Greetings. Welcome to Quaker Houghton Third Quarter 2020 Investor Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to Michael Barry, Chairman, CEO, and President.

Thank you. You may begin..

Good morning, everyone. Joining me today are Mary Hall, our CFO; Robert Traub; our General Counsel; and Shane Hostetter, our Head of Finance and Chief Accounting Officer. We have slides for our conference call. You can find them in the Investor Relations section of our website at www.quakerhoughton.com.

A great deal has changed in the world in 2020 with the COVID-19 pandemic. For us, our top priority is and has been to protect the health and safety of our employees and our customers, while ensuring our business continuity to meet our customers' requirements.

All of our 34 plants around the world are operating, and we are satisfying all of our customer needs. I am very proud of what the Quaker Houghton team has done to continuing to service our customers, as well to continue our integration efforts, which are going well.

We are pleased with our results for the third quarter when considering we were coming from such a weak second quarter. Overall, our sales were up sequentially 28% from the second quarter and down 5% from the third quarter of last year on a pro forma basis. Let me now give you a little more flavor on what we experienced by segment or region.

First, as we look sequentially, the Americas saw the largest quarterly net sales improvement as sales grew 48% sequentially, driven primarily by stronger volumes.

A similar story I heard in Asia Pacific, EMEA, and our Global Specialty Businesses, where volume improvement drove net sales increases of 24%, 21% and 16% respectively compared to the second quarter. So we saw good sequential improvement in all business segments.

Another way to indicate this sequentially quarterly sales trend is to look at what happened in our three main customer industry groups on a global basis.

Metalworking increased the most and grew 39% sequentially from the second quarter, due primarily to automotive OEMs and related suppliers coming back from the prolong shutdowns or significantly reduced production rates in the second quarter due to COVID.

Our other industry groups of metals and Global Specialty Businesses also increased and showed growth of 21% and 16% respectively. I hope these different cuts of our significant sequential sales increases help provide insight to what was happening in the quarter.

So overall, our sequential volumes were up 27% but our pro forma volumes were still down versus last year by approximately 10%, when excluding the positive impact of Norman Hay, which we acquired last October. This approximately 10% decline was felt in all regions and segments.

However, Asia Pacific was less impacted since China actually showed modest year-over-year growth.

I also want to point out that we did continue to take market share despite the weakness in our end markets as our continued analysis shows that we have total organic sales growth due to net share gains of approximately 2% in this quarter versus the third quarter of last year.

I am very pleased to see this strong rebound from last quarter, but we're certainly not all the way back. As we said previously, we estimate it will take at least two more years for our markets to fully return, and some markets like aerospace, which makes up about 3% of our sales, will take more time than that.

However, we expect our sales to rebound more quickly due to our projected continued market share gains, as well as our potential smaller bolt-on acquisitions in the future that we may make. Concerning gross margins for the third quarter, they were up significantly compared to both the second quarter and for last year.

The sequential increase is primarily due to higher volumes and its impact on the fixed portion of our manufacturing costs. The increase from last year was primarily due to the realization of our manufacturing and raw material cost synergy savings. This pandemic and its impacts have been similar in many ways to what we went through in late 2008.

Just like then, we took fast action to save costs in numerous ways. Essentially, all discretionary expenses have been eliminated, we stopped new hires where possible, some positions were furloughed, and our planned capital expenditures have been cut by over 30%.

And very importantly, we reviewed our integration and synergy plans in light of this situation and took additional actions as well as accelerated other synergies where possible. This has led to additional cost synergies as we have increased our guidance on synergy achievement again this quarter.

For 2020, our current estimate is $58 million of cost synergies achieved versus our earlier estimate of $53 million. Also, the total synergies we estimate that we will achieve in 2021 have been raised from $65 million to $75 million with '22 reaching $80 million.

In this quarter, we achieved $17 million in synergies, and we expect sequential improvement during our future quarters. So overall, we are pleased with the quarter, given the environment in which we were operating and we were - and we did see significant sequential improvement in our sales, gross margins, and adjusted EBITDA.

Also, our cash flow is very strong and our net debt decreased by 7% or $58 million. The positive cash flow nature of our business during severe downturns is something we have discussed with investors in the past, and we're now seeing its positive impacts again in these tough times.

Looking ahead, we anticipate that throughout the next year or two, our markets will show gradual sequential improvement. However, it's hard to predict that improvement by quarter, given the continued uncertainty in our operating environment.

For the fourth quarter, we expect our adjusted EBITDA to be in the ballpark of the third quarter, and for the full year, we expect our adjusted EBITDA to exceed $215 million.

Overall, our higher expected synergies, additional cost saving actions, and improvement in our product margins and our cash flow management are expected to continue to help us during this period of time when our markets are down versus pre-COVID levels.

As we look forward to 2021, we expect our adjusted EBITDA to increase by 20%-plus as we continue our integration savings, take market share in the marketplace, and benefit from an expect gradual rebound in demand.

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

I am so proud of how our team has performed in servicing our customers, meeting their needs, and successfully continue with our integration execution, which is both critical and difficult for us this year.

People are everything in our business and by far our most valuable asset, and ensuring their safety and well-being is and will continue to be a top priority for us. I'm proud of and very happy with our Quaker Houghton team and what we have and will be able to accomplish for our customers and investors both now and going forward.

And that concludes my prepared remarks. I'll now hand it over to Mary so that she can review some of the key financials for you for the quarter.

Mary?.

Thank you, Mike. And good morning all. Before I begin, let me remind you that comments made during this call include forward-looking statements, which are based on current expectations, estimates, projections and assumptions that are subject to risks 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 2019 Form 10-K filed with the SEC. These are available on our website.

Please also note that we continue to update our risk factors in our Form 10-Q to address the evolving COVID-19-related issues, and these risk factors should be reviewed along with those in our 2019 Form 10-K.

In our press release and in this presentation, we provided certain information, including non-GAAP earnings per diluted share, non-GAAP operating income 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, which we believe do not reflect our core operating performance.

Reconciliations are provided in the appendix of this investor deck. In this review, our comparison periods show actual and non-GAAP results, as well as pro forma sales and pro forma adjusted EBITDA as if we've been combined with Houghton throughout the periods presented.

Remember that we closed the Combination on August 1, 2019, so our actual reported and non-GAAP Q3 2019 results include only two months of Houghton. Please see slides six through 10 now, while I review some highlights.

As Mike noted, we saw sales rebound of $367 million in the third quarter, up 28% from $286 million in Q2, but still down 5% from pro forma Q3 2019 sales of $386 million, due primarily to lower volumes as a result of COVID-19.

Our gross margin of 38.2% is up significantly from our gross margin of 34% in Q2 and 32.3% in Q3 of last year, which we estimate would have been about 35.5%, excluding a purchase accounting adjustment.

We also saw a benefit to our gross margin this quarter that we estimated approximately 0.5%, which we attribute to price mix that we believe was unique to the quarter.

You might remember on our last call that I commented that we expected the benefits of our procurement synergies and manufacturing optimization to be more visible as volumes pick up and this is what you see coming through as part of our sequential improvement.

In addition, our cost synergies in these areas continue to increase as reflected in our updated cost synergy estimates.

Our non-GAAP operating income of $43.2 million rebounded significantly from Q2's $11.2 million and is also up 25% from $34.5 million in Q3 of last year, primarily due to the addition of Houghton and Norman Hay and the benefits of realized cost synergies, partially offset by the negative impact of COVID-19.

Similarly, our non-GAAP EPS of $1.56 is up significantly from Q2's $0.21, while it is flat to last year as a result of the additional shares issued at close of the Combination. Our effective tax rate in the current quarter was an expense of 8.1% versus a benefit of 27.6% in Q3 of last year.

We've seen significant volatility in our quarterly effective tax rates due to COVID-19-related changes in profitability as well as continued updates to the 2017 tax law. Excluding the impact of all unusual items, we estimate that our Q3 effective tax rates would have been approximately 24% and 20% for 2020 and 2019, respectively.

For the full year, we expect our effective tax rate, excluding all unusual items will be in the range of 23% to 25%.

As Mike mentioned earlier, we're pleased to see our adjusted EBITDA almost double to approximately $64 million in Q3 from the Q2 level of approximately $32 million and increased approximately 5% compared to our pro forma adjusted EBITDA of $61 million in Q3 of last year.

This is due primarily to the benefits of our realized cost synergies in the quarter and the inclusion of Norman Hay more than offsetting the negative impact of COVID-19. Another bright spot in the quarter was our cash flow.

As we discussed in our last call, because our business is so asset light, with most of our investment in working capital versus property, plant and equipment, when we experience a major downturn in volumes, we expect to see significant positive cash flow from releases in working capital.

Indeed, we saw this in both Q2 and Q3 and are pleased to report that our year-to-date operating cash flow more than tripled versus last year to $112 million.

In addition, our low capital intensity allows us flexibility with our capital spending, and consistent with our Q2 call, we're on pace to reduce our CapEx by more than 30% versus our original pre-COVID estimate. As a result of our strong cash flow, we were able to reduce net debt by $58 million, a 7% reduction from Q2.

This improves our leverage ratio to 3.4 times from 3.7 times at the end of June, and our bank calculated leverage at the end of Q3 was about 2.9 times versus our covenant maximum of 4.25 times. In short, our liquidity and leverage showed good improvement from already solid levels.

In addition, as Mike noted, we further increased our estimates of expected Combination cost synergies from $53 million to $58 million in 2020, from $65 million to $75 million in 2021, and from $75 million to $80 million in 2022.

In summary, our track record of navigating successfully through tough economic environments by gaining share, disciplined cost management, and generating good cash flow during major downturns all give us confidence in our ability to weather the current challenges.

This strong core operating performance is further enhanced by the cost synergies we are realizing from the Combination, and we're seeing the meaningful impact by [ph] synergies have on our financial performance. In 2021, as Mike mentioned, we expect to see a greater than 20% increase in adjusted EBITDA.

Finally, we believe the company is well positioned to leverage the expected upswing in business activity. Thank you all for your interest in Quaker Houghton, and now I will turn it back over to you, Mike..

Thank you, Mary. We'll now open it up for questions..

Thank you. [Operator Instructions] Our first question is from Mike Harrison with Seaport Global Securities. Please proceed..

Hi, good morning..

Good morning, Mike..

Good morning..

Congratulations on a nice quarter, and I hope they're counting your ballots, as we speak..

I think they are..

I was wondering if you can talk a little bit about what's driving the confidence in your 2021 EBITDA outlook.

Obviously, you increased the synergy assumptions and that's contributing, but what are you assuming around the rate of recovery in some of your key markets, and I guess, what are your thoughts on the potential impact of the second COVID wave?.

Sure. Yeah, it's hard to know obviously exactly what a second COVID wave will do and what the lockdowns that are going now in Europe and how they'll impact things. We're basing our 20%-plus kind of increase on really there's a gradual increase from where we kind of are today in our markets.

We expect on top of that to continue to get our market share gains in that 2% or over like we normally get. But we hopefully will not have a similar instance that we had in the second quarter of this year, which is a pretty severe drop.

And so, if you kind of eliminate that, have kind of gradual improvement in your markets, have -- continue with your -- our synergy achievements and kind of do the math on that and it's that.

But you're right, I mean if something else happen from a COVID perspective and the world lock down again and becomes worse than maybe what projections are for orders and steel, then that could impact that, but this is just based on what our best estimates at this time..

All right. And then, wanted to ask about the steel business, we've seen a little bit of consolidation with Cleveland Cliffs and AK Steel as well as our ArcelorMittal's U.S. assets.

Can you talk about what that consolidation means for your steel business?.

Both of those customers are very significant customers to us. In some ways, switching - probably we'll switch our largest customer from being ArcelorMittal to the AK Steel Group or the closed group. So - but essentially we don't expect to see any difference.

We have very strong relationships with those customers and we don't anticipate any impact on our business because of that..

Wanted to ask about the Americas business, it really seems like the margin performance there was a lot stronger than what we are anticipating and obviously a massive improvement on a year-over-year basis.

Can you give maybe a little bit more color about what drove that margin strength, particularly in the Americas?.

The Americas, we have, I would say a disproportionate amount of raw material savings. Our raw material savings that we're achieving are disproportionate and more of it in the Americas than in other regions or business segments. So that's one aspect. We also had - we're doing our manufacturing consolidations.

We've been pretty conservative or ensuring that we don't disrupt supply. So we have taken these shutdowns and while [ph] to make sure we plan them properly and transition materials and so forth before we shut down a certain plant.

Most of those shutdowns happened in the first wave of manufacturing consolidation, really happened in late in the second quarter, and of course in the Americas, we saw some of that too, but that's really everywhere around the world basically.

But when you add those two impacts together, I think it's - you just see - tend to see more of it in the gross margin area in the Americas and other places..

All right. And then last question for me for now is just a clarification on the EBITDA guidance. You're talking that Q4 EBITDA should look similar to Q3, which was $64 million. By my math, that would put you above $220 million for the full year and you're guiding to more than $215 million.

I'm aware that $220 million is more than $215 million, but just wondering should we be looking for Q4 to be more like high 50s than the $64 million you did in Q3? Or do you feel like it exceeds $64 million?.

I think it's just reflective of sometimes maybe our conservative nature, but also the uncertainty that we see in the marketplace right now. For example, we have -- we're having lockdowns take place in Europe now.

How will that eventually impact and could that, for example, make some of the seasonality impacts that we see at the end of the year be more extended or customers may shut down, we don't know yet.

So I think it's just kind of reflective of the uncertainty in there, but we were trying to at least give you kind of a range of where things could fall out..

Understood. All right, thanks very much..

Thank you, Mike..

Our next question is from Laurence Alexander with Jefferies. Please proceed..

Hey, guys. It's Dan Rizzo on for Laurence.

How are you?.

Good. Good morning, Dan..

Good morning, Dan..

Have you guys identified any Houghton revenue synergies yet and I missed it? I mean, is there any - kind of any - anything out there on that?.

Yes, we are getting synergies.

We haven't really pointed them amount or quantified them per se, but when I do say that we are getting net market share gains of 2% this quarter versus like say the third quarter of last year, part of that is due to the cost synergies that we're achieving -- not the cost synergies, the sales synergies that we're achieving due to the Combination..

Okay. That's helpful.

And then on the cost synergies and a temporary cost reductions, I was wondering how much of the temporary cost reductions will be coming back next year and when and how much that will be offsetting or how that will offset the synergies you're looking for from Houghton and just from general productivity?.

Sure. And that's a great question and I think a lot of that will probably depend upon how quick COVID goes away. For example, right now, it's very difficult for us to travel a lot. And so we do expect, for example, especially in the second half of the year hopefully getting back to a more normal situation next year, but -- so some will come back.

We hope that, but when I mentioned about our EBITDA being 20%-plus next year, that kind of takes into account those things that not only the additional synergies but also takes some additional costs that'd come back just because of getting back hopefully to a more normal business environment..

If I would just - hey, Dan, let me chime in there if I could just add to that. So when we talk about increasing the cost synergy estimate, that is only permanent what we view is permanent costs included in that. So -- and any temporary cost reductions, as Mike mentioned, we've attempted to factor into the overall adjusted EBITDA guidance..

Okay. All right. Thank you very much..

Thanks, Dan..

[Operator Instructions] Our next question is from Jon Tanwanteng with CJS Securities. Please proceed..

Hi, good morning and congratulations on the quarter..

Thanks. Good morning, Jon..

Good morning. I may have missed this, but I was wondering did you give any specific color on real-time demand in October and then heading into November as these cases spike and lockdown come in and if you've given any specific cushion for yourselves in the guidance for Q4 and maybe early next year as we run through the course of this..

I think I guess we did not comment specifically on October. I mean I think it's -- things are progressing like we expect it to be.

To me, again, as I kind of mentioned in the previous question that was asked that to me the more wildcard is it's not necessarily December or November, it's going to be more - sorry, October or November, it's going to be more of a December issue and something happen there.

So I think - I do think our guidance that we mentioned has a range and that indicates that one part December could be weaker and that will be something closer to that $215 million kind of number that we talked about. And then if it's not and we continue to progress and things are let's say more normal, then it could be higher than that..

Got it. That's helpful. And then a question for Mary, you've thrown out the kind of cash, it's kind of a function of your business model. I'm just wondering if any of that reverses out as the business recovers, you have to put more into working capital.

How should we think about cash flow going forward with that as a context?.

Sure. And typical working capital dynamics and sales continue to pick up. Obviously, the receivables will follow, but we're also showing good inventory management and overall good working capital management. So when we look at that on a percent of sales basis, again, we will continue to manage that prudently.

And while we would expect not true that as the business really begins to pick up that we'll be investing in working capital as opposed to releasing cash from working capital, we would still expect to see good positive cash flow as earnings pick up corresponding to the sales and volume pickup..

Okay, fair enough. And then last one for Mike, you've been delivering on these higher and higher synergies roughly about every six months or so.

I mean where are they all coming from? Is that low-grade or runouts, should we be expecting more as you dive deeper into the business, especially if you can travel more between locations and business tick back up?.

Sure. So I think initially there were kind of two major drivers we had. Early on, the raw material synergies and some of the supply chain synergies weren't able to be identified as good in the planning efforts just because we had to operate in a clean room environment.

And then, we saw that they were going to be greater as we got into the actual execution of those And then what - I think what you're seeing now more recently is an acceleration of putting our synergies into place.

So even if you take what we have today, and you say, $17 million this quarter multiplied by four, we're at a $68 million kind of run rate with that. So I think it's just showing that we're accelerating faster than we had.

And then the other element in here too is that when we -- as we went through the COVID situation, that hit us starting in March, April time frame, we kind of re-looked at a few things in light of the situation and in light of -- and learning about things being within the Combination in the first nine months and then decided to make even some additional changes as well.

So I think it's a combination of those things that have caused us to increase..

Okay. And we do have a follow-up from Mike Harrison with Seaport Global Securities. Please go ahead..

Hi. Just a couple of questions on maybe digging into some of your end markets. Can you talk a little more about your aerospace exposure? I know you have the chemical milling maskants business within Global Specialty.

But is there exposure in other products or other regions that you'd consider to be aerospace? And then is that -- is it all commercial, is there some military or business jet? And then how much of that is maintenance versus new aircraft production?.

So yeah, most of what -- I'd say the majority -- vast majority of what we do is new rather than maintenance, and you're right, the maskants business is certainly a significant part of it for new aircraft builds, but we also do have - we're in a metalworking fluids that get used in the production of NIM aircraft as well predominantly in U.S.

and Europe. So overall - all those things have been impacted. Right now, we're looking at the aerospace being in a roughly around 3% of our sales, and we don't really see much potential increase in our - in that particular market for a while. I said the other markets will come back probably over the next one to two years.

I think it will take much longer for aerospace to come up but that kind of gives you a magnitude but I think what we're seeing and experiencing right now is probably towards the bottom of that market at this point..

All right.

And then over on the tube and pipe business, is that something that just remains weak until oil and gas activity improves? Or have you seen some pick up there?.

Yeah. We have - it's been weak and probably - and I would say it's weaker now than it was in the past certainly just because of the overall situation, but we have seen some positives in the business as well recently, but we're certainly closer to our low point at this point, given where oil is..

All right. And then last, wanted to ask about the canning business. We're hearing that there are shortages and a lot of those can producers are running flat out to meet demand, they're talking about adding capacity.

Are there things that you're doing to help those customers run harder? Does it mean that they're using higher-end products from you guys? Or are they just using more of them, if they're running at a 100% capacity?.

Yeah. I think in general, of course, what our products try to do is make our customers' processes more efficient and productive. So -- but I would say, in general, I don't know if there's been any major changes in that, I think we've seen benefits in our business over the past couple of years.

We've been taking share in that business because of our products and our customers are operating pretty much flat out at this point. So I agree with your assessment on that. And I think it's just going to be a matter of time as they try to put on more capacity over time and that should help our business as well..

All right, thanks very much..

Thanks, Mike..

We have reached the end of our question-and-answer session. I would like to turn the conference back over to management for closing remarks..

Okay. Given there are no other questions, we will end our conference call now, and I want to thank all of you for your interest today. Our next conference call for the fourth quarter will be in late February or early March of 2021. And if you have any questions in the meantime, please feel free to reach out Mary or myself.

Thanks again for your interest in Quaker Houghton..

Thank you. This does conclude today's conference. And thank you for your participation. Have a wonderful day..