Quaker Chemical Corporation — Q1 2017 Form 10-Q Summary
Business context and reporting period
Quaker Chemical provides process fluids, chemical specialties and technical services to industrial customers globally, including steel, aluminum, automotive, mining, aerospace, tube and pipe, and other markets. This unaudited Form 10-Q covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016. Reportable segments are North America, EMEA, Asia/Pacific and South America.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $194.9 million | $178.1 million | +9% |
| Gross profit | $70.9 million | $68.0 million | +4% |
| Gross margin | 36.4% | 38.2% | Down 180 bps |
| Operating income | $13.8 million | $19.8 million | Down $6.1 million |
| Net income attributable to Quaker | $7.0 million | $12.9 million | Down 46% |
| Diluted EPS | $0.52 | $0.98 | Down $0.46 |
| Adjusted EBITDA | $28.2 million | $25.0 million | +13% |
| Adjusted EBITDA margin | 14.5% | 14.0% | Up 50 bps |
| Operating cash flow | $8.3 million | $10.9 million | Down $2.6 million |
SG&A was essentially flat at $48.1 million versus $48.1 million in the prior-year quarter. The company recorded $9.1 million of Houghton combination-related expenses, or $0.69 per diluted share. Excluding these and other non-core items, non-GAAP diluted EPS was $1.18 versus $0.98.
The effective tax rate was 50.8% versus 32.3%. The higher rate primarily reflected non-deductible Houghton transaction costs; management indicated that the rate would have been approximately 30% excluding those costs. Equity income from associated companies increased to $1.0 million from $0.1 million.
Liquidity, debt and cash flow
- Cash and cash equivalents were $90.6 million at March 31, 2017, up from $88.8 million at December 31, 2016.
- Net cash provided by operating activities was $8.3 million. Working-capital investment increased because of higher accounts receivable and inventory levels associated with sales growth.
- Capital expenditures were $2.5 million. Net cash used in investing activities was $2.3 million.
- Net cash used in financing activities was $5.8 million, including $4.6 million of dividends and $0.5 million of debt repayments. No shares were repurchased under the public repurchase program.
- Total reported debt was approximately $66.4 million, including $0.7 million of current debt and $65.6 million of long-term debt. Credit-facility borrowings were $47.9 million.
- The primary credit facility provides $300 million of capacity, potentially expandable to $400 million, and matures in June 2018. The consolidated leverage ratio was below 1.0 to 1.0 versus a covenant maximum of 3.50 to 1.0; the company was in compliance with its covenants.
Material changes versus the prior comparable period
- Sales growth reflected 10% organic volume growth, approximately $2.6 million of acquisition-related sales from Lubricor, and a $2.7 million negative foreign-currency translation effect.
- Gross profit increased, but gross margin contracted because of product mix and raw-material cost increases.
- Operating income and GAAP EPS declined because the prior-year period had no Houghton transaction costs and Q1 2017 included $9.1 million of such expenses.
- Adjusted EBITDA and non-GAAP EPS improved despite foreign-exchange headwinds of approximately 3% and $0.04 per diluted share, respectively.
- North America sales increased 6% and operating earnings increased 10%; EMEA sales increased 13% and operating earnings increased 14%; Asia/Pacific sales increased 9% but operating earnings declined 7%; South America sales increased 30% and operating earnings improved to $0.8 million from a loss of $0.3 million.
- The company adopted new guidance for pension-cost presentation and share-based-payment accounting. The pension standard resulted in retrospective income-statement reclassifications; the share-based-payment adoption had an immaterial current-quarter tax benefit and dilution effect.
Guidance, outlook, risks and unusual items
Management continued to expect 2017 sales and earnings growth, higher adjusted EBITDA and higher non-GAAP EPS for the eighth consecutive year. It expects foreign-exchange and raw-material headwinds to persist but potentially moderate as the year progresses. Management also expects market-share gains, SG&A discipline and acquisition benefits to provide support. The projected full-year 2017 effective tax rate is approximately 28% to 30%, excluding the impact of non-deductible Houghton transaction costs. The 2015 restructuring program is substantially complete, with approximately $5 million of expected 2017 pretax savings and no material additional restructuring charges expected.
On April 4, 2017, after quarter-end, Quaker entered into an agreement to acquire Houghton. Consideration comprises $172.5 million of cash, shares representing 24.5% of Quaker's post-closing common stock, and assumption of Houghton's estimated $690 million of net indebtedness. The transaction implies approximately $1.42 billion of enterprise value. Quaker obtained approximately $1.15 billion of financing commitments and expected closing in the fourth quarter of 2017 or first quarter of 2018, subject to shareholder, regulatory and other customary approvals. Additional transaction costs could be material.
Key risks include cyclical and customer-dependent demand, customer production shutdowns, raw-material inflation, foreign-currency volatility, economic and political conditions, tax-rate changes, and risks associated with financing, regulatory approval, potential divestitures, shareholder approval, closing, litigation and integration of Houghton.
Other contingencies include groundwater remediation costs estimated at approximately $0.1 million to $1.0 million, projected asbestos-related liability of approximately $2.2 million over the next 50 years excluding defense costs, and approximately $0.2 million accrued for other environmental matters. Gross unrecognized tax benefits, including interest and penalties, were $8.8 million at March 31, 2017.
Important facts for investors to verify
- Whether the Houghton transaction received shareholder and regulatory approvals, closed on schedule, and resulted in the expected debt, dilution and integration costs.
- The amount and timing of Houghton financing, interest expense, leverage and covenant compliance after closing.
- Whether gross-margin pressure from raw materials and product mix persisted or was offset through pricing and productivity actions.
- The sustainability of organic volume growth and the differing performance trends across the four geographic segments.
- Actual cash conversion as accounts receivable and inventory normalize and as transaction, pension, restructuring and capital-expenditure payments continue.
- The resolution and cash impact of uncertain tax positions, Italian tax assessments, environmental remediation and asbestos litigation.
- The company’s eventual implementation conclusions and financial-statement impact for the new revenue-recognition, lease and cash-flow accounting standards.