Quaker Chemical Corporation — 2014 Q2 Form 10-Q Summary
Business context and reporting period
Quaker Chemical provides process fluids, chemical specialties, and technical services to industrial markets including steel, aluminum, automotive, mining, aerospace, and related manufacturing industries. The filing covers the unaudited three and six months ended June 30, 2014, compared with the corresponding 2013 periods.
Key financial metrics
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $191.3 million | $184.8 million | $373.0 million | $361.0 million |
| Gross profit | $68.2 million | $67.3 million | $133.3 million | $129.9 million |
| Gross margin | 35.7% | 36.4% | 35.7% | 36.0% |
| Operating income | $20.9 million | $19.8 million | $40.3 million | $37.2 million |
| Net income attributable to Quaker | $15.4 million | $16.1 million | $28.2 million | $29.7 million |
| Diluted EPS | $1.16 | $1.22 | $2.13 | $2.26 |
| Adjusted EBITDA | $25.8 million | $24.5 million | $49.6 million | $45.8 million |
| Operating cash flow | Approximately $10.1 million | Not clearly provided for the quarter | $8.3 million | $27.5 million |
At June 30, 2014, cash and cash equivalents were $60.2 million, compared with $68.5 million at December 31, 2013. Total debt was approximately $26.0 million, including $7.5 million outstanding under the company’s revolving credit facility. The company had access to a $300 million multicurrency credit agreement maturing in June 2018, with an option to increase availability to $400 million subject to lender approval and conditions. The consolidated leverage ratio was below 1.0 to 1, compared with a maximum covenant of 3.50 to 1.
Six-month operating cash flow was reduced by working-capital investment, including a $20.6 million increase in accounts receivable and a $7.6 million increase in inventories. Capital expenditures were $5.5 million. Dividends paid were $6.6 million, and dividends declared increased to $0.30 per share in the second quarter from $0.25 per share in the prior-year quarter.
Material changes versus the prior comparable period
- Second-quarter sales increased 3.5%, primarily from a 3% increase in product volumes, including acquisitions, and a 1% benefit from price and product mix.
- Six-month sales increased 3.3%, with volume growth partly offset by approximately $3.2 million of unfavorable foreign-exchange translation.
- Second-quarter operating income increased approximately 5.8%, while six-month operating income increased approximately 8.4%.
- Gross margins declined because of higher raw-material costs, price and product mix, and additional EMEA manufacturing costs associated with the completion of a cost-streamlining initiative.
- GAAP diluted EPS declined to $1.16 from $1.22 in the quarter and to $2.13 from $2.26 year to date. Non-GAAP diluted EPS increased to $1.11 from $1.00 in the quarter and to $2.07 from $1.96 year to date, excluding specified unusual and non-core items.
- North America was the principal source of growth. South America sales declined 18% in both the quarter and first six months, and South America operating earnings declined 62% and 54%, respectively.
- In June 2014, Quaker acquired the remaining 49% of its Australian affiliate for approximately $7.6 million, funded partly through revolving-credit borrowings. The transaction increased additional paid-in capital by $6.45 million for the excess of purchase price over the carrying value of the noncontrolling interest.
- The company’s 2013 mineral-oil excise-tax refund and related unusual income did not recur in 2014, contributing to lower reported net income comparisons.
Guidance, outlook, risks, contingencies, and unusual items
Management continued to expect modest growth in most major markets and stated that it expected 2014 to be another good year, with revenue and earnings targeted to increase for the fifth consecutive year. Management estimated a full-year 2014 effective tax rate of approximately 31%, while noting that tax rates may remain volatile because of audits, statute expirations, and uncertain tax positions.
- Management cited increasing raw-material costs, uneven global economic conditions, foreign-exchange pressure, and continued challenges in countries such as India and Brazil.
- Demand depends substantially on customers’ production levels in cyclical industries, including steel, automotive, aircraft, appliances, and other durable goods.
- The company recorded a $321,000 charge in the second quarter for converting certain Venezuelan currency balances at the SICAD II exchange rate. Its Venezuelan equity affiliate investment was valued at $1.433 million at the CADIVI exchange rate.
- A $902,000 charge related to a United Kingdom pension-plan amendment was recorded in the first quarter of 2014.
- The company had $17.0 million of gross uncertain tax-position liabilities, including interest and penalties, at June 30, 2014. Potential offsetting tax benefits could reduce the payment amount by up to approximately $10.9 million.
- Environmental remediation liabilities for the AC Products site were estimated at $310,000 to $625,000 and were reserved. Other environmental accruals totaled approximately $171,000.
- An acquired inactive subsidiary remains involved in asbestos litigation. The subsidiary’s projected liability over the next 50 years was approximately $2.7 million, excluding defense costs; management stated that material losses to the parent were not considered probable, although additional losses cannot be estimated.
- A foreign value-added-tax matter could expose the company to additional potential liability estimated at $0 to $8.5 million, assuming future refunds and amnesty programs. The filing states that exposure could be higher if such programs are unavailable.
- The company adopted no early revenue-recognition changes; it was evaluating a new standard effective for annual and interim periods beginning after December 15, 2016.
Most important facts for investors to verify
- Whether volume growth and pricing actions can offset rising raw-material costs and sustain gross margins.
- Whether South America’s production, currency, and profitability pressures improve.
- Conversion of reported earnings growth into cash flow, particularly through accounts-receivable collection and inventory management.
- The effect of the Australian affiliate acquisition on Asia/Pacific growth, margins, and leverage.
- Progress and ultimate exposure related to uncertain taxes, VAT assessments, asbestos litigation, and environmental remediation.
- Whether the approximately 31% full-year effective tax-rate expectation remains achievable.
- The extent to which non-GAAP earnings and adjusted EBITDA depend on excluding recurring or unusual items, including captive-insurance equity income, Venezuelan currency effects, and restructuring costs.