QUAKER CHEMICAL CORP annual report, FY2018

Quaker Chemical Corporation: FY2018 Form 10-K Summary

Business context and reporting period

Quaker Chemical develops and markets formulated specialty chemicals and chemical management services for steel, metalworking, automotive, aerospace, mining, construction and other industrial customers. Reportable segments are North America, EMEA, Asia/Pacific and South America. This filing covers the fiscal year ended December 31, 2018, with comparisons primarily to fiscal 2017.

Approximately 60% of sales are generated by non-U.S. subsidiaries.
Approximately 2,160 full-time employees were employed globally at year-end.
The five largest customers represented approximately 17% of 2018 net sales; the largest represented approximately 8%.

Financial performance and key metrics

Metric	2018	2017	Change
Net sales	$867.5 million	$820.1 million	+6%
Gross profit	Approximately $312.3 million	Approximately $291.5 million	+7%
Gross margin	36.0%	35.5%	+50 bps
Operating income	$87.8 million	$62.7 million	+40%
Net income attributable to Quaker	$59.5 million	$20.3 million	+193%
Diluted EPS	$4.45	$1.52	+193%
Adjusted EBITDA	$125.6 million	$115.2 million	+9%
Adjusted EBITDA margin	14.5%	14.1%	+40 bps
Cash provided by operating activities	$78.8 million	$64.8 million	+$14.0 million

Sales growth reflected approximately 3% volume growth, 2% from selling price and product mix, and less than 1% from foreign-currency translation. Pricing and product mix more than offset higher raw-material costs. SG&A increased by $9.1 million, principally due to labor, incentive compensation and currency effects.

Income before taxes was $83.1 million versus $60.7 million in 2017.
The reported effective tax rate was 30.1% versus 68.7%; excluding U.S. Tax Reform and other specified items, management estimated adjusted rates of approximately 22% and 27%, respectively.
Research and development expense was $24.5 million, versus $23.9 million in 2017.
Cash, cash equivalents and restricted cash totaled $124.4 million, including $20.3 million of restricted cash, versus $111.1 million at December 31, 2017.
Capital expenditures were $12.9 million; cash used in investing activities was $12.4 million.
Cash used in financing activities was $46.9 million, including $26.8 million of debt repayments and $19.3 million of dividends.

Liquidity, debt and balance sheet

Total debt was $36.6 million at December 31, 2018, down from $66.8 million; long-term debt was $35.9 million.
Credit-facility borrowings were $24.0 million versus $48.5 million in 2017, at a weighted-average borrowing rate of approximately 1.0%.
The primary $300 million multicurrency credit facility was amended to mature March 15, 2020; the facility may be increased to $400 million subject to conditions.
Working capital was $267.0 million, total assets were $709.7 million and total equity was $436.4 million.
The company was in compliance with all debt covenants, and its total-debt-to-adjusted-EBITDA ratio was below 1.0 to 1 versus a 3.50 to 1 covenant limit.
Annual dividends declared increased to $1.465 per share from $1.41; no shares were repurchased under the company’s repurchase program in 2018.

Material changes versus the prior comparable period

Operating performance improved materially as sales, gross profit and margins increased, while combination-related expenses declined to $19.5 million from $30.8 million.
Net income and diluted EPS were affected by fewer Houghton-related costs and a substantially lower tax impact than in 2017, when U.S. Tax Reform generated a $22.2 million charge. The 2018 U.S. Tax Reform adjustment was $5.8 million.
Adjusted diluted EPS increased to $6.04 from $5.01, excluding specified non-core items.
North America sales increased 8% and operating earnings increased 14%; Asia/Pacific sales increased 7% and operating earnings increased 16%; EMEA sales increased 3% but volumes declined 4%; South America sales were essentially flat and operating earnings were unchanged.
Other comprehensive loss was $15.7 million, compared with comprehensive income of $23.0 million in 2017, primarily due to unfavorable currency translation.
The company adopted new revenue-recognition guidance using a modified retrospective approach, recording a $0.8 million reduction to retained earnings. Comparative periods were not restated.
During 2018, Quaker ceased applying equity-method accounting to its Venezuelan affiliate after concluding it no longer had significant influence; the investment had no remaining carrying value at year-end.

Guidance, outlook, risks and unusual items

Management expected final regulatory approval and closing of the pending Houghton combination within the next few months. The transaction is expected to approximately double Quaker’s annual sales and adjusted EBITDA before synergies, with anticipated cost synergies of at least $45 million by the third year after closing. Management expected approximately $25 million to $30 million of additional combination-related costs through closing, plus post-closing integration costs that were not yet estimable.

The Houghton transaction consideration includes $172.5 million of cash, issuance of shares representing 24.5% of Quaker’s outstanding shares after closing, and assumption of approximately $690 million of Houghton net debt at signing.
The pending $1.15 billion New Credit Facility is contingent on closing and includes a $400 million revolver, a $600 million U.S. dollar term loan and a $150 million euro-equivalent term loan. Estimated floating-rate cost was 3.75% to 4.0%.
The European Commission conditionally approved the transaction in December 2018; final EC approval and U.S. FTC approval remained outstanding. The proposed divestitures were expected to represent approximately 3% of combined revenue.
For the standalone Quaker business, management expected early-2019 headwinds from a strong U.S. dollar and global economic uncertainty, partially offset by continued market-share gains, and described 2019 as expected to be another good year.
Key operating risks include cyclicality in steel, automotive and other end markets; raw-material price volatility and supply availability; foreign-exchange movements; customer concentration and credit risk; competition; regulatory and environmental obligations; cyber risks; and integration, financing, dilution and regulatory risks related to Houghton.
The company began terminating its U.S. Pension Plan, expected to be completed in 2020. Required additional funding was estimated at $0 million to $10 million, while a future settlement charge had not been estimated; related gross AOCI was approximately $19 million at year-end.
Environmental remediation liabilities at the AC Products site were estimated at approximately $0.1 million to $1.0 million. An inactive subsidiary’s asbestos-related liability was projected at approximately $1.7 million over 50 years, excluding defense costs, with restricted insurance settlement proceeds of approximately $20.3 million.
The company expects adoption of the new lease standard in 2019 to add approximately $20 million to $30 million of right-of-use assets and lease liabilities to the balance sheet.

Most important facts for investors to verify

Whether the Houghton combination ultimately closed, on what terms, and whether the expected $45 million or more of synergies were achieved.
Post-closing leverage, interest expense, covenant compliance and refinancing requirements under the New Credit Facility.
Whether pricing continues to offset raw-material inflation without impairing volumes or customer retention.
2019 and subsequent regional volume trends, particularly the EMEA slowdown and the effects of foreign-exchange movements.
Actual integration, divestiture, regulatory and transaction costs compared with management’s estimates.
Funding requirements and accounting effects associated with the U.S. Pension Plan termination.
Developments in asbestos, environmental and tax matters, including the Italian tax assessments and uncertain tax positions.
Reconciliation of reported GAAP results to management’s non-GAAP measures, particularly adjusted EBITDA and adjusted diluted EPS.