Quaker Chemical Corporation — 2015 Q3 Form 10-Q Summary
Business context and reporting period
Quaker Chemical Corporation provides process fluids, chemical specialties, and technical services to industrial markets worldwide, including steel, automotive, mining, aerospace, and durable goods manufacturing. This unaudited Form 10-Q covers the three and nine months ended September 30, 2015, compared with the corresponding 2014 periods.
Key financial metrics
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Net sales | $189.2 million | $198.9 million | $554.3 million | $571.8 million |
| Gross profit | $71.3 million | $70.3 million | $208.3 million | $203.6 million |
| Gross margin | 37.7% | 35.4% | 37.6% | 35.6% |
| Operating income | $18.7 million | $20.6 million | $58.0 million | $60.9 million |
| Net income attributable to Quaker | $14.4 million | $15.7 million | $39.8 million | $43.9 million |
| Diluted EPS | $1.08 | $1.18 | $2.98 | $3.31 |
| Adjusted EBITDA | $26.8 million | $26.5 million | $76.3 million | $76.1 million |
- Q3 operating margin was approximately 9.9%, compared with approximately 10.3% in the prior-year quarter; diluted net income margin was approximately 7.6% versus 7.9%.
- Net cash provided by operating activities was $50.8 million for the first nine months, compared with $38.0 million in 2014. Management reported approximately $23.5 million of operating cash flow in Q3.
- Cash and cash equivalents were $96.2 million at September 30, 2015, up from $64.7 million at December 31, 2014.
- Total debt was approximately $108.3 million, including $107.9 million of long-term debt and $0.4 million of current borrowings. The primary $300.0 million credit facility had $87.3 million outstanding and matures in June 2018.
- The consolidated leverage ratio was approximately 1.1 to 1, below the 3.5 to 1 covenant limit. The company reported compliance with all facility covenants.
- Capital expenditures were $6.1 million and acquisition payments were $24.0 million during the first nine months. Dividends paid were $12.3 million, and $5.0 million was used to repurchase 59,110 shares.
Material changes versus the prior comparable period
- Q3 sales declined 5%, primarily because $14.9 million of foreign-currency translation effects outweighed 4% product-volume growth and acquisition-related sales. For the first nine months, sales declined 3%, with $41.2 million of currency translation pressure.
- Gross profit increased despite lower sales, reflecting higher volumes and favorable timing of raw-material cost decreases. Gross margin expanded 230 basis points in Q3 and 200 basis points for the nine-month period.
- SG&A increased $2.9 million in Q3 and $7.5 million for the first nine months, driven by labor costs, acquisition-related expenses, and a $2.8 million Verkol transaction charge in Q3.
- North America was the primary source of improvement: Q3 sales increased 2% and segment operating earnings increased 23%. EMEA, Asia/Pacific, and South America reported lower Q3 operating earnings, with South America particularly affected by recessionary conditions and currency weakness.
- Q3 reported EPS declined $0.10, but non-GAAP EPS was $1.19 in both periods after excluding specified unusual items. Nine-month non-GAAP EPS was $3.27 versus $3.26.
- Equity income declined for the nine-month period, partly because of a $2.8 million Venezuelan currency-related charge recorded in Q1 2015 and lower earnings from the captive insurance investment.
Acquisitions, unusual items, and accounting matters
- In July 2015, Quaker acquired Verkol, a Northern Spain specialty grease and lubricant manufacturer, for approximately $40.0 million, including cash acquired and assumed debt. The transaction added approximately $11.7 million of intangible assets and $3.9 million of goodwill; purchase-price allocation remained subject to finalization.
- Verkol generated $2.8 million of one-time transaction expenses, or $0.15 per diluted share, in Q3.
- Quaker remeasured its Venezuelan affiliate’s investment and related assets at the SIMADI exchange rate in Q1, recording an approximately $2.8 million charge. The investment was $0.2 million at September 30, 2015.
- The annual goodwill impairment assessment was completed in Q3 with no impairment charge. Management stated that each reporting unit’s estimated fair value substantially exceeded its carrying value.
- The company’s estimated 2015 full-year effective tax rate was approximately 28%, compared with 27.3% for the first nine months. The filing notes that tax rates may fluctuate based on audit developments and expiration of statutes of limitations.
Outlook, risks, and contingencies
Management expected fourth-quarter and full-year 2015 non-GAAP earnings to exceed 2014, supported by market-share gains, acquisitions, margin expansion, strong cash generation, and the balance sheet. Management also expected a strong U.S. dollar and generally weak market conditions in many countries to continue.
- Principal operating risks include foreign-currency volatility, weaker global steel production, economic weakness in South America, customer production declines or shutdowns, raw-material cost increases, customer financial instability, and broader economic and political conditions.
- The company expects to fund operating needs, pension contributions, dividends, share repurchases, acquisitions, capital expenditures, and contingencies through internally generated funds supplemented by debt or equity as needed.
- Environmental remediation liabilities related to the ACP site were estimated at approximately $0.4 million to $1.1 million, with sufficient reserves reported. Other environmental accruals totaled approximately $0.3 million.
- An inactive subsidiary faces asbestos claims. Management projected the subsidiary’s total liability over the next 50 years at less than $3.8 million, excluding defense costs, but stated that additional losses cannot be reliably estimated if insurance coverage and subsidiary assets are exhausted.
- Potential additional VAT exposure was estimated at $0 to $2.6 million assuming future amnesty programs or settlements; exposure could be higher without such programs.
- Gross unrecognized tax benefits, including interest and penalties, were approximately $14.0 million. Management stated that offsetting tax benefits could reduce any ultimate cash payment by up to $10.0 million.
- Disclosure controls and procedures were deemed effective, and no material changes to internal control over financial reporting were identified during the quarter.
Important facts for investors to verify
- Whether currency headwinds, global steel demand, and South American conditions continued to affect sales and segment profitability after September 30, 2015.
- The final purchase-price allocation, integration costs, and earnings contribution from Verkol and other recent acquisitions.
- Whether gross-margin expansion was sustainable after the reported timing benefits from raw-material cost declines.
- Actual full-year 2015 non-GAAP earnings and effective tax rate versus management’s outlook.
- Future borrowings, acquisition funding, covenant headroom, and the effect of the $100 million share-repurchase authorization on liquidity and share count.
- Developments in Venezuelan exchange controls, uncertain tax positions, VAT assessments, asbestos litigation, and ACP environmental remediation.