Quaker Chemical Corporation — Form 10-Q Summary
Business context and reporting period
Quaker Chemical Corporation, doing business as Quaker Houghton, is a global supplier of industrial process fluids, specialty chemicals and Fluidcare services to steel, aluminum, automotive, aerospace, mining, metalworking and other industrial customers. It operates in more than 25 countries through four reportable segments: Americas, Europe, Middle East and Africa (EMEA), Asia/Pacific and Global Specialty Businesses.
This unaudited Form 10-Q covers the three and nine months ended September 30, 2022, compared with the corresponding 2021 periods. The filing was signed November 3, 2022.
Financial performance and liquidity
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Net sales | $492.2 million | $449.1 million | $1,458.8 million | $1,314.1 million |
| Gross profit | $160.7 million | $145.1 million | $456.4 million | $455.8 million |
| Gross margin | 32.7% | 32.3% | 31.3% | 34.7% |
| Operating income | $44.6 million | $36.0 million | $105.9 million | $119.7 million |
| Net income attributable to Quaker | $25.9 million | $31.1 million | $60.0 million | $103.2 million |
| Diluted EPS | $1.44 | $1.73 | $3.35 | $5.76 |
| Adjusted EBITDA | $70.3 million | $66.2 million | $189.2 million | $213.4 million |
| Adjusted EBITDA margin | 14.3% | 14.7% | 13.0% | 16.2% |
Third-quarter sales increased 10%, primarily from approximately 25% higher selling price and product mix and 1% from acquisitions, partly offset by a 9% decline in organic volume and a 7% unfavorable foreign-currency impact. Nine-month sales increased 11%, reflecting approximately 21% higher price and mix, 1% acquisition contribution, a 6% volume decline and a 5% currency headwind.
Third-quarter operating income increased despite higher SG&A and inflationary costs. Reported net income and EPS declined because of higher interest expense, taxes and lower equity income. Nine-month profitability declined substantially as raw-material, manufacturing, supply-chain and logistics costs outpaced pricing benefits, while the prior-year period included significant Brazilian tax credits and a real-estate gain.
Cash and cash equivalents were $138.9 million at September 30, 2022, versus $165.2 million at December 31, 2021. Operating activities used $26.3 million in the first nine months, compared with $2.5 million provided in the prior-year period, primarily because of working-capital investment in receivables and inventories. Investing activities used $29.6 million, including $20.2 million of capital expenditures and $9.4 million for acquisitions. Financing activities provided $46.6 million, including net new debt financing, while dividends paid were $22.3 million.
Total debt was $954.1 million before debt issuance costs, including $941.2 million of borrowings under the amended credit facility. Net debt was $815.2 million. The June 2022 refinancing established a $500 million revolver, a $600 million U.S. term loan and a $150 million euro-equivalent term loan, generally maturing in June 2027. Approximately $295 million of revolver capacity remained available, net of letters of credit. The Company reported compliance with all debt covenants.
Material changes versus the prior comparable period
- Americas third-quarter sales rose 24% and segment operating earnings rose to $45.0 million from $31.3 million.
- EMEA sales declined 7% and operating earnings fell 51% to $9.9 million, reflecting currency pressure, weaker volumes and inflation exceeding price realization.
- Asia/Pacific sales declined 8%, while operating earnings were essentially flat at $23.3 million because improved margins offset lower sales.
- Global Specialty Businesses sales increased 31% and operating earnings increased 49% to $30.7 million, supported by price, volume and acquisitions.
- Third-quarter gross margin improved modestly, but nine-month gross margin declined 340 basis points to 31.3% because of input-cost inflation and supply-chain constraints.
- The Company incurred a $6.8 million loss on extinguishment of debt related to the June refinancing and increased interest expense due to higher borrowings and interest rates.
- The Company completed or announced several small acquisitions, including businesses focused on pickling inhibitors, lubrication, impregnation and related services. An additional EMEA acquisition for approximately $3.5 million occurred in October 2022 and was not included in third-quarter results.
- Accumulated other comprehensive loss increased to $217.7 million from $64.0 million at year-end 2021, primarily because of currency translation losses.
Guidance, outlook, commentary and risks
Management expects further sequential gross-margin improvement in the fourth quarter of 2022 and expects second-half 2022 earnings to exceed first-half 2022 and second-half 2021 earnings. The filing does not provide a specific full-year revenue or EPS guidance range.
Management cited persistent raw-material inflation, supply-chain and logistics disruption, foreign-currency volatility, softer European and Asian end markets, China COVID-19 restrictions, the Russia-Ukraine conflict and rising interest rates. The Company ceased operations in Russia during the second quarter; Russia, Ukraine and Belarus historically represented less than 2% of consolidated sales and less than 1% of total assets.
The EMEA reporting unit experienced a third-quarter impairment trigger. An interim assessment concluded that no impairment was required, with estimated fair value approximately 22% above carrying value. Management warned that further deterioration in EMEA performance, unsuccessful pricing actions or higher interest rates could lead to a future impairment.
The QH restructuring program continued in 2022, with final headcount reductions expected into 2023, although management does not expect material additional costs. Strategic planning and transformation expenses totaled $10.7 million in the first nine months and are expected to continue into 2022 and subsequent years.
Other contingencies include a potential $0 to $1.5 million exposure from a Coral acquisition-related claim, estimated environmental obligations of approximately $5.0 million to $6.0 million, an accrued environmental liability of $5.2 million, and an estimated asbestos-related liability of approximately $0.3 million over the next 50 years excluding defense costs. The Company believes other pending litigation will not materially affect its results, cash flows or financial condition.
The Company stated that existing cash, expected operating cash flow and available liquidity should support operations, dividends, acquisitions, capital expenditures, pension contributions and other obligations for at least the next twelve months and beyond. However, liquidity remains sensitive to operating performance, working-capital needs, interest rates, currency movements, recession risk and customer demand.
Important facts for investors to verify
- Whether price increases can continue to offset raw-material, manufacturing, logistics and other inflationary costs, particularly in EMEA.
- Whether organic volumes stabilize after declines in Europe, Asia/Pacific and automotive-related markets.
- Progress toward the stated fourth-quarter gross-margin improvement and second-half earnings outlook.
- Net leverage, covenant headroom, variable-rate debt exposure and the impact of the June refinancing on future interest expense.
- Working-capital conversion, including the elevated receivables and inventories that drove negative operating cash flow.
- Potential future impairment risk for EMEA goodwill and other long-lived assets.
- Execution and recurring costs of strategic transformation, restructuring, acquisitions and integration activities.
- Resolution of tax, environmental, remediation, litigation and acquisition-related contingencies.
- Impact of foreign exchange, China COVID-19 restrictions, the Russia-Ukraine conflict and broader industrial end-market conditions.