Quaker Chemical Corporation 2019 Q2 Form 10-Q Summary
Business context and reporting period
Quaker Chemical develops and sells specialty chemical products and chemical management services for steel, metalworking, automotive, aerospace, appliance, and other industrial customers across North America, EMEA, Asia/Pacific, and South America. This unaudited Form 10-Q covers the three and six months ended June 30, 2019. Houghton International was acquired on August 1, 2019, after the reporting period, so its results are not included.
Financial performance and liquidity
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $205.9 million | $222.0 million | $417.1 million | $434.0 million |
| Gross profit | $75.2 million | $80.9 million | $150.9 million | $156.4 million |
| Gross margin | 36.5% | 36.5% | 36.2% | 36.0% |
| Operating income | $20.5 million | $22.6 million | $40.4 million | $42.8 million |
| Net income attributable to Quaker | $15.6 million | $19.2 million | $29.4 million | $32.0 million |
| Diluted EPS | $1.17 | $1.44 | $2.20 | $2.40 |
| Adjusted EBITDA | $31.4 million | $32.2 million | $61.1 million | $63.1 million |
| Adjusted EBITDA margin | 15.3% | 14.5% | 14.6% | 14.5% |
| Net cash from operating activities | Not separately reported | Not separately reported | $22.4 million | $19.7 million |
Q2 sales declined 7%, reflecting a 3% negative foreign-currency translation impact, a 3% volume decline, and a 1% decrease from pricing and product mix. SG&A declined 8%, helping preserve the 36.5% gross margin. The effective tax rate increased to 24.2% from 16.8%, partly because the prior-year period included a $1.2 million favorable U.S. transition-tax adjustment.
At June 30, 2019, cash and cash equivalents were $86.4 million, including $20.1 million of restricted cash within total cash, cash equivalents, and restricted cash of $106.5 million. Total debt was approximately $12.5 million, consisting primarily of industrial development bonds and municipality-related loans; the Company had no borrowings under its old revolving credit facility. Long-term debt declined to $11.8 million from $35.9 million at December 31, 2018.
Six-month investing cash outflows were $5.8 million, including $5.5 million of capital expenditures. Financing cash outflows were $35.3 million, primarily the $24.0 million repayment of long-term debt and $9.9 million of dividends. The quarterly dividend increased to $0.385 per share from $0.370.
Material changes versus the prior comparable period
- Q2 net sales decreased $16.1 million, or 7%; six-month sales decreased $16.9 million, or 4%.
- Q2 operating income declined 9% and diluted EPS declined 19%; six-month operating income declined 6% and diluted EPS declined 8%.
- Adjusted EBITDA declined 2% in Q2 and 3% for the first six months, although margins improved due to cost control and stable or higher gross margins.
- Regional Q2 sales declined 3% in North America, 12% in EMEA, 10% in Asia/Pacific, and 6% in South America. South America was the only region with higher operating earnings.
- Operating cash flow increased $2.7 million year over year, primarily from improved working capital, partly offset by higher cash tax payments.
- The Company adopted the new lease standard in the first quarter of 2019, recording $24.8 million of right-of-use assets and $24.3 million of operating lease liabilities at June 30, 2019. The adoption did not materially affect earnings or cash flow.
Outlook, unusual items, risks, and contingencies
Management expected market conditions to improve in the second half of 2019 relative to the first half, while noting that steel and automotive customers had reduced production and undertaken inventory corrections. Management cited continued market-share gains and expected the Houghton combination to approximately double annual sales and adjusted EBITDA, excluding synergies. Estimated cost synergies were approximately $60 million when fully achieved by the second year after closing.
The August 1, 2019 Houghton transaction involved approximately $170.8 million of cash, approximately 4.3 million newly issued Quaker shares, and refinancing of approximately $660 million of Houghton net debt. Certain Houghton steel and aluminum product lines were divested for approximately $37 million to satisfy regulatory requirements. The new credit facility consisted of a $400 million revolver, a $600 million U.S. term loan, and a $150 million euro-equivalent term loan. At closing, the Company borrowed $750 million under the term loans and approximately $180 million under the revolver.
- Acquisition-related expenses were $5.5 million in Q2 and $10.8 million for the first six months. The Company expected additional transaction and integration costs, with post-closing costs generally approximating one times anticipated synergies over three years.
- The new facility includes a maximum initial net-debt-to-adjusted-EBITDA ratio of 4.25 to 1 and a minimum adjusted-EBITDA-to-interest-expense ratio of 3.0 to 1. The Company was in compliance at closing.
- The Company expected to contribute an additional $0 to $10 million to terminate its U.S. pension plan, targeted for completion in 2020. A non-cash settlement charge is expected, but its amount was not yet estimable; related gross AOCI was approximately $19 million at June 30, 2019.
- Gross uncertain tax positions, including interest and penalties, were $9.4 million. Italian tax assessments remained subject to competent-authority proceedings, and management believed adequate reserves had been recorded.
- Potential groundwater remediation liabilities at an inactive site were estimated at $0.1 million to $1.0 million. Projected asbestos litigation liability over the next 50 years was approximately $1.7 million, excluding defense costs.
- Demand is exposed to global industrial production, customer shutdowns, raw-material costs, customer credit, foreign exchange, tax changes, geopolitical conditions, and the execution and integration risks of Houghton.
- Disclosure controls were not effective at June 30, 2019 because of an unremediated material weakness involving information-technology user access, segregation of duties, and system or data-change controls. Management stated that no material misstatement existed and planned to evaluate remediation during the third quarter of 2019.
Important facts for investors to verify
- Confirm post-closing Houghton revenue, earnings, debt, purchase accounting, goodwill, and integration costs in subsequent filings.
- Assess the combined company’s leverage, covenant headroom, interest expense, refinancing requirements, and cash-flow generation under the new credit facility.
- Track achievement and timing of the approximately $60 million synergy target versus integration costs.
- Monitor demand in steel, automotive, and other cyclical end markets, as well as foreign-exchange effects on reported sales and earnings.
- Verify remediation of the material weakness in information-technology controls and the impact, if any, on future reporting.
- Follow the U.S. pension-plan termination, required contributions, and resulting settlement charge.
- Review developments in Italian tax proceedings, uncertain tax positions, environmental remediation, asbestos litigation, and other contingencies.