Quaker Chemical Corporation (Quaker Houghton) — FY2019 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2019. Results include Legacy Quaker for the full year, Houghton for the five months after its August 1, 2019 acquisition, and Norman Hay for the three months after its October 1, 2019 acquisition. The filing was dated March 20, 2020.
Business context
Quaker Houghton develops and sells specialty chemicals and technical services for metalworking, steel, aluminum, automotive, aerospace, industrial and other manufacturing markets. Reportable segments are Americas, EMEA, Asia/Pacific and Global Specialty Businesses. Approximately 60% to 65% of sales historically came from non-U.S. subsidiaries, and the five largest customers represented approximately 12% of 2019 net sales.
The major strategic event was the Houghton combination, which created a larger global industrial process-fluids supplier. Quaker paid $170.8 million in cash, issued approximately 4.3 million shares and refinanced approximately $702.6 million of Houghton debt. The company also acquired Norman Hay for an original purchase price of £80.0 million.
Financial performance and liquidity
| Metric | 2019 | 2018 | Change or observation |
|---|---|---|---|
| Net sales | $1,133.5 million | $867.5 million | Up 31%; includes $319.4 million from Houghton and Norman Hay |
| Gross profit | $392.1 million | $312.3 million | Up $79.8 million |
| Reported gross margin | 34.6% | 36.0% | 2019 included $11.7 million of acquisition inventory step-up expense and accelerated depreciation |
| Operating income | $46.1 million | $87.8 million | Reduced by acquisition and restructuring costs |
| Net income attributable to Quaker | $31.6 million | $59.5 million | Down 47% |
| Diluted EPS | $2.08 | $4.45 | Lower earnings and approximately 4.3 million new shares |
| Adjusted EBITDA | $173.1 million | $125.8 million | Up 38%; adjusted margin increased to 15.3% from 14.5% |
| Non-GAAP net income | $88.7 million | $82.5 million | Up 8% |
| Non-GAAP diluted EPS | $5.83 | $6.17 | Down primarily because of share issuance |
| Operating cash flow | $82.4 million | $78.8 million | Up $3.6 million |
| Capital expenditures | $15.5 million | $12.9 million | Higher, partly due to integration projects |
Excluding acquired businesses, 2019 sales declined approximately 6%, reflecting approximately 3% lower volumes and a 3% negative foreign-currency translation effect. Weak automotive and industrial markets, customer inventory corrections and lower consumption affected all major segments.
The effective tax rate was 7.2% in 2019 versus 30.1% in 2018, primarily because of a $5.3 million deferred tax benefit from an intercompany intangible asset transfer. Management estimated adjusted effective tax rates of approximately 22% in both years.
Cash, debt and balance sheet
- Cash, cash equivalents and restricted cash were $143.6 million at December 31, 2019, including $20.0 million of restricted cash.
- Total debt was $935.0 million, including $922.4 million outstanding under the new credit facility; long-term debt, net of issuance costs and current maturities, was $882.4 million.
- Aggregate net indebtedness was $811.4 million, excluding debt issuance costs.
- The new facility includes a $400.0 million revolver and $750.0 million of term loans, matures in August 2024 and had approximately $221 million of unused revolver capacity, net of letters of credit.
- The company was in compliance with its debt covenants at year-end. The initial maximum net debt-to-adjusted-EBITDA ratio was 4.25 to 1, and the minimum adjusted-EBITDA-to-interest ratio was 3.0 to 1.
- Total assets increased to $2.85 billion from $709.7 million, primarily because of the acquisitions. Goodwill increased to $607.2 million and other intangible assets to $1.12 billion.
- Cash dividends declared were $1.525 per share, or $23.7 million, compared with $1.47 per share and $19.5 million in 2018.
Material changes and unusual items
- Reported 2019 results included $38.0 million of combination and other acquisition-related costs, $26.7 million of restructuring expense and $11.7 million of acquired-inventory fair-value step-up expense.
- The restructuring program is expected to reduce global headcount by approximately 275 employees and close certain manufacturing and non-manufacturing facilities over approximately two years. The company expects total restructuring costs to approximate one times the anticipated cost savings.
- Management estimated at least $60 million of annual combination-related cost synergies once actions are fully implemented by the second year after closing and reported approximately $7 million of pro forma synergies achieved in 2019.
- The Houghton purchase price allocation remained preliminary at year-end. The company allocated $1.028 billion to Houghton intangible assets and recorded $494.9 million of Houghton goodwill; further measurement-period adjustments were possible.
- The company completed its annual goodwill and indefinite-lived intangible impairment tests with no impairment charge. The EMEA reporting unit and acquired Houghton indefinite-lived intangibles were significant judgment areas.
- The company began terminating its Legacy Quaker U.S. Pension Plan, expected to be completed in the first half of 2020. Additional funding was estimated at $1 million to $2 million, and a future non-cash settlement charge was expected, but no reliable amount was available.
- The company adopted the new lease accounting standard in 2019, adding $42.9 million of right-of-use lease assets and $42.5 million of operating lease liabilities at year-end, without a material earnings or cash-flow effect.
Guidance, outlook and risks
Management expected most business segments to show low to moderate growth entering 2020, but stated that the coronavirus outbreak and Boeing’s temporary suspension of 737 Max production created unusual uncertainty. The company expected COVID-19 to materially affect 2020 operating results but, as of the filing date, did not expect a material effect on liquidity or financial position. Management could not quantify the potential impact, and acknowledged that conditions could worsen.
- Demand is tied to global production in steel, aluminum, automotive, aerospace and industrial markets; downturns or customer shutdowns may reduce sales faster than costs can be adjusted.
- Raw-material prices and availability are significant risks. A one-percentage-point change in gross margin would have affected pretax earnings by approximately $11.3 million.
- Foreign exchange is material: a 10% change in specified major currencies was estimated to affect 2019 revenue by approximately $59.3 million and pretax earnings by approximately $4.5 million.
- Variable-rate debt creates interest-rate exposure. A 10% change in interest rates was estimated to affect 2019 interest expense by approximately $1.1 million; the company entered into $170.0 million of interest-rate swaps.
- Integration, synergy realization, acquisition accounting, goodwill and intangible valuations, customer credit, environmental matters, tax audits, cybersecurity and regulatory compliance are material risk areas.
- PricewaterhouseCoopers issued an unqualified opinion on the financial statements but concluded that internal control over financial reporting was not effective as of December 31, 2019 because of material weaknesses involving risk assessment, revenue data controls at certain smaller locations and data supporting business-combination accounting. Houghton and Norman Hay were excluded from management’s control assessment because they were acquired during 2019.
- The March 17, 2020 amendment to the credit agreement extended the deadline for delivery of the 2019 audited financial statements to April 16, 2020; without the amendment, failure to deliver by March 17 could have constituted an event of default.
Most important facts for investors to verify
- Whether Houghton and Norman Hay achieve the expected revenue, margin and synergy contribution after full-year integration.
- Progress, cash costs and savings from the QH restructuring program and the approximately 275 planned headcount reductions.
- Debt reduction, covenant headroom, refinancing requirements and exposure to variable interest rates through the August 2024 maturity.
- Remediation of the three material weaknesses and whether future filings identify control deficiencies or financial-statement adjustments.
- The effect of COVID-19, Boeing 737 Max production changes, industrial demand and customer inventory levels on 2020 sales and cash flow.
- Potential impairment of the substantial acquired goodwill and intangible assets, particularly the EMEA reporting unit and Houghton trademarks.
- Final purchase-accounting adjustments for Houghton and Norman Hay, including the estimated £2.7 million Norman Hay purchase-price settlement.
- Future pension termination funding and settlement charges, environmental liabilities, asbestos-related claims and uncertain tax positions.