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 the 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.
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 and gain scale or 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 compe
titors.
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 2021, 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,
features and lower prices that may render our products less competitive
or obsolete, and we may lose business and/or significant
8
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 identify and consummate the
strategic acquisitions we identify and to successfully integrate
these acquisitions into 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.
We have completed
several 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 such as 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 our 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 our recently completed or 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.
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 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
9
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 are also 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 the
London Interbank
Offered Rate (“LIBOR”).
The LIBOR benchmark has been subject of national, international, and other regulatory
guidance and
proposals for reform and will cease to be provided with certain rates as of December
31, 2021 through June 30, 2023.
In December
2021, the Company entered into the Second Amendment to Credit Agreement
(“Second Amendment”) with Bank of America N.A., to
provide an update for the use of a non-U.S. dollar (“non-USD”) currency LIBOR successor
rate.
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, it remains uncertain what rate will
succeed LIBOR.
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 may affect
the level of interest payments on our portion of indebtedness
that bear interest at variable rates.
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 our non
-U.S. operations.
Our success as a global business
depends, 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 restrictions on transportation
of materials;
●
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;
10
●
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, or as a result of political and/or
military conflict; 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 and 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,
and the precise impact of the Brexit decision will
only become clearer as Brexit progresses.
Brexit has caused and could cause further disruptions to, and create unce
rtainty
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.
Our financial results are affected by currency
fluctuations, particularly between the U.S. dollar and the euro, the Brazilian
real, the Mexican peso, the Chinese renminbi, and the
Indian rupee, and the impact of those currency fluctuations on the
underlying economies.
During the past three years, sales by our
non-U.S. subsidiaries, which use their local currencies as their functional currency,
accounted for approximately 60% to 70% of our
consolidated net sales.
We generally do not use
financial instruments that expose us to significant risk involving foreign curren
cy
transactions; however, the relative size of our non-U.S.
activities has a significant impact on reported operating results and our net
assets.
Therefore, as exchange rates change, our results can be materially
affected.
Incorporated by reference is the foreign exchange
risk information contained in Item 7A of this Report and the geographic information
in Note 4 of Notes to Consolidated Financial
Statements included in Item 8 of this Report.
Also, we occasionally source inventory in a different country
than that of the intended sale.
This practice can give rise to foreign
exchange risk.
We seek to mitigate this risk through
local sourcing of raw materials in the majority of our locations.
11
Risks Relating to Our Supply Chain
If we are unable to obtain price increases or contract concessions sufficient to
offset increases in the costs of raw materials, this
can continue to result in a loss of sales, gross profit, and/or market share and can
have a material adverse effect on our liquidity,
financial position and results of operations.
Conversely, if we fail to adjust prices in a declining raw material cost environment,
we
could lose sales, gross profit, and/or market share which could have a material
adverse effect on our liquidity, financial position
and results of operations.
Quaker Houghton uses approximately 3,000 different
raw materials, including animal fats, vegetable oils, mineral oils,
oleochemicals, ethylene, solvents, surfactant agents, various chemical
compounds that act as additives to our base formulations, and a
wide variety of other organic and inorganic
compounds, and various derivatives of the foregoing.
The price of mineral oils and their
derivatives can be affected by the price of crude oil
and industry refining capacity.
Animal fat and vegetable oil prices, as well as the
prices of other
raw materials, are impacted by their own specific supply and demand factors, as well as by
biodiesel consumption
which is also affected by the price of crude oil.
Accordingly, significant
fluctuations in the price of crude oil in the past have had and
are expected to continue to have a material impact on the cost of our raw materials.
In addition, many of the raw materials we use are
commodity chemicals, which can experience significant price volatility.
We generally
attempt to pass through changes in the prices of raw materials to our customers, but we
may be unable to do so (or
may be delayed in doing so).
In addition, raising prices we charge to our customers
in order to offset increases in the prices we pay
for raw materials could cause us to suffer a loss of sales volumes.
Although we have been successful in recovering a substantial
amount of raw material cost increases while retaining our customers as experienced
in 2021, there can be no assurance that we will be
able to continue to offset higher raw material costs or
retain customers in the future.
A significant change in margin or the loss of
customers due to pricing actions could result in a material adverse effect
on our liquidity, financial position
and results of operations
as described within Item 7 of this Report.
Lack of availability of raw materials and issues associated with sourcing from single suppliers
and suppliers in volatile economic
environments could have a material adverse effect on our liquidity,
financial position and results of operations.
The specialty chemical industry periodically experiences supply shortages
for certain raw materials.
In addition, we source some
materials from a single supplier or from suppliers in jurisdictions that have
experienced political or economic instability.
Even if we
have multiple suppliers of a particular raw material, there are occasionally
shortages.
Any significant disruption in supply could affect
our ability to obtain raw materials or satisfactory substitutes or could
increase the cost of such raw materials or substitutes, which
could have a material adverse effect on our liquidity,
financial position and results of operations.
In addition, certain raw materials
that we use are subject to various regulatory laws, and a change in our ability to legally
use such raw materials may impact the
products or services we are able to offer which could negatively
affect our ability to compete and could adversely affect
our liquidity,
financial position and results of operations.
Loss of a significant manufacturing facility or disruptions within our supply
chain or in transportation could have a material
adverse effect on our liquidity, financial
position and results of operations.
Our manufacturing facilities are located throughout the world.
While we have some redundant capabilities, if one of our facilities
is forced to shut down or curtail operations because of damage or other factors,
including natural disasters, labor difficulties or
widespread public health crises, such as the ongoing COVID-19 pandemic,
we may not be able to timely supply our customers.
This
could result in a loss of sales over an extended period or permanently.
While the Company seeks to mitigate this risk through business
continuity and contingency planning and other measures, the loss of production
in any one region over an extended period of time
could have a material adverse effect on our liquidity,
financial position and results of operations.
In addition, the coronavirus
pandemic has caused, and may in the future cause, significant travel disruptions,
quarantines and/or closures, which could result in
disruptions to our manufacturing and production operations at our facilities,
as well as those of our suppliers and customers.