Q4 2019 Earnings Call

Greetings and welcome to the Quaker, how and fourth quarter and full year 2019 results conference call.

They brief question and answer session will follow the formal presentation. If any watch require operator systems. During the conference. Please press star zero on your telephone keypad. As a reminder, this conference is being recorded it is now my pleasure to introduce your host Michael Barry Chairman, Chief Executive Officer, President for Clinker, how Ed. Thank you Mr. Barry you may begin.

Good morning, everyone. Joining me today are Mary horse CFO, Robert Traveler General Counsel and Shane host that are our head of finance at Chief Accounting Officer, Yes flights for conference call you can find them at the Investor Relations section of our website at Www Dot Quaker helped and Dot com.

We have recently passed the seventh month Mark of completing our combination and it certainly has been a very eventful period of time [laughter]. Since August we have seen or end markets continued to be challenged we're certainly some impacts from the trade war.

As we enter 2020, we expect that these market challenges to begin to turn around and now there were two new specific challenges to create a virus and the temporary halt the Boeing 737, Max production, which will be headwinds for us in 2020.

However, on the things, we can't control like margins, achieving synergies integrating well taking market share and investing in our strategic initiatives.

We are doing well and they are also helping us to more than overcome these market challenges.

[laughter]. So let me it started off now with some remarks about the fourth quarter results and then I'll get into our outlook for 2020.

Overall, our results came in somewhat over the high end of our previous guidance. This improvement was largely driven by faster Ci minutes synergies as we achieved 7 million versus the 5 million projected.

However, the real story, the fourth quarter with the poor to bad and most of our end markets and most of our geographies.

We experienced a 9% decline in our pro forma sales volumes for the quarter.

This was due to weak automotive markets and generally weaker industrial markets throughout the world.

Also we continue to face significant inventory corrections buyer customers throughout the world.

So a logical question based on these declines is where are we losing market share.

We have gone through our customer by customer analysis, and see what our gains and losses in the marketplace, we're at the customer and product level.

This analysis continues to show that we took share in the marketplace as we estimate total organic volume growth due to that share gains and the fourth quarter versus fourth quarter of 18 was approximately 1%, which is consistent with what we expected in the first year of the combination now that were twice the size.

As I've mentioned before there are other positives in the quarter as well we continued to perform well any areas that we have more control, which help offset market challenges, including keeping our gross margins that are perfectly target levels.

All in our operating expenses completing the purchase as norm in high.

And executing on our cross synergies.

Doing all this enabled us to have a fourth quarter pro forma adjusted EBITDA of 60.6 million.

Which is a 4% increase from the fourth quarter of last year. Despite the decline of volume.

Looking forward to 2020, there are two white house, which came up early in the or that will impact us what is the corona virus and the second is a temporary production hall of the Boeing 737 Max.

Let me now talk about both of these.

The krona viruses main impact on us so far has been in China, which makes up approximately 15% upsells.

We have tried to estimate the impact of the Crown a virus no what it for us that there's still a great deal of uncertainty surrounding that's duration a magnitude.

Based on our current knowledge, we estimate that sales in China will be down to 2020 by approximately 9% from where they would have been otherwise due to the current a virus.

[laughter] this translates into an approximate $10 million negative impact on adjusted EBITDA.

Our estimate assumes production returns to normal China in the second half a year.

It does not include any negative impact in other countries due to the virus and it does not include lower overall global production due to the virus, possibly causing overall global demand to be negatively impacted.

Now, let's discuss the temporary production halt the Boeing 737 Max.

Quaker help makes chemical milling mass against that get used in the production of new aircraft, including the some 37 Max.

We historically haven't talked too much about this business because it's been so study as aircraft build rarely show dramatic increases or decreases.

Even last year production remained normal despite the 737, Max being restricted from flying for the majority of the year.

However by only essentially holder production in January for the 737 Max at the end of January we learned through our main supplier spirit.

They estimate their production fuselages components for 216 737, Max's this year.

Compared to over seven six on our last year with the vast majority of the production happening in the second half.

We estimate this will negatively impact our adjusted EBITDA by approximately $6 million.

So in total we forecast these two items to impact our 2020, adjusted EBITDA by approximately $16 million and possibly more.

However, we still expect 2020 to be a good year for us we expect to benefit from having Norman high for full year.

We expect that should achieve our projected cost synergies.

And we expect to continue to take market share, including some cross selling opportunities from the combination.

When we put all this together, we still expect to see an increase of approximately $30 million one more in our adjusted EBITDA. This year.

As far as performance by quarter.

We expect the first quarter to be our weakest quarter for the reasons mentioned previously.

We then expect sequential improvement in each subsequent quarter as a negative impacts from the crowd a virus and the 736 737, Max production become less and we continue of course to achieve our projected cross synergies.

Also I would like to affirm all that to your projections, we mentioned during the last call.

By August 2021, we expect our adjusted EBITDA to be over $300 million on a going forward basis.

Our net debt to EBITDA to be 2.5 times were under.

And we expect to be growing above the market by 2% to 4% on our entire revenue base.

In closing I want to thank all of our colleagues I, Quaker Houghton, whose dedication and expertise helps to create value for our customers and shareholders and differentiate us in the marketplace.

Especial facts for everyone for the excellent job they have done during the integration process.

People are everything in our business and by far our most valuable asset and a very happy with our Quaker Halton team and what they have and will be able to accomplish for our customers going forward.

This concludes my prepared remarks, I'll now hand, it over to marry so that she can review that key financials for you. Thank you Mike and good morning Hall before I begin let me remind you. The comments made during this call include forward looking statements, which are based on current expectations estimates projections and assumptions that are subject to read.

Yes, and uncertainties, which may cause actual results to differ materially for a discussion of these risks. Please review the cautionary statements regarding forward looking statements included in our earnings release and in our 10 2018 form 10-K filed with the FCC. These are available on our website. Please also note that.

Updated risk factors will be included in our 2019 form 10-K, which we will file before they extension deadline of March 17, as we disclosed in our press release furnished last night and the subsequent form Twelveb 25 of filing submitted to the FCC. The company is filed for that 15.

Calendar day extension permitted by the FCC to allow it's time to complete our year end procedures and file our annual report on form 10-K, which we will do no later than March 17. Therefore, all 2019 numbers were presenting our preliminary unaudited and subject to change as the number of regular.

Auditing controls procedures remain open that's sad management believes that the financial statements included in our press release and the results discuss during this call will not change materially if at all when our form 10-K is filed.

In our press release and in this presentation, we have provided certain information, including non-GAAP earnings per diluted share non-GAAP operating earnings and adjusted EBITDA as well as certain pro forma items in an effort to provide shareholders with better visibility into the company's core operations, excluding certain items.

Ends, which we believe do not reflect our core operating performance reconciliations are provided in chart 15 to 24 of this investor deck and some are in the press release as well.

We followed a similar review format for the stack as the one we use for our Q3 call where our comparison periods show actual and non-GAAP results and also pro forma sales and adjusted EBITDA as if we had been combined with howden throughout the periods presented for the stack we have those views.

For both Q4 and full year.

Please see slide six and seven as I begin the review of Q4, which includes Houghton as the combination was completed August onest of last year.

As Mike discussed and similar to our discussion in Q3, we continue to say strong headwinds from global automotive and and general industrial weakness as well as a stronger US dollar. So while I reported net sales are up Q4 versus Q4 last year. This is due to the inclusion of housing.

Norman high excluding them net sales declined 10% due primarily to lower volumes of 9% and negative FX impact of 1%.

On a pro forma basis as this howden was also in Q4 2018 net sales were down 2%, which also reflects the impacts from lower volumes and negative FX, partially offset by the acquisition of norm Anhang.

For the full year as shown on slides eight nine we see a similar story with reported net sales increasing due to Houghton enormous hey, but excluding them sales are down 6% due to lower volumes of 3% and a negative FX impact of 3% as well due primarily to a weaker euro.

Versus the dollar.

On a pro forma basis sales are also down 6% due to similar impacts from volume and foreign exchange.

Gross margin of 34.8% for Q4 reflects point 5 million of accelerated depreciation and a 1.5 million inventory adjustment related to purchase accounting for norm and ahead.

Excluding these items, our gross margin would've been about 35.3% versus 35.4% last year.

On a full year basis gross margin was 34.6%, including similar purchase accounting adjustments for both Norman Hey, and how.

Excluding these items, our gross margin was about 35.7% versus 36% last year.

This is inline with our expectations and prior guidance, reflecting the somewhat lower gross margins in the legacy Howden business due in part to the accounting treatment for fluid care, the chemical management business as we discussed in Q3.

Please refer now to slide 10, first snapshot of certain key financial measures here you can see that our reported operating income of 20.3 million is up slightly compared to Q4 last year, but on a non-GAAP basis Q4 operating income increased to 37.6 million compared to 24.

4.3 million last year.

Full year non-GAAP operating income increased to 121.9 million versus 104.4 million last year.

Our operating margins in Q4 and for the full year declined driven primarily by the additional depreciation and amortization acquired with has an enormous pay on the decreases in sales.

Our reported effective tax rate was a benefit of 18.2% in Q4 up 19 versus inexpensive 59.8% in Q4 of 18.

This quarter. This current quarters rate includes a one time benefit from transferring certain intangible assets between non U.S subsidiaries.

In the prior years rate reflects additional one time expense related to use tax reform.

Excluding these items and various other acquisition related to non core items, our Q4 E. T ours would have been approximately 24% and 17% respectively.

For the full year, we estimate that our effective tax rate, excluding noncore and one time items would have been approximately 22% in both periods inline with our guidance of 20% to 24%, which we updated in Q3.

Our non-GAAP EPS of $1.34 for Q4, and $5.83, where the full year declined compared to $1.54 and $6.17 last year, primarily as a result of the additional 4.3 million shares issued to close of the combination.

On slide 11, we show the trend in our pro forma adjusted EBITDA.

A lot to 34 million of adjusted EBITDA declined slightly from 236 million in 2018, it exceeded our guidance in October in fact, our adjusted EBITDA margins improved for both the quarter and the full year, our pro forma adjusted EBITDA margin for Q4 of 15.5.

5% was up versus 15% last year.

On a full year basis, our adjusted EBITDA margin increased approximately 1% to 15% versus 14% last year.

The improved margins are primarily due to the inclusion of Norman Hay and the initial cost savings benefits, we have realized from the combination.

On slide 12, we provide an update on our leverage and liquidity.

As noted we finished the year with net debt to adjusted EBITDA of 3.47 times up only 0.05 times since the combination close despite significant cash outlays in Q4, which included the acquisition of Norman Hale for approximately 95 million Capex of UBS.

Now 5 million and dividends paid of approximately 7 million.

This reflects our good operating cash flow in Q4, which also allowed us to end the year with cash and cash equivalents of 124 million.

Our cash balances combined with the Undrawn portion of our revolving credit facility of about 221 million provide ample liquidity to the company.

Our cost of debt in Q4 was approximately 3.1% and about 2.9% at year end, reflecting the declining interest rates in Q4, we fixed about 20% of the interest costs on our debt at approximately 3.1% through interest rate swaps.

And we continue to focus on managing our balance sheet and debt prudently, we affirm our commitment to reducing leverage to less than 2.5 times within two years post close of the combination and currently expect our leverage ratio to be at or below three times by the end of 20 Twond.

In summary, Quaker has continued to deliver on its commitments. Despite the very challenging market conditions. We faced in 2019 as we head into 2020, the crystal ball as marquee, reflecting a volatile and unpredictable global environment, particularly with the unique challenges posed by the Corona virus outbreak.

However, we focused on what we can control our integration execution and synergy capture are on track and in fact, a bit ahead of schedule and we are confident and our ability to continue to drive market share gains.

Specifically, we currently estimate that we will realize total integration cost synergies of approximately 35 million in 2020 that our gross margin will be in the 36% area for the full year.

That our full year effective tax rate will be in the range of 20% to 24%.

We also continue to estimate that are onetime costs to achieve the totaled $60 million plus of integration cost synergies will be approximately one times the synergies realized.

So when we put it altogether, even with the 16 million negative impact from the Corona virus on the 737 Max issues. We believe we will show significant growth in our adjusted EBITDA.

As we expect to achieve approximately 264 million or more in 2020, a 13% increase compared to 234 million in 2019, and we expect to reduce our leverage to three times are less by year end as I mentioned.

As we discussed at our Investor Day in December we believe Quaker housing is well positioned for growth and we are focused on delivering long term value for our shareholders. Thank you for your interest in Quaker Houghton and now I'll turn it back over to Mark. Thanks, Mary will now open it up for questions.

Thank you will now be conducting a question and answer session.

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Our first question comes from the line of Jon Tanwanteng with CJS Securities. Please proceed with your question. Good morning. Thank you for taking my questions also nice job in the quarter.

Thanks, John.

Mike or Mary can you comment on what you're seeing from customers, who are in Italy in South Korea, Japan, and if you're seeing any slowdown or shares from.

Due to client of ours hurdle.

Yes, Italy, we have not seen any impact so far and doesn't mean that won't be but so far so good there.

Japan.

Is with a joint venture with us.

We haven't really heard on it any incidents or anything there that gives us any cause of concern not a big monitoring movement thing for us anyway there.

And then the.

China is really the area.

We've been impacted by far the most that's for sure.

Okay got any info on South Korea.

South Korea, not that so far for fall, we heard and things are continuing to progress there, but if things get worse it could happen, but so far.

Everything's fine Okay, Great and then just helping to bridge between this year is pro forma or excuse me 29 times pro forma EBITDA and the outlook for this year.

You are getting called 35 million and.

Synergy realization is you're seeing a 16 million dollar headwind.

But a net increase of 30 million year over year I assume the rest is market share.

Gains and growth is that right.

Yes that okay, Norman Hey, warm it Hayes wells in there right so the incremental.

EBITDA for Norman High maybe 10 ish.

A million, but just one thing clarity just one point I want to clarify limit for Mary mentioned about 35 million of synergies that was the cumulative synergies today.

That we would expect to have and the full year.

So the incremental amount there would be 28 million.

Okay. Great. Thanks, that's helpful and then I'll just on the synergies themselves.

Did you realize much more than expected or was it just a faster pace and expect it is still the same amount of total synergies.

And maybe were there any revenue synergies in the mix at all.

Hang on a year.

Yeah, there were some certainly not unless there is no revenue synergies included adding those numbers that we reflected that that's just build into our business and we certainly we've had some you know some relatively small at this point, but we've had some cross selling synergies of are taking place on we expect more next year.

And then what was the other part of your.

Two questions for that faster than expected or asking anymore.

Yeah, the faster it yet I mean is good question I mean, I think we're keeping our guidance where it is right now so we're trying to say we got in the first year, we expect to five got seven that's really just acceleration of some of the synergies that we did.

We're keeping to our overall guidance that we've already had so thats shows the 35 million for example in the.

By the end of 2021 or 20, rather and then so we're keeping that guidance doesn't mean, we're not trying and we certainly have plans in place to exceed this is just.

A really big year in our integration and are achieving of cost synergies. So as we go for the year, we could probably try to give you more updates for being where we are at this point of the year, where does continually look for.

Previous guidance, Okay got it and just a quick one what amount of on global steel in auto production are you assuming this year in your EBITDA outlook.

The.

The I would say the latest forecast that we seen certainly before the front a virus.

Steel was.

One of the half the 2% in that kind of range and now what I've seen lately is global steels, maybe closer to 1% growth.

And then from an automotive perspective, some of the forecast I saw before the krona viruses negative 1% and now.

But certainly going to be knock down.

Another person or two from that but.

Who knows exactly but that is a negative even was negative before grown of ours.

Okay, great. Thanks, guys good job.

Thank you. Thank you.

Thank you. Our next question comes from the line of Laurence Alexander with Jefferies. Please proceed with your question.

Hi, guys is down was one Florence how are you.

Yeah.

Just following up on your assumptions for this year, if global growth was quite a 50 basis points is or what are the will form a how your business will respond I mean is there's a third as much as that.

How should we think about it.

I mean, we yeah, we I don't know if we have a role fall me because it's so things can be very in different how we can rack and how fast we can react to instances.

So I thought I'd I mean, it's.

Ill, probably as good as any idea I didn't really have a specific answer for you on that.

Okay, and then I'm sorry, if I Miss is put you know obviously, we're talking about the effect of the Corona rose, but with a lower oil prices are falling I was just wondering what your outlook is for raw materials for 2020.

We expect our gross margins throughout the year to be come up.

In general just because of the cost synergies you might recall that.

Raw material savings in general are a significant part of what we're trying to achieve.

Overall over the full integration period, we expect our gross margins to increase by approximately 2% because of not only the cost synergies.

The raw materials synergies as well as the manufacturing so having said that our our projection this year's around that 36% range of plea as Mary mentioned.

And certainly we haven't seen much really happening in the raw material front, so far it takes a little while the.

Hit us and as things fall as we've said in the past that can be a tailwind a little bit for us.

Before things adjustment on the pricing side of things you know this tends to be a three to six month lag period, if pricing so but right now we're discounting on something in that 36% range for gross margins for this year.

Alright, Thank you very much.

Like that.

Once again.

A question Please press star one.

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Question.

There are no further questions at this time I'd like to turn the call back over to Mr. Barry for any closing remarks.

[noise], Okay, given that no other questions will enter conference call now and I want to thank all of your for your interest today or next conference call for the first quarter will be in early May and if you have any questions. In the meantime, please feel free to contact Mary or myself. Thanks again for your interest and Quaker Helen.

Thank you. This concludes today's teleconference. You may disconnect. Your lines at this time and have a nice day.