Item 1A.
Risk Factors.
There are many factors that may affect our
business and results of operations, including the following
risks relating to: (1) the
demand for our products and services and our ability
to grow our customer base; (2) our business operations, including
internal and
external factors that may impact our operational
continuity; (3) our international operations; (4) our supply chain
;
(5) domestic and
foreign taxation and government regulation and oversight;
and (6) more general risk factors that may impact our business.
Risks Related to the Demand for our Products
and Services and our Customer Base
Changes to the industries and markets that we serve could
have a material adverse effect on our liquidity,
financial position and
results of operations.
As a leader in industrial process fluids, the Company
is subject to the same business cycles as those experienced by our
customers
that participate in the steel, automobile, aircraft, industrial
equipment, aerospace, aluminum and durable goods industries.
Because
demand for our products and services is largely
derived from the global demand for their products, we are subject
to uncertainties
related to downturns in our customers’ businesses and unanticipated
shutdowns or curtailments of our customers’ production,
including as a result of adverse changes affecting
national, regional and global economies or increased competitive
pressure within our
customers’
industries.
For example, our business was adversely affected by the
production slowdown of the Boeing 737 Max aircraft
that occurred in 2020.
Our customers may experience deterioration of their businesses, cash
flow shortages and difficulty obtaining
financing, leading them to delay or cancel plans to purchase
products, and they may not be able to fulfill their obligations
in a timely
fashion.
We have limited ability to
adjust our costs contemporaneously with changes in sales; thus,
a significant sudden downturn in
sales due to reductions in global production within the industries we
serve and/or weak end-user markets could have a
material
adverse effect on our liquidity,
financial position and results of operations.
Further, our suppliers and other business partners
may
experience similar conditions, which could impact their
ability to fulfill their obligations to us and also result in material
adverse
effects on our liquidity,
financial position and results of operations.
Changes in competition in the industries and markets we serve
could have a material adverse effect on our liquidity,
financial
position and results of operations.
The specialty chemical industry is highly competitive
and there are many companies with significant financial resources
and/or
customer relationships that compete with us to provide
similar products and services.
Some competitors may be able to offer more
favorable or flexible pricing and service terms or,
due to their larger size or greater access to resources,
may be better able to adapt to
changes in conditions in our industries, fluctuations
in the costs of raw materials or changes in global economic conditions,
potentially
resulting in reduced profitability and/or a loss of market
share for us.
The pricing decisions of our competitors could lead us to
decrease our prices which could negatively affect
our margins and profitability.
In addition, our competitors could potentially
consolidate their businesses to gain scale to better position
their product offerings, which could have a negative
impact on our
profitability and market share.
Competition in our industry historically has also been
based on the ability to provide products that
meet the needs of the customer and render technical
services and laboratory assistance, which our competitors may be
able to
accomplish more effectively than we are
able to do.
Further, in connection with obtaining regulatory
approval of the Combination, we
divested certain of Houghton’s products
and related assets to a competitor which they may use to compete
with us in certain areas
where we continue to sell those products.
If we are unsuccessful with differentiating ourselves, it could
have a material adverse effect
on our liquidity,
financial position and results of operations and we could lose
market share to our competitors.
Loss of a significant customer,
bankruptcy of a major customer,
or the closure of or significant reduction in production at a
customer site could have a material adverse effect
on our liquidity, financial position and
results of operations.
During 2020, the Company’s
top five largest customers (each composed of multiple
subsidiaries or divisions with semi-
autonomous purchasing authority) together accounted
for approximately 10% of our consolidated net sales, with the
largest customer
accounting for approximately 3% of our consolidated
net sales.
The loss of a significant customer could have a material adverse
effect
on our liquidity,
financial position and results of operations.
Also, a significant portion of our revenues is derived from
sales to
customers in the cyclical steel, aerospace, aluminum
and automotive industries where bankruptcies have occurred
in the past and
where companies have periodically experienced financial
difficulties.
If a significant customer experiences financial difficulties
or
files for bankruptcy protection, we may be unable to collect
on our receivables, and customer manufacturing sites may
be closed or
contracts voided.
The bankruptcy of a major customer could therefore have a material
adverse effect on our liquidity,
financial
position and results of operations.
Also, some of our customers, primarily in the steel, aluminum
and aerospace industries, often have
fewer manufacturing locations compared to other metalworking
customers and generally use higher volumes of products at
a single
location.
The loss, closure or significant reduction in production at one or more
of these locations or other major sites of a significant
customer could have a material adverse effect
on our business.
We may not
be able to timely develop, manufacture and gain market acceptance
of new and enhanced products required to
maintain or expand our business, which could adversely affect
our competitive position and our liquidity, financial
position and
results of operations.
We believe that
our continued success depends on our ability to continuously
develop and manufacture new products and product
enhancements on a timely and cost-effective
basis in response to customer demands for higher performance
process chemicals and
other product offerings.
Our competitors may develop new products or enhancements to
their products that offer performance,
8
features and lower prices that may render our products less competitive
or obsolete, and we may lose business and/or significant
market share.
The development and commercialization of new products requires
significant expenditures over an extended period of
time, and some products that we seek to develop may
fail to gain traction or never become profitable.
In any event, ongoing
investments in research and development for the future
do not yield an immediate beneficial impact on our operating
results and
therefore could result in higher costs without a proportional
increase in revenues.
In addition, our customers use our specialty chemicals for
a broad range of applications.
Changes in our customers’ products or
processes or changes in regulatory,
legislative or industry requirements may lead our customers to reduce
consumption of the specialty
chemicals that we produce or make them unnecessary
or less attractive.
Customers may also adopt alternative materials or processes
that do not require our products.
An example of such evolving customer demands and
industry trends is the movement towards light
weighting of materials and electric vehicles.
Should a customer decide to use a different material due
to price, performance or other
considerations, we may not be able to supply a product that
meets the customer’s new requirements.
Consequently, it is important
that
we develop new products to replace the products that
mature and decline in use.
Despite our efforts, we may not be able to develop
and introduce products incorporating new technologies in a
timely manner that will satisfy our customers’ future needs or achieve
market acceptance.
Moreover, new products may have
lower margins than the products they replace.
Our business, results of
operations, cash flows and margins could
be materially adversely affected if we are unable to manage
successfully the maturation or
obsolescence of our existing products and the introduction
of new products.
Risks Related to Business Operations, Including Internal
and External Factors that May Impact Our Operational
Continuity
Our ability to profitably operate our consolidated company
as anticipated requires us to effectively complete
the integration of our
consolidated operations.
An inability to appropriately capitalize on growth, including organic
growth and future acquisitions,
could adversely affect our liquidity,
financial position and results of operations.
Completing the integration of the combined Quaker Houghton
presents the Company with significant risks, which may affect
our
ability to achieve expected cost synergies or
expand our combined business into new markets and geographies.
These risks include,
among others:
●
the diversion of management time and focus from operating
our business to address challenges that may arise in the
continued integration of Houghton;
●
the transition of further operations and customers of Houghton
to the combined business, including across different
cultures
and languages, and the need to address the particular economic,
currency, political, and
regulatory risks associated with
specific countries;
●
the failure to realize anticipated operational or financial
synergies;
●
delays in the implementation or remediation of controls, procedures,
and policies at Houghton;
●
possible liabilities for activities of Houghton before the acquisition,
such as possible violations of laws, commercial disputes,
tax liabilities (as discussed in Note 26 of Notes to Consolidated
Financial Statements included in Item 8 of this Report),
and
other known and unknown liabilities that may not be sufficiently
protected against in the Share Purchase Agreement.
In addition to the Combination, we have completed several
other acquisitions over the past several years as discussed
in Note 2 of
the Notes to the Consolidated Financial Statements included in
Item 8 of this Report.
Acquired companies may have significant latent
liabilities that may not be discovered before they are acquired
and may not be reflected in the price we pay.
Acquisitions also could
have a dilutive effect on our financial results and
while they generally result in goodwill, goodwill could be impaired
in the future
resulting in a charge to earnings.
Our ability to implement our growth strategy may be
limited by our ability to identify appropriate acquisition
or joint
venture
candidates, our financial resources, including available
cash and borrowing capacity,
and our ability to negotiate and complete suitable
arrangements.
Further, the success of our growth
depends on our ability to navigate risks similar to those listed above
and
successfully integrate acquisitions, including, but not
limited to, our ability to:
●
successfully execute the integration or consolidation
of the acquired or additional business into existing processes and
operations;
●
develop or modify financial reporting, information
systems and other related financial tools to ensure overall financial
integrity and adequacy of internal control procedures;
●
identify and take advantage of potential synergies,
including cost reduction opportunities, while retaining
legacy business and
other related attributes;
●
adequately address challenges arising from the increased scope,
geographic diversity and complexity of our operations; and
●
further penetrate existing, and expand into new,
markets with the product capabilities acquired in acquisitions.
If we fail to successfully integrate acquisitions into our
existing business, our financial condition and results of operations
could
be adversely affected.
We may fail
to obtain the benefits we anticipate from the Combination
or our other recently completed or
9
future acquisitions or joint ventures and we may not
create the appropriate infrastructure to support such additional
growth from
organic or acquired businesses, which could
also have a material adverse effect on our liquidity,
financial position and results of
operations.
Gulf and its wholly-owned subsidiary,
QH Hungary Holdings Limited, have a significant minority stake in the Company
and the
contractual ability to nominate certain directors of the Company,
which may enable them to influence the direction of our business
and significant corporate decisions.
As a result of the Combination, Gulf and its wholly
-owned subsidiary, QH Hungary
Holdings Limited (together, the
“Gulf
Affiliates”), have become our largest shareholders.
Subject to certain restrictions over timing and amount of sales in the
shareholders
agreement they have entered into with the Company,
if they were to make available for sale a portion of their shares,
that portion
could represent a significant amount of common
stock of the Company being sold which could have an adverse impact
on the
Company’s stock price.
In addition, the Gulf Affiliates currently have
the right to designate three individuals for election to our board
of directors (the
“Board”) and this right, together with their share ownership,
gives them substantial influence over our business, including
over matters
submitted to a vote of our shareholders, including the election
of directors, amendment of our organizational documents,
acquisitions
or other business combinations involving the Company,
and potentially the ability to prevent extraordinary transactions such
as a
takeover attempt or business combination.
The concentration of ownership of our shares held by the Gulf
Affiliates may make some
future actions more difficult without their support.
The Gulf Affiliates, however,
among other provisions in the shareholders
agreement, have agreed that for so long as any of their designees
are on the Board, and for six months thereafter,
they will vote all
Quaker Houghton shares consistent with the recommendations of
the Board for each director nominee as reflected in each proxy
statement of the Company,
including in support
of any Quaker Houghton directors nominated for election or
re-election to the Board
(except as would conflict with their rights to designees on
the Board).
Nevertheless, the interests of Gulf may conflict with our
interests or the interests of our other shareholders, though
we are not aware of any such existing conflicts of interest at this time.
Failure to comply with any material provision of our principal
credit facility or other debt agreements could have a material
adverse effect on our liquidity,
financial position and results of operations.
We significantly
increased our level of indebtedness in connection with
the closing of the Combination.
Our principal credit
facility requires the Company to comply with certain
provisions and covenants, and, while we do not currently
consider these
provisions and covenants to be overly restrictive, they
could become more difficult to comply with as business or
financial conditions
change.
We will also be subject
to interest rate risk due to the variable interest rates within the
credit facility and if interest rates rise
significantly, these
interest costs would increase as well.
Our principal credit facility contains provisions that
are customary for facilities of its type, including affirmative
and negative
covenants, financial covenants and events of default,
including restrictions on (a) the incurrence of additional
indebtedness, (b)
investments in and acquisitions of other businesses, lines of
business and divisions, (c) the making of dividends or capital stock
purchases and (d) dispositions of assets.
We may declare
dividends and make share repurchases in annual amounts not
exceeding the
greater of $50 million annually and 20% of consolidated
EBITDA (earnings before interest, taxes, depreciation and
amortization) if
we are otherwise in compliance with the credit facility
and we may also distribute certain other amounts to our shareholders if
we
satisfy a consolidated net leverage ratio.
Other financial covenants contained in our principal credit
facility include a consolidated
interest coverage test and a consolidated net leverage
test.
Customary events of default in the credit facility include,
among others,
defaults for non-payment, breach of representations and warranties,
non-performance of covenants, cross-defaults, insolvency,
and a
change of control of the Company in certain circumstances.
If we are unable to comply with the financial and
other provisions of our
principal facility,
we could become in default.
The occurrence of an event of default under the credit facility
could result in all loans
and other obligations becoming immediately due and payable and
the facility being terminated.
In addition, deterioration in the
Company’s results of
operations or financial position could significantly increase
borrowing costs.
Changes to the LIBOR calculation method or the replacement
of LIBOR may have adverse consequences for the Company
that
cannot yet reasonably be predicted.
The Company’s principal
credit facility permits interest on certain borrowings to be calculated based
on LIBOR.
The LIBOR
benchmark has been subject of national, international,
and other regulatory guidance and proposals for reform and is currently
expected to be discontinued after 2021.
The transition away from LIBOR presents various risks and challenges,
including with
respect to our borrowings and hedging arrangements that
rely on the LIBOR benchmark.
Further, the overall financial market
may be
disrupted as a result of the phase-out or replacement of
LIBOR.
Various
parties are working on industry wide and company specific
transition plans related to derivatives and cash markets exposed
to LIBOR.
The U.S. Federal Reserve, in conjunction with the
Alternative Reference Rates Committee, a steering
committee comprised of large U.S. financial institutions,
is considering replacing
LIBOR with the Secured Overnight Financing Rate (“SOFR”),
a new index calculated using short-term repurchase agreements,
backed by Treasury securities.
At this time, the future of LIBOR remains uncertain.
It is not possible to predict whether SOFR will
attain market traction as a LIBOR replacement or to
predict any other reforms to LIBOR that may be enacted.
The potential effect of
the phase-out or replacement of LIBOR on the Company’s
financial position or results of operations cannot yet be predicted,
but we
do not believe it would have a material adverse impact
on the financial results of the Company.
10
Risks Related to our International Operations
Our global presence subjects us to political and economic
risks that could adversely affect our business, liquidity,
financial
position and results of operations.
A significant portion of our revenues and earnings are generated
by non-U.S. operations.
Our success as a global business will
depend, in part, upon our ability to succeed across different
legal, regulatory, economic,
social and political conditions by developing,
implementing and maintaining policies and strategies that
are effective in all of the locations where we do
business.
Risks inherent in
our global operations include:
●
increased transportation and logistics costs, or transportation
may be restricted;
●
increased cost or decreased availability of raw materials;
●
trade protection measures including import and export
controls, trade embargoes, and trade sanctions between
countries or
regions we serve that could result in our losing access to customers
and suppliers in those countries or regions;
●
unexpected adverse changes in export duties, quotas and
tariffs and difficulties in obtaining export licenses;
●
termination or substantial modification of international
trade agreements that may adversely affect our access to
raw
materials and to markets for our products;
●
our agreements with counterparties in countries outside
the U.S. may be difficult for us to enforce
and related receivables
may take longer or be difficult for us to collect;
●
difficulties of staffing and managing
dispersed international operations;
●
less protective foreign intellectual property laws, and
more generally, legal
systems that may be less developed and
predictable than those in the U.S.;
●
limitations on ownership or participation in local enterprises as well
as the potential for expropriation or nationalization
of
enterprises;
●
the impact of widespread public health crises, such as the
COVID-19 pandemic;
●
instability in or adverse changes to the economic, political
,
social, legal or regulatory conditions in a country or region where
we do business, including hyperinflationary conditions or
as a result of terrorist activities; and
●
complex and dynamic local tax regulations, including
changes in foreign laws and tax rates or U.S. laws and tax
rates with
respect to foreign income that may unexpectedly increase
the rate at which our income is taxed, impose new and additional
taxes on remittances, repatriation or other payments by
subsidiaries, or cause the loss of previously recorded tax benefits.
The current global geopolitical and trade environment
creates the potential for increased escalation of domestic and international
tariffs and retaliatory trade policies.
Further changes in U.S. trade policy and additional
retaliatory actions by U.S. trade partners
could result in a worsening of economic conditions.
If we are unable to successfully manage these and other
risks associated with our
international businesses, the risks could have a material
adverse effect on our business, results of operations
or financial condition.
Additionally, on
January 31, 2020, the United Kingdom’s
(“U.K.”) ended its membership in the European Union (“EU”)
(commonly referred to as “Brexit”).
The U.K. and the EU entered into a trade and cooperation agreement
effective January 1, 2021,
but uncertainty remains regarding its implications and
implementation,
and whether any new trade agreements with other countries or
territories will be agreed upon and implemented and how any
such agreements may impact our business.
The long-term economic,
legal, political and social implications of Brexit, including
regarding data protection in the U.K. and the free movement
of goods,
services, and people between the U.K., the EU, and
elsewhere, also remains unclear.
Brexit has caused and could cause further
disruptions to, and create uncertainty surrounding, our
business in the U.K. and EU, including affecting our
relationships with our
existing and future customers, suppliers and employees.
Brexit could lead to legal uncertainty and potentially divergent
national laws
and regulations as the U.K. determines which EU laws to
replace or replicate.
Brexit could also lead to calls for similar referendums
in other European jurisdictions which could cause increased
economic volatility in the European and global markets.
Uncertainty
around these and related issues could lead to adverse
effects on the economy of the U.K. or in the other economies
in which we
operate.
There can be no assurance that any or all of these events will not
have a material adverse effect on our business operations,
results of operations and financial condition.
The scope of our international operations subjects us to risks from
currency fluctuations that could adversely affect
our liquidity,
financial position and results of operations.
Our non-U.S. operations generate significant revenues
and earnings.
Fluctuations in foreign currency exchange rates may affect
product demand and may adversely affect the
profitability in U.S. dollars of the products and services we provide
in international
markets where payment for our products and services is made
in the local currency.