Business Context and Reporting Period
Quaker Chemical Corporation, a global provider of industrial process fluids, chemical specialties, and technical services, filed this unaudited Form 10-Q for the quarter ended March 31, 2015. Operations are reported across North America, EMEA, Asia/Pacific, and South America.
Key Financial Metrics
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Net sales | $181.3 million | $181.7 million | Down less than 1% |
| Gross profit | $66.3 million | $65.1 million | Up 2% |
| Gross margin | 36.6% | 35.8% | Up 0.8 percentage points |
| Operating income | $17.9 million | $19.4 million | Down $1.5 million |
| Operating margin | 9.9% | 10.7% | Down approximately 0.8 percentage points |
| Net income attributable to Quaker | $10.4 million | $12.7 million | Down 18% |
| Diluted EPS | $0.78 | $0.96 | Down $0.18 |
| Adjusted EBITDA | $23.2 million | $23.7 million | Down 2% |
| Operating cash flow | $8.1 million | $(1.8) million | Improved $9.9 million |
Net margin attributable to Quaker was approximately 5.7%, compared with approximately 7.0% in the prior-year quarter. The effective tax rate declined to 30.8% from 34.8%; management estimated a full-year 2015 effective tax rate of approximately 30%.
Cash and cash equivalents were $64.3 million at March 31, 2015, compared with $64.7 million at December 31, 2014. Total debt was approximately $73.1 million, including $55.9 million outstanding under the company’s $300 million revolving credit facility and $17.2 million of other debt. The facility matures in June 2018, and the company was in compliance with its covenants, with a consolidated leverage ratio below 1.0 to 1.0 versus a maximum of 3.50 to 1.0.
Capital expenditures were $2.4 million. Cash used in financing activities was $5.1 million, including $4.0 million of dividends paid and $1.3 million of debt repayment. The declared quarterly dividend increased to $0.30 per share from $0.25 per share.
Material Changes Versus the Prior Comparable Period
- Reported sales were essentially flat because 7% product-volume growth, including $10.4 million from 2014 acquisitions, was offset by a $12.1 million foreign-exchange translation headwind.
- Gross profit and gross margin improved because of higher volumes and improved product mix.
- SG&A increased by approximately $2.7 million due mainly to acquisition-related costs and higher labor costs, partially offset by foreign-exchange translation and the absence of a $0.9 million U.K. pension-plan amendment cost recorded in Q1 2014.
- Operating income declined despite the higher gross profit because of increased SG&A and amortization.
- Equity in net income of associated companies changed from $1.0 million of income to a $1.4 million loss, primarily because of a $2.8 million charge related to the company’s Venezuelan affiliate.
- Operating cash flow improved substantially because of better accounts-receivable collections and more stable inventory levels, partly offset by timing-related cash outflows for accounts payable and accrued liabilities.
- North America sales increased 8% and Asia/Pacific sales increased 7%, while EMEA sales declined 12% and South America sales declined 27%, with foreign-exchange translation the principal adverse factor in EMEA and South America.
Outlook, Commentary, Risks, and Unusual Items
Management described the market environment as challenging but stable, with continued strong U.S. dollar effects and lower oil prices. Management expects market-share gains and acquisition contributions to offset these pressures and stated that it expects 2015 to produce increased earnings for a sixth consecutive year. The filing does not provide formal revenue or EPS guidance beyond this commentary and the approximately 30% full-year tax-rate expectation.
- Venezuela: Changes in foreign-exchange controls eliminated access to the previously used CADIVI rate for the company’s Venezuelan affiliate. Revaluation to the SIMADI rate resulted in a $2.8 million pretax charge, or approximately $0.21 per diluted share, and reduced the affiliate investment to $137,000 at March 31, 2015.
- Foreign exchange: Currency movements reduced sales by approximately $12.1 million and reduced net income by approximately $1.1 million, or $0.08 per diluted share.
- Tax exposures: Gross unrecognized tax benefits were $11.1 million, with total uncertain-tax-position liabilities including interest and penalties of approximately $14.3 million. Management expects statute-of-limitations expirations to reduce unrecognized tax benefits by approximately $1.8 million to $1.9 million during 2015, before considering new or additional positions.
- Environmental remediation: Remaining AC Products groundwater-remediation liabilities were estimated at approximately $280,000 to $890,000 and were sufficiently reserved. The remaining treatment system was expected to operate for approximately nine months to two years and nine months.
- Asbestos litigation: An inactive subsidiary faces asbestos claims. Projected liability over the next 50 years was less than $3.8 million, excluding defense costs, but available insurance and subsidiary assets could be exhausted. Management did not believe material losses to the parent were probable, although additional losses could not be estimated.
- VAT contingency: Potential additional exposure from other jurisdictions was estimated at $0 to $3.4 million assuming future amnesty programs or settlements; exposure could be higher if those programs are unavailable.
- Controls: Management concluded 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 foreign-exchange pressure, especially in Venezuela, Europe, and South America, continues to offset volume growth and acquisition benefits.
- Whether higher SG&A, labor, and amortization costs moderate or reverse the gross-margin improvement.
- The sustainability of improved operating cash flow and the timing of working-capital movements.
- Compliance with the $300 million credit facility’s covenants and the company’s leverage ratio as acquisitions or capital allocation continue.
- Future developments in Venezuelan exchange controls and any additional impairment or revaluation charges.
- Resolution and cash requirements related to uncertain tax positions, VAT assessments, environmental remediation, and asbestos claims.
- Whether management achieves its expectation of increased full-year 2015 earnings and maintains an effective tax rate near 30%.