Forward-Looking Statements
Statements and information in this Quarterly Report on Form 10-Q that are not
historical are forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995 and are made pursuant to the "safe
harbor" provisions of such Act.
Forward-looking statements include, but are not limited to, statements regarding
our outlook, guidance, expectations, beliefs, hopes, intentions and strategies.
Words such as "may," "will," "plan," "should," "expect," "anticipate,"
"believe," "if," "estimate," "intend," "project" and similar words or
expressions are used to identify these forward-looking statements. These
statements are subject to a number of risks, uncertainties, assumptions and
other factors, including the unfavorable effects of COVID-19, that may cause our
actual results, performance or achievements to be materially different. All
forward-looking statements are based on information available to us at the time
the statements are made. We undertake no obligation to update any
forward-looking statements, whether as a result of new information, future
events or otherwise, except as required by law.
You should not place undue reliance on our forward-looking statements. Actual
events or results may differ materially from those expressed or implied in the
forward-looking statements. The risks, uncertainties, assumptions and other
factors that could cause actual results to differ from the results predicted or
implied by our forward-looking statements include factors discussed in our
filings with the SEC, including those disclosed under the captions "Risk
Factors" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in our 2019 Form 10-K and in our subsequent Quarterly
Reports on Form 10-Q (including this Quarterly Report).
Overview
We are a global distributor of vehicle products, including replacement parts,
components and systems used in the repair and maintenance of vehicles, and
specialty products and accessories to improve the performance, functionality and
appearance of vehicles.
Buyers of vehicle replacement products have the option to purchase from
primarily five sources: new products produced by OEMs; new products produced by
companies other than the OEMs, which are referred to as aftermarket products;
recycled products obtained from salvage and total loss vehicles; recycled
products that have been refurbished; and recycled products that have been
remanufactured. We distribute a variety of products to collision and mechanical
repair shops, including aftermarket collision and mechanical products; recycled
collision and mechanical products; refurbished collision products such as
wheels, bumper covers and lights; and remanufactured engines and transmissions.
Collectively, we refer to the four sources that are not new OEM products as
alternative parts.
We are a leading provider of alternative vehicle collision replacement products
and alternative vehicle mechanical replacement products, with our sales,
processing, and distribution facilities reaching most major markets in the
United States and Canada. We are also a leading provider of alternative vehicle
replacement and maintenance products in Germany, the United Kingdom, the Benelux
region (Belgium, Netherlands, and Luxembourg), Italy, Czech Republic, Austria,
Slovakia, Poland, and various other European countries. In addition to our
wholesale operations, we operate self service retail facilities across the U.S.
that sell recycled automotive products from end-of-life-vehicles. We are also a
leading distributor of specialty vehicle aftermarket equipment and accessories
reaching most major markets in the U.S. and Canada.
We are organized into four operating segments: Wholesale - North America;
Europe; Specialty and Self Service. We aggregate our Wholesale - North America
and Self Service operating segments into one reportable segment, North America,
resulting in three reportable segments: North America, Europe and Specialty.
Our 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
factors referred to in Forward-Looking Statements above. Due to these factors
and others, which may be unknown to us at this time, 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 and Investments
Since our inception in 1998, we have pursued a growth strategy through both
organic growth and acquisitions. We have pursued acquisitions that we believe
will help drive profitability, cash flow and stockholder value. We target
companies that are market leaders, will expand our geographic presence and will
enhance our ability to provide a wide array of vehicle products to our customers
through our distribution network.
See "Investments in Unconsolidated Subsidiaries" in Note 3, "Financial Statement
Information," to the unaudited condensed consolidated financial statements in
Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information
related to our investments.
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Sources of Revenue
We report our revenue in two categories: (i) parts and services and (ii) other.
Our parts revenue is generated from the sale of vehicle products,
including replacement parts, components and systems used in the repair and
maintenance of vehicles, and specialty products and accessories to improve the
performance, functionality and appearance of vehicles. Our service revenue is
generated primarily from the sale of service-type warranties, fees for admission
to our self service yards, and diagnostic and repair services. Revenue from
other sources includes scrap sales, bulk sales to mechanical manufacturers
(including cores) and sales of aluminum ingots and sows from our furnace
operations. Other revenue will vary from period to period based on fluctuations
in commodity prices and the volume of materials sold. See Note 4, "Revenue
Recognition" to the unaudited condensed consolidated financial statements in
Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information
related to our sources of revenue.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations
are based upon our unaudited condensed consolidated financial statements, which
have been prepared in accordance with 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. Our 2019 Form 10-K includes a
summary of the critical accounting policies and estimates we believe are the
most important to aid in understanding our financial results. Other than as
described below, there have been no changes to those critical accounting
policies or estimates that have had a material impact on our reported amounts of
assets, liabilities, revenue or expenses during the six months ended June 30,
2020.
COVID-19 Projections and Assumptions
In the first and second quarters of 2020, we prepared forecasts of future
revenues, profits and cash flows to use in multiple analyses, including the
interim goodwill impairment test, other impairment tests of long-lived assets,
assessments of the recoverability of inventory, determination of customer and
supplier rebate balances, calculation of the annual effective tax rate and
evaluations of the realizability of deferred tax assets. Our first quarter
projections assumed that the COVID-19 impact would be severe, with revenue down
in the second quarter of 2020 compared to our prior forecasts, but temporary, as
revenue would improve gradually in the second half of 2020. We expected that
cost mitigation actions would dampen the negative impact of the projected
revenue decline but still result in a significant reduction in profitability in
the second quarter of 2020. Actual results for the three months ended June 30,
2020 tracked in the same direction as our forecast, but the decline was
significantly less severe than projected. Our updated forecasts for use in
preparing the June 30 financial statements reflect a further recovery in revenue
and profitability in the second half but with amounts still below the comparable
prior year period. We expect to generate positive free cash flows in the second
half of 2020 but at a lower level than the first half of the year.
As the economic impact of the pandemic is dependent on variables that are
difficult to project and in many cases are outside of our control, it is
possible that the estimates underlying our analyses may change materially in
future periods. This is particularly the case because it appears that the
prevalence of the virus outbreak fluctuates depending on various factors,
including the level of economic and social activity in a region.
Goodwill and Indefinite-Lived Intangibles Impairment
We are required to test goodwill and indefinite-lived intangible assets for
impairment at least annually and between annual tests whenever events indicate
that an impairment may exist. When testing goodwill for impairment, we are
required to evaluate events and circumstances that may affect the performance of
the reporting unit and the extent to which the events and circumstances may
impact the future cash flows of the reporting unit to determine whether the fair
value of the assets exceeds the carrying value. Developing the estimated future
cash flows and fair value of the reporting unit requires management's judgment
in projecting revenues and profits, allocation of shared corporate costs, tax
rates, capital expenditures, working capital requirements, discount rates and
market multiples. Many of the factors used in assessing fair value are outside
the control of management, and it is reasonably likely that assumptions and
estimates can change in future periods. If these assumptions or estimates change
in the future, we may be required to record impairment charges for these assets.
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 impairment assessment is performed at the reporting unit level. A
reporting unit is an operating segment, or a business one level below an
operating segment (the "component" level), for which discrete financial
information is prepared and regularly reviewed by segment management. However,
components are aggregated as a single reporting unit if they have similar
economic characteristics. For the purpose of aggregating our components into
reporting units, we review the long-term performance of Segment EBITDA.
Additionally, we review qualitative factors such as type or class of customers,
nature of products, distribution methods, inventory procurement methods, level
of integration, and interdependency of
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processes across components. Our assessment of the aggregation includes both
qualitative and quantitative factors and is based on the facts and circumstances
specific to the components.
We have four operating segments: Wholesale - North America, Europe, Specialty
and Self Service. Each of these operating segments consists of multiple
components that have discrete financial information available that is reviewed
by segment management on a regular basis. We have evaluated these components and
concluded that the components that compose each of the Wholesale - North
America, Europe, Specialty, and Self Service operating segments are economically
similar and thus were aggregated into those four separate reporting units for
our interim goodwill impairment test in the first quarter of 2020.
Our goodwill would be considered impaired if the carrying value of a reporting
unit exceeded its estimated fair value. The fair value estimates are established
using weightings of the results of a discounted cash flow methodology and a
comparative market multiples approach. We believe that using two methods to
determine fair value limits the chances of an unrepresentative valuation.
Discount rates, growth rates and cash flow projections are the assumptions that
are most sensitive and susceptible to change as they require significant
management judgment. Impairment may result from, among other things,
deterioration in the performance of our reporting units' businesses, increases
in our cost of capital, adverse market conditions, and adverse changes in
applicable laws or regulations, including modifications that restrict the
activities of our reporting units' businesses. To assess the reasonableness of
the fair value estimates, we compare the sum of the reporting units' fair values
to the Company's market capitalization and calculate an implied control premium,
which is then evaluated against recent market transactions in our industry, or
in the case of our interim test against transactions during the 2008-2009
financial crisis. If we were required to recognize goodwill impairments, we
would report those impairment losses as part of our operating results.
We determined no impairments existed on any of our four reporting units when we
performed our interim goodwill impairment testing in the first quarter of 2020,
as each of those reporting units had a fair value estimate that exceeded the
carrying value by at least 12%, the level at which our Europe reporting unit
exceeded its carrying value. We did not identify a triggering event in the
second quarter that necessitated an interim test of goodwill impairment. See
Note 3, "Financial Statement Information" to the unaudited condensed
consolidated financial statements in Part I, Item 1 of this Quarterly Report on
Form 10-Q for additional information related to our interim goodwill impairment
test.
We review indefinite-lived intangible assets for impairment annually or on an
interim basis if events or changes in circumstances indicate that the carrying
value may not be recoverable. We determined that the effect of the uncertainty
relating to the COVID-19 pandemic on our forecasted results represented a change
in circumstances indicating that the carrying value of the Warn trademark, which
is our only indefinite-lived intangible asset, may not be recoverable. As a
result, we performed a quantitative impairment test in the first quarter as of
March 31, 2020 using the relief-from-royalty method and determined no impairment
existed, as the trademark had a fair value estimate which exceeded the carrying
value by approximately 9%. We did not identify a triggering event in the second
quarter that necessitated an interim test of impairment.
Recently Issued Accounting Pronouncements
See "Recent Accounting Pronouncements" in Note 3, "Financial Statement
Information" to the unaudited condensed consolidated financial statements in
Part I, Item 1 of this Quarterly Report on Form 10-Q for information related to
new accounting standards.
Financial Information by Geographic Area
See Note 14, "Segment and Geographic Information" to the unaudited condensed
consolidated financial statements in Part I, Item 1 of this Quarterly Report on
Form 10-Q for information related to our revenue and long-lived assets by
geographic region.
1 LKQ Europe Program
We have undertaken the 1 LKQ Europe program to create structural centralization
and standardization of key functions to facilitate the operation of the Europe
segment as a single business. Under this multi-year program, we have recognized
to date and expect to continue to recognize the following:

•Restructuring expenses - Non-recurring costs resulting directly from the implementation of the 1 LKQ Europe program from which the business will derive no ongoing benefit. See Note 5, "Restructuring and Acquisition Related Expenses" to the unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further details. •Transformation expenses - Period costs incurred to execute the 1 LKQ Europe program that are expected to contribute to ongoing benefits to the business (e.g. non-capitalizable implementation costs related to a common ERP system). These expenses are recorded in Selling, general and administrative expenses. •Transformation capital expenditures - Capitalizable costs for long-lived assets, such as software and facilities, that directly relate to the execution of the 1 LKQ Europe program.


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Costs related to the 1 LKQ Europe program incurred to date are reflected in
Selling, general and administrative expenses and Purchases of property, plant
and equipment in our unaudited condensed consolidated financial statements in
Part I, Item 1 of this Quarterly Report on Form 10-Q. We continue to expect that
costs of the program, reflecting all three categories noted above, will range
between $100 million and $125 million for the period from 2020 through 2021 with
an additional $80 million to $100 million between 2022 and the original
projected completion date of the project in 2024. Beginning in the second half
of March, management delayed certain projects under the 1 LKQ Europe program to
reduce expenses and preserve capital in response to the COVID-19 pandemic. Based
on our expectations in the second quarter of 2020 that the impacts on our
business from COVID-19 had stabilized, we restarted the program in July 2020
with substantially the same initiatives and projects as prior to the pandemic,
although we are evaluating the impact of the delay on our estimates of the
related expenditures and timelines. We may also identify additional initiatives
and projects under the 1 LKQ Europe program in future periods that may result in
additional expenditures, although we are currently unable to estimate the range
of charges for such potential future initiatives and projects.
COVID-19 Impact on Our Operations
In late February 2020, the Italian government began placing restrictions on
activity as a result of the COVID-19 outbreak. Sales volumes fell as fewer cars
were on the road and less maintenance activity was performed. While our Italian
operation is an important part of our European business, it represented
approximately 10% of the segment's revenue in 2019, and thus the disruption did
not have a material impact on the Company. By mid-March, the COVID-19 impact
began spreading across the rest of the geographies where we operate at a very
rapid pace. Governments adopted aggressive restrictions on the operation of
non-essential businesses and personal movement, which reduced miles driven and
collisions. While our businesses have been deemed essential in most
jurisdictions in which we operate, the change in behavior driven by the COVID-19
restrictions negatively impacted our sales volume. Our organic parts and
services revenue declined by 16.8% in the second quarter of 2020, relative to
the comparable prior period, but showed improvement over the quarter as
governments gradually lifted restrictions for nonessential businesses and
personal movement. As anticipated, April experienced the most negative revenue
impact, with organic parts and services revenue (on a per day basis) down 30.3%.
As movement restrictions lessened in May and June, we experienced organic parts
and services revenue (on a per day basis) declines of 13.2% and 7.3%,
respectively. However, the pace of improvement has flattened into July as the
increasing level of COVID-19 cases, especially in the United States, appears to
have slowed the recovery. In the second half of 2020, we expect revenue to
decrease on a year over year basis, but at a lower rate than reported for the
first half. This expectation is based on the assumption that there will not be a
recurrence in the second half of 2020 of the extensive lockdown measures taken
in March and April. Such measures may materialize with the expansion of economic
and social activity in a region if the prevalence of the virus outbreak
increases as a result thereof.
Recognizing the demand changes in the first quarter of 2020, we took action in
all of our business units to reduce our cost structure. These actions included,
but were not limited to, employee furloughs and reductions in force, decreases
in hours and overtime, lowering compensation for salaried employees, a hiring
freeze, elimination of temporary labor, route consolidation, deferral of
projects, and temporary branch closures. These cost actions contributed to a
reduction of approximately 18% of quarterly selling, general and administrative
expenses compared to our first quarter 2020 run rate. We estimate that the cost
actions generated an additional $10 million benefit in cost of goods sold. Some
of the savings from the cost actions were delayed as we paid out vacation
balances in April and covered medical benefits for employees in the United
States during their furlough period. We pursued certain financial assistance and
relief programs that were available to us from governments in Europe and Canada,
primarily in the form of grants to offset personnel expenses; through June 30,
2020, we qualified for $33 million of assistance, and we estimate that we may
qualify for additional assistance in the second half of 2020, but at a lower
level than we received in the second quarter of 2020. However, these actions
lagged the revenue impact, which meant there was a negative timing impact of
COVID-19 on our first half profitability in addition to the negative effect from
reduced revenue. If our revenue increases in the second half of 2020 as
projected, we still expect that some of the costs that were reduced as a result
of COVID-19 will remain at a lower level; the management team has been
implementing productivity initiatives to create lower cost structures going
forward. We also emphasized the preservation of capital with a deferral of
growth driven capital projects, reductions in inventory orders, more active
monitoring of customer receivables and terms, income and value added tax payment
deferrals, and suspension of our share buyback program. This focus was
successful as we improved our liquidity position relative to March 31 despite a
decline in profitability.
One of our top priorities is the health and safety of our employees, customers
and the communities in which we operate. We are using our best efforts to follow
all governmental instructions and safety guidelines with respect to the
operations of our facilities. We have implemented protocols across our business
units to help ensure the health and safety of our employees, customers and
communities including, but not limited to: restricting access to and enhancing
cleaning and disinfecting protocols of our facilities; use of personal
protection equipment; adhering to social distancing guidelines; instituting
remote work arrangements for many of our employees; and restricting travel.

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See the Results of Operations and Liquidity sections for further detail on the year over year trends.



Key Performance Indicators
We believe that organic revenue growth, Segment EBITDA and free cash flow are
key performance indicators for our business. Segment EBITDA is our key measure
of segment profit or loss reviewed by our chief operating decision maker.  Free
cash flow is a financial measure that is not prepared in accordance with U.S.
generally accepted accounting principles ("non-GAAP").
•Organic revenue growth - We define organic revenue growth as total revenue
growth from continuing operations excluding the effects of acquisitions and
divestitures (i.e. revenue generated from the date of acquisition to the first
anniversary of that acquisition, net of reduced revenue due to the disposal of
businesses) and foreign currency movements (i.e. impact of translating revenue
at prior period exchange rates). Organic revenue growth includes incremental
sales from both existing and new (i.e. opened within the last twelve months)
locations and is derived from expanding business with existing customers,
securing new customers and offering additional products and services. We believe
that organic revenue growth is a key performance indicator as this statistic
measures our ability to serve and grow our customer base successfully.
•Segment EBITDA - Refer to Note 14, "Segment and Geographic Information," in
Part I, Item 1 of this Form 10-Q for a description of the calculation of Segment
EBITDA. We believe that Segment EBITDA provides useful information to evaluate
our segment profitability by focusing on the indicators of ongoing operational
results.
•Free Cash Flow - We calculate free cash flow as net cash provided by operating
activities, less purchases of property, plant and equipment. Free cash flow
provides insight into our liquidity and provides useful information to
management and investors concerning our cash flow available to meet future debt
service obligations and working capital requirements, to make strategic
acquisitions and to repurchase stock.
These three key performance indicators are used as targets to determine
incentive compensation at various levels of the organization, including senior
management.  By using these performance measures, we attempt to motivate a
balanced approach to the business that rewards growth, profitability and cash
flow generation in a manner that enhances our long-term prospects.
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