Quaker Chemical Corporation — 2011 Q3 Form 10-Q Summary
Business context and reporting period
Quaker Chemical Corporation is a global provider of process chemicals, specialty chemicals, technical services, and chemical management services to industries including steel, aluminum, automotive, mining, aerospace, and construction materials. This unaudited Form 10-Q covers the three and nine months ended September 30, 2011, compared with the corresponding 2010 periods.
Financial performance and position
| Metric | Q3 2011 | Q3 2010 | 9M 2011 | 9M 2010 |
|---|---|---|---|---|
| Net sales | $182.3 million | $137.7 million | $510.0 million | $402.0 million |
| Gross profit | $59.5 million | $49.0 million | $166.0 million | $144.9 million |
| Gross margin | 32.6% | 35.6% | 32.5% | 36.0% |
| Operating income | $17.5 million | $9.4 million | $46.5 million | $36.5 million |
| Net income attributable to Quaker | $13.4 million | $6.3 million | $33.8 million | $24.9 million |
| Diluted EPS | $1.03 | $0.55 | $2.73 | $2.19 |
- Q3 sales increased 32%; management attributed the increase to 16% higher volumes, 11% from pricing and mix, and 5% from foreign exchange translation. Nine-month sales increased 27%.
- SG&A was $42.0 million in Q3 and $119.4 million for the first nine months. SG&A as a percentage of sales improved to 23.0% in Q3 from 25.2% and to 23.4% year to date from 25.7%.
- Net cash provided by operating activities was $4.5 million in the first nine months, down from $19.5 million in 2010, primarily because higher receivables and inventories absorbed cash.
- Investing cash flow was an $18.4 million use, including $8.9 million of capital expenditures and $11.0 million of acquisition-related payments.
- Cash and cash equivalents were $20.6 million at September 30, 2011, compared with $25.8 million at December 31, 2010.
- Total debt was approximately $44.2 million, including $43.4 million of long-term debt and $0.8 million of current borrowings, versus approximately $74.7 million at December 31, 2010.
- The company had a $175.0 million syndicated multicurrency credit facility expiring in 2014, with approximately $25.0 million outstanding at September 30, 2011. Its consolidated leverage ratio was below 1.0 to 1.0 versus a 3.50 to 1.0 covenant limit.
- The quarterly dividend was $0.24 per share; dividends declared for the first nine months were $0.715 per share.
Material changes versus the prior comparable period
- Gross margin declined despite higher gross profit because raw material costs remained at or near record levels. Management stated that pricing actions were beginning to produce sequential quarterly margin improvement.
- Operating income increased 86% in Q3 and 27% year to date, supported by higher volumes, pricing, acquisitions, and improved SG&A leverage.
- Q3 2011 included a $2.7 million non-cash gain, or approximately $0.22 per diluted share, from revaluing the previously held interest in TecniQuimia Mexicana after acquiring the remaining 60% ownership interest.
- Q3 2010 included a $3.6 million non-income-tax contingency charge and a $1.3 million former-CEO supplemental retirement charge, totaling approximately $0.29 per diluted share.
- The company issued approximately 1.3 million shares in Q2 2011 for $48.1 million of net proceeds and used the proceeds to repay revolving credit borrowings. Management estimated that the offering reduced Q3 2011 diluted EPS by approximately $0.09.
- Metalworking Process Chemicals generated approximately 94% of Q3 sales. Its sales rose 33% and segment operating income increased by $5.2 million. Coatings sales increased 23% and segment operating income increased by $0.5 million.
- Total assets increased to $499.8 million from $449.4 million at December 31, 2010, while total liabilities declined to $240.6 million from $262.3 million.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected good fourth-quarter volumes, subject to normal holiday seasonality. It noted increased uncertainty in global economies, particularly Europe, but stated that the company had not been significantly affected to date.
- Raw material inflation, customer demand, economic cycles, foreign currency movements, and the operating conditions of steel, automotive, aircraft, appliance, and other durable-goods customers could materially affect results.
- Management expects the balance sheet and internally generated funds, supplemented by debt or equity if needed, to support operations, pensions, dividends, capital expenditures, acquisitions, and contingencies.
- The annual goodwill impairment assessment completed at the end of Q3 2011 resulted in no impairment charge.
- Environmental liabilities related to the AC Products site were estimated at approximately $1.1 million to $2.1 million and were stated to be adequately reserved. Other environmental accruals were approximately $0.5 million.
- An inactive subsidiary faces asbestos claims. The company estimated the subsidiary’s projected liability over the next 50 years at approximately $7.7 million, excluding defense costs, but stated that insurance and other coverage were expected to limit the company’s exposure and that a material loss was not probable. Additional losses could not be estimated.
- A foreign subsidiary’s VAT matters could have a material adverse effect. Remaining exposure under potential additional assessments was estimated at $0 to $28.0 million assuming future refunds, amnesty programs, or settlements; exposure could be higher without such relief. Accrued amounts for existing settlements were $0.3 million at September 30, 2011.
- Gross unrecognized tax benefits, including accrued interest and penalties, were approximately $13.9 million. The company stated that payment could be reduced by up to $8.1 million through offsetting benefits in other tax jurisdictions.
- Subsequent to quarter-end, the company acquired G.W. Smith & Sons for approximately $13.3 million in cash, subject to a working-capital adjustment and a $1.0 million hold-back.
- Management reported that disclosure controls were effective and that no material changes occurred in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether pricing actions fully offset raw material inflation and sustain or improve gross margins.
- The quality and sustainability of sales growth after separating volume, acquisitions, pricing, mix, and foreign exchange effects.
- Working-capital requirements, particularly the significant increases in accounts receivable and inventories and the resulting decline in operating cash flow.
- Debt levels, credit-facility availability, covenant compliance, and the company’s use of cash for acquisitions and capital expenditures.
- The earnings impact of the one-time TecniQuimia revaluation gain and the absence of the prior-year tax-contingency and CEO-transition charges.
- Potential cash exposure from VAT assessments, environmental remediation, asbestos litigation, uncertain tax positions, acquisition earnouts, and other contingencies.
- Execution and integration risks related to TecniQuimia, G.W. Smith, and other recent acquisitions, as well as the effect of the 2011 equity issuance on per-share results.