Quaker Chemical Corporation: FY2016 Form 10-K Summary
Business context and reporting period
Quaker Chemical Corporation develops and sells formulated specialty chemicals, process fluids, and chemical management services for steel, automotive, aerospace, mining, metalworking, and other industrial markets. Operations are reported across North America, EMEA, Asia/Pacific, and South America. This Form 10-K covers the fiscal year ended December 31, 2016, including fourth-quarter results. The financial statements were audited by PricewaterhouseCoopers LLP, which reported effective internal control over financial reporting.
Financial performance and key metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Net sales | $746.7 million | $737.6 million | +1% |
| Gross profit | $279.6 million | $277.0 million | +1% |
| Gross margin | 37.4% | 37.6% | Down 0.2 points |
| Operating income | $83.1 million | $71.3 million | +17% |
| Income before taxes | $84.0 million | $70.2 million | +20% |
| Net income attributable to Quaker | $61.4 million | $51.2 million | +20% |
| Diluted EPS | $4.63 | $3.84 | +21% |
| Adjusted EBITDA | $106.6 million | $101.6 million | +5% |
| Adjusted EBITDA margin | 14.3% | 13.8% | Up 0.5 points |
| Operating cash flow | $73.8 million | $73.4 million | +1% |
| Cash and equivalents | $88.8 million | $81.1 million | +$7.8 million |
| Long-term debt | $65.8 million | $81.4 million | Down $15.7 million |
Net sales benefited from 3% organic volume growth and 2% acquisition-related growth, offset by a $21.7 million foreign-exchange translation impact and approximately 1% unfavorable pricing and product mix. SG&A declined $2.0 million, while the effective tax rate increased to 27.6% from 25.3%. Dividends declared increased to $1.355 per share from $1.260.
Cash flow included $23.8 million used in investing activities, including $15.0 million for acquisitions and $10.0 million for capital expenditures. Financing activities used $38.1 million, including $14.5 million of debt repayments, $17.6 million of dividends, and $5.9 million of share repurchases.
Material changes versus the prior comparable period
- Operating income increased primarily because of higher volumes, lower SG&A, and the absence of the $6.8 million restructuring charge recorded in 2015. Quaker recognized a $0.4 million restructuring credit in 2016.
- Adjusted EBITDA increased 5%, and adjusted diluted EPS rose 4% to $4.60 after excluding non-core items.
- EMEA sales increased 12% and regional operating earnings increased 20%, aided by volume growth and the 2015 Verkol acquisition.
- North America sales declined 2% and operating earnings declined 3%; Asia/Pacific sales declined 1% while operating earnings increased 2%. South America sales declined 6% and operating earnings declined 22% amid economic weakness and currency pressure.
- Quaker acquired Lubricor for approximately $11.9 million in November 2016 and a mining dust-control business for approximately $1.9 million in May 2016. Purchase-price allocations remained subject to measurement-period adjustments at year-end.
- Foreign-exchange translation reduced reported results; management estimated a roughly 4% negative impact on 2016 net income, or approximately $0.18 per diluted share.
- Accumulated other comprehensive loss increased to $87.4 million from $73.3 million, primarily reflecting currency translation and pension-related effects.
Guidance, outlook, risks, contingencies, and unusual items
Management expected 2017 net sales and earnings growth despite continued currency headwinds and uncertain economic conditions. The company expected its 2015 restructuring program to generate approximately $5 million of pretax savings in 2017 and targeted a 2017 effective tax rate of 28% to 30%. Management also expected adjusted EBITDA and non-GAAP earnings to increase for an eighth consecutive year.
The primary credit facility is a $300 million unsecured multicurrency facility maturing in June 2018, with potential expansion to $400 million subject to lender approval and conditions. Borrowings were $47.9 million at December 31, 2016, and the company was in compliance with its covenants; its consolidated leverage ratio was below 1.0 to 1 versus a maximum of 3.50 to 1.
- Demand is tied to global production in steel, automotive, aerospace, appliances, and other cyclical industries. The five largest customers represented approximately 19% of sales and the largest represented approximately 8%.
- Raw-material volatility, supply disruptions, and the ability to recover cost increases through pricing could materially affect margins. A one-percentage-point change in gross margin would affect pretax earnings by approximately $7.5 million.
- Foreign-exchange exposure is significant because approximately 60% of sales are generated by non-U.S. subsidiaries. A simultaneous 10% currency movement in key currencies was estimated to affect 2016 revenue by approximately $37.8 million and pretax earnings by approximately $5.5 million.
- The company had approximately $220 million of undistributed foreign earnings for which U.S. income taxes had not been provided, based on its intention to reinvest those earnings.
- Environmental remediation liabilities at the AC Products site were estimated at approximately $0.1 million to $1.0 million. An inactive subsidiary also faced asbestos-related claims; projected liability over 50 years was approximately $2.2 million excluding defense costs, with insurance and other coverage potentially available. The company stated that a material loss was not probable, but additional losses could not be estimated.
- Goodwill and indefinite-lived intangible assets totaled approximately $81.9 million. The 2016 impairment test identified no impairment and no reporting unit was considered at risk under the applicable test.
- Adoption of the deferred-tax classification standard was applied retrospectively without affecting earnings or cash flow. The company had not completed its assessment of the new revenue-recognition standard and expected increased sales disclosures.
Most important facts for an investor to verify
- Whether organic volume growth, acquisition synergies, and restructuring savings offset foreign-exchange and pricing pressures in 2017 and later periods.
- The renewal or refinancing of the $300 million credit facility before its June 2018 maturity and continued covenant compliance.
- Exposure to steel and automotive production cycles, major-customer concentration, customer credit quality, and accounts receivable aging.
- Changes in raw-material prices and the company’s ability to implement timely pricing actions without losing volume or market share.
- Final purchase-price allocations and operating contribution from Lubricor and the mining dust-control acquisition.
- Developments in asbestos litigation, environmental remediation, tax audits, pension funding, and other contingencies.
- The eventual accounting and disclosure impact of the new revenue-recognition, lease, cash-flow, and share-based-payment standards.