Quaker Chemical Corporation — Form 10-Q Summary
Business Context and Reporting Period
Quaker Chemical Corporation is a global provider of formulated process fluids, specialty chemicals, and chemical management services for steel, metalworking, automotive, aerospace, mining, and other industrial customers. The unaudited filing covers the three months ended March 31, 2018, compared with the three months ended March 31, 2017.
Financial Performance and Key Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $212.1 million | $194.9 million | +9% |
| Gross profit | $75.4 million | $70.9 million | +6% |
| Gross margin | 35.6% | 36.4% | Down 80 bps |
| Operating income | $20.2 million | $13.8 million | +47% |
| Net income attributable to Quaker | $12.7 million | $7.0 million | +82% |
| Diluted EPS | $0.95 | $0.52 | +$0.43 |
| Adjusted EBITDA | $30.8 million | $28.2 million | +9% |
| Adjusted EBITDA margin | 14.5% | 14.5% | Flat |
| Operating cash flow | $2.7 million | $8.3 million | Down $5.6 million |
Sales growth reflected approximately 1% volume growth, 2% benefit from selling price and product mix, and a 6% favorable foreign-currency translation impact. Higher raw-material costs and product mix reduced gross margin. SG&A increased modestly, but remained disciplined relative to sales growth.
The effective tax rate declined to 29.8% from 50.8%, benefiting from the reduction in the U.S. statutory tax rate under U.S. tax reform and lower non-deductible combination costs. The quarter included a $0.2 million Venezuelan currency conversion charge and a loss from an associated captive insurance company.
Liquidity, Cash Flow, Debt, and Balance Sheet
- Cash and cash equivalents were $92.6 million at March 31, 2018; cash, cash equivalents, and restricted cash totaled $113.7 million, including $21.1 million of restricted cash associated with asbestos litigation claims.
- Operating cash flow declined primarily because accounts receivable and inventories absorbed cash to support higher sales, and because of working-capital timing.
- Investing cash outflows were $3.9 million, including $3.4 million of capital expenditures and $0.5 million paid for mining-industry formulations and product technology.
- Financing cash inflows were $1.5 million, including $8.2 million of long-term debt proceeds, partly offset by $4.7 million of dividends and other payments.
- Total credit-facility borrowings were $57.2 million, compared with $48.5 million at December 31, 2017. Long-term debt was $69.6 million and current debt was $5.7 million at March 31, 2018.
- The existing $300 million multicurrency credit facility matures in June 2019. Net debt to adjusted EBITDA was below 1.0 times, versus a covenant limit of 3.50 times, and the company reported compliance with all covenants.
- Total assets were $744.5 million and total equity was $422.8 million at March 31, 2018.
Material Changes Versus the Prior Comparable Period
- All four regions reported higher sales: North America +5%, EMEA +15%, Asia/Pacific +8%, and South America +11%. EMEA sales benefited heavily from currency translation, while volume was lower because Q1 2017 had an atypical sales pattern.
- Asia/Pacific operating earnings increased 19% and EMEA operating earnings increased 11%; North America and South America operating earnings declined modestly because of lower gross margins.
- Combination-related expenses fell to $6.1 million from $9.1 million, including $0.9 million of ticking fees in 2018. These costs reduced reported earnings but were excluded from non-GAAP measures.
- Non-GAAP diluted EPS increased to $1.38 from $1.18, while adjusted EBITDA increased to a record $30.8 million from $28.2 million.
- The company paid $3.9 million for pension contributions and $0.1 million for other postretirement benefits during the quarter.
- The company adopted new revenue-recognition and restricted-cash presentation standards. Revenue recognition had no material effect on earnings or cash flow but reduced retained earnings by $0.8 million through a December 31, 2017 balance-sheet adjustment.
Houghton Combination, Outlook, and Management Commentary
Quaker continues to pursue the pending combination with Houghton International. The transaction is expected to require $172.5 million in cash, issuance of shares representing 24.5% of Quaker’s outstanding common stock at closing, and assumption of Houghton net debt, which was approximately $690 million at signing. Remaining regulatory approvals in the United States and Europe and other customary closing conditions were outstanding at the filing date.
In April 2018, the company extended its $1.15 billion financing commitment through August 4, 2018. The proposed facility includes a $400 million revolver, a $600 million U.S. dollar term loan, and a $150 million euro-equivalent term loan. Estimated floating-rate borrowing costs were 3.50% to 3.75%. Quaker expected to incur an additional $25 million to $30 million of combination-related expenses and cash outflows through closing, excluding post-closing integration costs.
Management expected current-business volume growth, continued SG&A leverage, and improving pricing to support gross margin trending toward approximately 36% for 2018. Management also expected the combination to approximately double annual sales and adjusted EBITDA before synergies, with anticipated synergies of at least $45 million when fully achieved by the third year.
Risks, Contingencies, and Unusual Items
- Results are exposed to demand cycles and production levels in steel, automotive, aerospace, appliance, and other durable-goods industries.
- Higher raw-material costs, foreign-exchange volatility, customer financial conditions, and global economic or political developments could pressure results.
- The Houghton transaction could be delayed, terminated, require unanticipated divestitures, increase leverage, or generate greater integration costs than expected.
- Asbestos litigation relates to an inactive subsidiary. Projected liability over the next 50 years was approximately $1.9 million excluding defense costs; restricted cash of $21.1 million was available for claims and defense costs.
- Potential liabilities for an environmental groundwater-remediation program were estimated at approximately $0.1 million to $1.0 million.
- Gross liabilities for uncertain tax positions, including interest and penalties, totaled $9.7 million. The company expects approximately $1.0 million to $1.1 million of unrecognized tax benefits to expire during 2018, subject to other changes.
- The company expects most operating leases to be recorded on the balance sheet when the new lease standard is adopted; the filing does not provide a quantified impact.
- The company reported effective disclosure controls and procedures and no material changes to internal control over financial reporting.
Investor Verification Checklist
- Verify the timing and final terms of the Houghton closing, including regulatory approvals, share issuance, purchase consideration, and debt assumed.
- Reconcile reported GAAP earnings with management’s non-GAAP EPS and adjusted EBITDA, particularly combination expenses, captive-insurance results, and Venezuelan currency effects.
- Monitor gross-margin recovery, raw-material inflation, pricing actions, and whether 2018 gross margin approaches management’s approximately 36% expectation.
- Assess working-capital needs and operating cash conversion as sales continue to grow.
- Review post-closing leverage, financing costs, covenant compliance, and integration expenditures if the Houghton transaction closes.
- Track asbestos, environmental, tax, and other contingent liabilities, as well as the impact of future lease-accounting adoption.