Quaker Chemical Corporation — 2011 Q2 Form 10-Q Summary
Business context and reporting period
Quaker Chemical provides process chemicals, specialty chemicals, technical services, and chemical management services to industries including steel, aluminum, automotive, mining, aerospace, coatings, and construction materials. This unaudited report covers the three and six months ended June 30, 2011, compared with the corresponding 2010 periods.
Key financial metrics
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $167.8 million | $136.0 million | $327.7 million | $264.3 million |
| Gross profit | $53.8 million | $48.5 million | $106.5 million | $95.9 million |
| Gross margin | 32.0% | 35.7% | 32.5% | 36.3% |
| Operating income | $14.9 million | $13.4 million | $29.0 million | $27.1 million |
| Net income attributable to Quaker | $9.8 million | $9.2 million | $20.4 million | $18.6 million |
| Diluted EPS | $0.79 | $0.80 | $1.69 | $1.64 |
| Dividends declared per share | $0.24 | $0.235 | $0.475 | $0.465 |
Sales increased 23% in the quarter and 24% year to date. Management attributed the growth to acquisitions, selling-price and mix increases, higher volumes, and favorable foreign-exchange translation. Metalworking process chemicals represented approximately 93% of second-quarter sales and 94% of first-half sales.
SG&A increased $3.7 million in the quarter and $8.7 million year to date, but declined as a percentage of sales to 23.1% from 25.8% in the quarter and to 23.6% from 26.0% year to date. Interest expense declined with lower borrowings and rates. The year-to-date effective tax rate was 25.7%, compared with 27.3% in 2010.
Cash flow, debt, and liquidity
- Cash and cash equivalents were $23.5 million at June 30, 2011, compared with $25.8 million at December 31, 2010.
- Operating cash flow was $0.2 million in the first half of 2011, down from $10.3 million in the prior-year period. Working-capital investment and higher pension contributions offset higher earnings.
- Investing cash flow was negative $6.3 million, including $6.6 million of capital expenditures and $0.7 million of acquisition-related payments.
- Financing cash flow was positive $2.6 million. A common-stock offering generated $48.1 million of net proceeds, which were used to repay revolving credit borrowings.
- Total long-term debt declined to $33.6 million from $73.9 million at year-end 2010. Approximately $15.0 million was outstanding under the $175.0 million syndicated credit facility at June 30, 2011, versus approximately $55.0 million at December 31, 2010.
- The credit facility expires in 2014 and includes a maximum consolidated leverage ratio of 3.50 to 1. The reported ratio was below 1.0 to 1 at June 30, 2011.
- Interest-rate swaps with a $15.0 million notional amount fixed the rate on a portion of variable-rate debt.
Material changes versus the prior comparable period
- Revenue growth was strong, but accelerating raw-material costs reduced gross margin by 370 basis points in the quarter and 380 basis points year to date.
- Quarterly diluted EPS declined to $0.79 from $0.80 despite higher net income, reflecting the dilutive effect of the equity offering and approximately 1.3 million additional shares issued.
- First-half operating cash generation weakened materially because of increased receivables and inventories, higher capital spending, and pension contributions.
- Debt was substantially reduced using equity-offering proceeds, improving liquidity and leverage.
- Acquisitions of D.A. Stuart’s U.S. aluminum hot-rolling-oil business and Summit Lubricants contributed to growth; Summit required an additional $0.7 million post-closing payment during the period.
Guidance, outlook, risks, and unusual items
Management maintained its overall 2011 outlook and expected to build on 2010 profitability. It was implementing additional price increases to restore historically acceptable margins. Management identified potential demand uncertainty in China, India, and Brazil as governments addressed inflation, while continuing to expect longer-term growth in emerging markets.
- Major operating risks include raw-material inflation, customer production downturns or shutdowns, cyclical exposure to steel, automotive, aerospace, appliance, and durable-goods markets, foreign-currency movements, and global economic or political conditions.
- Gross unrecognized tax benefits were $11.3 million at June 30, 2011; including accrued interest and penalties, the gross uncertain-tax-position liability was $14.6 million. Management estimated a $1.4 million to $1.6 million reduction in unrecognized tax benefits during 2011 from statute expirations, before considering new or additional positions.
- A VAT matter could expose the Company to additional liability ranging from $0 to $26.0 million, net of potential refunds, if other jurisdictions assess taxes. The potential exposure could be higher without future amnesty programs or settlements.
- Environmental remediation liabilities related to the ACP site were estimated at approximately $1.2 million to $2.2 million, with sufficient reserves recorded. Other environmental accruals were approximately $0.4 million.
- An inactive subsidiary faces asbestos claims. The subsidiary’s projected liability over the next 50 years was approximately $7.7 million excluding defense costs, but the Company believes it is not probable that it will incur material losses; additional losses cannot be reliably estimated.
- After quarter-end, the Company acquired the remaining 60% of its Mexican affiliate for approximately $10.5 million in cash, with an additional $2.0 million payable in 2012 subject to conditions. Management expected to record a one-time gain in the third quarter of 2011.
Important facts for investors to verify
- Whether price increases offset continuing raw-material inflation and restore gross margins.
- The conversion of earnings into operating cash flow, particularly receivables and inventory trends.
- Post-quarter-end cash usage, financing, and accounting effects from the Mexican affiliate acquisition.
- Progress and ultimate exposure related to the VAT matter, uncertain tax positions, environmental remediation, and asbestos litigation.
- The effect of the equity issuance, acquisition integration, and further growth investments on diluted EPS and returns on capital.