Business Context and Reporting Period
Quaker Chemical Corporation filed its Form 10-K for the fiscal year ended December 31, 2011. The company develops and sells specialty process chemicals, coatings, lubricants, hydraulic fluids and chemical management services primarily to steel, automotive, aerospace, aluminum, construction and other industrial customers. Metalworking process chemicals represented approximately 94% of 2011 sales. Non-U.S. subsidiaries generated approximately 62%–65% of consolidated annual sales during the past three years.
The filing also provides fourth-quarter 2011 results. The independent auditor reported that the consolidated financial statements and internal control over financial reporting were fairly presented and effective as of December 31, 2011, excluding two recently acquired entities from management’s internal-control assessment.
Key Financial Metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Net sales | $683.2 million | $544.1 million | +26% |
| Gross profit | $222.7 million | $192.8 million | +15% |
| Gross margin | 32.6% | 35.4% | Down 2.8 points |
| Operating income | $57.9 million | $48.1 million | +20% |
| Income before taxes | $59.4 million | $46.2 million | +29% |
| Net income attributable to Quaker | $43.6 million | $31.8 million | +37% |
| Diluted earnings per share | $3.47 | $2.77 | +25% |
| Cash flow from operations | $19.7 million | $37.5 million | Down $17.9 million |
| Capital expenditures | $12.1 million | $9.4 million | Higher |
| Cash and equivalents | $16.9 million | $25.8 million | Down $8.9 million |
| Long-term debt | $46.7 million | $73.9 million | Down $27.2 million |
| Total equity | $255.7 million | $187.1 million | +37% |
Reported operating margin was approximately 8.5% and net margin attributable to Quaker was approximately 6.4%. SG&A increased 18% to $164.7 million, while SG&A as a percentage of sales improved to 24.1% from 25.6%. The effective tax rate was 24.0%, compared with 27.3% in 2010.
Fourth-quarter 2011 net sales were $173.3 million, gross profit was $56.7 million, operating income was $11.4 million and net income attributable to Quaker was $9.8 million, or $0.75 diluted EPS.
Cash Flow, Debt and Liquidity
- Operating cash flow declined primarily because higher sales volumes and raw-material prices required increased investment in receivables and inventories. Accounts receivable increased to $150.7 million and inventories to $74.8 million at year-end.
- Investing cash use was $35.4 million, including $25.5 million for acquisitions and $12.1 million of capital expenditures. The 2011 acquisitions were Tecniquimia Mexicana and G.W. Smith & Sons.
- Financing cash flow was positive $9.2 million, including $48.1 million of net proceeds from a 1.3 million-share equity offering, partially used to repay revolving debt. Dividends paid were $11.6 million.
- The primary unsecured revolving credit facility provides $175.0 million of capacity, expandable to $225.0 million subject to conditions, and matures in June 2014. Borrowings were $28.5 million at December 31, 2011, with approximately $146.5 million of additional borrowing capacity reported as available.
- The consolidated leverage ratio was below 1.0 to 1. The company was in compliance with its debt covenants. Interest-rate swaps with a $15.0 million notional value hedged part of the variable-rate debt and mature in 2012.
Material Changes Versus the Prior Comparable Period
- Revenue growth reflected approximately 13% higher volumes, including acquisitions, a 10% benefit from pricing and sales mix, and approximately 3% from foreign-currency translation.
- Raw-material inflation, particularly in crude-oil derivatives, reduced gross margin despite pricing actions. Crude oil averaged approximately $95 per barrel in 2011 versus $79 in 2010.
- Metalworking process chemicals sales increased approximately 25%, and coatings sales increased approximately 26%. Operating income increased approximately $11.7 million and $2.2 million, respectively, for those segments.
- In July 2011, Quaker acquired the remaining 60% of Tecniquimia Mexicana for approximately $10.5 million. In October 2011, it acquired G.W. Smith & Sons for approximately $14.5 million.
- The Tecniquimia transaction generated a $2.7 million non-cash gain from revaluing the previously held interest. A $0.6 million gain resulted from reducing the fair value of contingent acquisition consideration.
- Quaker issued approximately 1.3 million common shares for $48.1 million of net proceeds. Management estimated an approximately $0.20 dilutive effect on 2011 diluted EPS.
- Compared with 2010, the year did not include the prior year’s $4.1 million non-income-tax contingency charge or $1.3 million former-CEO retirement charge.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management described 2011 as a record year for sales and earnings despite a challenging global environment. For 2012, management expected another strong year and projected net income to exceed 2011 net income of $40.9 million excluding the Mexican acquisition revaluation gain. The filing identifies potential benefits from the full-year contribution of acquisitions, continued North American manufacturing recovery and strategic investments.
Management identified risks from a sluggish global economy, weakness in Europe, slower Chinese growth, rising SG&A costs in emerging markets and a stronger U.S. dollar. Additional risks include customer production downturns or shutdowns, concentration in steel and automotive customers, raw-material price and supply volatility, foreign-currency movements, competition, acquisition integration, interest-rate exposure, environmental and asbestos matters, VAT disputes, tax-asset realizability and climate-related regulation.
- The five largest customers represented approximately 20% of 2011 consolidated sales; ArcelorMittal Group represented approximately 9%.
- A 10% movement in the Brazilian real, euro and Chinese renminbi against the U.S. dollar would have changed 2011 revenue by approximately $33.0 million and pretax earnings by approximately $4.0 million, according to the filing.
- A one-percentage-point change in gross margin would have changed 2011 pretax earnings by approximately $6.8 million.
- Environmental remediation liabilities associated with AC Products were estimated at $1.4 million–$2.4 million and were sufficiently reserved. Other environmental accruals were approximately $0.5 million.
- Potential future VAT exposure was estimated at $0–$16.0 million net of refunds, assuming future amnesty programs or settlements; exposure could be higher without such relief.
- Asbestos-related claims against an inactive subsidiary were projected at approximately $4.9 million over 50 years, excluding defense costs. Management stated that material losses to the parent were not probable, but additional losses could not be estimated.
- Gross liabilities for uncertain tax positions, including interest and penalties, were $16.3 million at year-end. The company expected approximately $1.7 million–$1.8 million of reductions during 2012 from expiring statutes of limitations, before considering new positions.
Most Important Facts to Verify
- Whether price increases continue to offset raw-material inflation without causing customer losses or further gross-margin compression.
- Whether the 2012 outlook is supported by sustainable volume growth rather than acquisitions, foreign-exchange translation or one-time benefits.
- Integration progress and operating performance of Tecniquimia Mexicana and G.W. Smith & Sons.
- Working-capital conversion and the recovery of operating cash flow, particularly receivables and inventory growth.
- Compliance with the 2014 credit-facility maturity and leverage covenant requirements, including refinancing needs.
- Potential cash requirements for pensions, environmental remediation, asbestos litigation and VAT assessments.
- Impact of currency movements, customer concentration and industrial end-market cycles on reported earnings.
- Reconciliation of GAAP net income of $43.6 million with management’s 2011 outlook reference to $40.9 million excluding the $2.7 million non-cash Mexican acquisition gain.