Quaker Chemical Corporation — 2014 First-Quarter 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 related markets. The unaudited report covers the three months ended March 31, 2014, compared with the three months ended March 31, 2013. Reportable segments are North America, EMEA, Asia/Pacific, and South America.
Key Financial Metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net sales | $181.7 million | $176.2 million | +3% |
| Gross profit | $65.1 million | $62.6 million | +4% |
| Gross margin | 35.8% | 35.5% | +0.3 percentage points |
| Operating income | $19.4 million | $17.4 million | +11% |
| Operating margin | 10.7% | 9.9% | Improved |
| Net income attributable to Quaker | $12.7 million | $13.6 million | -7% |
| Diluted EPS | $0.96 | $1.04 | -8% |
| Adjusted EBITDA | $23.7 million | $21.4 million | +11% |
| Cash flow from operations | $(1.8) million | $11.3 million | Declined $13.1 million |
Net income was $13.3 million, including $0.6 million attributable to noncontrolling interests. The effective tax rate increased to 34.8% from 24.1%; management continued to estimate a full-year 2014 effective tax rate of approximately 30%.
Cash and cash equivalents were $60.5 million at March 31, 2014, down from $68.5 million at December 31, 2013. Investing activities used $2.7 million, primarily for $3.1 million of capital expenditures, and financing activities used $3.5 million, including $3.3 million of dividends. Total debt was approximately $18.5 million, consisting of $1.3 million of current borrowings and $17.2 million of long-term debt.
Quaker had no borrowings under its $300 million syndicated multicurrency credit facility, which matures in June 2018. The facility may be increased to $400 million subject to lender approval and other conditions. The consolidated leverage ratio was below 1.0 to 1, compared with a covenant limit of 3.50 to 1, and all covenants were met.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected approximately 6% higher product volumes, including acquisitions, partly offset by a $2.7 million foreign-exchange translation impact and a 1% unfavorable price and product-mix effect.
- North America sales increased 3%, EMEA increased 5%, and Asia/Pacific increased 10%. South America sales declined 17%, primarily due to lower volumes and adverse currency translation.
- Operating income benefited from higher volume and gross profit. SG&A increased by approximately $0.5 million, including $0.9 million of costs related to a U.K. pension-plan amendment.
- Other income of $0.3 million in Q1 2013 became other expense of $0.5 million in Q1 2014, primarily because of approximately $0.8 million of net foreign-exchange losses.
- Reported EPS declined despite higher operating income because of higher taxes, foreign-exchange losses, and lower equity income from the captive insurance affiliate.
- Adjusted EPS was $0.95 versus $0.96. Adjusted EBITDA increased 11% to $23.7 million.
- Operating cash flow turned negative because of increased investment in accounts receivable and inventories, higher incentive compensation payments, and the absence of a prior-year dividend from the captive insurance affiliate.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management expected modest growth in most major markets, while identifying India and Brazil as potentially challenging. The company expected rising raw-material costs but believed market-share gains, recent acquisitions, and cost initiatives would help offset market pressures. Management remained confident that 2014 would be another good year and sought a fifth consecutive year of revenue and earnings growth; no formal full-year revenue or EPS guidance was provided.
- The Q1 2014 U.K. pension-plan amendment generated approximately $0.9 million of non-recurring expense, or $0.05 per diluted share.
- Q1 2013 included a $1.0 million out-of-period increase in equity income related to errors in the captive insurance affiliate’s 2012 financial statements. The company did not restate prior periods because it considered the adjustment immaterial.
- The company recorded no Venezuelan currency-devaluation charge in Q1 2014; Q1 2013 included a $0.4 million charge related to the Bolivar Fuerte devaluation.
- Gross liabilities for uncertain tax positions, including interest and penalties, were $16.3 million. The company estimated that up to $10.5 million could be offset by benefits in other tax jurisdictions, but the timing of related cash flows was not reliably estimable.
- Subsequent to quarter-end, Quaker paid approximately $4.7 million to settle the Summit Lubricants earnout liability.
- Environmental remediation liabilities for the AC Products site were estimated at approximately $0.4 million to $0.7 million and were adequately reserved. Other environmental accruals totaled approximately $0.2 million.
- An inactive subsidiary faces asbestos claims. Management projected approximately $2.7 million of subsidiary liability over 50 years, excluding defense costs, but stated that insurance and other coverage may be insufficient and that additional losses cannot be estimated. Management did not believe material losses to Quaker were probable.
- A foreign VAT matter could expose the company to an estimated additional net range of $0 to $7.9 million if other jurisdictions initiate assessments, with potentially higher exposure absent future amnesty programs or settlements.
- Management stated that disclosure controls were effective and that no material changes to internal control over financial reporting occurred during the quarter.
Important Facts for Investors to Verify
- Whether working-capital investment normalizes and operating cash flow improves after the quarter-end sales and inventory build.
- The sustainability of volume-led growth and gross-margin performance amid rising raw-material costs and unfavorable price or product mix.
- South America’s recovery prospects, including exposure to Brazilian and Argentine currency weakness and market conditions.
- The full-year effective tax rate and the timing and cash impact of uncertain tax positions.
- The financial impact and resolution status of VAT assessments, asbestos claims, environmental remediation, and other contingencies.
- Whether management’s expectation of modest market growth and another year of revenue and earnings growth is achieved.
- The effect of the $4.7 million Summit earnout payment and continuing pension contributions on liquidity and capital allocation.