Quaker Chemical Corporation — Q2 2020 Form 10-Q Summary
Business context and reporting period
Quaker Houghton develops and supplies industrial process fluids, specialty chemicals and technical services to steel, aluminum, automotive, aerospace, mining, metalworking and other industrial customers. The filing covers the unaudited three and six months ended June 30, 2020.
Results include Houghton International and Norman Hay for the relevant 2020 periods, while 2019 primarily reflects Legacy Quaker. Houghton was acquired on August 1, 2019, and Norman Hay was acquired on October 1, 2019; therefore, reported year-over-year comparisons are not fully comparable.
Key financial metrics
| Metric | Three months ended June 30, 2020 | Three months ended June 30, 2019 | Six months ended June 30, 2020 | Six months ended June 30, 2019 |
|---|---|---|---|---|
| Net sales | $286.0 million | $205.9 million | $664.6 million | $417.1 million |
| Gross profit | $97.4 million | $75.2 million | $231.2 million | $150.9 million |
| Gross margin | 34.0% | 36.5% | 34.8% | 36.2% |
| Operating income (loss) | $2.2 million | $20.5 million | $(10.2) million | $40.4 million |
| Net income (loss) attributable to Quaker | $(7.7) million | $15.6 million | $(36.1) million | $29.4 million |
| Diluted earnings (loss) per share | $(0.43) | $1.17 | $(2.03) | $2.20 |
| Adjusted EBITDA | $32.1 million | $31.4 million | $92.5 million | $61.1 million |
| Adjusted EBITDA margin | 11.2% | 15.3% | 13.9% | 14.6% |
Six-month operating cash flow was $44.7 million versus $22.4 million in the prior-year period. Capital expenditures were $7.5 million, acquisition-related investing cash outflows were $3.1 million, and dividends paid were $13.7 million. Cash, cash equivalents and restricted cash totaled $341.8 million at June 30, 2020, including $19.3 million of restricted cash.
Total debt was $1.12 billion before debt issuance costs, compared with $935.0 million at December 31, 2019. Net debt was reported at $798.7 million. Long-term debt was $1.07 billion, and the Company had approximately $15 million of unused revolver capacity after letters of credit, plus approximately $37 million of unused capacity under other arrangements. The Company was in compliance with its credit facility covenants at June 30, 2020.
Material changes versus the prior comparable period
- Reported second-quarter sales increased 39%, and six-month sales increased 59%, primarily because of the Houghton and Norman Hay acquisitions. Excluding those acquisitions, second-quarter sales declined approximately 30%, reflecting a 27% volume decline and a 4% unfavorable foreign-exchange impact; six-month legacy sales declined approximately 20%.
- COVID-19 caused significant customer production declines, particularly in automotive and other industrial markets. April and May were the weakest months, while sales improved across all segments in June.
- Gross margin declined because lower volumes increased the effect of fixed manufacturing costs, and acquired Houghton operations had lower gross margins. Cost savings from integration, logistics and procurement partially offset the decline.
- Interest expense increased to $6.8 million in the second quarter and $15.3 million for the first six months, primarily because of debt incurred to finance the Houghton combination.
- Operating results included $15.9 million of combination, integration and acquisition-related expenses and $2.2 million of restructuring charges for the first six months. The Company also recorded a $38.0 million non-cash impairment charge in the first quarter related to Houghton and Fluidcare trademarks and tradenames.
- The Company recognized a $22.7 million non-cash pension settlement charge in the first quarter upon terminating the Legacy Quaker U.S. Pension Plan.
Guidance, outlook, commentary and risks
- Management expected the second quarter to be the most severe COVID-19 impact and anticipated gradual sequential improvement during the remainder of 2020, subject to effective containment and customer recovery. The filing does not provide formal full-year revenue or earnings guidance.
- Management expects Combination synergies of $53 million in 2020, $65 million in 2021 and $75 million in 2022. Approximately $22 million of savings were realized during the first six months of 2020, with cumulative savings of approximately $29 million since closing.
- Management expects significant adjusted EBITDA growth in 2021 and 2022 from integration synergies, additional cost savings, market-share gains and a projected gradual recovery in end-market demand.
- The Company reduced discretionary spending, delayed or froze salary increases where permitted, reduced executive salaries, targeted a roughly 30% reduction in capital expenditures and accelerated integration actions to preserve cash.
- The QH restructuring program targets approximately 325 global headcount reductions and facility closures during 2020 and 2021. Total program costs are expected to approximate one times the anticipated cost synergies, although timing and total costs may change.
- COVID-19 remains the principal uncertainty, with potential effects on volumes, customer credit quality, supply availability, facility operations, foreign exchange, liquidity, covenant compliance and asset valuations. Further deterioration could result in additional impairment charges.
- The Company stated that existing cash, operating cash flow and available liquidity should be sufficient for at least the next twelve months, but acknowledged that the pandemic could materially affect liquidity and financial position.
- Disclosure controls were not effective as of June 30, 2020 because of material weaknesses related to risk assessment, revenue data review and controls over data supporting business-combination accounting. Management began a remediation plan, but COVID-19 may delay remediation activities.
Important facts for investors to verify
- Whether COVID-19-related volume declines and lower gross margins improve as projected, particularly in the Americas and automotive, aerospace and other cyclical markets.
- The Company’s remaining revolver capacity, net leverage and interest coverage relative to covenant thresholds as operating conditions evolve.
- Actual realization of the $53 million, $65 million and $75 million annual synergy targets and the cash costs required to achieve them.
- Potential additional impairment of goodwill or indefinite-lived intangible assets if demand recovery is delayed or discount-rate assumptions increase.
- Progress in remediating the material weaknesses in internal control over financial reporting and the potential for future reporting adjustments.
- Final purchase-price allocations for Houghton, Norman Hay and Tel Nordic, which remained subject to measurement-period adjustments at June 30, 2020.
- Developments in uncertain tax positions, foreign tax credit valuation allowances, environmental obligations, asbestos litigation and other contingencies.