Quaker Chemical Corporation: Q2 2017 Form 10-Q Summary
Business context and reporting period
Quaker Chemical provides process fluids, chemical specialties, and technical services to industrial markets including steel, aluminum, automotive, mining, aerospace, tube and pipe, and cans. This unaudited Form 10-Q covers the three and six months ended June 30, 2017, compared with the corresponding 2016 periods.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $201.2 million | $186.9 million | $396.1 million | $365.0 million |
| Gross profit | $71.8 million | $71.4 million | $142.7 million | $139.4 million |
| Gross margin | 35.7% | 38.2% | 36.0% | 38.2% |
| Operating income | $17.9 million | $22.7 million | $31.7 million | $42.5 million |
| Net income attributable to Quaker | $11.9 million | $15.0 million | $18.9 million | $28.0 million |
| Diluted EPS | $0.89 | $1.13 | $1.42 | $2.11 |
| Adjusted EBITDA | $28.0 million | $27.7 million | $56.2 million | $52.6 million |
| Adjusted EBITDA margin | 13.9% | 14.8% | 14.2% | 14.4% |
Six-month operating cash flow was $20.8 million, down from $36.0 million in the prior-year period. Investing cash flow was negative $10.1 million, including $5.4 million for an acquisition and $5.2 million of capital expenditures. Financing cash flow was negative $3.7 million, including $9.2 million of dividends and $6.4 million of net long-term debt proceeds. Cash and cash equivalents increased to $98.8 million from $88.8 million at December 31, 2016.
At June 30, 2017, total debt included $73.9 million of long-term debt and $0.7 million of short-term borrowings and current maturities. Credit facility borrowings were $56.1 million. The consolidated net debt-to-adjusted-EBITDA ratio was below 1.0 to 1, versus a principal covenant limit of 3.50 to 1, and the company stated that it was in compliance with all covenants.
Material changes versus the prior comparable period
- Second-quarter sales increased 8%, driven by 5% organic volume growth, 2% from the Lubricor acquisition, and 2% from price and product mix, partly offset by a 1% foreign-currency headwind.
- Six-month sales increased 9%, with 7% organic volume growth, 2% from Lubricor, and 2% from price and mix, partly offset by a 2% currency headwind.
- Gross margin declined because of rising raw-material costs, timing of price adjustments, and product mix. Management stated that the prior-year comparison benefited from declining raw-material costs.
- Reported operating income and EPS declined primarily because of $4.3 million of second-quarter and $13.4 million of year-to-date Houghton combination-related expenses. These expenses were not incurred in 2016.
- Non-GAAP diluted EPS increased to $1.24 from $1.11 in Q2 and to $2.42 from $2.09 for the first six months, excluding specified non-core items. Adjusted EBITDA increased 1% in Q2 and 7% year to date.
- Regional second-quarter sales increased in North America, EMEA, Asia/Pacific, and South America. Asia/Pacific and South America increased operating earnings, while North America and EMEA declined primarily because of lower margins.
- The company completed the remaining initiatives under its 2015 restructuring program and does not expect further restructuring charges under that program.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected gross margins to improve over the following two quarters, gradually returning toward the 37% range. It continued to expect 2017 sales growth, higher adjusted EBITDA, and higher non-GAAP EPS for the eighth consecutive year.
- Quaker agreed to acquire Houghton International for $172.5 million in cash, approximately 24.5% of Quaker’s post-closing common stock, and assumed Houghton net debt estimated at approximately $690 million. Closing was expected in Q4 2017 or Q1 2018, subject to shareholder and regulatory approvals and other conditions.
- A contingent $1.15 billion New Credit Facility was established for the Houghton transaction, consisting of a $400 million revolver, a $575 million U.S. term loan, and a $175 million euro-equivalent term loan. Estimated floating-rate cost was approximately 3.25%, with leverage and interest-coverage covenants.
- Management estimated an additional $15 million to $20 million of Houghton-related expenses and associated cash payments during the second half of 2017, assuming an early-2018 closing. China regulatory approval was received in July 2017.
- The quarter included a $1.9 million U.S. pension settlement charge, a $0.3 million Venezuelan currency conversion charge, and $4.3 million of Houghton-related expenses. The Venezuela affiliate’s equity investment was $0.2 million at June 30, 2017.
- Key risks include industrial-cycle and customer-demand weakness, customer shutdowns or financial instability, raw-material inflation, foreign-exchange volatility, tax-rate changes, political and economic conditions, and execution, financing, approval, integration, and potential divestiture risks related to Houghton.
- Environmental and legal matters included an estimated $0.1 million to $1.0 million range for remaining groundwater remediation costs at AC Products and an estimated approximately $2.2 million of asbestos-related liability over the next 50 years, excluding defense costs. The company stated that other litigation was not expected to have a material adverse effect.
- Management concluded that disclosure controls were effective and that no material changes occurred in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the Houghton transaction closed on the expected timetable, received all required approvals, and resulted in the projected debt, equity dilution, and integration costs.
- Whether gross margin recovered toward management’s indicated 37% range as pricing caught up with raw-material inflation.
- The sustainability of volume growth and market-share gains across the four geographic segments.
- Post-transaction leverage, interest expense, covenant compliance, and liquidity under the new financing structure.
- Actual cash generation after combination-related payments, working-capital investment, capital expenditures, dividends, and pension contributions.
- Progress and final impact of the company’s planned adoption of the new revenue-recognition standard in the first quarter of 2018.