QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 001-12019
QUAKER CHEMICAL CORPORATION
(Exact name of Registrant as specified in its charter)
Pennsylvania
23-0993790
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
One Quaker Park, 901 E. Hector Street,
Conshohocken, Pennsylvania
19428 – 2380
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: 610-832-4000
Not Applicable
Former name, former address and former fiscal year, if changed since last report.
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $1 par value
KWR
New York Stock Exchange
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes☒ No ☐
Indicate by check mark whether the Registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes☒No ☐
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer☒
Accelerated filer ☐
Non-accelerated filer ☐
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐No ☒
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Number of Shares of Common Stock
Outstanding on October 31, 2019
17,732,310
QUAKER CHEMICAL CORPORATION AND CONSOLIDATED SUBSIDIARIES
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
Quaker Chemical Corporation
Condensed Consolidated Statements of Cash Flows
(Dollars in thousands)
Unaudited
Nine Months Ended
September 30,
2019
2018
Cash flows from operating activities
Net income
$
16,568
$
51,928
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of debt issuance costs
792
—
Depreciation and amortization
23,868
14,911
Equity in undistributed earnings of associated companies, net of dividends
(129)
2,658
Acquisition-related fair value adjustments related to inventory
10,214
—
Deferred compensation, deferred taxes and other, net
(17,204)
(898)
Share-based compensation
3,042
2,847
Gain on disposal of property, plant, equipment and other assets
(111)
(680)
Insurance settlement realized
(624)
(680)
Combination and other acquisition-related expenses, net of payments
(14,218)
(349)
Restructuring and related activities
24,045
—
Pension and other postretirement benefits
434
(1,113)
Increase (decrease) in cash from changes in current assets and current
liabilities, net of acquisitions:
Accounts receivable
2,655
(14,029)
Inventories
1,376
(12,719)
Prepaid expenses and other current assets
(10,931)
2,196
Restructuring liabilities
(4,645)
—
Accounts payable and accrued liabilities
344
6,824
Net cash provided by operating activities
35,476
50,896
Cash flows from investing activities
Investments in property, plant and equipment
(10,112)
(8,815)
Payments related to acquisitions, net of cash acquired
(798,064)
(500)
Proceeds from disposition of assets
75
803
Insurance settlement interest earned
185
102
Net cash used in investing activities
(807,916)
(8,410)
Cash flows from financing activities
Proceeds from term loan debt
750,000
—
Borrowings (repayments) on revolving credit facilities, net
85,966
(11,040)
Borrowings (repayments) on other long-term debt, net
415
(478)
Financing-related debt issuance costs
(23,747)
—
Dividends paid
(15,003)
(14,385)
Stock options exercised, other
733
(227)
Distributions to noncontrolling affiliate shareholders
—
(834)
Net cash provided by (used in) financing activities
798,364
(26,964)
Effect of foreign exchange rate changes on cash
(1,889)
(6,168)
Net increase in cash, cash equivalents and restricted cash
24,035
9,354
Cash, cash equivalents and restricted cash at the beginning of the period
124,425
111,050
Cash, cash equivalents and restricted cash at the end of the period
$
148,460
$
120,404
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements
(Dollars in thousands, except share and per share amounts, unless otherwise stated)
(Unaudited)
Note 1 – Condensed Financial Information
As used in these Notes to Condensed Consolidated Financial Statements, the terms “Quaker”, “Quaker Houghton”, the “Company”, “we” and “our” refer to Quaker Chemical Corporation (doing business as Quaker Houghton), its subsidiaries, and associated companies, unless the context otherwise requires. As used in these Notes to Condensed Consolidated Financial Statements, the term Legacy Quaker refers to the Company prior to closing of its combination with Houghton International, Inc. (“Houghton”) (herein referred to as the “Combination”). The condensed consolidated financial statements included herein are unaudited and have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) for interim financial reporting and the United States Securities and Exchange Commission (“SEC”) regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the financial statements reflect all adjustments which are of a normal and recurring nature and are necessary for a fair statement of the financial position, results of operations and cash flows for the interim periods. The results for the three and nine months ended September 30, 2019, respectively, are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with the Company’s Annual Report filed on Form 10-K, as amended by the Company’s Form 10-K/A, for the year ended December 31, 2018.
Hyper-inflationary economies
Economies that have a cumulative three-year rate of inflation exceeding 100% are considered hyper-inflationary under U.S. GAAP. A legal entity that operates within an economy deemed to be hyper-inflationary is required to remeasure its monetary assets and liabilities to the applicable published exchange rates and record the associated gains or losses resulting from the remeasurement directly to the Condensed Consolidated Statements of Operations. The Company has a 50-50 joint venture in a Venezuelan affiliate, Kelko Quaker Chemical, S.A. Venezuela’s economy has been considered hyper-inflationary under U.S. GAAP since 2010. During the three and nine months ended September 30, 2018, the Company recorded remeasurement losses of less than $0.1 million and $0.3 million, respectively, associated with the applicable currency conversions related to Venezuela. These losses were recorded within equity in net income of associated companies in the Company’s Condensed Consolidated Statements of Operations. Due to heightened foreign exchange controls and restrictions currently present within Venezuela, during the third quarter of 2018 the Company concluded that it no longer had significant influence over this affiliate. Prior to this determination, the Company historically accounted for this affiliate under the equity method. As of September 30, 2019 and December 31, 2018, the Company has no remaining carrying value for its investment in Kelko Venezuela.
Based on various indices or index compilations currently being used to monitor inflation in Argentina as well as recent economic instability, effective July 1, 2018, Argentina’s economy was considered hyper-inflationary under U.S. GAAP. As a result, the Company began applying hyper-inflationary accounting with respect to the Company's wholly owned Argentine subsidiary beginning July 1, 2018. In addition, Houghton has an Argentine subsidiary to which hyper-inflationary accounting also is applied. As of, and for the nine months ended September 30, 2019, the Company's Argentine subsidiaries represented less than 1% of the Company’s consolidated total assets and net sales, respectively. During the three and nine months ended September 30, 2019, the Company recorded $0.7 million and $0.9 million, respectively, of remeasurement losses associated with the applicable currency conversions related to Argentina.Comparatively, during each of the three and nine months ended September 30, 2018, the Company recorded approximately $0.5 million of remeasurement losses associated with the applicable currency conversion related to Argentina. These losses were recorded within foreign exchange gains (losses), net, which is a component of other income (expense), net, in the Company’s Condensed Consolidated Statements of Operations.
Note 2 – Business Combinations
Houghton
On August 1, 2019, the Company completed the Combination with Houghton, whereby the Company acquired all of the issued and outstanding shares of Houghton from Gulf Houghton Lubricants, Ltd. and certain other selling shareholders in exchange for a combination of cash and shares of the Company’s common stock in accordance with the share purchase agreement dated April 4, 2017. Houghton is a leading global provider of specialty chemicals and technical services for metalworking and other industrial applications. Combining Quaker and Houghton’s product and service offerings will allow Quaker Houghton to better serve its customers in its various end markets.
The Combination was subject to certain regulatory and shareholder approvals. At a shareholder meeting held during 2017, the Company’s shareholders approved the issuance of new shares of the Company’s common stock at closing of the Combination. Also in 2017, the Company received regulatory approvals for the Combination from China and Australia. The Company received regulatory approvals from the European Commission (“EC”) during the second quarter of 2019 and the U.S. Federal Trade Commission (“FTC”) in July 2019. The approvals from the FTC and the EC required the concurrent divestiture of certain steel and aluminum related product lines of Houghton, which were sold by Houghton on August 1, 2019 for approximately $37 million in cash. The final remedy agreed with the EC and the FTC was consistent with the Company’s previous expectation that the total divested product lines would be approximately 3% of the combined company’s net sales.
6
Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements - Continued
(Dollars in thousands, except share and per share amounts, unless otherwise stated)
(Unaudited)
The following table summarizes the fair value of consideration transferred in the Combination:
Cash transferred to Houghton shareholders (a)
$
170,829
Cash paid to extinguish Houghton debt obligations
702,556
Fair value of common stock issued as consideration (b)
789,080
Total fair value of consideration transferred
$
1,662,465
(a)A portion is held in escrow by a third party, subject to indemnification rights that lapse upon the achievement of certain milestones.
(b)Amount was determined based on 4.3 million shares, comprising 24.5% of the common stock of the Company at closing, and the closing price per share of Quaker Chemical Corporation common stock of $182.27 on August 1, 2019.
The Company accounted for the Combination under the acquisition method of accounting. This method requires the recording of acquired assets, including separately identifiable intangible assets, at their fair value on the acquisition date. Any excess of the purchase price over the estimated fair value of the identifiable net assets acquired is recorded as goodwill. The determination of the estimated fair value of assets acquired requires management’s judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, royalty rates, asset lives and market multiples, among other items. Fair values were determined by management, using a variety of methodologies and resources, including external independent valuation experts. The valuation methods consisted of physical appraisals, discounted cash flow analyses, excess earnings, relief from royalty, and other appropriate valuation techniques to determine the fair value of assets acquired and liabilities assumed.
The following table presents the preliminary estimated fair values of Houghton net assets acquired:
Cash and cash equivalents
$
75,821
Accounts receivable, net
179,745
Inventories, net
95,193
Prepaid expenses and other assets
11,373
Deferred tax assets
8,703
Property, plant and equipment
125,099
Right of use lease assets
10,747
Investments in associated companies
69,683
Other non-current assets
1,368
Intangible assets
1,022,500
Goodwill
483,921
Total assets purchased
2,084,153
Short-term borrowings, not refinanced at closing
9,297
Accounts payable, accrued expenses and other current liabilities
152,829
Deferred tax liabilities
213,779
Long-term lease liabilities
6,655
Other non-current liabilities
39,128
Total liabilities assumed
421,688
Total consideration paid for Houghton
1,662,465
Less: cash acquired
75,821
Less: fair value of common stock issued as consideration
789,080
Net cash paid for Houghton
$
797,564
Investments in associated companies presented in the table above represents the Company’s initial fair value estimate of its 50% interest in a Houghton joint venture in Korea. The Company accounts for this interest under the equity method of accounting. The Company allocated $1,022.5 million of the purchase price to intangible assets, comprised of $242.0 million of trademarks and formulations, to which management has assigned indefinite lives; $671.4 million of customer relationships, to be amortized over 16 to 18 years; and $109.1 million of existing product technology, to be amortized over 20 years. In addition, the Company recorded $483.9 million of goodwill related to expected value not allocated to other acquired assets, none of which will be tax deductible. Factors contributing to the purchase price that resulted in goodwill included the acquisition of management, technology, intellectual property, business processes and personnel that will allow Quaker Houghton to better serve its customers. The expanded portfolio is expected to generate significant cross-selling opportunities and allow further expansion into growth markets such as India, Korea, Brazil and Mexico.
7
Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements - Continued
(Dollars in thousands, except share and per share amounts, unless otherwise stated)
(Unaudited)
As of September 30, 2019, the allocation of the purchase price for the Combination has not been finalized and the one-year measurement period has not ended. Further adjustments may be necessary as a result of the Company’s on-going assessment of additional information related to the fair value of assets acquired and liabilities assumed.
Commencing August 1, 2019, the Company’s Condensed Consolidated Statements of Operations included the results of Houghton. Net sales of Houghton subsequent to closing of the Combination and included in the Company’s Condensed Consolidated Statements of Operations were $119.5 million. The following unaudited pro forma consolidated financial information has been prepared as if the Combination had taken place on January 1, 2018. The unaudited pro forma results include certain adjustments to each company’s historical actual results, including: (i) additional depreciation and amortization expense based on the initial estimates of fair value step up and estimated useful lives of depreciable fixed assets, definite-lived intangible assets and investment in associated companies acquired; (ii) adoption of required accounting guidance and alignment of related accounting policies, (iii) elimination of transactions between Quaker and Houghton; (iv) elimination of results associated with the divested product lines; (v) adjustment to interest expense, net, to reflect the impact of the financing and capital structure of the combined Company; and (vi) adjustment for certain Combination and other acquisition-related costs to reflect such costs as if they were incurred in the period immediately following the pro-forma closing of the Combination on January 1, 2018. The adjustments described in (vi) include an expense recorded in costs of goods sold (“COGS”) associated with selling inventory acquired in the Combination which was adjusted to fair value as part of purchase accounting, restructuring expense incurred associated with the Company’s global restructuring program initiated post-closing of the Combination and certain other integration costs incurred post-closing included in combination and other acquisition-related expenses. These costs have been presented in the pro forma results as if they were incurred during the nine months ended September 30, 2018. Pro forma results are not necessarily indicative of the results that would have occurred if the acquisition had occurred on the date indicated, or that may result in the future for various reasons, including the potential impact of revenue and cost synergies on the business.
Three Months Ended
Nine Months Ended
Unaudited Pro Forma
September 30,
September 30,
(as if the Combination occurred on January 1, 2018)
2019
2018
2019
2018
Net sales
$
386,396
$
417,460
$
1,170,981
$
1,255,242
Net income attributable to Quaker Chemical Corporation
22,491
28,459
70,533
41,322
Combination and other acquisition-related expenses have been and are expected to continue to be significant. The Company incurred total costs of $15.1 million and $25.9 million during the three and nine months ended September 30, 2019, and $3.8 million and $14.4 million during the three and nine months ended September 30, 2018, respectively, related to the Combination and other acquisition-related activities. These costs included certain legal, financial and other advisory and consultant costs related to due diligence, regulatory approvals and integration planning as well as professional fees associated with closing the Combination. These costs also include interest costs to maintain the bank commitment (“ticking fees”) for the Combination during each of three and nine months ended September 30, 2019 and 2018, and specifically during the nine months ended September 30, 2018, a gain on the sale of an available-for-sale asset. As of September 30, 2019 and December 31, 2018, the Company had current liabilities related to the Combination and other acquisition-related activities of $6.8 million and $8.2 million, respectively, primarily recorded within other current liabilities on its Condensed Consolidated Balance Sheets.
Norman Hay
On October 1, 2019, the Company completed its acquisition of the operating divisions of Norman Hay plc, a private U.K. company that provides specialty chemicals, operating equipment, and services to industrial end markets, for a purchase price of 80.0 million GBP or approximately $98 million, subject to certain normal and routine post-closing adjustments. The results of operations of the acquired operating divisions of Norman Hay plc are not included in the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2019, because the date of closing was after September 30, 2019. Transaction expenses associated with this acquisition that were incurred during the three and nine months ended September 30, 2019 are included in Combination and other acquisition-related expenses in the Company’s Condensed Consolidated Statements of Operations. A preliminary purchase price allocation of assets acquired and liabilities assumed has not been presented as that information is not available as of the date of these Condensed Consolidated Financial Statements.
Other Acquisitions
In March 2018, the Company purchased certain formulations and product technology for the mining industry for $1.0 million. The Company allocated the entire purchase price to intangible assets representing formulations and product technology, to be amortized over 10 years. In accordance with the terms of the applicable purchase agreement, $0.5 million of the purchase price was paid at signing, and the remaining $0.5 million of the purchase price was paid during the first quarter of 2019.
8
Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements - Continued
(Dollars in thousands, except share and per share amounts, unless otherwise stated)
(Unaudited)
Note 3 – Recently Issued Accounting Standards
The Financial Accounting Standards Board (“FASB”) issued an accounting standard update in August 2018 that modifies certain disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. The amendments in this accounting standard update remove disclosures that are no longer considered cost beneficial, clarify the specific requirements of certain disclosures, and add new disclosure requirements as relevant. The guidance within this accounting standard update is effective for annual periods beginning after December 15, 2020, and should be applied retrospectively to all periods presented. Early adoption is permitted. The Company has not early adopted the guidance and is currently evaluating its implementation.
The FASB also issued an accounting standard update in August 2018 that clarifies the accounting for implementation costs incurred in a cloud computing arrangement under a service contract. This guidance generally aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement under a service contract with the requirements for capitalizing implementation costs related to internal-use software. The guidance within this accounting standard update is effective for annual periods beginning after December 15, 2019 and may be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. Early adoption is permitted. The Company has not early adopted the guidance and is currently evaluating its implementation.
The FASB issued an additional accounting standard update in August 2018 that modifies certain disclosure requirements for fair value measurements. The guidance removes certain disclosure requirements regarding transfers between levels of the fair value hierarchy as well as certain disclosures related to the valuation processes for certain fair value measurements. Further, the guidance added certain disclosure requirements including unrealized gains and losses and significant unobservable inputs used to develop certain fair value measurements. The guidance within this accounting standard update is effective for annual and interim periods beginning after December 15, 2019, and may be applied prospectively in the initial year of adoption or retrospectively to all periods presented, depending on the amended disclosure requirement. Early adoption is permitted. The Company has not early adopted the guidance and is currently evaluating its implementation.
The FASB issued an accounting standard update in February 2018 that allows a reclassification from accumulated other comprehensive (loss) income (“AOCI”) to retained earnings for stranded tax effects resulting from the U.S. Tax Cuts and Jobs Act (“U.S. Tax Reform”) enacted in December 2017. The guidance within this accounting standard update is effective for annual and interim periods beginning after December 15, 2018, and may be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in U.S. Tax Reform is recognized. Early adoption was permitted. The Company adopted this guidance in the first quarter of 2019, as required, but elected not to reclassify any stranded tax effects resulting from U.S. Tax Reform, therefore adoption of this guidance did not have any impact on its financial statements.
The FASB issued an accounting standard update in June 2016 related to the accounting for and disclosure of credit losses. In May 2019, the FASB issued an accounting standard update to provide targeted transition relief to increase comparability of financial statements. The guidance introduces a new model for recognizing credit losses on financial instruments, including customer accounts receivable, based on an estimate of current expected credit losses. The guidance within this accounting standard update is effective for annual and interim periods beginning after December 15, 2019, and aspects of the guidance which may be applicable to the Company should be applied on a modified retrospective basis. Early adoption is permitted. The Company has not early adopted the guidance and is currently evaluating its implementation.
The FASB issued an accounting standard update in February 2016 regarding the accounting and disclosure for leases. During 2018 and 2019, the FASB issued a series of accounting standard updates to clarify and expand on the original 2016 implementation guidance, including providing an accounting policy election for lessors, certain targeted improvements around comparative reporting requirements and accounting for lease and non-lease components by lessors as well as other technical corrections and improvements. The amendments in these 2018 and 2019 updates did not change the core principles of the guidance previously issued in February 2016. The guidance within all of the leasing accounting standard updates were effective for annual and interim periods beginning after December 15, 2018, and should have been applied on a modified retrospective basis, applying the transition requirements either (a) at the beginning of the earliest period presented in the financial statements in the year of adoption (January 1, 2017) or (b) in the period of adoption (January 1, 2019). Early adoption was permitted.
As part of the Company’s implementation planning and its impact assessment related to the new lease accounting guidance, the Company developed a detailed project plan, identified and established a cross-functional implementation team and developed pre-adoption internal controls. In addition, the Company gathered an inventory of the Company’s outstanding leases globally, performed certain review procedures to ensure completeness of its lease population and abstracted required information from its lease population for inclusion within the Company’s leasing software. The Company performed similar implementation planning and impact assessment procedures as it relates to Houghton.
9
Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements - Continued
(Dollars in thousands, except share and per share amounts, unless otherwise stated)
(Unaudited)
For legacy Quaker, the Company adopted the guidance in the first quarter of 2019, as required, electing to use a modified retrospective transition approach and applied transition requirements as of January 1, 2019, as permitted. Subsequent to the acquisition of Houghton, previously a private company, the Company adopted the guidance and elected to use a modified retrospective transition approach and applied transition requirements as of August 1, 2019. Comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. In addition, the Company elected to apply certain of the permitted transition practical expedients within the new lease accounting related to lease identification, lease classification, and initial direct costs. The Company made certain accounting policy elections as a result of adopting the new lease accounting guidance, which include not separating lease and non-lease components, applying a portfolio approach in the development of the Company’s discount rates, applying the short-term lease exemption and establishing a capitalization threshold policy.
Adoption of the lease accounting guidance did not have a material impact on the Company’s reported earnings or cash flows, however, adoption did result in a material impact to the Company’s balance sheet to establish the right of use lease assets and associated lease liabilities. As of January 1, 2019, legacy Quaker recorded a cumulative effect of an accounting change that resulted in an increase to its right of use lease assets of $27.3 million, an increase of $5.3 million of short-term lease liabilities and $21.4 million of long-term lease liabilities, a decrease in property, plant and equipment, net of $1.1 million, a decrease in other current liabilities of $0.4 million and a decrease to retained earnings of less than $0.1 million. The cumulative effect of an accounting change related to Houghton as of August 1, 2019 resulted in an increase to its right of use lease assets of $10.7 million, and an increase of $4.1 million of short-term lease liabilities and approximately $6.6 million of long-term lease liabilities. See Note 6 of Notes to Condensed Consolidated Financial Statements.
Note 4 – Business Segments
The Company’s reportable segments reflect the structure of the Company’s internal organization, the method by which the Company’s resources are allocated and the manner by which the Company assesses its performance. During the third quarter of 2019 and in connection with the Combination, the Company reorganized its executive management team to align with its new business structure, which reflects the method by which the Company assesses its performance and allocates its resources. The Company’s new reportable segment structure includes four segments: (i) Americas; (ii) Europe, Middle East and Africa (“EMEA”); (iii) Asia/Pacific; and (iv) Global Specialty Businesses. The three geographic segments are composed of the net sales and operations in each respective region, excluding net sales and operations managed globally by the Global Specialty Businesses segment, which includes the Company’s container, metal finishing, mining, offshore, specialty coatings and specialty grease businesses. All prior period information for legacy Quaker has been recast to reflect these four segments as the Company’s new reportable segments. Prior to the Company’s re-segmentation during the third quarter of 2019, the Company’s historical reportable segments were four geographic regions: (i) North America; (ii) EMEA; (iii) Asia/Pacific; and (iv) South America.
Though the Company changed its reportable segments in the third quarter of 2019, the calculation of the reportable segments’ measures of earnings remains otherwise generally consistent with past practices. Segment operating earnings for the Company’s reportable segments are comprised of net sales less COGS and selling, general and administrative expenses (“SG&A”) directly related to the respective segment’s product sales. Operating expenses not directly attributable to the net sales of each respective segment are excluded from segment operating earnings, which includes certain corporate and administrative costs, Combination and other acquisition-related expenses, restructuring and related activities and COGS related to acquired Houghton inventory sold, which was adjusted to fair value as a part of purchase accounting. Other items not specifically identified with the Company’s reportable segments include interest expense, net and other income (expense), net.
10
Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements - Continued
(Dollars in thousands, except share and per share amounts, unless otherwise stated)
(Unaudited)
The following table presents information about the performance of the Company’s reportable segments for the three and nine months ended September 30, 2019 and 2018:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2019
2018
2019
2018
Net sales
Americas
$
116,710
$
77,374
$
260,682
$
225,115
EMEA
82,468
51,346
184,280
164,753
Asia/Pacific
74,266
49,928
165,234
143,388
Global Specialty Businesses
51,686
43,374
132,013
122,783
Total net sales
$
325,130
$
222,022
$
742,209
$
656,039
Segment operating earnings
Americas
$
23,880
$
16,998
$
52,235
$
47,877
EMEA
13,370
8,592
31,232
28,102
Asia/Pacific
20,404
14,012
45,375
39,631
Global Specialty Businesses
14,983
12,215
36,100
33,224
Total segment operating earnings
72,637
51,817
164,942
148,834
Combination and other acquisition-related expenses
(14,702)
(2,904)
(23,789)
(12,404)
Restructuring and related activities
(24,045)
—
(24,045)
—
Fair value step up of Houghton inventory sold
(10,214)
—
(10,214)
—
Non-operating and administrative expenses
(29,123)
(22,064)
(68,266)
(63,044)
Depreciation of corporate assets and amortization
(9,055)
(1,930)
(12,770)
(5,673)
Operating (loss) income
(14,502)
24,919
25,858
67,713
Other income (expense), net
203
(523)
(389)
(631)
Interest expense, net
(6,102)
(989)
(7,611)
(3,223)
(Loss) income before taxes and equity in net income of
associated companies
$
(20,401)
$
23,407
$
17,858
$
63,859
Inter-segment revenues for the three and nine months ended September 30, 2019 were $2.1 million and $4.8 million for Americas, $5.3 million and $15.4 million for EMEA, less than $0.1 million and $0.1 million for Asia/Pacific, and $1.4 million and $4.1 million for Global Specialty Businesses, respectively. Inter-segment revenues for the three and nine months ended September 30, 2018 were $2.4 million and $6.5 million for Americas, $4.5 million and $16.8 million for EMEA, less than $0.1 million and $0.5 million for Asia/Pacific, and $1.2 million and $3.7 million for Global Specialty Businesses, respectively. However, all inter-segment transactions have been eliminated from each reportable segment’s net sales and earnings for all periods presented above.
Note 5 – Net Sales and Revenue Recognition
Business Description
The Company develops, produces, and markets a broad range of formulated chemical specialty products and offers chemical management services (“Fluidcare”) for various heavy industrial and manufacturing applications throughout its four segments. The Combination increased the Company’s addressable metalworking, metals and industrial end markets, which include: steel, aluminum, aerospace and defense, transportation and OEM, transportation components, offshore, architectural aluminum, fire-resistant hydraulics, die casting, tube and pipe, can and container, mining, specialty coatings and specialty greases. The Combination also strengthened the product portfolio of the combined Company. The major product lines of Quaker Houghton include metal removal and cleaning fluids, corrosion preventatives and cleaners, metal drawing and forming fluids, die cast mold releases, heat treatment and quenchants, metal forging fluids, hydraulic fluids, specialty greases, offshore control fluids, rolling lubricants, rod and wire drawing and surface treatments.
A substantial portion of the Company’s sales worldwide are made directly through its own employees and its Fluidcare programs, with the balance being handled through distributors and agents. The Company’s employees visit the plants of customers regularly, work on site, and, through training and experience, identify production needs which can be resolved or alleviated either by adapting the Company’s existing products or by applying new formulations developed in its laboratories. The chemical specialty industry comprises many companies similar in size to the Company, as well as companies larger and smaller than Quaker Houghton. The
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Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements - Continued
(Dollars in thousands, except share and per share amounts, unless otherwise stated)
(Unaudited)
offerings of many of the Company’s competitors differ from those of Quaker Houghton; some offer a broad portfolio of fluids, including general lubricants, while others have a more specialized product range. All competitors provide different levels of technical services to individual customers. Competition in the industry is based primarily on the ability to provide products that meet the needs of the customer, render technical services and laboratory assistance to the customer and, to a lesser extent, on price.
As part of the Company’s Fluidcare business, certain third-party product sales to customers are managed by the Company. Where the Company acts as a principal, revenues are recognized on a gross reporting basis at the selling price negotiated with its customers. Where the Company acts as an agent, revenue is recognized on a net reporting basis generally at the amount of the administrative fee earned by the Company for ordering the goods. In determining whether the Company is acting as a principal or an agent in each arrangement, the Company considers whether it is primarily responsible for the obligation to provide the specified good, has inventory risk before the specified good has been transferred to the customer and has discretion in establishing the prices for the specified goods. The Company transferred third-party products under arrangements recognized on a net reporting basis of $13.6 million and $34.4 million for the three and nine months ended September 30, 2019, respectively, and $11.7 million and $35.8 million for the three and nine months ended September 30, 2018, respectively.
A significant portion of the Company’s revenues are realized from the sale of process fluids and services to manufacturers of steel, automobiles, aircraft, appliances, and durable goods, and, therefore, the Company is subject to the same business cycles as those experienced by these manufacturers and their customers. The Company’s financial performance is generally correlated to the volume of global production within the industries it serves, rather than discretely related to the financial performance of such industries. Furthermore, steel customers typically have limited manufacturing locations compared to metalworking customers and generally use higher volumes of products at a single location. As previously disclosed in its Annual Report filed on Form 10-K, as amended by Form 10-K/A, for the year ended December 31, 2018, during 2018 the Company’s five largest customers (each composed of multiple subsidiaries or divisions with semiautonomous purchasing authority) accounted for approximately 17% of consolidated net sales, with its largest customer accounting for approximately 8% of consolidated net sales.
Revenue Recognition Model
The Company applies the FASB’s guidance on revenue recognition which requires the Company to recognize revenue in an amount that reflects the consideration to which the Company expects to be entitled in exchange for goods or services transferred to its customers. To do this, the Company applies the five-step model in the FASB’s guidance, which requires the Company to: (i) identify the contract with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when, or as, the Company satisfies a performance obligation.
The Company identifies a contract with a customer when a sales agreement indicates approval and commitment of the parties; identifies the rights of the parties; identifies the payment terms; has commercial substance; and it is probable that the Company will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. In most instances, the Company’s contract with a customer is the customer’s purchase order. For certain customers, the Company may also enter into a sales agreement which outlines a framework of terms and conditions which apply to all future and subsequent purchase orders for that customer. In these situations, the Company’s contract with the customer includes both the sales agreement and the specific customer purchase order. Because the Company’s contract with a customer is typically for a single transaction or customer purchase order, the duration of the contract is almost always one year or less. As a result, the Company has elected to apply certain practical expedients and omit certain disclosures of remaining performance obligations for contracts that have an initial term of one year or less as permitted by the FASB.
The Company identifies a performance obligation in a contract for each promised good or service that is separately identifiable from other obligations in the contract and for which the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer. The Company determines the transaction price as the amount of consideration it expects to be entitled to in exchange for fulfilling the performance obligations, including the effects of any variable consideration, significant financing elements, amounts payable to the customer or noncash consideration. For any contracts that have more than one performance obligation, the Company allocates the transaction price to each performance obligation in an amount that depicts the amount of consideration to which the Company expects to be entitled in exchange for satisfying each performance obligation.
In accordance with the last step of the FASB’s guidance, the Company recognizes revenue when, or as, it satisfies the performance obligation in a contract by transferring control of a promised good or providing the service to the customer. The Company recognizes revenue over time whenever the customer simultaneously receives and consumes the benefits provided by the Company’s performance; the Company’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced; or the Company’s performance does not create an asset with an alternative use to the entity, and the entity has an
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Quaker Chemical Corporation
Notes to Condensed Consolidated Financial Statements - Continued
(Dollars in thousands, except share and per share amounts, unless otherwise stated)