Quaker Chemical Corporation — Q1 2020 Form 10-Q Summary
Business Context and Reporting Period
Quaker Chemical Corporation, doing business as Quaker Houghton, reported unaudited results for the three months ended March 31, 2020. The company develops and supplies specialty process fluids and related services to industrial and manufacturing customers globally. The first-quarter 2020 results include a full quarter of Houghton, acquired August 1, 2019, and Norman Hay, acquired October 1, 2019; the prior-year comparison primarily reflects Legacy Quaker.
Financial Performance and Position
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net sales | $378.6 million | $211.2 million | +79% |
| Gross profit | $133.9 million | $75.8 million | +77% |
| Gross margin | 35.4% | 35.9% | Down 50 basis points |
| Operating income | $(12.4) million | $19.8 million | Declined to a loss |
| Net income attributable to Quaker | $(28.4) million | $13.8 million | Declined to a loss |
| Diluted EPS | $(1.60) | $1.03 | Declined |
| Operating cash flow | $20.2 million | Less than $0.1 million | Improved |
| Adjusted EBITDA | $60.5 million | $29.6 million | +104% |
| Adjusted EBITDA margin | 16.0% | 14.0% | Up 200 basis points |
Excluding Houghton and Norman Hay, net sales declined 11%, reflecting a 5% volume decline, a 3% unfavorable foreign-exchange impact, and a 3% decline from price and product mix. Reported sales benefited from $190.3 million of Houghton and Norman Hay revenue.
Cash, cash equivalents and restricted cash totaled $336.0 million at March 31, 2020, including $19.5 million of restricted cash. Total debt was $1.128 billion, net debt was $811.4 million, and long-term debt was $1.076 billion. The company drew $205.5 million under its revolving facility as a precautionary COVID-19 liquidity measure and had approximately $15 million of remaining revolver capacity, net of letters of credit. The company remained compliant with its debt covenants.
Investing cash outflows were $8.0 million, including $4.9 million of capital expenditures and $3.2 million of acquisition-related payments. Financing cash inflows were $186.6 million, primarily from revolver borrowings, partially offset by $9.4 million of scheduled term-loan repayments and $6.8 million of dividends paid. The quarterly dividend was $0.385 per share, compared with $0.370 in the prior-year quarter.
Material Changes Versus the Prior Comparable Period
- Reported sales and segment earnings increased substantially because of the Houghton and Norman Hay acquisitions; underlying Legacy Quaker sales declined.
- COVID-19 caused volume declines initially in China and increasingly across global markets beginning in the second half of March. Boeing’s temporary suspension of 737 Max production also reduced demand.
- The company recorded a $38.0 million non-cash impairment charge on Houghton and Fluidcare trademarks and tradenames after COVID-19 reduced projected sales and increased the valuation discount rate.
- The company recorded a $22.7 million non-cash pension settlement charge upon terminating the Legacy Quaker U.S. pension plan and funded approximately $1.8 million to complete the termination.
- Combination and acquisition-related expenses increased to $7.9 million from $4.5 million, while restructuring charges were $1.7 million versus none in the prior-year quarter.
- Interest expense increased to $8.5 million from $0.8 million, primarily because of debt incurred to finance the Houghton transaction.
- Other comprehensive loss was $43.5 million, primarily reflecting a $54.8 million currency translation loss, partially offset by defined-benefit plan adjustments.
Guidance, Outlook, Risks and Unusual Items
Management expects COVID-19 to significantly adversely affect results, particularly in the second quarter of 2020. The company expects lower volumes and net sales in the second quarter compared with both the first quarter of 2020 and the prior-year quarter, with a possible gradual sequential improvement later in 2020 depending on virus containment and economic recovery. The filing does not provide formal revenue or EPS guidance.
Management increased expected Combination cost synergies to $53 million in 2020, $65 million in 2021, and $75 million in 2022, compared with prior expectations of $35 million, $50 million, and $60 million, respectively. Approximately $10 million of cost savings were realized in the first quarter, and cumulative pro forma synergies since closing were approximately $17 million.
The global restructuring program targets approximately 325 headcount reductions and facility closures during 2020 and 2021. Total program costs are expected to approximate one times the anticipated cost synergies. The company also reduced discretionary spending, delayed or froze salary increases where permitted, reduced executive salaries, and targeted a roughly 30% reduction in capital expenditures.
Management believes available cash, operating cash flow, and additional liquidity will be sufficient for at least the next twelve months. Key risks include prolonged COVID-19 disruption, customer production shutdowns, supply-chain interruptions, customer credit losses, foreign-exchange volatility, covenant compliance, elevated leverage, further intangible-asset impairments, and integration execution.
The company disclosed material weaknesses in internal control over financial reporting. The weaknesses relate to risk assessment, controls over the completeness and accuracy of certain revenue data, and controls over data supporting business-combination accounting. Management stated that the financial statements are fairly presented and began a remediation program, but disclosure controls were not effective as of March 31, 2020.
Other contingencies include environmental liabilities, asbestos-related litigation, tax audits and uncertain tax positions. The filing reports an estimated $5 million to $6 million present-value range for Houghton environmental matters, with $5.9 million accrued at March 31, 2020, and a gross uncertain-tax-position liability of $24.5 million including interest and penalties.
Facts Investors Should Verify
- Whether COVID-19-driven volume declines and customer shutdowns were materially worse than management’s expectations for the second quarter and remainder of 2020.
- Revolver availability, net leverage, interest coverage, and compliance with the New Credit Facility covenants as earnings and EBITDA change.
- Progress toward the revised Combination synergy targets and the cash cost of integration and restructuring activities.
- Whether additional impairment charges are required for goodwill, trademarks, tradenames, or other long-lived assets if the recovery is delayed.
- Remediation of the disclosed material weaknesses in revenue and business-combination controls.
- Underlying organic sales, volumes, pricing, product mix, and margins excluding Houghton and Norman Hay acquisition effects.
- Resolution and cash exposure associated with tax audits, environmental obligations, asbestos litigation, and other contingencies.