KWR

Business Context and Reporting Period

Company: Quaker Chemical Corporation
Filing Type: Form 10-Q (Unaudited)
Period Ended: September 30, 2010
Business Overview: Quaker Chemical is a global provider of process chemicals, chemical specialties, and technical expertise to industries including steel, automotive, mining, aerospace, and construction. The company operates through three segments: Metalworking Process Chemicals, Coatings, and Other Chemical Products.

Key Financial Metrics

(All figures in thousands, except per share data)

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 16% in Q3 2010 and 26% in the first nine months of 2010 compared to the same periods in 2009. This growth was driven primarily by a 15% increase in product volumes globally, particularly in the steel industry in China, Brazil, India, and Russia.
• Profitability: Net income attributable to Quaker increased 25% in Q3 and 201% for the nine-month period. However, gross margins declined slightly in Q3 (35.6% vs. 37.4% in Q3 2009) due to rising raw material costs, though they remained flat compared to Q2 2010.
• Unusual Items:
  • Contingency Charge: A net charge of $3,581 ($0.21 per diluted share) was recorded in Q3 2010 related to a non-income tax contingency (VAT dispute).
  • CEO Transition: A final charge of $1,317 ($0.08 per diluted share) was recorded for the former CEO's supplemental retirement plan.
  • Acquisition: In July 2010, the company acquired D.A. Stuart's U.S. aluminum hot rolling oil business for $6,862, adding $3,125 in goodwill.
• Cash Flow: Operating cash flow for the nine months ended Sep 30, 2010, was $19.5 million, a decrease from $34.7 million in the prior year period, primarily due to increased working capital investment as business volumes recovered.

Guidance, Outlook, and Risks

• Outlook: Management anticipates somewhat lower demand in Q4 2010 due to seasonal factors and economic plateauing in certain markets. While Q4 results are expected to remain strong, they are projected to be below the levels experienced in the first half of 2010. Long-term growth is expected to be solid.
• Margin Pressure: The company continues to face pressure on margins due to increasing raw material costs, despite implementing price increases.
• Key Risks and Contingencies:
  • VAT Dispute: A subsidiary discovered potential errors in Value-Added Tax (VAT) payments. While a $3.6 million charge was taken, the remaining exposure could range from $0 to $27.0 million if all impacted jurisdictions initiate audits, with one jurisdiction representing ~80% of this exposure.
  • Asbestos Litigation: An inactive subsidiary faces asbestos claims. While insurance settlements cover most liabilities, there is a risk that claims could exceed available assets and coverage, potentially exposing the parent company.
  • Environmental Remediation: Ongoing remediation costs for soil and groundwater contamination at the AC Products, Inc. site are estimated between $1,500 and $2,600.
  • Market Risk: Significant exposure to foreign currency fluctuations (Euro, Brazilian Real, Chinese Renminbi) and commodity price volatility.

Investor Verification Checklist

• VAT Exposure: Verify the status of the VAT dispute and the likelihood of the remaining $27 million exposure materializing, particularly regarding the jurisdiction representing 80% of the risk.
• Raw Material Costs: Monitor the company's ability to pass on raw material cost increases to customers to maintain gross margins.
• Debt Covenants: Confirm continued compliance with the credit facility leverage ratio covenant (currently below 2.0 to 1, with a limit of 3.5 to 1).
• Asbestos Liability: Review updates on the inactive subsidiary's asbestos litigation and the sufficiency of insurance settlements.
• Working Capital: Assess the trend in working capital investment as global volumes continue to recover, which may impact operating cash flow.