Quaker Chemical (KWR) 10-Q2023 Q2 Quarterly report

As used in these Notes to Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q for the period ended June 30, 2023 (the “Report”), the terms “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. The “Combination” refers to the legacy Quaker combination with Houghton International, Inc. (“Houghton”).

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 consisting only of normal recurring adjustments, which are necessary for a fair statement of the financial position, results of operations and cash flows for the interim periods. The results for the six months ended June 30, 2023 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 for the year ended December 31, 2022 (the “2022 Form 10-K”).

During the first quarter of 2023, the Company reorganized its executive management team to align with its new business structure. The Company’s new structure includes three reportable segments: (i) Americas; (ii) Europe, Middle East and Africa (“EMEA”); and (iii) Asia/Pacific. Prior to the Company’s reorganization, the Company’s historical reportable segments were: (i) Americas; (ii) EMEA; (iii) Asia/Pacific; and (iv) Global Specialty Businesses. Prior period information has been recast to align with the Company’s business structure as of January 1, 2023, including reportable segments, customer industry disaggregation. As a result of the Company’s new organizational structure effective January 1, 2023, the Company reallocated goodwill previously held by the former Global Specialty Businesses segment to the remaining business segments as of January 1, 2023. However, the Company did not recast the carrying amount of goodwill for the year ended December 31, 2022. See Notes 4, 5, and 13 of Notes to Condensed Consolidated Financial Statements.

Argentina’s and Türkiye’s economies were considered hyper-inflationary under U.S. GAAP effective July 1, 2018 and April 1, 2022, respectively. As of, and for the three and six months ended June 30, 2023, the Company's Argentine and Turkish subsidiaries represented a combined 1% and 2% of the Company’s consolidated total assets and net sales, respectively. During the three and six months ended June 30, 2023, the Company recorded $1.1 million and $1.6 million of remeasurement losses associated with the applicable currency conversions, respectively. Comparatively, during the three and six months ended June 30, 2022, the Company recorded less than $0.1 million and $0.2 million of remeasurement losses associated with the applicable currency conversions, respectively. These losses were recorded within foreign exchange losses, net, which is a component of Other expense, net, in the Company’s Condensed Consolidated Statements of Operations.

In October 2022, the Company acquired a business that provides pickling and rinsing products and services, which is part of the EMEA reportable segment, for approximately 3.5 million EUR or approximately $3.5 million. This acquisition, along with the Company’s January 2022 acquisition in the Americas (described below), which had similar specializations and product offerings in pickling inhibitor technologies, strengthens Quaker Houghton’s position in pickling inhibitors and additives, enabling the Company to better support and optimize production processes for customers across the Metals industry. As of June 30, 2023, the allocation of the purchase of this acquisition in October 2022 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 ongoing assessment of additional information related to the fair value of assets acquired and liabilities assumed.

In January 2022, the Company acquired a business that provides pickling inhibitor technologies, drawing lubricants and stamping oil, and various other lubrication, rust preventative, and cleaner applications, which is part of the Americas reportable segment for approximately $8.0 million. This business broadens the Company’s product offerings within its existing metals and metalworking business in the Americas region. During the third quarter of 2022 the Company finalized post-closing adjustments that resulted in the Company paying less than $0.1 million of additional purchase consideration. Also in January 2022, the Company acquired a business related to the sealing and impregnation of metal castings for the automotive sector, as well as impregnation resin and impregnation systems for metal parts, which is part of the EMEA reportable segment for approximately 1.2 million EUR or approximately $1.4 million. This business broadens its product offerings and service capabilities within its existing impregnation business. The allocation of the purchase prices of both of these January 2022 acquisitions have been finalized.

In November 2021, the Company acquired Baron Industries, a privately held company that provides vacuum impregnation services of castings, powder metals and electrical components for its Americas reportable segment for $11.0 million, including an initial cash payment of $7.1 million, subject to post-closing adjustments, as well as certain earn-out provisions that are payable at various times from 2022 through 2025. The earn-out provisions could total a maximum of $4.5 million. As of June 30, 2023, the Company has remaining earn-out liabilities recorded on its Condensed Consolidated Balance Sheet of $1.3 million. Additionally, during the third quarter of 2022 the Company finalized post-closing adjustments that resulted in the Company receiving a payment of less than $0.1 million.

In December 2020, the Company acquired Coral Chemical Company, LLC (“Coral”), a privately held U.S.-based provider of metal finishing fluid solutions. Subsequent to the acquisition, the Company and the sellers of Coral (the “Sellers”) have worked to finalize certain post-closing adjustments. During the second quarter of 2022, after failing to reach resolution, the Sellers filed suit asserting certain amounts owed related to tax attributes of the acquisition. During the first six months of 2023, there have been no material changes to the facts and circumstances of the claim asserted by the Sellers, and the Company continues to believe the potential range of exposure for this claim is $0 to $1.5 million.

There have been no recently issued accounting standards that will have a material impact on the Company’s condensed consolidated financial statements and related footnote disclosures.

The Company has three reportable segments: (i) Americas; (ii) EMEA; and (iii) Asia/Pacific. The three segments are composed of the net sales and operations in each respective region. All prior period information has been recast to reflect the Company’s new reportable segments. See Note 1 of Notes to Condensed Consolidated Financial Statements.

A significant portion of the Company’s revenues are realized from the sale of process fluids and services to manufacturers of steel, aluminum, automobiles, aerospace, industrial and agricultural equipment, and durable goods. As previously disclosed in the Company’s 2022 Form 10-K, for the year ended December 31, 2022, the Company’s five largest customers combined (each composed of multiple subsidiaries or divisions with semiautonomous purchasing authority) accounted for approximately 11% of consolidated net sales, with its largest customer accounting for approximately 3% of consolidated net sales.

The Company had no material contract assets recorded on its Condensed Consolidated Balance Sheets as of June 30, 2023 or December 31, 2022.

The Company had approximately $3.1 million and $5.7 million of deferred revenue as of June 30, 2023 and December 31, 2022, respectively. For the six months ended June 30, 2023, the Company satisfied all of the associated performance obligations and recognized into revenue the advance payments received and recorded as of December 31, 2022.

The Company sells its various industrial process fluids, its specialty chemicals and its technical expertise as a global product portfolio. The Company generally manages and evaluates its performance by reportable segment first, and then by customer industries. Net sales of each of the Company’s major product lines are generally spread throughout all three of the Company’s geographic regions, and in most cases, are approximately proportionate to the level of total sales in each region.

The following tables disaggregate the Company’s net sales by geographic region, customer industries, and timing of revenue recognized. Prior period information has been recast to reflect the Company’s current period customer industry disaggregation. See Note 1 of Notes to Condensed Consolidated Financial Statements.

In the fourth quarter of 2022, the Company’s management initiated a global cost and optimization program to improve its cost structure and drive a more profitable and productive organization. As of June 30, 2023, the program included restructuring and associated severance costs to reduce headcount by approximately 80 positions globally. These headcount reductions began in the fourth quarter of 2022 and are expected to continue throughout 2023. The exact timing to complete all actions and final costs associated will depend on a number of factors that are subject to change.

Employee separation benefits vary depending on local regulations within certain foreign countries and include severance and other benefits. Restructuring costs include severance costs to reduce headcount, including customary and routine adjustments to initial estimates for employee separation costs, as well as costs to close certain facilities under the QH Program. These costs are recorded in Restructuring and related charges in the Company’s Consolidated Statements of Operations. As described in Note 4 of Notes to Consolidated Financial Statements, Restructuring and related charges are not included in the Company’s calculation of reportable segments’ measure of operating earnings and therefore these costs are not reviewed by or recorded to reportable segments.

In July 2023, one of the Company’s pension plans in the U.K. liquidated approximately $50 million of its invested assets and subsequently funded and entered into an insurance annuity contract, which will provide for the pension plan’s defined benefit obligations to participants.

The components of Other expense, net are as follows:

Non-income tax refunds and other related credits (expense) during both the three and six months ended June 30, 2023 and 2022, include adjustments to a Combination-related indemnification asset associated with the settlement of certain income tax audits for tax periods prior to August 1, 2019. See Note 11 of Notes to Condensed Consolidated Financial Statements.

Facility remediation recovery, net, during the three and six months ended June 30, 2023, reflects gains recorded on the payments received from insurers related to previously incurred costs from the remediation and restoration of property damage. See Note 18 of Notes to the Condensed Consolidated Financial Statements.

Loss on extinguishment of debt during the three and six months ended June 30, 2022, represents a write-off of certain previously unamortized deferred financing costs as well as a portion of third party and creditor debt issuance costs incurred to execute an amendment to the Company’s primary credit facility. See Note 14 of Notes to Condensed Consolidated Financial Statements.

The Company’s effective tax rates for the three and six months ended June 30, 2023 were 34.2% and 31.2%, respectively, compared to 8.1% and 10.9% for the three and six months ended June 30, 2022, respectively. The Company’s effective tax rate for the three months ended June 30, 2023 was primarily impacted by changes to the valuation allowance for and the usage of foreign tax credits due to an enacted law change in Brazil and the effects of lower pre-tax earnings and the mix of such earnings. The effective tax rate for the first six months of 2023 was further impacted by various other items including foreign tax inclusions, withholding taxes, and net tax expense related to share-based compensation, partially offset with changes in uncertain tax positions and favorable return to provision adjustments. Comparatively, the prior year effective tax rates were largely impacted by state tax benefits, changes in the foreign tax credit valuation allowance, the impact of audit settlements, a deferred tax benefit associated with an intercompany asset transfer, a reduction in reserves for uncertain tax positions relating to management fees, withholding taxes, and the effects of lower pre-tax earnings and the mix of such earnings. In addition, the Company’s effective tax rates for three and six months ended June 30, 2022 were impacted by the Company recording earnings at a statutory tax rate of 25% while the recertification of its concessionary 15% tax rate was pending receipt.

As previously reported, Houghton Italia, S.r.l was involved in a corporate income tax audit with the Italian tax authorities covering tax years 2014 through 2018. The Company settled all years 2014 through 2018 for $3.7 million and, accordingly, released all reserves relating to this audit for the settled tax years during the first quarter of 2022. The settlement is to be paid via installments through 2026 and, through June 30, 2023, the Company paid $1.3 million of such installments. The Company has an indemnification receivable of $4.4 million in connection with its claim against the former owners of Houghton for any pre-Combination tax liabilities arising from this matter, as well as other audit settlements and tax matters.

In the first quarter of 2023, the Company was notified by the Spanish tax authorities of audits to commence for several of its legal entities operating in Spain and spanning tax years 2018 through 2021. In addition, in July 2023, the Company was notified by the Italian tax authorities of an audit to commence for one of the Company’s Italian subsidiaries for tax year 2019. Both of these audit proceedings are ongoing and the Company has been providing documentation in response to all of their inquiries. The Company has not established any reserves for these matters at this time.

The following table summarizes earnings per share calculations:

Certain stock options, restricted stock units, and PSUs are not included in the diluted earnings per share calculation when the effect would have been anti-dilutive. The calculated amount of anti-diluted shares not included were 8,232 and 10,940 for the three and six months ended June 30, 2023, respectively, and 33,039 and 24,731 for the three and six months ended June 30, 2022, respectively.

In connection with the Company’s reorganization and the associated change in reportable segments and reporting units during the first quarter of 2023, the Company performed the required impairment assessments directly before and immediately after the change in reporting units and concluded that it was not more likely than not that the fair values of any of the Company’s previous or new reporting units were less than their respective carrying amounts.

Changes in the carrying amount of goodwill were as follows. Prior period information has been recast to reflect the Company’s current period reportable segments. See Note 1 of Notes to Condensed Consolidated Financial Statements.

Gross carrying amounts and accumulated amortization for definite-lived intangible assets were as follows:

As of June 30, 2023 and December 31, 2022, the Company had indefinite-lived intangible assets for trademarks and tradenames totaling $191.3 million and $189.1 million, respectively.

During June 2022, the Company, and its wholly owned subsidiary, Quaker Houghton B.V., as borrowers, Bank of America, N.A., as administrative agent, U.S. Dollar swing line lender and letter of credit issuer, Bank of America Europe Designated Active Company, as Euro Swing Line Lender, certain guarantors and other lenders entered into an amendment to its primary credit facility. The amended credit facility (the “Credit Facility”) established (A) a $150.0 million Euro equivalent senior secured term loan (the “Euro Term Loan”), (B) a $600.0 million senior secured term loan (the “U.S. Term Loan”), and (C) a $500.0 million senior secured revolving credit facility (the “Revolver”), each maturing in June 2027. The Company has the right to increase the amount of the Credit Facility by an aggregate amount not to exceed the greater of $300.0 million or 100% of Consolidated EBITDA, subject to certain conditions including the agreement to provide financing by any lender providing such increase.

As of June 30, 2023, the Company was in compliance with all of the Credit Facility covenants. See Note 20 of Notes to Consolidated Financial Statements in the Company’s 2022 Form 10-K.

In order to manage the Company’s exposure to variable interest rate risk associated with the Credit Facility, in the first quarter of 2023, the Company entered into $300.0 million notional amounts of three year interest rate swaps to convert a portion of the Company’s variable rate borrowings to an average fixed rate of 3.64% plus an applicable margin as provided in the Credit Facility based on the Company’s consolidated net leverage ratio. As of June 30, 2023, the aggregate interest rate on the swaps, including the fixed base rate plus the applicable margin, was 5.2%. See Note 17 of Notes to Condensed Consolidated Financial Statements.

In connection with executing the original credit facility in 2019 and the amended Credit Facility during the second quarter of 2022, the Company capitalized an aggregate of $2.2 million of certain third-party and creditor debt issuance costs. Approximately $0.7 million of the capitalized costs were attributed to the Euro Term Loan and U.S. Term Loan. These costs were recorded as a direct reduction of Long-term debt on the Condensed Consolidated Balance Sheet. Approximately $1.5 million of the capitalized costs were attributed to the Revolver and recorded within Other assets on the Condensed Consolidated Balance Sheet. These capitalized costs will collectively be amortized into Interest expense over the five year term of the Credit Facility. As of June 30, 2023, the Company had $1.8 million of debt issuance costs recorded as a reduction of Long-term debt on the Condensed Consolidated Balance Sheet and $3.8 million of debt issuance costs recorded within Other assets on the Condensed Consolidated Balance Sheet. Comparatively, as of December 31, 2022, the Company had $2.0 million of debt issuance costs recorded as a reduction of Long-term debt on the Condensed Consolidated Balance Sheet and $4.3 million of debt issuance costs recorded within Other assets on the Condensed Consolidated Balance Sheet.

As of June 30, 2023 and December 31, 2022, the Company had fixed rate, industrial development authority bonds totaling $10.0 million in principal amount due in 2028. These bonds have similar covenants to the Credit Facility noted above.

The Company has certain unsecured bank lines of credit and discounting facilities in certain foreign subsidiaries, which are not collateralized. The Company’s other debt obligations primarily consist of certain domestic and foreign low interest rate or interest-free municipality-related loans, local credit facilities of certain foreign subsidiaries, and capital lease obligations. Total unused capacity under these arrangements as of June 30, 2023 was approximately $34 million.

In addition to the bank letters of credit described in the “Credit facilities” subsection above, the Company’s other off-balance sheet arrangements include certain financial and other guarantees. The Company’s total bank letters of credit and guarantees outstanding as of June 30, 2023 were approximately $5 million.

The Company incurred the following debt related expenses included within Interest expense, net, in the Condensed Consolidated Statements of Operations:

Based on the variable interest rates associated with the Credit Facility, as of June 30, 2023 and as of December 31, 2022, the amounts at which the Company’s total debt were recorded are not materially different from their fair market value.