Quaker Chemical Corporation: 2013 Third-Quarter 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 and nine months ended September 30, 2013, with comparisons to the corresponding 2012 periods.
During the quarter, Quaker changed its reportable segments from product-based categories to four geographic regions: North America, Europe, Middle East and Africa (EMEA), Asia Pacific, and South America. Prior periods were recast for comparability.
Financial performance and liquidity
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Net sales | $184.1 million | $180.9 million | $545.1 million | $535.4 million |
| Gross profit | $66.0 million | $59.1 million | $195.9 million | $179.6 million |
| Gross margin | 35.9% | 32.7% | 35.9% | 33.5% |
| Operating income | $18.8 million | $15.9 million | $56.0 million | $49.5 million |
| Operating margin | 10.2% | 8.8% | 10.3% | 9.3% |
| Net income attributable to Quaker | $12.6 million | $10.9 million | $42.3 million | $34.4 million |
| Diluted EPS | $0.95 | $0.83 | $3.21 | $2.63 |
| Operating cash flow | $24.5 million | Not separately provided | $52.0 million | $41.8 million |
Q3 revenue increased approximately 2%, primarily from higher volumes, including acquisitions. Nine-month revenue also increased approximately 2%. Gross margin improvement reflected a return of product margins to more acceptable levels. SG&A increased 9% in the quarter and 8% year to date, driven by higher selling-related costs, merit increases, acquisitions, and operational streamlining expenses.
Cash and cash equivalents were $53.9 million at September 30, 2013, compared with $32.5 million at December 31, 2012. Nine-month cash flow included $8.7 million used in investing activities, including $7.3 million of capital expenditures and $2.5 million of acquisition payments, and $21.7 million used in financing activities, including $12.3 million of debt repayment and $9.7 million of dividends.
Total reported debt was approximately $19.2 million, consisting of $1.4 million of current borrowings and $17.8 million of long-term debt. Quaker had no borrowings under its revised revolving credit facility at September 30, 2013. The facility provides up to $300 million of revolving capacity, expandable to $400 million subject to conditions, and matures in June 2018. The consolidated leverage ratio was below 1.0 to 1, versus a covenant limit of 3.50 to 1.
Material changes versus the prior comparable period
- Q3 gross profit increased approximately 12%, while operating income increased approximately 19% and diluted EPS increased from $0.83 to $0.95.
- Nine-month gross profit increased approximately 9%, operating income increased approximately 13%, and diluted EPS increased approximately 22%.
- Operating earnings excluding indirect expenses improved across all regions in Q3: North America increased 11%, EMEA 22%, Asia Pacific 11%, and South America 345%. South America benefited from improved margins and cost-streamlining initiatives.
- For the first nine months, EMEA sales increased 7% and Asia Pacific sales increased 6%; North America sales declined 2% and South America sales declined 3%, primarily due to volume and foreign-exchange effects.
- The effective tax rate increased to 33.8% in Q3 from 28.6% and to 30.0% for nine months from 26.9%, principally because an Asia Pacific concessionary tax rate had not yet been recognized.
- Equity income from associated companies increased materially, including a $1.038 million out-of-period increase related to errors in a captive insurance affiliate’s 2012 estimated financial statements. No prior-period restatement was recorded.
- Quaker received approximately $2.057 million of Italian excise-tax refunds and approximately $0.483 million of interest in Q2 2013; the total was recorded in other income.
- Quaker acquired two businesses in 2013 for aggregate net consideration of approximately $2.5 million, adding operations and goodwill in North America.
Guidance, outlook, risks, contingencies, and unusual items
Management expected Q4 operating results to remain good, subject to typical holiday seasonality, and stated that its full-year expectations had not changed: 2013 was expected to be another strong year. Management also cited strong liquidity and the balance sheet as supporting potential acquisitions and other strategic growth opportunities.
The Asia Pacific subsidiary received approval for renewal of a 15% concessionary tax rate for 2013 through 2015, compared with a 25% statutory rate. Assuming no adverse developments, management expected to recognize the benefit in Q4 2013; the estimated Q3 benefit would have been approximately $0.08 per diluted share.
- Key business risks include customer-driven cyclicality, production shutdowns, raw-material cost increases, global economic and political conditions, foreign-exchange volatility, and exposure to steel, automotive, aircraft, appliance, and durable-goods markets.
- A VAT audit initiated in Q3 remains unresolved. Potential exposure across affected jurisdictions was estimated at $0 to $12.5 million assuming future refunds, amnesties, or settlements; exposure could be higher without such relief.
- Environmental remediation liabilities related to the AC Products groundwater program were estimated at approximately $0.475 million to $0.850 million, with reserves considered adequate. Other environmental accruals were approximately $0.205 million.
- An inactive subsidiary faces asbestos claims. Its projected total liability over the next 50 years was approximately $3.3 million, excluding defense costs, although management does not believe material losses to Quaker are probable. The ultimate exposure remains difficult to estimate.
- The company’s Italian subsidiary is appealing a tax court decision affirming a transfer-pricing adjustment; penalties were denied, and management believes it should prevail.
- Other unusual items included approximately $1.1 million of year-to-date operational streamlining costs, a $0.675 million increase in an acquisition-related earnout liability, and a $0.357 million Venezuelan currency-devaluation charge.
- Goodwill impairment testing under the revised geographic reporting structure produced no impairment charge, and management reported substantial excess fair value over carrying value for all reporting units.
Most important facts for investors to verify
- Whether product-margin improvement and the 35.9% gross margin are sustainable after Q3.
- Whether the Asia Pacific concessionary tax rate is recognized in Q4 and how it affects the full-year effective tax rate and EPS.
- The recurring versus nonrecurring nature of captive-insurance affiliate income, including the $1.038 million out-of-period adjustment.
- Progress and potential financial exposure from the open VAT audit, Italian tax appeal, asbestos claims, and environmental remediation.
- Whether operating cash flow remains sufficient to fund dividends, acquisitions, capital expenditures, pension obligations, and potential contingencies.
- Regional volume, pricing, foreign-exchange trends, and the effect of continued weakness or cyclicality in end markets.