Quaker Houghton - 10-Q quarterly report FY2012 FY

SECURITIES AND EXCHANGE COMMISSION

 

FORM 10-Q

 

 

 

For the quarterly period ended September 30, 2012

OR

 

For the transition period from              to             

Commission file number 001-12019

 

(Exact name of Registrant as specified in its charter)

 

 

 

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.

 

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   x     No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).Yes   x     No   ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 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  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

PART I

FINANCIAL INFORMATION

Item 1.                                Financial Statements (Unaudited).

 

 

 

 

 

Note 1 – Condensed Financial Information

The condensed consolidated financial statements included herein are unaudited and have been prepared in accordance with generally accepted accounting principles in the United States for interim financial reporting and the United States Securities and Exchange Commission regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States 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, except as discussed below) 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 three and nine months ended September 30, 2012 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, 2011.

During the first quarter of 2012, the Company adopted the Financial Accounting Standards Board’s (“FASB’s”) guidance regarding presentation of comprehensive income.  The guidance requires that comprehensive income be presented with the Condensed Consolidated Statement of Income or as a separate statement immediately following the Condensed Consolidated Statement of Income, and can no longer be presented as part of the Consolidated Statement of Changes in Equity.  The Company adopted the guidance using the two statement approach, and the adoption of this guidance did not have a material impact on the Company’s results or financial condition.

 

During the second quarter of 2012, the Company recorded charges of $1,156 to its allowance for doubtful accounts and selling, general and administrative expenses due to the bankruptcies of two U.S. customers.

 

As part of the Company’s chemical management services, certain third-party product sales to customers are managed by the Company. Where the Company acts as the principal, revenue is recognized on a gross reporting basis at the selling price negotiated with customers. Where the Company acts as an agent, such revenue is recorded using net reporting as service revenues, at the amount of the administrative fee earned by the Company for ordering the goods. Third-party products transferred under arrangements resulting in net reporting totaled $30,878 and $37,787 for the nine months ended September 30, 2012 and September 30, 2011, respectively.

Note 2 – Recently Issued Accounting Standards

The FASB updated its guidance in July 2012 regarding indefinite-lived intangible asset impairment testing.  The updated guidance permits a Company to first assess qualitative factors to determine whether it is more likely than not that the fair value of the indefinite-lived intangible asset is less than its carrying value.  If the Company determines that the fair value is more likely than not above its carrying value, no further impairment testing is required.  However, if the Company concludes otherwise, then the first step of the traditional two-step impairment test is required to be performed.  The guidance is effective for annual and interim fiscal periods beginning after September 15, 2012, with early adoption permitted if an entity’s financial statements have not been issued as of the date of the entity’s interim or annual impairment test.  The Company elected to test its indefinite-lived intangible assets for impairment under the traditional two-step method during the current year but is currently evaluating the effect of this guidance for future applicability.

The FASB updated its guidance in December 2011 regarding disclosures pertaining to the netting and offsetting of derivatives and financial instruments on an entity’s Consolidated Balance Sheet.  Disclosures required under the updated guidance include presenting gross amounts of assets and liabilities related to financial instruments that may have been historically offset on the Consolidated Balance Sheet.  The guidance is effective for annual and interim fiscal periods beginning on or after January 1, 2013.   The Company is currently evaluating the effect of this guidance.

The Company's year-to-date 2012 effective tax rate of 26.9% was lower than the year-to-date 2011 effective tax rate of 27.1%.  Both year-to-date effective tax rates reflect decreases in reserves for uncertain tax positions due to the expiration of applicable statutes of limitations for certain tax years of approximately $0.15 and $0.14 per diluted share for the nine months ended September 30, 2012 and September 30, 2011, respectively.

 

The FASB’s guidance regarding accounting for uncertainty in income taxes prescribes the recognition threshold and measurement attributes for financial statement recognition and measurement of tax positions taken or expected to be taken on a tax return. The guidance further requires the determination of whether the benefits of tax positions will be more likely than not sustained upon audit

 

 

based upon the technical merits of the tax position. For tax positions that are determined to be more likely than not sustained upon audit, a company recognizes the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not determined to be more likely than not sustained upon audit, a company does not recognize any portion of the benefit in the financial statements. Additionally, the guidance provides for derecognition, classification, penalties and interest, accounting in interim periods, disclosure and transition.

 

As of September 30, 2012, the Company’s cumulative liability for gross unrecognized tax benefits was $12,043.  At December 31, 2011, the Company’s cumulative liability for gross unrecognized tax benefits was $12,719.

 

The Company continues to recognize interest and penalties associated with uncertain tax positions as a component of taxes on income before equity in net income of associated companies in its Condensed Consolidated Statement of Income. The Company recognized $57 and $6 for interest and $70 and $264 for penalties on its Condensed Consolidated Statement of Income for the three and nine months ended September 30, 2012, respectively, and recognized $63 and $122 for interest and $110 and $535 for penalties on its Condensed Consolidated Statement of Income for the three and nine months ended September 30, 2011, respectively. As of September 30, 2012, the Company had accrued $2,266 for cumulative interest and $1,555 for cumulative penalties, and $2,268 for cumulative interest and $1,298 for cumulative penalties at December 31, 2011.

 

During the three and nine months ended September 30, 2012, the Company recognized decreases of approximately $426 and $1,498, respectively, in its cumulative liability for gross unrecognized tax benefits due to the expiration of the applicable statutes of limitations for certain tax years.  During the three and nine months ended September 30, 2011, the Company recognized decreases of approximately $424 and $1,382, respectively, in its cumulative liability for gross unrecognized tax benefits due to the expiration of the applicable statutes of limitations for certain tax years.

 

The Company estimates that during the year ending December 31, 2012 it will reduce its cumulative liability for gross unrecognized tax benefits by approximately $1,700 to $1,800 due to the expiration of the statute of limitations with regard to certain tax positions. This estimated reduction in the cumulative liability for unrecognized tax benefits does not consider any increase in liability for unrecognized tax benefits with regard to existing tax positions or any increase in cumulative liability for unrecognized tax benefits with regard to new tax positions for the year ending December 31, 2012.

 

The Company and its subsidiaries are subject to U.S. Federal income tax, as well as the income tax of various state and foreign tax jurisdictions. Tax years that remain subject to examination by major tax jurisdictions include the Netherlands and the United Kingdom from 2006, Brazil from 2007, Spain from 2008, the United States and China from 2009, Italy from 2010, and various domestic state tax jurisdictions from 1993.

 

In the second quarter of 2012, the Internal Revenue Service (“IRS”) initiated a limited scope audit of the Company’s 2009 Federal income tax return.  By letter dated October 15, 2012, the IRS notified the Company that it had completed the review of the Company’s 2009 Federal income tax return without any changes to the reported information, completing the audit.  Also, during the second quarter of 2012, the Italian tax authorities initiated a transfer pricing audit of the Company’s Italian subsidiary.  On July 7, 2012, the Company received a preliminary tax report related to this transfer pricing audit, which proposed several adjustments to the taxable income of the subsidiary.  In conjunction with outside counsel, the Company reviewed the report and believes it should prevail on its merits.  As a result, the Company does not believe it has any exposures warranting an uncertain tax position reserve.  There has been no change in this matter during the third quarter of 2012.

 

Note 4 – Fair Value Measurements

 

The FASB’s guidance regarding fair value measurements establishes a common definition for fair value to be applied to guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements.  The guidance does not require any new fair value measurements, but rather applies to all other accounting guidance that requires or permits fair value measurements.

 

The guidance utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

 

The Company values its company-owned life insurance policies, various deferred compensation assets and liabilities, acquisition-related consideration and an obligation related to a non-competition agreement at fair value, and valued its interest rate swaps at fair value prior to their maturity in the third quarter of 2012.  The Company’s assets and liabilities subject to fair value measurement are as follows:

The fair values of Company-owned life insurance (“COLI”) and COLI deferred compensation assets are based on quotes for like instruments with similar credit ratings and terms.  The fair values of other deferred compensation assets and liabilities are based on quoted prices in active markets.  The fair values of interest rate derivatives were based on quoted market prices from various banks for similar instruments.  The fair value of the earnout is based on unobservable inputs and is classified as Level 3.  Significant inputs and assumptions are management’s estimate of the probability of the earnout ultimately being met/paid and the discount rate used to present value the liability.  The fair value of the holdbacks and the obligation related to a non-competition agreement are also based on unobservable inputs and are classified as Level 3.  The significant input or assumption for both the obligation related to the non-competition agreement and the holdbacks is management’s estimate of the discount rate used to present value the liabilities.  Significant changes in any Level 3 input or assumption in isolation would result in increases or decreases to the fair value measurements for the holdbacks, the earnout and the obligation related to the non-competition agreement.

 

Changes in the fair value of the Level 3 liabilities during the nine months ended September 30, 2012 were as follows:

Quantitative information about the Company’s Level 3 fair value measurements at September 30, 2012 were as follows:

The fair value of the Summit earnout is based on the weighted average probability of the outcome of different payout scenarios.  As of September 30, 2012, the probabilities applied to the payout scenarios ranged from 15% to 50%, depending on the Company’s estimate of the likelihood of each payout scenario.

Note 5 – Hedging Activities

 

The Company is exposed to the impact of changes in interest rates, foreign currency fluctuations, changes in commodity prices and credit risk.  The Company does not use derivative instruments to mitigate the risks associated with foreign currency fluctuations, changes in commodity prices or credit risk.  Quaker had interest rate swaps with a combined notional amount of $15,000 as of December 31, 2011, which matured during the third quarter of 2012.  These interest rate swaps were used to mitigate the impact of changes in interest rates, by converting a portion of the Company’s variable interest rate debt to fixed interest rate debt.  These instruments were designated as cash flow hedges and were reported on the balance sheet at fair value.  The effective portions of the hedges were reported in Other Comprehensive Income (“OCI”) until reclassified to earnings during the same period the hedged item affected earnings.  The Company has no derivatives designated as fair value hedges or derivatives designated as hedging instruments under the FASB’s guidance as of September 30, 2012, and only had the interest rate swaps, discussed above, as of December 31, 2011 which were designated as hedging instruments.

 

Information about the Company’s interest rate derivatives is as follows:

 

 

Note 6 – Stock-Based Compensation

 

The Company recognized share-based compensation expense in selling, general and administrative expenses in its Condensed Consolidated Statement of Income as follows:

 

Based on historical experience, the Company has assumed a forfeiture rate of 13% on the nonvested stock. The Company will record additional expense if the actual forfeiture rate is lower than estimated, and will record a recovery of prior expense if the actual forfeiture is higher than estimated.

 

The Company has a long-term incentive program (“LTIP”) for key employees which provides for the granting of options to purchase stock at prices not less than market value on the date of the grant. Most options become exercisable between one and three years after the date of the grant for a period of time determined by the Company not to exceed seven years from the date of grant.  Common stock awards issued under the LTIP program are subject only to time vesting over a three to five-year period. In addition, as part of the Company’s Global Annual Incentive Plan (“GAIP”), nonvested shares may be issued to key employees, which generally vest over a two to five-year period.

 

As of September 30, 2012 and September 30, 2011, the Company recorded $2,164 and $153, respectively, of excess tax benefits in capital in excess of par value on its Condensed Consolidated Balance Sheets, related to stock option exercises. The Company’s estimated taxes payable was sufficient to fully recognize these benefits as cash inflows from financing activities in its Condensed Consolidated Statement of Cash Flows, which represented the Company’s estimate of cash savings through September 30, 2012 and September 30, 2011, respectively.

 

Stock option activity under all plans is as follows:

As of September 30, 2012, the total intrinsic value of options outstanding was approximately $2,051, and the total intrinsic value of exercisable options was $699.  Intrinsic value is calculated as the difference between the current market price of the underlying security and the strike price of a related option.

 

A summary of the Company’s outstanding stock options at September 30, 2012 is as follows: 

As of September 30, 2012, unrecognized compensation expense related to options granted during 2010 was $64, for options granted during 2011 was $223 and for options granted in 2012 was $516.

 

During the first quarter of 2012, the Company granted stock options under the Company’s LTIP plan that are subject only to time vesting over a three-year period.  In connection with a transition of key employees in the Company during the second quarter of 2012, stock options were granted under the Company’s LTIP plan that are also subject only to time vesting over a three-year period.  For the purposes of determining the fair value of stock option awards, the Company uses the Black-Scholes option pricing model and the assumptions set forth in the table below:

Approximately $115 of expense was recorded on these options during the first nine months of 2012.  The fair value of these awards is amortized on a straight-line basis over the vesting period of the awards.

Activity of shares granted under the Company’s LTIP plan is shown below:

The fair value of the nonvested stock is based on the trading price of the Company’s common stock on the date of grant. The Company adjusts the grant date fair value for expected forfeitures based on historical experience for similar awards.  As of September 30, 2012, unrecognized compensation expense related to these awards was $2,078 to be recognized over a weighted average remaining period of 1.93 years.

 

In 2012, the Company granted restricted stock units under the Company’s LTIP plan.  Activity of restricted stock units granted is shown below:

 

The fair value of the nonvested restricted stock units is based on the trading price of the Company’s common stock on the date of grant.  The Company adjusts the grant date fair value for expected forfeitures based on historical experience for similar awards. As of September 30, 2012, unrecognized compensation expense related to these awards was $56 to be recognized over a weighted average remaining period of 2.50 years.

Activity of shares granted under the Company’s GAIP plan is shown below:

As of September 30, 2012, these shares were fully vested and all related compensation expense was recognized.

 

Employee Stock Purchase Plan

 

In 2000, the Board adopted an Employee Stock Purchase Plan (“ESPP”) whereby employees may purchase Company stock through a payroll deduction plan. Purchases are made from the plan and credited to each participant’s account at the end of each month, the “Investment Date.” The purchase price of the stock is 85% of the fair market value on the Investment Date. The plan is compensatory and the 15% discount is expensed on the Investment Date. All employees, including officers, are eligible to participate in this plan. A participant may withdraw all uninvested payment balances credited to a participant’s account at any time. An employee whose stock ownership of the Company exceeds five percent of the outstanding common stock is not eligible to participate in this plan.

 

2003 Director Stock Ownership Plan

 

In March 2003, the Company’s Board of Directors approved a stock ownership plan for each member of the Company’s Board to encourage the Directors to increase their investment in the Company. The Plan was effective on the date it was approved and remains in effect for a term of ten years or until it is earlier terminated by the Board. The maximum number of shares of Common Stock which may be issued under the Plan is 75,000, subject to certain conditions that the Compensation/Management Development Committee (the “Committee”) may elect to adjust the number of shares. As of September 30, 2012, the Committee has not made any elections to adjust the shares under this plan. Each Director is eligible to receive an annual retainer for services rendered as a member of the Board of Directors. Currently, each Director who owns less than 7,500 shares of Company Common Stock is required to receive 75% of the annual retainer in Common Stock and 25% of the annual retainer in cash. Each Director who owns 7,500 or more shares of Company Common Stock may elect to receive payment of a percentage (up to 100%) of the annual retainer in shares of common stock. Currently, the annual retainer is $40.  The number of shares issued in payment of the fees is calculated based on an amount equal to the average of the closing prices per share of Common Stock as reported on the composite tape of the New York Stock Exchange for the two trading days immediately preceding the retainer payment date. The retainer payment date is June 1.

Note 7 – Earnings Per Share

 

The Company follows FASB’s guidance regarding the calculation of earnings per share (“EPS”) for nonvested stock awards with rights to non-forfeitable dividends.  The guidance requires nonvested stock awards with rights to non-forfeitable dividends to be included as part of the basic weighted average share calculation under the two-class method.

 

The following table summarizes the EPS calculations:

The following number of stock options are not included in diluted earnings per share since the effect would have been anti-dilutive: 4,537 and 15,740 for the three months ended September 30, 2012 and September 30, 2011, and 6,386 and 11,356 for the nine months ended September 30, 2012 and September 30, 2011, respectively.

Note 8 – Business Segments

 

The Company organizes its segments by the nature of the products sold.  The Company’s reportable segments are as follows:

 

Segment data includes direct segment costs as well as general operating costs.  Any inter-segment transactions are immaterial for each period presented.

The table below presents information about the Company’s reported segments:

Operating income comprises revenue less related costs and expenses. Non-operating items primarily consist of general corporate expenses identified as not being a cost of operation, interest expense, interest income, and license fees from non-consolidated affiliates.

Note 9 – Equity and Noncontrolling Interest

 

The following table presents the changes in equity and noncontrolling interest for the three and nine months ended September 30, 2012 and September 30, 2011:

 

The items in Accumulated Other Comprehensive Loss are net of tax benefits of $311 and $143 for defined benefit retirement plans and $39 and $61 for current period changes in fair value for derivatives for the three months ended September 30, 2012 and September 30, 2011, respectively.  The items in Accumulated Other Comprehensive Loss are net of tax benefits of $838 and $478 for defined benefit retirement plans and $146 and $154 for current period changes in fair value for derivatives for the nine months ended September 30, 2012 and September 30, 2011, respectively.

 

The Company sold 1,265,000 shares of its common stock during the second quarter of 2011.  The Company received proceeds of $48,143, net of related offering expenses, commissions and underwriting fees.  The Company used the proceeds to repay a portion of its revolving credit line during the second quarter of 2011.

Note 10 – Business Acquisitions

 

In July 2012, the Company acquired NP Coil Dexter Industries, S.r.l. for approximately $2,748, including short-term debt and long-term debt of approximately $44 and $854, respectively.  NP Coil Dexter is a European manufacturer and supplier of metal surface treatment products.  The Company allocated $3,825 of intangible assets, comprised of trademarks and formulations, to be amortized over 10 years; two customer lists to be amortized over 8 and 4 years, respectively; and a non-competition agreement to be amortized over 5 years.  In addition, the Company recorded $2,180 of goodwill, none of which will be tax deductible and was assigned to the metalworking process chemical segment.  Liabilities assumed include a hold-back of consideration to be paid to the former shareholders at eighteen months from the acquisition date, absent the occurrence of unforeseen obligations.

 

In October 2011, the Company acquired G.W. Smith & Sons, Inc. for approximately $14,518. G.W Smith manufactures and distributes high quality die casting lubricants, and also distributes metalworking fluids.  The Company allocated $6,260 of intangible assets, comprised of trade names and formulations, to be amortized over 15 years; a trademark to be amortized over 5 years; a non-competition agreement to be amortized over 5 years; and customer lists to be amortized over 16 years.  In addition, the Company recorded $1,120 of goodwill, all of which will be tax deductible and was assigned to the metalworking process chemical segment.   Liabilities assumed include a hold-back of consideration of $1,000 to be paid to the former shareholder at one year from the acquisition date, which was paid subsequent to September 30, 2012.

 

In July 2011, the Company acquired the remaining 60% ownership interest in Tecniquimia Mexicana, S.A. de C.V., the Company’s Mexican equity affiliate, for approximately $10,500.  As part of the acquisition, the Company recorded a one-time non-cash gain in other income of approximately $2,718 to revalue the previously held ownership interest in Tecniquimia to its fair value.  The acquisition strengthened the Company’s position in the growing Mexican market. The Company allocated $3,556 of intangible assets, comprised of trade names and trademarks, to be amortized over 5 years; and customer lists, to be amortized over 20 years.  In addition, the Company recorded $6,773 of goodwill, none of which will be tax deductible, and was assigned to the metalworking process chemicals segment.  Liabilities assumed included a hold-back of consideration to be paid to the former shareholders at one year from the purchase date, which was settled during the third quarter of 2012 with a payment of approximately $2,000 to Tecniquimia’s former shareholders.

 

In December 2010, the Company completed the acquisition of Summit Lubricants, Inc., which manufactures and distributes specialty greases and lubricants, for approximately $29,116, which was subject to certain post closing adjustments.  During 2011, the Company paid an additional $717 to finalize the post closing adjustments and recorded non-cash adjustments to fixed assets and goodwill to finalize its valuation of the assets acquired and liabilities assumed at the acquisition date. The Company allocated $17,100 to intangible assets, comprised of formulations, to be amortized over 15 years; customer lists, to be amortized over 20 years; a non-competition agreement, to be amortized over 5 years; and a trademark, which was assigned an indefinite life.  In addition, the Company recorded $3,423 of goodwill, all of which will be tax deductible, and was assigned to the metalworking process chemicals segment.  Liabilities assumed include an earnout to be paid to the former shareholders if certain earnings targets are met by the end of 2013.

 

The following table shows the allocation of the purchase price of the assets and liabilities acquired during 2012 and 2011.  The pro forma results of operations have not been provided because the effects were not material:

 

 

Included in the 2012 acquisition of NP Coil Dexter Industries, S.r.l. was approximately $113 of cash acquired.  Included in the 2011 acquisitions of Tecniquimia Mexicana, S.A. de C.V. and G.W. Smith & Sons, Inc. was approximately $236 and $22 of cash acquired, respectively.

 

Certain pro forma and other disclosures have not been provided as of September 30, 2012, because the effects were not material.

 

Note 11 – Goodwill and Other Intangible Assets

 

The Company completed its annual impairment assessment as of the end of the third quarter of 2012 and no impairment charge was warranted.  The Company has recorded no impairment charges in the past.  Changes in the carrying amount of goodwill for the nine months ended September 30, 2012 were as follows:

Gross carrying amounts and accumulated amortization for definite-lived intangible assets as of September 30, 2012 and December 31, 2011 are as follows:

The Company recorded $2,283 and $1,596 of amortization expense in the nine months ended September 30, 2012 and September 30, 2011, respectively.