Quaker Chemical Corporation — Form 10-Q Summary
Business Context and Reporting Period
Quaker Chemical is a global provider of process fluids, chemical specialties and technical services to industries including steel, aluminum, automotive, mining, aerospace, tube and pipe, and cans. This unaudited Form 10-Q covers the three and nine months ended September 30, 2017, compared with the corresponding 2016 periods.
Key Financial Metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $212.9 million | $190.4 million | $609.0 million | $555.4 million |
| Gross profit | $74.8 million | $70.9 million | $217.5 million | $210.3 million |
| Gross margin | 35.1% | 37.2% | 35.7% | 37.9% |
| Operating income | $14.0 million | $21.9 million | $45.7 million | $64.4 million |
| Net income attributable to Quaker | $11.1 million | $16.0 million | $30.0 million | $44.0 million |
| Diluted EPS | $0.83 | $1.21 | $2.25 | $3.32 |
| Adjusted EBITDA | $29.4 million | $28.3 million | $85.6 million | $80.9 million |
| Adjusted EBITDA margin | 13.8% | 14.9% | 14.1% | 14.6% |
Q3 revenue increased 12%, driven by 7% volume growth including acquisitions, a 3% contribution from price and product mix, and a 2% favorable currency impact. Nine-month revenue increased 10%, driven by 6% organic volume growth, 2% from the Lubricor acquisition, and 2% from price and product mix.
Reported profitability was reduced by $9.7 million of Houghton combination-related expenses in Q3 and $23.1 million in the first nine months. Excluding specified non-core items, non-GAAP diluted EPS was $1.32 in Q3 versus $1.25 in the prior-year quarter, and $3.74 for the first nine months versus $3.34.
Cash Flow, Liquidity and Debt
- Cash provided by operating activities was $40.8 million for the first nine months of 2017, versus $53.0 million in 2016. The decline reflected Houghton-related payments and increased working-capital investment.
- Capital expenditures were $8.0 million and acquisition payments were $5.4 million during the first nine months.
- Cash and cash equivalents increased to $109.1 million at September 30, 2017, from $88.8 million at December 31, 2016.
- Total debt was approximately $73.1 million, including $72.4 million of long-term debt and $0.7 million of current debt. Credit-facility borrowings were $54.7 million.
- The existing $300 million credit facility matures in June 2019. Net debt to adjusted EBITDA was below 1.0x versus a 3.50x covenant limit, and the Company reported compliance with all covenants.
- The Company paid $13.9 million in dividends during the first nine months and declared quarterly dividends of $0.355 per share in Q3.
Material Changes Versus the Prior Comparable Period
- Revenue and volume growth were strong across the business, particularly in EMEA and Asia/Pacific. Q3 segment sales increased 5% in North America, 18% in EMEA, 18% in Asia/Pacific and 11% in South America.
- Gross margin declined because of higher raw-material costs and product-mix changes, partially offsetting the benefit of higher volumes.
- Operating income and reported EPS declined primarily because Houghton-related costs increased from $1.2 million to $9.7 million in Q3 and from $1.2 million to $23.1 million year to date.
- Adjusted EBITDA increased 4% in Q3 and 6% for the first nine months, despite lower adjusted EBITDA margins.
- A $1.9 million U.S. pension settlement charge was recorded in the second quarter of 2017. The 2015 restructuring program was completed during the second quarter, with no further charges expected under the program.
- Other comprehensive income benefited from $18.5 million of favorable currency translation adjustments in the first nine months, compared with a $1.1 million loss in the prior-year period.
Guidance, Outlook, Risks and Unusual Items
Management expects strong volumes to continue, gross margin to gradually recover toward its 37% target, and market-share gains, SG&A discipline and acquisition benefits to offset market challenges. The Company continued to expect 2017 year-over-year growth in net sales, adjusted EBITDA and non-GAAP EPS for the eighth consecutive year.
The Houghton transaction remained subject to U.S. and European regulatory approvals and other customary closing conditions. Closing was expected in late fourth quarter 2017 or the first quarter of 2018. Consideration included $172.5 million in cash, shares representing 24.5% of Quaker’s post-closing common stock, and assumption of Houghton net debt of approximately $690 million at signing. A contingent $1.15 billion new credit facility was arranged, with estimated floating-rate costs of 3.0% to 3.5% and leverage and interest-coverage covenants. Management estimated an additional $5 million to $10 million of Houghton-related expenses and comparable cash payments, primarily in the fourth quarter of 2017.
- Key operating risks include customer demand and production shutdowns, exposure to steel and other cyclical industries, raw-material inflation, foreign-exchange movements, economic and political conditions, and customer financial stability.
- Combination risks include failure or delay in regulatory approvals, required divestitures, financing risks, termination of the transaction, integration challenges and management distraction.
- Environmental remediation liabilities associated with the ACP groundwater program were estimated at approximately $0.1 million to $1.0 million.
- An inactive subsidiary’s asbestos-related liability was projected at approximately $2.2 million over the next 50 years, excluding defense costs.
- Gross liabilities for uncertain tax positions, including interest and penalties, were approximately $9.7 million at September 30, 2017.
- The Company reported no goodwill impairment as of the third-quarter 2017 annual assessment.
Important Facts for Investors to Verify
- Whether the Houghton transaction closed on the expected timetable and the final purchase consideration, assumed debt, financing terms and post-closing leverage.
- Whether gross margin recovered toward management’s 37% target and whether raw-material inflation continued to pressure profitability.
- The sustainability of volume growth, market-share gains and adjusted EBITDA improvement after excluding combination-related and other non-core items.
- The timing and amount of remaining Houghton-related costs and cash payments.
- Changes in working capital, operating cash flow and liquidity as acquisition and integration activities progressed.
- Developments in U.S. and European regulatory approvals, environmental remediation, asbestos litigation and uncertain tax positions.