Quaker Chemical Corporation — Form 10-Q Summary
Business context and reporting period
Quaker Chemical Corporation provides industrial process fluids, chemical specialties, and technical services to industries including steel, aluminum, automotive, mining, aerospace, tube and pipe, and other durable-goods manufacturers. The filing covers the unaudited three and nine months ended September 30, 2014, compared with the corresponding 2013 periods. Reportable segments are North America, Europe/Middle East/Africa, Asia/Pacific, and South America.
Financial performance and position
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net sales | $198.9 million | $184.1 million | $571.8 million | $545.1 million |
| Gross profit | $70.3 million | $66.0 million | $203.6 million | $195.9 million |
| Gross margin | 35.4% | 35.9% | 35.6% | 35.9% |
| Operating income | $20.6 million | $18.8 million | $60.9 million | $56.0 million |
| Operating margin | 10.3% | 10.2% | 10.6% | 10.3% |
| Net income attributable to Quaker | $15.7 million | $12.6 million | $43.9 million | $42.3 million |
| Diluted EPS | $1.18 | $0.95 | $3.31 | $3.21 |
| Adjusted EBITDA | $26.5 million | $22.8 million | $76.1 million | $68.6 million |
| Operating cash flow | Approximately $29.8 million | Approximately $24.5 million | $38.0 million | $52.0 million |
At September 30, 2014, cash and cash equivalents were $64.2 million, compared with $68.5 million at December 31, 2013. Total debt was approximately $62.6 million, including $45.0 million outstanding under the company’s revolving credit facility, compared with approximately $18.7 million at year-end 2013. The company had a $300 million syndicated multicurrency facility maturing in June 2018, with potential capacity of $400 million subject to conditions. The consolidated leverage ratio was below 1.0 to 1, versus a covenant maximum of 3.50 to 1, and all facility covenants were satisfied.
Total assets were $644.2 million and total equity was $367.0 million at September 30, 2014. Accounts receivable increased to $189.0 million from $165.6 million at year-end, and inventories increased to approximately $80.5 million from $71.6 million.
Material changes versus the prior comparable period
- Third-quarter sales increased 8%, primarily from higher base-product volumes; ECLI Products contributed approximately 2% of quarterly sales growth. Nine-month sales increased 5%, with ECLI contributing approximately 1%.
- North America, EMEA, and Asia/Pacific reported higher third-quarter volumes and operating earnings. South America remained weak: sales declined 25% and operating earnings declined 66% year over year in the quarter.
- Gross margin was broadly stable but declined modestly to 35.4% in the quarter and 35.6% for the nine months, reflecting price and product mix and higher manufacturing costs.
- SG&A increased $2.6 million in the quarter and $2.9 million for the nine months, driven by labor costs, incentive compensation, acquisition-related costs, and a $0.3 million U.S. customer bankruptcy charge. The nine-month period also included a $0.9 million U.K. pension-plan amendment charge.
- Net income benefited in the quarter from other income of $0.9 million versus $0.7 million of other expense in the prior year and from a lower effective tax rate of 26.7% versus 33.8%. For the nine months, the effective tax rates were 30.5% and 30.0%, respectively.
- Equity income from associated companies decreased to $0.4 million in the quarter from $1.6 million and to $2.5 million for the nine months from $4.7 million, primarily because of lower captive-insurance-company earnings.
- Operating cash flow declined year to date because of higher receivables and inventory investment, delayed collections in certain regions, and lower accounts-payable-related inflows.
- Investing cash outflows increased to $58.9 million from $8.7 million, principally due to the $52.0 million acquisition of ECLI and higher capital expenditures. Financing cash flow changed to a $19.6 million inflow from a $21.7 million outflow, primarily because of new borrowings.
Outlook, commentary, risks and unusual items
Management described the third quarter as one of the company’s strongest in recent years and remained confident that 2014 would be another good year. Management expected the full-year 2014 effective tax rate to approximate 31% and believed market-share gains and recent acquisitions could help offset an uncertain global economic environment. No formal revenue or earnings guidance was provided.
- In August 2014, Quaker acquired ECLI Products, a specialty grease manufacturer, for approximately $52.0 million. The preliminary purchase-price allocation included $31.1 million of intangible assets and $13.4 million of goodwill.
- The company acquired the remaining 49% interest in its Australian affiliate for approximately $7.6 million and paid a $4.7 million acquisition-related earnout during the nine months.
- Foreign exchange remains material, particularly in South America. The company cited economic weakness, low customer production, and currency pressure in the region.
- Demand depends substantially on customers’ production levels, exposing Quaker to customer downturns and unplanned shutdowns. Other principal risks include raw-material costs, global economic and political conditions, foreign currency fluctuations, and industry cyclicality.
- The company’s Venezuela investment was valued using the CADIVI exchange rate; a $0.3 million charge related to Bolivar conversion was recorded during the second quarter.
- Goodwill and indefinite-lived intangible assets passed the annual impairment assessment; no impairment charge was recorded. Management stated that reporting-unit fair values substantially exceeded carrying values.
- Environmental remediation liabilities for the AC Products groundwater program were estimated at $0.4 million to $1.1 million and were adequately reserved. Remaining treatment operations were expected to continue for approximately 15 months to three years.
- Asbestos litigation involving an inactive subsidiary remains difficult to predict. Management did not believe a material loss to the parent was probable, but stated that additional losses or a range of loss could not be estimated.
- Potential VAT exposures could materially affect financial position, liquidity, capital resources, and results of operations. The filing described possible additional exposure of $0 to $7.8 million, assuming future refunds and amnesty or settlement programs.
- Gross unrecognized tax benefits, including interest and penalties, were approximately $15.2 million. The company estimated that up to $10.4 million could be offset by benefits in other tax jurisdictions if the liability were paid.
Most important facts for investors to verify
- Whether the ECLI acquisition produces the expected volume, earnings, and cash-flow contribution after acquisition-related costs and purchase-accounting amortization.
- Whether South American demand, margins, currency conditions, and customer production recover or continue to deteriorate.
- Whether receivables and inventory normalize and operating cash conversion improves after the year-to-date working-capital investment.
- The effect of higher borrowings on interest expense, leverage, covenant headroom, and acquisition capacity.
- The ultimate cost and timing of VAT disputes, asbestos claims, environmental remediation, uncertain tax positions, and other contingencies.
- The sustainability of reported earnings excluding tax benefits, nonrecurring items, equity income from the captive insurer, and other adjustments used in non-GAAP measures.