Quaker Chemical Corporation — Q2 2012 Form 10-Q Summary
Business context and reporting period
Quaker Chemical provides process chemicals, specialty chemicals, chemical-management services and technical expertise to industries including steel, aluminum, automotive, mining, aerospace, tube and pipe, coatings and construction materials. This unaudited report covers the three and six months ended June 30, 2012, compared with the corresponding 2011 periods.
Key financial metrics
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net sales | $176.8 million | $167.8 million | $354.4 million | $327.7 million |
| Gross profit | $60.6 million | $53.8 million | $120.4 million | $106.5 million |
| Gross margin | 34.3% | 32.0% | 34.0% | 32.5% |
| Operating income | $17.0 million | $14.9 million | $33.7 million | $29.0 million |
| Net income attributable to Quaker | $10.5 million | $9.8 million | $22.5 million | $20.4 million |
| Diluted EPS | $0.81 | $0.79 | $1.72 | $1.69 |
| Operating cash flow | Not separately provided | Not separately provided | $21.9 million | $0.2 million |
- Q2 sales increased 5%; management attributed the change to 6% higher volume, including acquisitions, and a 5% benefit from selling price and mix, partly offset by a 6% foreign-exchange translation headwind.
- Six-month sales increased 8%, reflecting 5% higher volume, a 7% benefit from price and mix, and a 4% foreign-exchange headwind.
- Q2 selling, general and administrative expense increased to $43.7 million from $38.8 million; SG&A represented 24.7% of sales versus 23.1% in the prior-year quarter.
- At June 30, 2012, cash and cash equivalents were $25.3 million, up from $16.9 million at December 31, 2011. Total assets were $519.4 million and total equity was $273.4 million.
- Total debt was approximately $45.6 million, consisting primarily of $45.0 million of long-term debt. The company had approximately $27.1 million outstanding under its $175.0 million revolving credit facility.
- The consolidated leverage ratio was below 1.0-to-1.0 versus a maximum covenant of 3.50-to-1.0. The facility expires in 2014 and may be expandable to $225.0 million subject to lender approval and conditions.
- Capital expenditures were $6.4 million during the first six months. Dividends paid were $6.2 million, and the declared dividend was $0.245 per share in Q2.
Material changes versus the prior comparable period
- Gross margin expanded 230 basis points in Q2 and 150 basis points year to date, primarily from price increases and favorable mix as management continued its margin-restoration initiative.
- Operating income increased 14% in Q2 and 16% year to date. The metalworking process chemicals segment generated approximately 93% of Q2 sales and increased segment operating income by approximately $4.5 million.
- Coatings sales increased 4% in Q2 and 13% year to date, supported primarily by aerospace chemical milling maskant sales. Other chemical products also improved, benefiting from increased oil and gas activity.
- Foreign-exchange translation was a significant offset, particularly from the euro and Brazilian real. Demand was weaker in Europe, China, Brazil and India, while North American manufacturing recovery, acquisitions and new business provided support.
- Q2 SG&A included a $1.156 million allowance charge related to the bankruptcies of two U.S. customers, approximately $0.06 per diluted share, and approximately $0.03 per diluted share of CFO transition costs.
- Operating cash flow improved substantially from $0.2 million to $21.9 million, driven by better working-capital performance, lower pension contributions and higher net income.
- The company repaid $1.754 million of long-term debt during the first half of 2012. This compares with $40.4 million of repayments in the first half of 2011, when proceeds from a $48.1 million equity offering were used to reduce the revolving credit line.
- Comprehensive income attributable to Quaker declined to $4.4 million in Q2 and $20.2 million for the first half, primarily because of adverse currency translation adjustments.
Guidance, outlook, risks and unusual items
- Management expected the global economic environment to remain challenging in the second half of 2012, with continued weakness in most regions, but stated that 2012 was expected to be another good year. No specific revenue or EPS guidance was provided.
- Management expects the full-year 2012 effective tax rate to be higher than the 26.1% first-half rate. Tax-rate volatility may result from audits and the timing of expiration of statutes of limitations for uncertain tax positions.
- Gross unrecognized tax benefits were $12.4 million at June 30, 2012; total uncertain tax positions including interest and penalties were approximately $16.1 million. The company estimated a $1.7 million to $1.8 million reduction in gross unrecognized tax benefits during 2012, before considering new or increased exposures.
- The IRS initiated a limited-scope audit of the 2009 federal return, and Italian tax authorities initiated a transfer-pricing audit. Management believed it should prevail in the Italian matter and recorded no related uncertain-tax-position reserve.
- Potential remaining VAT exposure at an affected subsidiary was estimated at $0 to $16.5 million assuming future refunds, amnesty programs or settlements; exposure could be higher if such programs are unavailable.
- Environmental liabilities related to the ACP contamination site were estimated at $1.1 million to $2.1 million, for which the company stated it had sufficient reserves. The company also disclosed asbestos-related litigation involving an inactive subsidiary and stated that material losses at the parent level were not considered probable, although additional losses could not be estimated.
- The company acquired NP Coil Dexter Industries after June 30, 2012. The acquired European business had annual sales of approximately $11.0 million; pro forma disclosures were omitted because the effects were not material.
- The company’s primary operating risks include cyclical demand from steel, automotive, aircraft, appliance and durable-goods customers; raw-material cost inflation; foreign-currency movements; economic and political conditions; customer shutdowns; and execution of acquisitions and chemical-management contracts.
- Disclosure controls and procedures were assessed as effective, and management reported no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether price increases and mix improvements can offset ongoing foreign-exchange pressure, weaker regional demand and rising operating expenses.
- The sustainability of the improved gross margin and the extent to which acquisitions contributed to sales and operating-income growth.
- Availability under the revolving credit facility, compliance with the leverage covenant and the company’s capacity to fund acquisitions, pensions, dividends and capital expenditures.
- Developments in the VAT matter, Italian transfer-pricing audit, IRS audit and other uncertain tax positions.
- The ultimate cost and duration of ACP environmental remediation and asbestos-related claims.
- Integration and performance of the 2011 acquisitions and the post-quarter NP Coil Dexter acquisition, including the Summit earnout and other acquisition-related liabilities.
- Cash conversion, working-capital requirements and pension contributions; the company had made $4.7 million of pension contributions and $0.5 million of other postretirement-plan contributions by June 30, 2012.