investment under the receivables facility. There were no borrowings outstanding under the receivables facility as of December 31, 2013.
Under the receivables facility, we pay variable interest rates plus a margin on the outstanding amounts invested by the Purchasers. The variable rates are based on (i) commercial paper rates, (ii) the London InterBank Offered Rate ("LIBOR") plus 1.25%, or (iii) base rates, and are payable monthly in arrears. Commercial paper rates will be the applicable variable rate unless conduit investors are not available to invest in the receivables at commercial paper rates. In such case, financial institutions will invest at the LIBOR rate plus 1.25% or at base rates. We also pay a commitment fee on the excess of the investment maximum over the average daily outstanding investment, payable monthly in arrears. As of June 30, 2014, the interest rate under the receivables facility was based on commercial paper rates and was 0.99%. The outstanding balance of $80 million as of June 30, 2014 was classified as long-term on the Unaudited Condensed Consolidated Balance Sheets because we have the ability and intent to refinance these borrowings on a long-term basis.

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

12





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

 
$
420,000

 
$
6,786

 
$

 
$
8,099

GBP denominated
 
£
50,000

 
£
50,000

 
111

 

 
345

CAD denominated
 
C$
25,000

 
C$
25,000

 
35

 

 
26

Foreign currency forward contracts
 
 
 
 
 
 
EUR denominated
 

 
149,976

 

 
11,632

 

GBP denominated
 
£

 
£
70,000

 

 
10,186

 

Total cash flow hedges
 
$
6,932

 
$
21,818

 
$
8,470

 
While our derivative instruments executed with the same counterparty are subject to master netting arrangements, we present our cash flow hedge derivative instruments on a gross basis in our Unaudited Condensed Consolidated Balance Sheets. The impact of netting the fair values of these contracts would not have a material effect on our Unaudited Condensed Consolidated Balance Sheets at June 30, 2014 or December 31, 2013.
The activity related to our cash flow hedges is included in Note 12, "Accumulated Other Comprehensive Income (Loss)." Ineffectiveness related to our cash flow hedges was immaterial to our results of operations during the three and six months ended June 30, 2014 and June 30, 2013. We do not expect future ineffectiveness related to our cash flow hedges to have a material effect on our results of operations.
As of June 30, 2014, we estimate that $3.8 million of derivative losses (net of tax) included in Accumulated Other Comprehensive Income will be reclassified into our consolidated statements of income within the next 12 months.
Other Derivative Instruments
We hold other short-term derivative instruments, including foreign currency forward contracts to manage our exposure to variability related to inventory purchases and intercompany financing transactions denominated in a non-functional currency, as well as commodity forward contracts to manage our exposure to fluctuations in metals prices. We have elected not to apply hedge accounting for these transactions, and therefore the contracts are adjusted to fair value through our results of operations as of each balance sheet date, which could result in volatility in our earnings. The notional amount and fair value of these contracts at June 30, 2014 and December 31, 2013, along with the effect on our results of operations during each of the six month periods ended June 30, 2014 and June 30, 2013, were immaterial.

Note 6.
Fair Value Measurements
Financial Assets and Liabilities Measured at Fair Value
We use the market and income approaches to value our financial assets and liabilities, and during the six months ended June 30, 2014, there were no significant changes in valuation techniques or inputs related to the financial assets or liabilities that we have historically recorded at fair value. The tiers in the fair value hierarchy include: Level 1, defined as observable inputs such as quoted market prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

13





The following tables present information about our financial assets and liabilities measured at fair value on a recurring basis and indicate the fair value hierarchy of the valuation inputs we utilized to determine such fair value as of June 30, 2014 and December 31, 2013 (in thousands):
 
Balance as of June 30, 2014
 
Fair Value Measurements as of June 30, 2014
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
Cash surrender value of life insurance
$
27,410

 
$

 
$
27,410

 
$

Total Assets
$
27,410

 
$

 
$
27,410

 
$

Liabilities:
 
 
 
 
 
 
 
Contingent consideration liabilities
$
8,762

 
$

 
$

 
$
8,762

Deferred compensation liabilities
26,805

 

 
26,805

 

Interest rate swaps
6,932

 

 
6,932

 

Total Liabilities
$
42,499

 
$

 
$
33,737

 
$
8,762

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

 
$

 
$
25,745

 
$

Total Assets
$
25,745

 
$

 
$
25,745

 
$

Liabilities:
 
 
 
 
 
 
 
Contingent consideration liabilities
$
55,653

 
$

 
$

 
$
55,653

Deferred compensation liabilities
25,232

 

 
25,232

 

Foreign currency forward contracts
21,818

 

 
21,818

 

Interest rate swaps
8,470

 

 
8,470

 

Total Liabilities
$
111,173

 
$

 
$
55,520

 
$
55,653


The cash surrender value of life insurance and deferred compensation liabilities are included in Other Assets and Other Noncurrent Liabilities, respectively, on our Unaudited Condensed Consolidated Balance Sheets. The contingent consideration liabilities are classified as a separate line item in current liabilities and within Other Noncurrent Liabilities on our Unaudited Condensed Consolidated Balance Sheets based on the expected timing of the related payments. The balance sheet classification of the interest rate swaps and foreign currency forward contracts is presented in Note 5, "Derivative Instruments and Hedging Activities."
Our Level 2 assets and liabilities are valued using inputs from third parties and market observable data. We obtain valuation data for the cash surrender value of life insurance and deferred compensation liabilities from third party sources, which determine the net asset values for our accounts using quoted market prices, investment allocations and reportable trades. We value our derivative instruments using a third party valuation model that performs a discounted cash flow analysis based on the terms of the contracts and market observable inputs such as current and forward interest rates and current and forward foreign exchange rates.
Our contingent consideration liabilities are related to our business acquisitions as further described in Note 8, "Business Combinations." Under the terms of the contingent consideration agreements, payments may be made at specified future dates depending on the performance of the acquired business subsequent to the acquisition. The liabilities for these payments are classified as Level 3 liabilities because the related fair value measurement, which is determined using an income approach, includes significant inputs not observable in the market. These unobservable inputs include internally-developed assumptions of the probabilities of achieving specified targets, which are used to determine the resulting cash flows and the applicable discount rate. Our Level 3 fair value measurements are established and updated quarterly by our corporate accounting department using current information about these key assumptions, with the input and oversight of our operational and executive management teams. We evaluate the performance of the business during the period compared to our previous expectations, along with any changes to our future projections, and update the estimated cash flows accordingly. In addition, we consider changes to our cost of capital and changes to the probability of achieving the earnout payment targets when updating our discount rate on a quarterly basis.

14





The significant unobservable inputs used in the fair value measurements of our Level 3 contingent consideration liabilities were as follows:
 
June 30,
 
December 31,
 
2014
 
2013
Unobservable Input
(Weighted Average)
Probability of achieving payout targets
94.0
%
 
70.6
%
Discount rate
7.5
%
 
6.5
%
A significant decrease in the assessed probabilities of achieving the targets or a significant increase in the discount rate, in isolation, would result in a significantly lower fair value measurement. Changes in the values of the liabilities are recorded in Change in Fair Value of Contingent Consideration Liabilities within Other Expense (Income) on our Unaudited Condensed Consolidated Statements of Income.
Changes in the fair value of our contingent consideration obligations are as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Beginning Balance
$
57,091

 
$
49,565

 
$
55,653

 
$
90,009

Contingent consideration liabilities recorded for business acquisitions
2,740

 
261

 
7,057

 
2,650

Payments
(50,299
)
 
(581
)
 
(52,305
)
 
(38,349
)
(Decrease) increase in fair value included in earnings
(790
)
 
230

 
(2,012
)
 
1,053

Exchange rate effects
20

 
(2
)
 
369

 
(5,890
)
Ending Balance
$
8,762

 
$
49,473

 
$
8,762

 
$
49,473

The purchase price for our 2011 acquisition of Euro Car Parts Holdings Limited included contingent payments depending on the achievement of certain annual performance targets in 2012 and 2013. The performance target for each of the measurement periods was exceeded, and therefore, we settled the liabilities related to the 2012 and 2013 performance periods for the maximum amounts of £25 million and £30 million, respectively. During the three months ended June 30, 2014, we settled the liability for the 2013 performance period through a cash payment of $44.8 million (£26.9 million) and the issuance of notes for $5.1 million (£3.1 million). The liability for the 2012 performance period was settled during the three months ended March 31, 2013 through a cash payment of $33.9 million (£22.4 million) and the issuance of notes for $3.9 million (£2.6 million).
Of the amounts included in earnings for the three and six months ended June 30, 2014, $0.3 million and $0.2 million of gains, respectively, were related to contingent consideration obligations outstanding as of June 30, 2014. Substantially all of the losses included in earnings during the three and six months ended June 30, 2013 related to contingent consideration obligations that were settled by June 30, 2014. The changes in the fair value of contingent consideration obligations during the respective periods in 2014 and 2013 are a result of the quarterly assessment of the fair value inputs.
Financial Assets and Liabilities Not Measured at Fair Value
Our debt is reflected on the Unaudited Condensed Consolidated Balance Sheets at cost. Based on market conditions as of June 30, 2014 and December 31, 2013, the fair value of our credit agreement borrowings reasonably approximated the carrying value of $1.2 billion and $673 million, respectively. In addition, based on market conditions, the fair value of the outstanding borrowings under the receivables facility reasonably approximated the carrying value of $80 million at June 30, 2014; we did not have any borrowings outstanding under the receivables facility as of December 31, 2013. As of June 30, 2014, the fair value of our senior notes was approximately $591 million compared to a carrying value of $600 million.
The fair value measurements of the borrowings under our credit agreement and receivables facility are classified as Level 2 within the fair value hierarchy since they are determined based upon significant inputs observable in the market, including interest rates on recent financing transactions with similar terms and maturities. We estimated the fair value by calculating the upfront cash payment a market participant would require to assume these obligations. The fair value of our senior notes is classified as Level 1 within the fair value hierarchy since it is determined based upon observable market inputs including quoted market prices in an active market.


15





Note 7.
Commitments and Contingencies
Operating Leases
We are obligated under noncancelable operating leases for corporate office space, warehouse and distribution facilities, trucks and certain equipment.
The future minimum lease commitments under these leases at June 30, 2014 are as follows (in thousands):
Six months ending December 31, 2014
$
69,215

Years ending December 31:
 
2015
128,982

2016
108,931

2017
89,365

2018
72,992

2019
57,470

Thereafter
221,946

Future Minimum Lease Payments
$
748,901

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

Note 8.
Business Combinations
On January 3, 2014, we completed our acquisition of Keystone Specialty, which is a leading distributor and marketer of specialty aftermarket equipment and accessories in North America serving the following six product segments: truck and off-road; speed and performance; recreational vehicle; towing; wheels, tires and performance handling; and miscellaneous accessories. Total acquisition date fair value of the consideration for our Keystone Specialty acquisition was $471.8 million, composed of $427.1 million of cash (net of cash acquired), $31.5 million of notes payable and $13.3 million of other purchase price obligations (non-interest bearing). The purchase price is subject to certain adjustments, including an adjustment related to the net working capital amount of Keystone Specialty at closing. We recorded $234.4 million of goodwill related to our acquisition of Keystone Specialty, which we do not expect to be deductible for income tax purposes. In the period between January 3, 2014 and June 30, 2014, Keystone Specialty generated approximately $394.8 million of revenue and $17.4 million of net income.
In addition to our acquisition of Keystone Specialty, we made 15 acquisitions during the six months ended June 30, 2014, including 7 wholesale businesses in North America, 6 wholesale businesses in Europe, and 2 self service retail operations. Our European acquisitions included five aftermarket parts distribution businesses in the Netherlands, all of which were customers of and distributors for our Netherlands subsidiary, Sator Beheer B.V. ("Sator"), and were acquired with the objective of expanding our distribution network in the Netherlands. Our other acquisitions completed during the six months ended June 30, 2014 enabled us to expand into new product lines and enter new markets. Total acquisition date fair value of the consideration for these additional acquisitions was $218.6 million, composed of $195.1 million of cash (net of cash acquired), $11.5 million of notes payable, $0.2 million of other purchase price obligations (non-interest bearing), $7.1 million for the estimated value of contingent payments to former owners (with maximum potential payments totaling $8.3 million), and $4.8 million of pre-existing balances between us and the acquired entities considered to be effectively settled as a result of the acquisitions. During the six months ended June 30, 2014, we recorded $123.8 million of goodwill related to these acquisitions and immaterial adjustments to preliminary purchase price allocations related to certain of our 2013 acquisitions. We expect $35.6 million of the $123.8 million of goodwill recorded to be deductible for income tax purposes. In the period between the acquisition dates and June 30, 2014, these acquisitions generated $67.9 million of revenue and $3.4 million of net income.
On May 1, 2013, we acquired the shares of Sator, a vehicle mechanical aftermarket parts distribution company based in the Netherlands, with operations in the Netherlands, Belgium and Northern France. With the acquisition of Sator, we expanded our geographic presence in the European vehicle mechanical aftermarket products market into continental Europe to complement our existing U.K. operations. Total acquisition date fair value of the consideration for the acquisition of Sator was €209.8 million ($272.8 million) of cash, net of cash acquired. We recorded $142.7 million of goodwill related to our acquisition of Sator, which we do not expect will be deductible for income tax purposes.

16





In addition to our acquisition of Sator, we made 19 acquisitions during 2013, including 10 wholesale businesses in North America, 7 wholesale businesses in Europe and 2 self service retail operations. Our European acquisitions included five automotive paint distribution businesses in the U.K., which enabled us to expand our collision product offerings. Our other acquisitions completed during 2013 enabled us to expand into new product lines and enter new markets. Total acquisition date fair value of the consideration for these additional 2013 acquisitions was $146.1 million, composed of $134.6 million of cash (net of cash acquired), $7.5 million of notes payable, $0.2 million of other purchase price obligations (non-interest bearing) and $3.9 million for the estimated value of contingent payments to former owners (with maximum potential payments totaling $5.0 million). During the year ended December 31, 2013, we recorded $92.7 million of goodwill related to these acquisitions and immaterial adjustments to preliminary purchase price allocations related to certain of our 2012 acquisitions. We expect $18.3 million of the $92.7 million of goodwill recorded to be deductible for income tax purposes.
Our acquisitions are accounted for under the purchase method of accounting and are included in our unaudited condensed consolidated financial statements from the dates of acquisition. The purchase prices were allocated to the net assets acquired based upon estimated fair market values at the dates of acquisition. The purchase price allocations for the acquisitions made during the six months ended June 30, 2014 and the last six months of 2013 are preliminary as we are in the process of determining the following: 1) valuation amounts for certain receivables, inventories and fixed assets acquired; 2) valuation amounts for certain intangible assets acquired; 3) the acquisition date fair value of certain liabilities assumed; and 4) the final estimation of the tax basis of the entities acquired. We have recorded preliminary estimates for certain of the items noted above and will record adjustments, if any, to the preliminary amounts upon finalization of the valuations.
The preliminary purchase price allocations for the acquisitions completed during the six months ended June 30, 2014 and the year ended December 31, 2013 are as follows (in thousands):
 
 
Six Months Ended
 
Year Ended
 
June 30, 2014
 
December 31, 2013
 
Keystone Specialty
 
Other Acquisitions
 
Total
 
Sator
 
Other Acquisitions
 
Total
Receivables
$
48,473

 
$
52,992

 
$
101,465

 
$
61,639

 
$
38,685

 
$
100,324

Receivable reserves
(4,403
)
 
(2,539
)
 
(6,942
)
 
(8,563
)
 
(3,246
)
 
(11,809
)
Inventory
151,013

 
71,335

 
222,348

 
71,784

 
26,455

 
98,239

Income taxes receivable
13,972

 

 
13,972

 

 

 

Prepaid expenses and other current assets
8,339

 
1,846

 
10,185

 
7,184

 
1,933

 
9,117

Property and equipment
38,095

 
13,293

 
51,388

 
19,484

 
14,015

 
33,499

Goodwill
234,381

 
123,764

 
358,145

 
142,721

 
92,726

 
235,447

Other intangibles
70,830

 
20,234

 
91,064

 
45,293

 
12,353

 
57,646

Other assets
7,805

 
1,493

 
9,298

 
2,049

 
1,251

 
3,300

Deferred income taxes
(17,418
)
 
915

 
(16,503
)
 
(14,100
)
 
(564
)
 
(14,664
)
Current liabilities assumed
(65,112
)
 
(30,606
)
 
(95,718
)
 
(49,593
)
 
(36,799
)
 
(86,392
)
Debt assumed

 
(26,425
)
 
(26,425
)
 

 
(664
)
 
(664
)
Other noncurrent liabilities assumed
(14,147
)
 
(7,670
)
 
(21,817
)
 
(5,074
)
 

 
(5,074
)
Contingent consideration liabilities

 
(7,057
)
 
(7,057
)
 

 
(3,854
)
 
(3,854
)
Other purchase price obligations
(13,278
)
 
(228
)
 
(13,506
)
 

 
(214
)
 
(214
)
Notes issued
(31,500
)
 
(11,454
)
 
(42,954
)
 

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

 
(4,841
)
 
(4,841
)
 

 

 

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

 
$
195,052

 
$
622,102

 
$
272,824

 
$
134,595

 
$
407,419

The primary reason for our acquisitions made during the six months ended June 30, 2014 and the year ended December 31, 2013 was to create economic value for our stockholders by enhancing our position as a leading source for alternative collision and mechanical repair products and expanding into other product lines and businesses that may benefit from our operating strengths. Our acquisition of Keystone Specialty allows us to enter into new product lines and increase the size of our addressable market. In addition, we believe that the acquisition creates potential cross-selling opportunities and logistics and administrative cost synergies, which contributed to the goodwill recorded on the Keystone Specialty acquisition. Our other acquisitions enabled us to further expand our market presence, including continental Europe through the Sator acquisition, as well as to widen our product offerings such as paint and related equipment in the U.K. We believe that our Sator

17





acquisition will allow for synergies within our European operations, most notably in procurement, warehousing and product management. These projected synergies contributed to the goodwill recorded on the Sator acquisition.
When we identify potential acquisitions, we attempt to target companies with a leading market share, an experienced management team and a workforce that provide a fit with our existing operations and strong cash flows. For certain of our acquisitions, we have identified cost savings and synergies as a result of integrating the company with our existing business that provide additional value to the combined entity. In many cases, acquiring companies with these characteristics can result in purchase prices that include a significant amount of goodwill.

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

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Revenue, as reported
$
1,709,132

 
$
1,251,748

 
$
3,334,909

 
$
2,447,745

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

 
196,059

 
3,443

 
363,502

Sator

 
31,306

 

 
126,309

Other acquisitions
36,707

 
125,624

 
93,550

 
250,850

Pro forma revenue
$
1,745,839

 
$
1,604,737

 
$
3,431,902

 
$
3,188,406

 
 
 
 
 
 
 
 
Net income, as reported
$
104,882

 
$
75,722

 
$
209,535

 
$
160,314

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

 
10,891

 
438

 
17,600

Sator

 
2,861

 

 
5,726

Other acquisitions
4,387

 
4,737

 
5,147

 
5,543

Pro forma net income
$
109,269

 
$
94,211

 
$
215,120

 
$
189,183

 
 
 
 
 
 
 
 
Earnings per share-basic, as reported
$
0.35

 
$
0.25

 
$
0.69

 
$
0.54

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

 
0.04

 
0.00

 
0.06

Sator

 
0.01

 

 
0.02

Other acquisitions
0.01

 
0.02

 
0.02

 
0.02

Pro forma earnings per share-basic (a) 
$
0.36

 
$
0.31

 
$
0.71

 
$
0.63

 
 
 
 
 
 
 
 
Earnings per share-diluted, as reported
$
0.34

 
$
0.25

 
$
0.69

 
$
0.53

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

 
0.04

 
0.00

 
0.06

Sator

 
0.01

 

 
0.02

Other acquisitions
0.01

 
0.02

 
0.02

 
0.02

Pro forma earnings per share-diluted (a) 
$
0.36

 
$
0.31

 
$
0.70

 
$
0.62


(a) The sum of the individual earnings per share amounts may not equal the total due to rounding.
Unaudited pro forma supplemental information is based upon accounting estimates and judgments that we believe are reasonable. The unaudited pro forma supplemental information includes the effect of purchase accounting adjustments, such as the adjustment of inventory acquired to net realizable value, adjustments to depreciation on acquired property and equipment,

18





adjustments to rent expense for above or below market leases, adjustments to amortization on acquired intangible assets, adjustments to interest expense, and the related tax effects. The pro forma impact of our Keystone Specialty acquisition reflects the elimination of acquisition related expenses totaling $0.2 million for the six months ended June 30, 2014, which do not have a continuing impact on our operating results. The pro forma impact of our other acquisitions includes the elimination of revenue and cost of goods sold related to transactions between Sator and the five Netherlands distributors that would have been reflected as intercompany sales if the acquisitions had occurred on January 1, 2013. Additionally, the pro forma impact of our other acquisitions reflects the elimination of acquisition related expenses totaling $1.7 million for the three and six months ended June 30, 2014, primarily related to our May 2014 acquisitions of five aftermarket parts distribution businesses in the Netherlands. The pro forma impact of our acquisition related expenses for the three and six months ended June 30, 2013 totaled $2.9 million and $4.0 million, respectively, primarily related to our May 2013 acquisition of Sator. Refer to Note 9, "Restructuring and Acquisition Related Expenses," for further information on our acquisition related expenses. These pro forma results are not necessarily indicative of what would have occurred if the acquisitions had been in effect for the periods presented or of future results.

Note 9.
Restructuring and Acquisition Related Expenses
Acquisition Related Expenses
Acquisition related expenses for the three and six months ended June 30, 2014 totaled $1.7 million and $1.9 million, respectively. These expenses were primarily related to our May 2014 acquisitions of five aftermarket parts distribution businesses in the Netherlands. Expenses incurred during the three and six months ended June 30, 2013 totaled $2.9 million and $4.0 million, respectively, and primarily related to our May 2013 acquisition of Sator. Acquisition related expenses include external costs such as legal, accounting and advisory fees, and are expensed as incurred.
Acquisition Integration Plans
During the three and six months ended June 30, 2014, we incurred $2.6 million and $5.4 million, respectively, of restructuring expenses as a result of the integration of our acquisition of Keystone Specialty into our existing business. These integration activities included the closure of duplicate facilities, termination of employees in connection with the consolidation of overlapping facilities with our existing business, and moving expenses. Future expenses to complete our integration plan in the second half of 2014, including expenses for additional closures of overlapping facilities and termination of duplicate headcount, are expected to be less than $1.0 million.
Other restructuring costs incurred during the three and six months ended June 30, 2014 totaled $1.6 million and $1.9 million, respectively. Restructuring costs incurred during the three and six months ended June 30, 2013 totaled $0.8 million and $1.2 million, respectively. These costs are a result of activities to integrate our acquisitions into our existing business, including the closure of duplicate facilities, termination of employees in connection with the consolidation of overlapping facilities with our existing business, moving expenses, and other third party services directly related to our acquisitions.
During the second half of 2014, we expect to incur additional integration expenses related to the integration of certain of our 2013 and 2014 acquisitions into our existing operations. These integration activities are expected to include the closure of duplicate facilities, termination of employees in connection with the consolidation of overlapping facilities with our existing business, and moving expenses. Future expenses to complete these integration plans are not expected to be material.


19





Note 10.
Earnings Per Share
The following chart sets forth the computation of earnings per share (in thousands, except per share amounts):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Net Income
$
104,882

 
$
75,722

 
$
209,535

 
$
160,314

Denominator for basic earnings per share—Weighted-average shares outstanding
302,030

 
299,159

 
301,719

 
298,690

Effect of dilutive securities:
 
 
 
 
 
 
 
RSUs
821

 
758

 
876

 
721

Stock options
2,981

 
3,728

 
3,074

 
3,865

Restricted stock
5

 
12

 
8

 
19

Denominator for diluted earnings per share—Adjusted weighted-average shares outstanding
305,837

 
303,657

 
305,677

 
303,295

Earnings per share, basic
$
0.35

 
$
0.25

 
$
0.69

 
$
0.54

Earnings per share, diluted
$
0.34

 
$
0.25

 
$
0.69

 
$
0.53

The following table sets forth the number of employee stock-based compensation awards outstanding but not included in the computation of diluted earnings per share because their effect would have been antidilutive for the three and six months ended June 30, 2014 and 2013 (in thousands).
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Antidilutive securities:
 
 
 
 
 
 
 
RSUs
405

 

 
203

 

Stock Options
117

 

 
122

 


Note 11.
Income Taxes
At the end of each interim period, we estimate our annual effective tax rate and apply that rate to our interim earnings. We also record the tax impact of certain unusual or infrequently occurring items, including changes in judgment about valuation allowances and the effects of changes in tax laws or rates, in the interim period in which they occur.
The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment including, but not limited to, the expected operating income for the year, projections of the proportion of income earned and taxed in state and foreign jurisdictions, permanent and temporary differences between book and taxable income, and the likelihood of recovering deferred tax assets generated in the current year. The accounting estimates used to compute the provision for income taxes may change as new events occur, additional information is obtained or as the tax environment changes.
Our effective income tax rate for the six months ended June 30, 2014 was 34.0% compared with 35.4% for the comparable prior year period. The lower effective income tax rate for the six months ended June 30, 2014 is primarily a result of our expanding international operations as we expect a larger proportion of our annual pretax income will be generated in lower tax rate jurisdictions, combined with lower statutory tax rates in effect in the U.K. compared to the prior year.
    

20





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

 
 
Three Months Ended
 
Three Months Ended
 
 
 
June 30, 2014
 
June 30, 2013
 
 
 
Foreign
Currency
Translation
 
Unrealized Gain (Loss)
on Cash Flow Hedges
 
Change in Unrealized Gain on Pension Plan
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Foreign
Currency
Translation
 
Unrealized Gain (Loss)
on Cash Flow Hedges
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Beginning balance
 
$
24,343

 
$
(4,803
)
 
$
664

 
$
20,204

 
$
(8,130
)
 
$
(9,359
)
 
$
(17,489
)
 
Pretax income (loss)
 
15,879

 
466

 

 
16,345

 
(3,204
)
 
1,648

 
(1,556
)
 
Income tax effect
 

 
(122
)
 

 
(122
)
 

 
(481
)
 
(481
)
 
Reclassification of unrealized loss (gain)
 

 
133

 
(43
)
 
90

 

 
2,117

 
2,117

 
Reclassification of deferred income taxes
 

 
(20
)
 
13

 
(7
)
 

 
(760
)
 
(760
)
 
Hedge ineffectiveness
 

 

 

 

 

 
167

 
167

 
Income tax effect
 

 

 

 

 

 
(62
)
 
(62
)
 
Ending balance
 
$
40,222

 
$
(4,346
)
 
$
634

 
$
36,510

 
$
(11,334
)
 
$
(6,730
)
 
$
(18,064
)
 

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

 
$
(5,596
)
 
$
701

 
$
20,011

 
$
10,850

 
$
(10,091
)
 
$
759

 
Pretax income (loss)
 
15,316

 
(176
)
 

 
15,140

 
(22,184
)
 
1,145

 
(21,039
)
 
Income tax effect
 

 
46

 

 
46

 

 
(342
)
 
(342
)
 
Reclassification of unrealized loss (gain)
 

 
2,093

 
(90
)
 
2,003

 

 
3,815

 
3,815

 
Reclassification of deferred income taxes
 

 
(713
)
 
23

 
(690
)
 

 
(1,362
)
 
(1,362
)
 
Hedge ineffectiveness
 

 

 

 

 

 
167

 
167

 
Income tax effect
 

 

 

 

 

 
(62
)
 
(62
)
 
Ending balance
 
$
40,222

 
$
(4,346
)
 
$
634

 
$
36,510

 
$
(11,334
)
 
$
(6,730
)
 
$
(18,064
)
 

Unrealized losses on our interest rate swap contracts totaling $1.6 million and $3.1 million were reclassified to interest expense in our Unaudited Condensed Consolidated Statements of Income during the three and six months ended June 30, 2014, respectively. During the three and six months ended June 30, 2013, unrealized losses of $1.6 million and $3.3 million, respectively, related to our interest rate swaps were reclassified to interest expense. The remaining reclassification of unrealized gains during the three and six months ended June 30, 2014 and reclassification of unrealized losses during the three and six months ended June 30, 2013 related to our foreign currency forward contracts and was recorded to other income in our Unaudited Condensed Consolidated Statements of Income. These gains offset the remeasurement of certain of our intercompany balances as discussed in Note 5, "Derivative Instruments and Hedging Activities." The deferred income taxes related to our cash flow hedges were reclassified from Accumulated Other Comprehensive Income to income tax expense.

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

21





reportable segment, North America, because they possess similar economic characteristics and have common products and services, customers, and methods of distribution. Therefore, we present three reportable segments: North America, Europe and Specialty.
The following tables present our financial performance by reportable segment for the periods indicated (in thousands):
 
North America
 
Europe
 
Specialty
 
Eliminations
 
Consolidated
Three Months Ended June 30, 2014
 
 
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
 
 
Third Party
$
1,025,989

 
$
465,173

 
$
217,970

 
$

 
$
1,709,132

Intersegment
101

 

 
430

 
(531
)
 

Total segment revenue
$
1,026,090

 
$
465,173

 
$
218,400

 
$
(531
)
 
$
1,709,132

Segment EBITDA
$
137,150

 
$
45,945

 
$
28,356

 
$

 
$
211,451

Depreciation and amortization
17,508

 
8,491

 
5,048

 

 
31,047

Three Months Ended June 30, 2013
 
 
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
 
 
Third Party
$
953,918

 
$
297,830

 
$

 
$

 
$
1,251,748

Intersegment