Quaker Chemical Corporation — Fiscal 2017 Form 10-K Summary
Business context and reporting period
Quaker Chemical develops and markets specialty chemical products and chemical management services for steel, metalworking, automotive, aerospace, mining, construction and other industrial markets. The filing covers the fiscal year ended December 31, 2017, with comparative results for 2016 and 2015. Operations are reported across North America, EMEA, Asia/Pacific and South America; approximately 60% of sales are generated by non-U.S. subsidiaries.
Major 2017 actions included acquiring the remaining 45% of Quaker Chemical India Private Limited for approximately $31.8 million and acquiring North American metalworking-fluid assets for approximately $5.4 million. The proposed Houghton International combination remained pending at year-end.
Financial performance and position
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Net sales | $820.1 million | $746.7 million | +10% |
| Gross margin | 35.5% | 37.5% | Down 2.0 percentage points |
| Operating income | $62.7 million | $85.4 million | Down $22.6 million |
| Net income attributable to Quaker | $20.3 million | $61.4 million | Down $41.1 million |
| Diluted EPS | $1.52 | $4.63 | Down $3.11 |
| Adjusted EBITDA | $115.2 million | $106.6 million | +8% |
| Adjusted EBITDA margin | 14.1% | 14.3% | Down 0.2 percentage points |
| Operating cash flow | $64.8 million | $73.8 million | Down $9.0 million |
| Cash and cash equivalents | $89.9 million | $88.8 million | Up $1.1 million |
| Total debt | $66.8 million | $66.5 million | Approximately flat |
Reported earnings were materially affected by $30.8 million of Houghton combination-related expenses, a $22.2 million U.S. Tax Reform charge, a $1.9 million pension settlement charge, and other non-core items. Excluding specified adjustments, non-GAAP diluted EPS increased 9% to $5.01 from $4.60.
Net sales growth reflected 6% organic volume growth, 1% from the Lubricor acquisition, 2% from selling price and product mix, and 1% from foreign currency translation. Higher raw-material costs and unfavorable product mix reduced gross margin. SG&A increased only modestly, benefiting from cost discipline and prior restructuring actions.
Cash flow from operations was reduced by $25.9 million of cash payments for combination-related expenses. Investing cash use was $13.9 million, including $10.9 million of capital expenditures. Financing cash use was $55.2 million, including $31.8 million for the India acquisition and $18.6 million of dividends.
At December 31, 2017, working capital was $251.8 million, total assets were $722.1 million and total equity was $409.6 million. Borrowings under credit facilities were $48.5 million at a weighted-average rate of approximately 1.88%; the company was in compliance with its covenants and reported net debt to adjusted EBITDA below 1.0x.
Material changes versus the prior comparable period
- Sales increased 10%, driven primarily by volume growth and acquisitions, while gross margin declined from 37.5% to 35.5%.
- Operating income declined 27% because combination-related costs and higher SG&A more than offset higher gross profit.
- Reported net income and diluted EPS declined sharply, primarily because of Houghton transaction costs and the one-time U.S. Tax Reform charge.
- Adjusted EBITDA rose 8% to a record $115.2 million, and adjusted diluted EPS rose 9% to $5.01.
- Operating cash flow declined 12% because of transaction-related cash payments, despite stronger operating performance and improved accounts-receivable cash flow.
- South America operating earnings increased 183% to $3.9 million; EMEA and Asia/Pacific operating earnings increased 5% each, while North America was approximately flat.
- The company completed the 2015 restructuring program, with no restructuring charge in 2017 and estimated pretax savings of approximately $5 million for the year.
Fourth-quarter items, outlook and commentary
Fourth-quarter 2017 net sales were $211.1 million and operating income was $17.1 million. The company reported a fourth-quarter net loss attributable to Quaker of $9.8 million, or a diluted loss of $0.73 per share, primarily due to the $22.2 million U.S. Tax Reform charge and $7.7 million of Houghton-related expenses, partially offset by a $0.6 million insurance insolvency recovery.
Management expected the Houghton combination to close in the first half of 2018, subject to remaining regulatory approvals in the United States and Europe and customary closing conditions. The transaction was expected to approximately double annual sales and adjusted EBITDA before synergies, with expected synergies of at least $45 million when fully achieved by the third year. The transaction would require approximately $172.5 million in cash, issuance of shares representing 24.5% of the post-closing common stock, and assumption of Houghton net debt that was approximately $690 million at signing.
For the existing Quaker business, management expected continued volume growth and SG&A leverage. Gross margin was expected to improve gradually from approximately 35% toward 36% in 2018 and ultimately toward a 37% target. The company estimated additional 2018 pre-closing combination expenses and related cash outflows of approximately $30 million to $35 million, excluding post-closing integration costs.
Risks, contingencies and unusual items
- The Houghton transaction could be delayed, terminated or require unanticipated divestitures. It would materially increase leverage, interest-rate exposure, dilution, integration risk and transaction costs. The transaction agreement could be terminated if not completed by April 4, 2018.
- Demand depends heavily on global production in steel, automotive, aerospace, appliance and durable-goods markets. Customer shutdowns, bankruptcies or loss of major customers could materially affect results; the five largest customers represented approximately 18% of 2017 sales and the largest represented approximately 8%.
- Raw-material prices are volatile and affected by crude oil, biodiesel and commodity-chemical markets. A one-percentage-point change in gross margin would affect pretax earnings by approximately $8.2 million.
- Foreign-currency exposure is significant. A simultaneous 10% change in the euro, Brazilian real, Mexican peso, Chinese renminbi and Indian rupee would have changed 2017 revenue by approximately $42.6 million and pretax earnings by approximately $5.8 million.
- Environmental, asbestos-related and other legal matters remain outstanding. Known liabilities for the AC Products groundwater remediation program were estimated at approximately $0.1 million to $1.0 million. Projected asbestos-related liability of an inactive subsidiary was approximately $1.9 million over 50 years, excluding defense costs, although insurance and other coverage may be insufficient.
- U.S. Tax Reform produced a provisional transition-tax obligation of approximately $18.4 million and total 2017 tax charges of approximately $22.2 million. The company continues to evaluate certain tax provisions and could incur additional withholding or distribution taxes if foreign earnings are remitted.
- The company expects 2018 pension and other postretirement contributions of approximately $10.3 million and regulatory-compliance capital expenditures of approximately $2.4 million.
- The company identified no goodwill impairment at year-end. Management and the auditor concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2017.
Important facts for investors to verify
- Whether and when the Houghton combination closed, the final purchase consideration, acquired debt, share dilution, financing terms and realized synergies.
- Progress toward restoring gross margin from approximately 35% toward the 36% 2018 expectation and 37% longer-term target.
- The sustainability of 6% organic volume growth and the extent to which future growth depends on acquisitions, pricing or favorable currency translation.
- Post-combination leverage, covenant compliance, floating-rate interest expense and debt amortization requirements.
- Final accounting for U.S. Tax Reform, including the transition tax, GILTI exposure and any additional taxes on repatriation of approximately $300 million of undistributed foreign earnings.
- Cash requirements for combination expenses, integration costs, capital expenditures, pension contributions, dividends and environmental or asbestos-related contingencies.
- Customer concentration, raw-material inflation, foreign-exchange sensitivity and exposure to cyclical industrial end markets.