Quaker Chemical Corporation — Q3 2018 Form 10-Q Summary
Business context and reporting period
Unaudited results for the three and nine months ended September 30, 2018. Quaker develops and sells specialty process fluids, chemical products and chemical management services to global steel, metalworking, automotive, aerospace, mining and other industrial customers. Reportable regions are North America, EMEA, Asia/Pacific and South America.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net sales | $222.0 million | $212.9 million | $656.0 million | $609.0 million |
| Gross profit | $81.1 million | $74.8 million | $237.5 million | $217.5 million |
| Gross margin | 36.5% | 35.1% | 36.2% | 35.7% |
| Operating income | $24.9 million | $14.0 million | $67.7 million | $45.7 million |
| Net income attributable to Quaker | $19.7 million | $11.1 million | $51.7 million | $30.0 million |
| Diluted EPS | $1.47 | $0.83 | $3.87 | $2.25 |
| Adjusted EBITDA | $33.0 million | $29.4 million | $96.0 million | $85.6 million |
| Adjusted EBITDA margin | 14.8% | 13.8% | 14.6% | 14.1% |
Q3 sales increased 4%, driven by 4% volume growth and 3% pricing/product mix, partly offset by approximately 3% unfavorable foreign-currency translation. Nine-month sales increased 8%, reflecting 3% volume growth, 3% pricing/product mix and a 2% favorable currency effect.
- Q3 operating income increased 78%; nine-month operating income increased 48%.
- Q3 net income attributable to Quaker increased 77%; nine-month net income increased 72%.
- Q3 and nine-month effective tax rates were 18.5% and 21.2%, respectively, versus 22.1% and 32.5% in the comparable periods, benefiting from the lower U.S. statutory rate and tax adjustments related to the Tax Cuts and Jobs Act.
- Dividends declared were $0.370 per share in Q3 and $1.095 per share year to date, compared with $0.355 and $1.055, respectively, in 2017.
Cash flow, liquidity and debt
- Net cash provided by operating activities was $50.9 million for the first nine months, compared with $40.8 million in 2017. Q3 operating cash flow was $31.2 million.
- Capital expenditures were $8.8 million, and acquisition-related investing cash outflows were $0.5 million during the first nine months.
- Cash used in financing activities was $27.0 million, including $11.5 million of debt repayments and $14.4 million of dividends paid.
- Cash, cash equivalents and restricted cash totaled $120.4 million at September 30, 2018, including $20.6 million restricted for asbestos litigation claims and defense costs. Unrestricted cash and cash equivalents were $99.8 million.
- Total debt was approximately $52.5 million, consisting of $5.7 million of current debt and $46.9 million of long-term debt. Credit facility borrowings were $34.8 million, down from $48.5 million at December 31, 2017.
- The company reported a total debt-to-adjusted-EBITDA ratio below 1.0x and compliance with its debt covenants. The existing $300 million credit facility was amended to extend maturity to December 15, 2019.
Material changes versus the prior comparable period
- Pricing actions and product mix more than offset higher raw-material costs, increasing gross margin by 140 basis points in Q3 and 50 basis points year to date.
- Houghton combination-related expenses declined to $2.9 million in Q3 and $12.4 million year to date, from $9.7 million and $23.1 million, respectively, in 2017.
- SG&A increased $2.2 million in Q3 and $8.6 million year to date, primarily from higher labor and incentive compensation costs.
- North America was the strongest Q3 region: sales increased 12% and segment operating earnings increased 30%. EMEA sales declined 6% and operating earnings declined 3%, primarily due to lower volumes, order timing and currency effects. Asia/Pacific sales increased 3% and operating earnings increased 6%; South America sales declined 5% while operating earnings increased 26%.
- Foreign exchange reduced Q3 earnings by approximately 6%, or $0.09 per diluted share. Argentina became subject to hyper-inflationary accounting on July 1, 2018; related remeasurement losses were approximately $0.5 million in Q3 and $0.8 million year to date for Argentina and Venezuela combined.
- The company purchased the remaining 45% interest in its India affiliate in December 2017, reducing noncontrolling-interest expense in 2018.
Guidance, outlook, risks and unusual items
- Management expected regulatory approval and closing of the Houghton combination in December 2018 or January 2019. The transaction remained subject to U.S. and European regulatory approvals and other customary closing conditions.
- The proposed Houghton transaction was expected to approximately double annual sales and adjusted EBITDA, before synergies. Expected fully achieved synergies were at least $45 million by the third year after closing.
- Management expected fourth-quarter 2018 headwinds from a strong U.S. dollar and higher raw-material costs, while pricing actions and market-share gains were expected to support gross margins in the low-to-mid 36% range and year-over-year growth in adjusted EBITDA and non-GAAP diluted EPS.
- The company estimated an additional $25 million to $30 million of combination-related costs and cash outflows through closing, excluding post-closing integration costs. Regulatory remedies were expected to require divestitures representing approximately 3% of combined sales.
- Principal operating risks include cyclical demand from steel, automotive, aircraft, appliance and durable-goods customers; customer production shutdowns; raw-material inflation; foreign exchange volatility; economic and political conditions; tax uncertainty; and risks that the Houghton transaction may be delayed, modified, terminated or require greater divestitures.
- Other contingencies include asbestos litigation, environmental remediation and uncertain tax positions. The projected asbestos liability over the next 50 years was approximately $1.9 million excluding defense costs; groundwater remediation liabilities were estimated at $0.1 million to $1.0 million. Gross uncertain tax positions including interest and penalties were approximately $8.7 million.
- The company expected to adopt the new lease standard on January 1, 2019 and anticipated a material increase in reported assets and liabilities from recognition of right-of-use assets and lease liabilities. Previously disclosed undiscounted operating lease obligations totaled $27.6 million.
Important facts for investors to verify
- Confirm the timing, final financing terms, regulatory remedies and closing status of the Houghton combination.
- Assess the effect of the transaction on leverage, interest expense, dilution, integration costs and realized synergies.
- Monitor whether pricing continues to offset raw-material inflation and whether gross margins remain near management’s stated target.
- Separate recurring operating performance from combination costs, Tax Reform adjustments, foreign-exchange effects, pension items and hyper-inflationary remeasurement losses.
- Review cash availability after funding the Houghton transaction, repaying the $5.0 million industrial development bond due in December 2018, paying dividends and meeting pension and capital-expenditure requirements.
- Evaluate regional volume trends, particularly the Q3 decline in EMEA and the company’s exposure to cyclical industrial end markets.