Quaker Chemical Corporation (Quaker Houghton) — Q3 2020 Form 10-Q Summary
Business context and reporting period
Quaker Houghton is a global supplier of industrial process fluids, specialty chemicals and related technical services for steel, aluminum, automotive, aerospace, mining, metalworking and other industrial customers. The unaudited filing covers the three and nine months ended September 30, 2020. Results include Houghton for the full 2020 periods but only two months of Houghton in the comparable 2019 periods; Norman Hay is included for the full 2020 periods and not in the comparable 2019 periods.
Key financial metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Net sales | $367.2 million | $325.1 million | $1,031.8 million | $742.2 million |
| Gross profit | $140.2 million | $105.1 million | $371.4 million | $256.0 million |
| Gross margin | 38.2% | 32.3% | 36.0% | 34.5% |
| Operating income (loss) | $34.9 million | $(14.5) million | $24.7 million | $25.9 million |
| Net income (loss attributable to Quaker) | $27.3 million | $(13.1) million | $(8.8) million | $16.4 million |
| Diluted EPS | $1.53 | $(0.80) | $(0.50) | $1.14 |
| Adjusted EBITDA | $63.9 million | $51.4 million | $156.5 million | $112.5 million |
| Adjusted EBITDA margin | 17.4% | 15.8% | 15.2% | 15.2% |
| Operating cash flow | $67.3 million | $13.1 million | $112.0 million | $35.5 million |
Q3 net sales increased 13% year over year, but acquisition-adjusted sales declined approximately 10%, reflecting an 8% volume decline, a 1% foreign-exchange headwind and a 1% price/mix decline. Management reported 28% sequential sales growth from Q2 2020. Q3 non-GAAP earnings per diluted share were $1.56 in both periods.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $155.8 million at September 30, 2020, compared with $123.5 million at December 31, 2019. Cash, cash equivalents and restricted cash totaled $174.7 million, including approximately $19.0 million restricted for asbestos-related claims.
- Total debt was $896.6 million, consisting primarily of a $155.0 million revolver, $577.5 million U.S. term loan and $152.1 million euro term loan. Net debt was approximately $740.8 million.
- The company had approximately $239 million of unused revolver capacity, net of approximately $6 million of letters of credit, plus approximately $38 million of unused capacity under other arrangements.
- During the first nine months, the company repaid $28.1 million of term loans and reduced revolver borrowings by $16.5 million. It paid $20.5 million of dividends.
- The company was in compliance with its debt covenants at September 30, 2020. Management stated that existing cash, operating cash flow and available liquidity should support operating needs and obligations for at least the next twelve months.
Material changes versus the prior comparable period
- Reported results benefited materially from the August 2019 Houghton combination and the October 2019 Norman Hay acquisition. Acquisition-related sales contributed approximately $74.6 million in Q3 and $407.4 million in the first nine months.
- Excluding acquisitions, nine-month sales declined approximately 16%, driven by a 13% volume decline, a 2% foreign-exchange impact and a 1% price/mix decline.
- Q3 operating income improved from a loss of $14.5 million to income of $34.9 million, helped by lower restructuring and acquisition-related costs, the absence of the prior-year $10.2 million inventory fair-value step-up, acquisition contributions and synergy savings.
- Nine-month net income attributable to Quaker declined to a loss of $8.8 million, primarily because of a $38.0 million non-cash impairment charge on acquired indefinite-lived Houghton and Fluidcare trademarks, a $22.7 million non-cash pension settlement charge and higher interest expense.
- Operating cash flow increased substantially, primarily from acquired earnings, working-capital releases associated with lower volumes and reduced combination-related cash outflows.
- The company corrected immaterial prior-quarter errors involving over-recognized cost of goods sold and under-recognized inventory. The cumulative Q3 adjustment reduced 2020 cost of goods sold by approximately $1.7 million.
Guidance, outlook, commentary and risks
- Management expects COVID-19 effects to improve sequentially, subject to virus containment, but stated that demand remained below pre-pandemic levels, particularly in automotive and aerospace. The filing does not provide clear GAAP revenue or EPS guidance for full-year 2020.
- Management expects combination synergies of approximately $58 million in 2020, $75 million in 2021 and $80 million in 2022, above prior expectations. Approximately $40 million of savings were realized during the first nine months of 2020.
- Management expects a gradual demand recovery and significant adjusted EBITDA growth in 2021 and 2022, but cautioned that COVID-19 could materially affect the remainder of 2020 and future periods.
- The global restructuring program targets approximately 350 headcount reductions and facility closures. The company recorded $3.6 million of related charges in the first nine months of 2020 and expects activity to continue through 2021.
- COVID-19 risks include lower customer production, supply-chain disruptions, delayed customer payments, credit losses, facility interruptions, foreign-exchange volatility, covenant pressure and additional impairment charges. The company recorded no additional impairment in Q2 or Q3 but warned that worsening conditions could trigger further charges.
- Other contingencies include asbestos litigation, environmental remediation and tax audits. At September 30, 2020, accrued Houghton environmental liabilities were $5.7 million; the estimated ACP groundwater remediation exposure was approximately $0.1 million to $1.0 million.
- Disclosure controls and procedures were not effective at September 30, 2020 because of previously identified material weaknesses involving risk assessment, revenue data controls and controls over data supporting business-combination assumptions. Management was implementing a remediation plan.
Most important facts for investors to verify
- Separate acquisition-driven growth from underlying volume trends and monitor whether organic volumes recover from COVID-19-related declines.
- Reconcile GAAP results with adjusted EBITDA and non-GAAP EPS, particularly the $38.0 million impairment, $22.7 million pension settlement charge, restructuring costs and acquisition expenses.
- Monitor leverage, debt amortization, revolver availability and compliance with the 4.25-to-1 initial net-leverage covenant and 3.0-to-1 interest-coverage covenant.
- Assess whether projected Houghton integration synergies and restructuring benefits are realized relative to the required integration and restructuring cash costs.
- Review remediation of the material weaknesses and any subsequent impact on revenue recognition, acquisition accounting or reported results.
- Track COVID-19 developments, end-market production, foreign-exchange movements, impairment indicators and the company’s ability to sustain dividends and liquidity.