Quaker Chemical Corporation Form 10-Q Summary
Business context and reporting period
Quaker Chemical Corporation, doing business as Quaker Houghton, filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2019. The Company develops and supplies specialty chemical products and technical services for metalworking, metals and other industrial applications across the Americas, EMEA, Asia/Pacific and Global Specialty Businesses.
The August 1, 2019 combination with Houghton International materially changed the Company’s scale, capital structure and reported results. The third-quarter results include two months of Houghton operations and $119.5 million of Houghton net sales.
Key financial metrics
| Metric | Q3 2019 | Q3 2018 | First 9M 2019 | First 9M 2018 |
|---|---|---|---|---|
| Net sales | $325.1 million | $222.0 million | $742.2 million | $656.0 million |
| Gross profit | $105.1 million | $81.1 million | $256.0 million | $237.5 million |
| Gross margin | 32.3% | 36.5% | 34.5% | 36.2% |
| Operating income | $(14.5) million | $24.9 million | $25.9 million | $67.7 million |
| Net income attributable to Quaker | $(13.1) million | $19.7 million | $16.4 million | $51.7 million |
| Diluted earnings per share | $(0.80) | $1.47 | $1.14 | $3.87 |
| Net cash provided by operating activities | $13.1 million | $31.2 million | $35.5 million | $50.9 million |
Third-quarter sales increased 46% year over year, primarily from Houghton. Excluding Houghton, sales declined 7%, reflecting approximately 4% lower volumes, a 2% negative foreign-currency effect and a 1% decline from price and mix. First-nine-month sales increased 13%; excluding Houghton, sales declined 5%.
Reported third-quarter gross margin included a $10.2 million purchase-accounting charge for the sale of Houghton inventory recorded at fair value. Excluding this charge, gross margin was approximately 35.5%, versus 36.5% in the prior-year quarter. Adjusted EBITDA was $51.4 million, or 15.8% of sales, compared with $33.0 million, or 14.9%, in the prior-year quarter. Non-GAAP net income was $25.3 million, or $1.56 per diluted share, compared with $21.8 million, or $1.63, respectively.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $128.2 million at September 30, 2019, compared with $104.1 million at December 31, 2018. Cash, cash equivalents and restricted cash totaled $148.5 million, including $20.3 million of restricted cash.
- Total debt was $878.0 million, including $600.0 million of U.S. term debt, $147.2 million of euro term debt and $110.0 million drawn on the revolver. Aggregate net indebtedness was approximately $749.8 million, excluding debt issuance costs.
- The new secured credit facility matures in August 2024 and provides a $400.0 million revolver plus term loans. Approximately $281 million of revolver capacity remained available, net of letters of credit.
- The Company was in compliance with its debt covenants at September 30, 2019. Key covenant thresholds include an initial consolidated net debt-to-adjusted EBITDA ratio not exceeding 4.25 to 1 and adjusted EBITDA-to-interest expense of at least 3.0 to 1.
- Cash used for acquisitions was $798.1 million during the first nine months, principally reflecting the Houghton transaction. Financing activities provided $798.4 million, primarily from new borrowings.
Material changes versus the prior comparable period
- The Houghton combination added substantial sales, assets, goodwill, intangible assets and debt. Preliminary purchase accounting recorded $483.9 million of goodwill and $1.02 billion of intangible assets.
- Operating results were reduced by $14.7 million of acquisition-related expenses, $24.0 million of restructuring expense and the $10.2 million Houghton inventory fair-value step-up charge in the third quarter.
- The Company initiated a global restructuring program expected to reduce headcount by approximately 275 employees and close certain facilities over approximately two years. Accrued restructuring liabilities were $19.3 million at September 30.
- Interest expense increased to $6.1 million in the third quarter from $1.0 million, primarily because of acquisition-related borrowings.
- Foreign-currency translation reduced other comprehensive income by $28.3 million in the third quarter and $29.3 million for the first nine months.
- Shares outstanding increased materially following the issuance of approximately 4.3 million shares to Houghton sellers, representing approximately 24.5% of the Company’s common stock at closing.
Outlook, commentary, risks and unusual items
Management stated that weak global automotive demand, softer industrial conditions, customer inventory corrections and a strong U.S. dollar were expected to persist into the fourth quarter. Management nevertheless reported continued market-share gains, progress on integration and approximately $2 million of third-quarter combination synergies on a pro forma basis.
Management estimates total combination-related cost synergies of approximately $60 million once actions are completed by the second year after closing. Related costs and cash payments, including restructuring but excluding incremental combination capital expenditures, are expected to approximate one times the anticipated synergies, with a significant portion incurred in 2019 and 2020. The Company expects the combined business to deliver above-market growth on a consistent basis, but the filing does not provide formal quantified revenue or earnings guidance.
On October 1, 2019, after the reporting date, the Company acquired the operating divisions of Norman Hay plc for approximately $98 million. Those operations are not included in the reported quarter.
- The Company’s demand is tied to production levels in steel, automotive, aerospace, appliances and other durable-goods industries.
- Key risks include economic and political conditions, raw-material costs, foreign-exchange movements, customer financial stability, tax changes, integration execution, retention of personnel and the possibility that synergy costs exceed estimates.
- The Company expects to complete termination of its U.S. pension plan in 2020 and may need to contribute an estimated $0 to $10 million. A future non-cash pension settlement charge is also expected, but its amount is not currently estimated.
- The Company participates in a multiemployer pension plan classified as in critical status; potential future additional contributions cannot be reasonably estimated.
- Known Houghton environmental obligations were estimated at $4 million to $5 million, with $4.8 million accrued. Other disclosed matters include groundwater remediation, asbestos litigation and tax assessments.
- Disclosure controls were not effective at September 30 because of a previously reported material weakness involving certain information-technology controls. Management expected remediation before year-end 2019, but the weakness had not yet been considered remediated.
Investor verification checklist
- Verify whether Houghton integration synergies reach the approximately $60 million target and whether related costs remain near one times expected synergies.
- Monitor legacy Quaker volumes, automotive and industrial end-market demand, pricing, product mix and foreign-exchange effects.
- Assess deleveraging progress, revolver availability, interest-rate exposure and compliance with the new credit facility covenants.
- Reconcile GAAP performance with management’s non-GAAP measures and evaluate the recurrence of acquisition, restructuring and purchase-accounting charges.
- Review the final Houghton purchase-price allocation, including goodwill, intangible values, deferred taxes and potential impairment exposure.
- Track the Norman Hay acquisition’s contribution and financing requirements after October 1, 2019.
- Confirm remediation of the material weakness in information-technology controls.
- Evaluate pension termination funding, environmental obligations, tax contingencies and other litigation exposures.