Quaker Chemical Corporation — 2016 Q1 Form 10-Q Summary
Business Context and Reporting Period
Quaker Chemical Corporation is a global provider of process fluids, chemical specialties and technical services serving steel, aluminum, automotive, mining, aerospace, tube and pipe, cans and other industries. This unaudited Form 10-Q covers the three months ended March 31, 2016, compared with the three months ended March 31, 2015. Reportable segments are North America, EMEA, Asia/Pacific and South America.
Key Financial Metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net sales | $178.1 million | $181.3 million | Down 2% |
| Gross profit | $67.9 million | $66.3 million | Up 2% |
| Gross margin | 38.1% | 36.6% | Up 150 basis points |
| Operating income | $19.2 million | $17.9 million | Up 8% |
| Operating margin | 10.8% | 9.9% | Improved |
| Net income attributable to Quaker | $12.9 million | $10.4 million | Up 25% |
| Diluted EPS | $0.98 | $0.78 | Up $0.20 |
| Adjusted EBITDA | $25.0 million | $23.2 million | Up 8% |
| Net cash from operating activities | $10.9 million | $8.1 million | Up 34% |
Cash and cash equivalents were $94.4 million at March 31, 2016, compared with $81.1 million at December 31, 2015. Total debt on the balance sheet was approximately $98.3 million, including $97.6 million of long-term debt and $0.6 million of current debt. Borrowings under credit facilities were $79.1 million, compared with $62.9 million at year-end. The company’s leverage ratio was below 1.0 to 1.0, versus a principal covenant limit of 3.50 to 1.0, and all debt covenants were satisfied.
Investing cash outflows were $3.3 million, including $2.2 million of capital expenditures and $1.4 million related to the Verkol acquisition. Financing cash inflows were $4.3 million, including $14.7 million of long-term debt proceeds, offset by $4.2 million of dividends, $5.9 million of share repurchases and $0.2 million of debt repayments.
Material Changes Versus the Prior Comparable Period
- Sales declined despite a 5% increase in product volume, including approximately $7.3 million of Verkol sales. Foreign currency translation reduced sales by approximately $8.0 million, while pricing and product mix reduced sales by approximately 2%.
- Gross margin expanded because the timing of raw-material cost reductions preceded related customer price reductions.
- SG&A increased by $0.2 million, primarily from Verkol-related costs and higher labor costs, partly offset by favorable currency translation and lower one-time charges.
- Other income improved to $0.7 million from a $0.2 million expense, primarily due to foreign-exchange transaction gains.
- Equity income from associated companies improved to $0.1 million from a $1.4 million loss. The prior-year result included a $2.8 million Venezuela currency conversion charge; the 2016 charge was $0.1 million.
- The effective tax rate increased to 32.3% from 30.8%, primarily because a subsidiary was taxed at 25% while awaiting recertification of a prior 15% concessionary rate.
- Regional sales increased 10% in EMEA, but declined 1% in North America, 8% in Asia/Pacific and 35% in South America. Operating earnings excluding indirect expenses increased in North America, EMEA and Asia/Pacific, but South America reported a $0.3 million operating loss.
- The company repurchased 83,879 shares for $5.9 million under its $100 million repurchase authorization and declared a quarterly dividend of $0.32 per share, compared with $0.30 in the prior-year quarter.
Guidance, Outlook, Risks and Unusual Items
Management continued to expect 2016 growth in both revenue and earnings, including higher non-GAAP earnings and adjusted EBITDA for the seventh consecutive year. Management expects the restructuring program to generate approximately $3 million of pretax savings in 2016 and approximately $6 million annually thereafter. The program is expected to be substantially completed during 2016; no additional restructuring expense was incurred in the first quarter.
Management expects some gross-margin decline later in 2016 as raw-material cost changes and customer pricing adjustments normalize. The estimated second-quarter effective tax rate is 31% to 33%, while the full-year 2016 effective tax rate is expected to be approximately 28% to 30%.
Key risks include weak global steel and industrial production, customer demand and production shutdowns, raw-material price increases, foreign-exchange volatility, economic and political conditions, customer financial stability, and cyclicality in steel, automotive, aircraft, appliance and durable-goods markets. South America remained particularly weak, and Venezuela continued to present currency-control and economic risks.
The filing identifies environmental remediation liabilities, asbestos-related litigation involving an inactive subsidiary, uncertain tax positions, and potential VAT assessments. The company believes it has adequate reserves and that it is not probable that it will incur losses related to the asbestos matters, but additional losses cannot be estimated. The company’s gross uncertain-tax-position liability, including interest and penalties, was $14.8 million at March 31, 2016, potentially offset by up to $9.3 million of benefits in other jurisdictions.
The company revised December 31, 2015 deferred-tax asset and liability classifications by $3.6 million each; management considered the revision immaterial, with no impact on equity, net income or operating cash flow. The company also early adopted the lower-of-cost-or-net-realizable-value inventory guidance without material impact.
Important Facts for Investors to Verify
- Whether the anticipated restructuring savings materialize and offset expected gross-margin normalization.
- Whether foreign-exchange pressure, especially in South America and Asia/Pacific, continues to affect sales and earnings.
- Progress on the Verkol integration and any final purchase-price allocation adjustments.
- Utilization of the $300 million credit facility, debt maturity in June 2018, and compliance with leverage covenants.
- Developments in Venezuela’s DICOM exchange-rate system and the carrying value of the Kelko Venezuela investment.
- Resolution and cash impact of uncertain tax positions, Italian, Dutch and French tax matters, VAT exposure and asbestos litigation.
- Whether full-year 2016 tax-rate, revenue-growth and adjusted-EBITDA expectations remain achievable.