Quaker Chemical Corporation — 2019 Q1 Form 10-Q Summary
Business Context and Reporting Period
Quaker Chemical develops and sells formulated process fluids, chemical specialties, and chemical management services for steel, metalworking, automotive, aerospace, mining, and other industrial customers. The unaudited report covers the three months ended March 31, 2019, compared with the three months ended March 31, 2018. Operations are reported across North America, EMEA, Asia/Pacific, and South America.
Key Financial Metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales | $211.2 million | $212.1 million | Down less than 1% |
| Gross profit | $75.8 million | $75.4 million | Up less than 1% |
| Gross margin | 35.9% | 35.6% | Up 30 basis points |
| Operating income | $19.8 million | $20.2 million | Down 2% |
| Net income attributable to Quaker | $13.8 million | $12.7 million | Up 9% |
| Diluted earnings per share | $1.03 | $0.95 | Up 8% |
| Adjusted EBITDA | $29.6 million | $30.9 million | Down 4% |
| Adjusted EBITDA margin | 14.0% | 14.6% | Down 60 basis points |
| Net cash from operating activities | Less than $0.1 million | $2.7 million | Down $2.7 million |
Reported net sales reflected approximately 3% volume growth and a 1% benefit from selling price and product mix, offset by approximately 5% unfavorable foreign-currency translation. The effective tax rate was 26.8%, compared with 29.8% in the prior-year quarter. The company declared a quarterly dividend of $0.370 per share, compared with $0.355.
Liquidity, Debt, and Balance Sheet
- Cash and cash equivalents were $72.0 million at March 31, 2019, compared with $104.1 million at December 31, 2018.
- Cash, cash equivalents, and restricted cash totaled $92.1 million, including $20.2 million restricted for asbestos-related litigation.
- Total debt was approximately $12.4 million, consisting primarily of industrial development bonds and municipality-related loans. The company had no borrowings under its $300 million primary credit facility at quarter-end, compared with $24.0 million at December 31, 2018.
- The company used $23.9 million to repay long-term debt and paid $4.9 million of dividends during the quarter.
- The primary credit facility maturity was extended to July 15, 2020. The company reported a total-debt-to-adjusted-EBITDA ratio below 1.0x, versus a 3.50x covenant limit, and stated that it remained in compliance with its covenants.
- Adoption of the new lease standard added $26.1 million of right-of-use lease assets and $25.5 million of operating lease liabilities to the balance sheet, without a material impact on reported earnings or cash flow.
Material Changes Versus the Prior Comparable Period
- Gross margin improved due primarily to pricing initiatives and product mix, but SG&A increased $1.4 million because of higher labor-related costs and professional fees.
- Combination-related expenses declined to $4.5 million from $5.2 million; total Houghton-related costs, including items outside operating income, were $5.3 million in Q1 2019 versus $6.1 million in Q1 2018.
- Reported operating income declined despite higher gross profit, while net income increased because of lower interest expense, a lower tax rate, and improved equity earnings from associated companies.
- North America sales rose 4% and Asia/Pacific sales rose 4%; EMEA sales fell 9% and South America sales fell 3%, primarily because of currency translation.
- Operating cash flow was nearly zero, largely because of higher tax payments and higher cash payments related to the pending Houghton transaction.
- The company adopted lease accounting guidance in Q1 2019 and elected not to reclassify stranded tax effects under the related accounting standard.
Guidance, Outlook, Risks, and Unusual Items
Management expected final U.S. Federal Trade Commission and European Commission approvals for the Houghton combination and closing to occur within the next couple of months. The transaction is expected to approximately double annual sales and adjusted EBITDA before synergies; expected synergies are at least $45 million when fully achieved by the third year. The company expected to incur approximately $25 million to $30 million of additional pre-closing combination expenses and cash outflows, plus significant post-closing integration costs that were not yet precisely estimable.
For the existing business, management expected foreign-exchange headwinds and underlying market challenges to continue into Q2 2019, with more favorable comparisons in the second half. Q2 gross margin was expected in the low-to-mid 36% range. Management continued to expect 2019 sales and earnings growth in Quaker’s current business, although no specific full-year numerical guidance was provided.
- Key risks include industrial production cycles, customer shutdowns, raw-material cost inflation, foreign-currency volatility, customer credit risk, economic and political conditions, and changes in tax rates or regulations.
- The Houghton transaction remained subject to regulatory approval, closing conditions, financing availability, potential divestitures, and integration risks.
- The company expected to terminate its primary U.S. pension plan in 2020. Additional funding was estimated at $0 million to $10 million, and a future pension settlement charge was expected, but its amount was not yet estimated.
- Known contingencies included groundwater remediation liabilities estimated at approximately $0.1 million to $1.0 million, projected asbestos-related liability of approximately $1.7 million over 50 years excluding defense costs, and accrued environmental liabilities of approximately $0.2 million.
- Gross unrecognized tax benefits, including interest and penalties, totaled approximately $9.3 million at March 31, 2019. The company was also contesting Italian tax assessments and stated that it had adequate reserves.
Most Important Facts for Investors to Verify
- Whether the Houghton acquisition received all required regulatory approvals and closed on the expected timetable, including the final divestiture requirements and financing terms.
- The actual debt increase, interest burden, leverage ratio, share issuance, and integration costs following any Houghton closing.
- Whether reported volume and pricing gains offset continuing foreign-exchange and industrial-market headwinds.
- Whether operating cash flow normalizes after the unusually low Q1 level and after combination-related payments and tax payments.
- The eventual funding requirement and settlement charge associated with the U.S. pension plan termination.
- Developments in Italian tax proceedings, asbestos litigation, groundwater remediation, and other environmental contingencies.