KWR

Quaker Chemical Corp. 10-Q Summary: Period Ended June 30, 2009

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2009, and the six months ended June 30, 2009. Quaker Chemical Corporation is a global provider of process chemicals and technical expertise to industries including steel, automotive, mining, and aerospace. The reporting period was significantly impacted by a global economic downturn, resulting in substantial volume declines across all regions. The company also navigated the bankruptcy and subsequent emergence of two major customers, General Motors and Chrysler.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 35% in Q2 2009 and 34% in the first six months of 2009 compared to the prior year periods. This was driven primarily by a 36% volume decline due to the global economic downturn, partially offset by a 6% increase in selling price and mix.
• Margin Expansion: Despite lower sales, gross margin percentage improved significantly to 35.2% in Q2 2009 (from 28.3% in Q2 2008) and 32.2% for the six months (from 28.9% in 2008). This was due to cost reduction actions, favorable raw material costs, and a shift in reporting for automotive Chemical Management Services (CMS) revenue.
• Expense Reduction: Selling, general, and administrative (SG&A) expenses decreased 22% in Q2 2009, driven by restructuring savings, reduced discretionary spending, and lower commissions.
• One-Time Items: Q2 2008 included a $1.0 million net arbitration award not present in 2009. Q2 2009 included $1.2 million in CEO transition costs.
• Cash Flow: Operating cash flow for the first six months of 2009 was $26.8 million, a significant increase from $8.1 million in the same period in 2008, largely due to a $33.5 million improvement in working capital (reduced receivables and inventory).

Guidance, Outlook, and Risks

• Outlook: Management expects demand to remain soft for the foreseeable future due to the global economic environment, particularly in steel and automotive end-markets. Visibility on underlying business activity remains limited.
• CEO Transition Costs: The company expects to incur total CEO transition costs of $2.4 million for 2009 and $1.0 million in 2010 related to the former CEO's supplemental retirement plan.
• Customer Bankruptcies: Contracts with General Motors and Chrysler were assumed by successor companies. The company has received over 85% of pre-bankruptcy receivables and expects full payment on remaining invoices.
• Liquidity: The company maintains a $125 million credit facility. The leverage ratio covenant was temporarily amended to allow up to 4.0 to 1 through September 30, 2009. As of June 30, 2009, the leverage ratio was below 2.4 to 1.
• Contingencies: The company faces ongoing environmental remediation costs (estimated $1.6M to $3.6M) and asbestos litigation liabilities for an inactive subsidiary (projected $12.2M), though the company believes it has adequate reserves and insurance coverage.

Key Facts for Investor Verification

• Volume Sensitivity: Verify the correlation between global steel and automotive production indices and Quaker's future revenue, given the 36% volume drop in Q2 2009.
• Working Capital Quality: Confirm the sustainability of the $33.5 million working capital improvement, specifically the collection of pre-petition receivables from GM and Chrysler.
• Debt Covenants: Monitor the company's leverage ratio against the amended covenant limits (4.0 to 1) to ensure continued access to the $125 million credit facility.
• Restructuring Execution: Track the completion of the 2008 and 2009 restructuring programs to ensure projected cost savings are realized.
• Asbestos Liability: Review the status of the inactive subsidiary's asbestos litigation and the final installment of the $20 million insurance settlement, which is contingent on federal legislation.